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1.0 Background of the Study
Local governments try to influence decisions concerning business locations and economic development via the deployment of property tax (International Coucil of Shopping Malls, 2007). Tax Increment Financing (TIF) appropriates property tax revenues resulting from the growth in evaluated valuation, is the most accepted form of public finance for economic development projects. Moreover, it is delivering tremendous success in various development projects throughout the United States. TIF was established in 1952 in California and has gained popularity throughout the US since then. Nowadays, the District of Columbia and 49 states have a legislation that allows the deployment of TIF. According to Briffault (2010), the revenues are to be utilized for economic development projects, though they might also be diverted for other uses. Before assessing why it is important to use TIF, it is imperative to find out why local governments in the US offer economic development incentives (EDIs). TIF is just a form of economic development incentive.
Many states including California use EDIs to correct certain market failures in the development process (International Coucil of Shopping Malls, 2007). Government policies might persuade a suitable combination of industries in certain area and improve on what developers of real estate would be capable of bringing forth. The deployment of EDIs to promote economic growth necessitates the government to withstand the temptations to curry favor by subsidizing powerful industries (Kerth & Baxandall, 2011). EDIs might be deployed for a simple purpose of helping economically distressed geographic areas. Governments help disfigured regions either because they care about the interpersonal income distribution or redistribute the income. According to Brueckner (2001), this kind of redistribution is effective since depressed regions, which need growth, might pursue aggressive policies. In addition, extensive economic development subsidies might promote the expansion of federal employment, resulting into a reduced rate of unemployment.
EDIs might lack positive social function, though straightforwardly be the outcome of bidding war among various localities not only in Los Angeles but also in other states (International Coucil of Shopping Malls, 2007). Viable governments bidding for development of business might be zero-sum with offset by losses and with wins by some players. Dye & Merriman (2000) suggest that the bidding for business development presents a negative-sum game in which players might be well of if no one decides to play. Despite the fact that the revenues of local government might be lost in bidding war, the result is not essentially socially detrimental. Cities like Los Angeles might charge business taxes more than the marginal cost of providing services to business. According to Gibson (2003), businesses might threaten to change their locality in order to gain EDIs, which reduces their tax burden to the marginal cost of the services they consume.
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Another reason why governments might issue EDIs is that it allows them to pass the cost along to another government level (Dye & Merriman, 2000). For instance, many states in the US have implemented redistributive grant programs giving high levels of state subsidy to local governments with small base of property taxes. Based on the state subsidy formula, low-level governments might recoup some income foregone via EDIs with high state subsidy. Alternatively, Kerth & Baxandall (2011) claim that when special purpose administration geographically overlaps the general-purpose government, they might issue a tax relief at the cost of special purpose governments (Briffault, 2010). These reasons for the implementation of EDIs have various implications for the growth of property values. A government aid to rectify a market failure should elevate the rate of growth of property values in the area of target depending on whether or not there are spillover effects. Consequently, government subsidy aimed at correcting market failures might also affect the rest of territory apart from the target area.
This paper focuses on a certain type of EDI, known as Tax Increment Financing as mentioned above. According to International Coucil of Shopping Malls (2007), it refers to a tool for economic development available to municipalities and local governments. What differentiates TIF from other EDI tools is that it lacks direct subsidy from higher levels of government. Instead of having a direct subsidy, Tax Increment Finance is funded out of the incremental revenues from property tax (Kerth & Baxandall, 2011). In order to qualify for the designation of TIF, a region often needs to fulfill the statutory definition of disfigured status. According to Kerth & Baxandall (2011), the checklist of qualifications for disfigured states is usually a carryover from the state or federal grant programs for local economic development.
The price guidelines for the designation of TIF vary from one state to another (International Coucil of Shopping Malls, 2007). However, the increment to tax base is computed as the difference between the assessed value of property at the instance of setting up of the district and the current assessed value of property in the district. According to Naccarato (2007), revenues from incremental tax are the product of the aggregate rate of tax of all local property jurisdictions times incremental tax base. These revenues can be deployed in paying allowable costs of economic development within the district, like the site of infrastructure or assembly improvement. Due to the timing differences between receipts and TIF expenditures, the normal practice is to use TIF based on the district taxing authority to borrow for expenditures of development in the initial years and then pay off later using incremental revenues (International Coucil of Shopping Malls, 2007).
As mentioned above, the designation of a region within a municipality as a TIF district might have a decrease, an increase or no change in the economic development of the municipality. If the TIF allows municipalities to rectify market failures, according to Dye & Merriman (2000), municipalities having TIF would develop faster than they would have. In addition, if TIF restructures development towards disfigured and inherently less appropriate areas, according to Briffault (2010), municipalities adopting TIF might grow extremely slowly. If these tw impacts cancel out, then municipalities having it might have the same extent of development as those without.
The case that TIF district has an access to incremental revenues computed from the rate of aggregate tax from every local jurisdiction of taxing is critical for the understanding of the economics and politics of TIF (Kerth & Baxandall, 2011). The deployment of revenues, which in the nonexistence of TIF would belong to the overlying governments to fund economic development of the expenditure, raises a very crucial question: Does the adoption of TIF result into development of property values or does the expected development in property values result into the decision to adopt Tax Increment Financing?
If the expenditures of the TIF districts are the only cause of future development in property values, then the deployment of Tax Increment Financing associates revenues, which might not have otherwise been available with the development expenditures, which result in these revenues (Dye & Merriman, 2000). In this scenario, enabling non-municipal governments to take part in future revenues without necessitating them to take part in costs of development would be both inefficient and unfair. In most cases, like in the case of Los Angeles, in order to establish a TIF district, municipality must frequently specify that there are no prospects for development in property values (Gibson, 2003). Nevertheless, this ascription test is frequently criticized as a sheer pro forma declaration in the self-interest of the local government without rational standards of proof.
