Basics of Tax Increment Financing

Tax Increment Financing has been a powerful tool, which has incentivized billions in new development in our local communities, and revitalized cities and towns across America. If used appropriately, it can be a engine that can generate growth that would have otherwise not happened without it.

What is Tax Increment Financing?

“Tax Increment Financing is one of the most impactful tools local governments can use to spur new developments.”

Tax Increment Financing has been a powerful tool, which has incentivized billions in new development in our local communities, and revitalized cities and towns across America. If used appropriately, it can be a engine that can generate growth that would have otherwise not happened without it.

“Tax Increment” refers to the additional, or the incremental taxes, generated from new developments compared to the taxes generated from what was there before (whether land, old, abandoned building, etc.).

Financing” refers to borrowing against that future cash flow, and “Bond” is the debt instrument which is sold to an investor for an exchange of returns. In essence, a Tax Increment Financing bond borrows against the future increase in taxes from a new development, for a lump sum that can be used in the project, today.

For example:

Anytown, USA has a vacant lot downtown, that has stayed unoccupied for years. The Mayor of Anytown realizes that if a new building were to be built on that lot, it would pay more taxes in the future than the current vacant land would. The Mayor and City council believes that a 200 unit apartment building, and some first floor restaurants will help drive activity to downtown, and possibly promote future development in their town.

However, ABC Development Co (a local developer), is not interested in developing such a large project on this land right now. The costs of building materials have been increasing, and additionally, because of the lower rents in the area the returns this apartment will generate for their investors does not make sense for them to build in the first place. There exists a financing gap between the current cost, and what a project needs to cost for the developer to start the project.

To bridge the development gap, and to incentivize ABC Development Company to build this apartment (which would increase the taxes the Town would collect), Anytown is allowing ABC to capture 90% of the future taxes of their development for 25 years, but only taxes above and beyond the current taxes (the “Tax Increment”), and use a debt instrument to secure that cash flow (the “Financing” and the “Bond”).

ABC Development Company then finds an investor willing to give them a lump sum on that potential future cash flow to provide the necessary capital to fill the development gap.

Because of the TIF, the apartment building is able to be completed, and generate more than enough tax increment revenue to support the TIF bond investor’s yearly debt service. The project is a huge success, and Anytown is able to keep the additional incremental revenue in the meantime to support and fund other projects.

After the bond investor is paid off in 25 years, Anytown keeps the full amount of taxes that will be generated from the project, and adds it to their existing tax base for future generations. This is how Tax Increment Financing allows for new development that would have never been able to take place to become viable for a developer.

Tax Increment Financing has been a powerful tool, which has incentivized billions in new development in our local communities, and revitalized cities and towns across America. If used appropriately, it can be a engine that can generate growth that would have otherwise not happened without it.

Additionally, single-site TIFs, meaning, a tax increment financing that is only supported by a single development project, shifts the real estate risk from the municipality to the developers and their investors, further allowing municipalities to incentivize growth without putting their tax base at risk.