An Evaluation of the District’s Tax Increment Financing: Is it a net fiscal gain to the District?

Tax Increment Financing in the District

Tax Increment Financing (TIF) is an economic development policy tool used by state and local governments to stimulate economic development in a specific area. Its popularity stems from the notion that a TIF project is self-financing, that is, that the tax revenue generated by the project covers the bond payments for the publicly subsidized loan needed to implement the project. The District of Columbia implemented its first TIF project in 2002 and that was followed by seven additional large TIF projects. (There are some smaller TIF projects but these eight projects in our analysis are the largest, most important ones.) Our recent study (See here) is a retrospective evaluation of the economic and fiscal performance of these District TIF projects.  The study’s objective was to answer two questions: 1) does each project produce a positive net fiscal gain for the city; and 2) does the entire TIF program produce a positive net fiscal gain for the city?

The study of the eight projects finds that five were indeed self-financing, while three were not (see Table 1). We also found the net tax revenue from the five positive projects (property and sales taxes minus debt service) covers the shortfalls in the three lagging projects so that the District’s TIF program in the aggregate appears to be a net fiscal gain to the city.

A Review of the District’s TIF Projects

By and large, tax increment financing in the District of Columbia is generally used to help produce large but unconventional development projects in specific locations of the city that otherwise, arguably, would not happen. The actual amount of a project’s TIF subsidy is the principal amount plus interest of the TIF debt service. Typically, this subsidy directly finances all or a portion of the total development costs of the project. Theoretically, the TIF subsidy is justified as the amount needed to overcome some stated economic impediment for example, environmental damage, keeping a site location from achieving its highest and best use. But in the District of Columbia, it appears that TIFs are applied for a slightly different reason.

The District of Columbia is a relatively small city with over half of its land area prohibited from being developed by the private markets, largely because of the federal presence. The city also has a vibrant economy that generates steady growth in jobs and population. The result is that development of one sort or the other is happening in almost all areas of the city. As such, TIFs in the District are used to facilitate development projects in specific neighborhoods that, possibly, might not see that exact type of development, usually to achieve important socio-economic goals beyond just job and income growth. For example, the Gallery Place and Mandarin sites may have likely been developed as predominately Class A office space without TIF. But Gallery Place is now the entertainment and retail hub of the city’s central business district, and the Mandarin is a 4-star international hotel that was the first to bring upscale hotel and retail activity to the Southwest waterfront. DC USA may have likely been a predominately residential development without TIF.  But, it was the first new large-scale retail complex in a residential neighborhood anchored by one of the nation’s leading national retail chains. And the Convention Center Hotel site may have also likely been a predominately Class A office space or even a hotel development (with only a fraction of hotel rooms, thus precluding it from being classified and marketed as a convention center hotel). Instead, it is now the city’s largest hotel with 1,175 rooms and an underground concourse connecting it to the Convention Center (See here).  So, we can view TIF subsidies in the District of Columbia as the amount needed to overcome the additional project costs above and beyond the costs of a project that would be the highest and best use of land in that location. The subsidy is justified as a means of achieving important socio-economic goals for the city (e.g., grocery stores to eliminate food deserts in certain neighborhoods, broadening the market for business travel to the District, and increasing affordable housing).

The District of Columbia implemented its inaugural TIF project in 2002, and that was followed by seven additional large TIF projects up until 2010. District TIF projects have been used to facilitate retail, residential, hotel, and other mixed-use developments in the city (Table 1).

Measuring the benefits: TIF vs. A privately financed alternative project

One of the key assumptions in the analysis conducted by many state and local governments to decide whether to greenlight a potential TIF project is that the location site for the TIF project has prohibitively high economic costs that precludes a purely private sector financed development of the project (the so-called “but for” test).

The model used for this analysis does not make such an assumption. Our model assumes each actual TIF location would eventually be developed by the private sector absent a TIF but as a project much more in line with the conventional economic and social characteristics of the existing neighborhood (i.e., less investment risk).

We assume the privately financed alternative for each project starts sometime between the TIF start date and 2019 and that the 2019 real property value of the alternative project is 75 percent of the TIF project’s real property value in 2019.[1]

For example, the property value of the Gallery Place TIF project grew from $6.9 million in 2002 to $596.6 million in 2019.  We assume the property value of the counterfactual at the Gallery place location grows such that it reaches 75 percent of the Gallery Place project’s real property value (that is, $447.2 million) in 2019 but for the public financial support.

Earlier TIF projects were self-financing, but later ones were not

We use the model to evaluate each TIF project and present the results in Table 2. The table shows that the Gallery Place project achieved a positive cash flow in year 4 of the 25-year debt service schedule and reached its breakeven point in year 8. The table also shows that when we divide total cumulative net tax revenue for the 25 years period by the TIF bond amount (in 2019 dollars), the District is estimated to achieve a 67 percent return on investment (ROI) in year 25 of the debt payment schedule (adjusted for inflation). Also, five years after the project was delivered to the market, the TIF bond amount was 21 percent of the project site’s total property value.

When the estimated ROI in year 25 of each project’s debt service schedule is greater than zero for any project, we conclude the project will ultimately be a net positive fiscal gain for the city. Consequently, the District’s first five TIF projects produced a net positive cash flow, a financial breakeven point (all within eight years), and ultimately a positive fiscal gain (ROI) for the District. However, the Capper Carrollsburg, Convention Center Hotel and Rhode Island Row projects are not expected to produce a positive ROI over the life of the TIF loan as indicated by the negative ROI in column 5.

Based on a closer examination of the model results and the actual specifics of each project, it appears that the first five TIF projects achieved sound financial standing and an early breakeven point primarily because the total debt for each project was relatively low and the net tax revenue generated at each site was relatively high. In contrast, despite their important socio-economic roles, the last three projects (Capper Carrollsburg, which subsidizes senior housing; Rhode Island Row, which subsidizes affordable housing; and the Convention Center Hotel, which was developed to land more and larger annual conventions to fully utilize the Washington Convention Center), are not expected to generate enough net tax revenue over 25 years to service the TIF debt. (See study here)

What is the net fiscal impact of all the District’s TIF program so far?

When we aggregate all eight TIF projects between the date of the first TIF bond issuance (2002) and when the model estimates that the last debt service payment is due (2034), we can calculate the annual total debt service (including interest) and the total annual net tax generated at each TIF site. We find that the entire District’s TIF program achieves a positive cash flow starting in 2005. The model results indicate that the Gallery Place and Mandarin Hotel projects are the primary sources of excess net tax revenue for the program and, hence, are the source of cross subsidizing the seemingly uneconomic projects of Capper Carrollsburg, Convention Center Hotel, and Rhode Island Row.

The District’s TIF fiscal balancing act

According to the analysis, five TIF projects generated a net fiscal gain, and 3 did not. We conclude that while the financials of each new potential TIF in the future must continue to be highly scrutinized, policy makers should also remain cognizant of the financial health of the District’s entire TIF portfolio. The study finds that, to date, several large projects with high ROIs are cross subsidizing those seemingly uneconomic projects. The cross subsidy enables the “uneconomic” projects to achieve very important socio-economic goals for the District (e.g. affordable housing and broadening the market for business travel to the District) without jeopardizing the District’s overall fiscal health.

What is this data?

The model used in this study is designed to determine if each TIF project produced or is likely to produce enough incremental tax revenue to cover its debt service. We define incremental tax revenue as the tax revenue from the TIF project in excess of tax revenue from a comparable (a counterfactual) but totally privately financed project in that location. The model assumes a 25-year loan (i.e. TIF) at a 6 percent interest rate applied to each TIF project but for the actual TIF loan amount for each project. The interest rate for fixed rate debts range from 4 to 7.5 percent, and the actual median interest rate for the seven projects was 6.1 percent.

This analysis is based on annual real property assessment values and real property tax collections for years 2002 through 2019 for each TIF project. The analysis for three projects (Gallery Place, DC USA (Target) and Rhode Island Row) include retail sales activity (sales taxes), and four projects (the Mandarin, Capitol Hill Towers, Embassy Suites, and Convention Center Hotels) include hotel sales activity (hotel taxes). In the model, that actual property, retail and hotel taxes generated at each site is also used to finance each respective project’s TIF debt.

[1] 1 Given that most TIF projects are in prime locations and the city has experience significant property development in nearly all areas of the city, we assume the estimated 2019 real property valuation of each counterfactual would range between 50 and 100 percent of the actual 2019 TIF property valuation. Hence, we assume an average 75 percent 2019 real property valuation of each counterfactual in the model.

What percentage of the District’s revenue is from federal dollars?

On  February 25, Pew released a study on the proportion of federal funds in each state’s total revenue between fiscal year 2000 and fiscal year 2013.  The study uses the Annual Survey of State Government Finances  and shows that the federal share of total state revenue reverted back from near historic highs during the Great Recession to historical norms in fiscal year 2013.

To our dismay, the U.S. Census did not release comparative revenue data for the District of Columbia, so we compiled the data ourselves to see how the District would compare to the rest of the country.

Calculating the District’s federal revenue is not as easy as it seems.  The District – like every other state – receives project based grants and formula based grants.  It differs in that it receives additional contributions from the federal government – including payments to administer the District’s court system and payments to offset unusual costs incurred as a result of the federal government’s use of the District (the Revitalization Act of 1997 specifies these payments).

Using the Comprehensive Annual Financial Report, which is an annual audit of the District’s finances, and by totaling federal contributions to the District’s court system, we calculated the District’s federal share of total revenue between fiscal year 2000 and fiscal year 2013.

The graph below shows the percentage of District revenue that was federal dollars since fiscal year 2000 and draws a comparison with the total 50 state federal share.  The District’s federal share of total revenue is historically one of the highest in the country.  This seems to be primarily driven by the District’s unique status as the nation’s capital, high concentration of poverty, and federally operated court system.

Overall Comparison
We also compared the District’s federal share of total revenue to both Maryland and Virginia.  The District’s federal share in fiscal year 2013 was the highest in the region and was larger than Virginia (22.9%)  and Maryland (28.6%).  The District was the highest in the region every year since 2000 with two exceptions – fiscal year 2011 and fiscal year 2012 – when we were overtaken by Maryland.

Neighbor Comparison
Overall the District had the 31st highest federal share of total revenue in the country in fiscal year 2013.  This was a large drop from its peak in fiscal year 2000 when the District had the seventh highest share in the country.  Here’s how the District compared to every state in fiscal year 2013:All States

What exactly is this data? We used data from the Comprehensive Annual Financial Report for every year starting in 2000 through 2013 to obtain total revenue and federal government contributions.  In order to calculate federal spending on the District’s judicial system, we collected information from the District of Columbia Budget Request Act and the Budget of the United States Government starting  in fiscal year 2000 through fiscal year 2013.  Federal share percentages for all 50 states were collected from Pew Research and the U.S. Census Annual Survey of State Government Finances.