Why might the local government of Los Angeles have an incentive to implement TIF even if there is no growth for the use of it? According to the International Coucil of Shopping Malls (2007), if any increase in the tax base, arising from new development, real appreciation, improvements or inflationary increases in the values of current properties, would have taken place autonomous of the TIF expenditures, then it automatically becomes a tool for capturing property tax revenue, which might have gone to non-local government like school districts. The combination of local tax rates varies immensely from one town to another. However, in Los Angeles the shares of the aggregate tax rate are almost sixty per cent school district, fifteen per cent municipal, and twenty-five per cent other forms of local governments (International Coucil of Shopping Malls, 2007). Consequently, for every 15 per cent of Los Angeles’s revenues, the municipality diverts 85 per cent of the revenue from other government into the budget of TIF district. According to International Coucil of Shopping Malls (2007), the direction of causation is, therefore, an empirical question with significant implications on policy.
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As TIF proliferates, it also evolves, shifting from what was originally an urban renewal program targeted at disfigured central city areas to a more general investment of the public and infrastructure finance scheme (Kerth & Baxandall, 2011). The expansion, or redirection, of tax increment finance is efficiently captured via the change in language used to describe its activity from redevelopment to development. It is also evident via the decreasing significance of “blight” as a prerequisite for TIF investment. Considering the roots of TIF in urban renewal, it is not surprising that the early determination that an area was disfigured or blighted was in various states a prerequisite for TIF investment. This will be helpful in offering crucial insights into the effectiveness of tax increment financing to foster development in the areas of blight (International Coucil of Shopping Malls, 2007).
1.1 Aims and Objectives
It is in the interest of local governments to offer economic development incentives. The use of TIF does not only foster development but also generates revenue. Local governments promote economic development, provide housing to both the low- and middle-income earners, fund infrastructure projects and reduce blight using this revenue (Kerth & Baxandall, 2011). TIF is self-sustaining in that its expenditures are covered using the increased revenues arising from the new growth without increase in taxation. Despite the evolution and widespread adoption of TIF, it has faced a lot of criticism. Still, it continues to emerge as an efficient public policy implemented by local governments (Dye & Merriman, 2000). There is little pragmatic evidence that affirms its effectiveness in promoting economic growth (Kerth & Baxandall, 2011). Amidst these conflicting views, the focus of this research will be to explore the effects of TIF and analyze its efficiency in relation to achieving its predetermined goal of economic development. Particularly, this research will evaluate the effect of tax increment financing on economic development and property taxes. It will also assess the impacts of TIF and non-TIF regions and overlapping governments. The study will explore TIF by emphasizing its adoption in Los Angeles County, particularly in the Los Angeles City. The research will achieve its main objectives by using the following research questions:
- Is tax increment financing an efficient economic development incentive tool for local government?
- What is the impact of tax increment on economic development and property values, on Non-TIF regions and on overlapping governments?
- Why might the local government of Los Angeles have an incentive to implement TIF even if there is no growth for the use of TIF?
1.2 Significance of the Study
There is a consensus that the effective function of Tax Increment Financing fosters economic development among economic analysts (International Coucil of Shopping Malls, 2007). Consequently, there is a need to ascertain that economic development incentive tool used in Los Angeles contributes considerably to the economic development of the region. In addition, it is apparent that the failures of local governments to address economic disparities within their municipalities weaken the economic stability of the country (Kerth & Baxandall, 2011). As a result, it is critical to measure the effectiveness of the economic development incentive tools used by local governments and potential challenges facing the implementation of EDIs. The importance of this research will not only supplement the current knowledge of the economic development in Loos Angeles but will also point out the potential effectiveness of Tax Increment Financing for the economic growth.
This study will be significant to various states within the United States. Municipalities that have already adopted the TIF tool might learn from the strengths and loopholes Los Angeles experiences in their adoption of TIF. This states will correct the necessary loopholes experienced by Los Angeles and strengthen on their strengths in the adoption of TIF (Kerth & Baxandall, 2011). This is because various states adopt TIF differently, which implies that they realize the benefits of TIF differently and experience various problems associated with the adoption of TIF. States that will channel their efforts towards eliminating the problems experienced by Los Angeles might in the end experience high rates of economic development.
This study will be useful to investors who might use it to make investment decisions. In fact, it will influence their decision of choosing Los Angeles as the best place for investing as TIF is often deployed as a driver for economic development (Gibson, 2003). If the economic performance of a region is poor, it becomes extremely difficult to attract investors and residents to the area and maintain them. When both businesses and people move out of an area, they move along with their spending ability. Areas that have a supply of jobs and appealing to investors encourage residents to stay and attract new growth. The adoption of TIF in Los Angeles will attract more investors who prefer regions developing economically (Dye & Merriman, 2000). Since the research will explain the effectiveness of TFI in Los Angeles, investors can use this information to determine whether Los Angeles is an economically viable region to invest. However, those who might feel that TFI is not effective might prefer relocating to other economically viable regions. Examples of such investors include Wal-Mart and Lewiston.
The municipal of Los Angeles will also benefit from this study since it will be able to know when and where to deploy TIF. The laws of the state determine elements that need to be met in order to use TIF (Kerth & Baxandall, 2011). Various considerations will help the municipal of Los Angeles to make the decision whether to use TIF as an EDI tool. The various considerations that will be analyzed by the study include the existence of blight and the role played by a proposed development in fulfilling the needs of the community (International Coucil of Shopping Malls, 2007). One of the most popular determinants for the deployment of Tax Increment Financing is when there is a need to eradicate blight or when there is a need to rejuvenate the needs of the economy (Dye & Merriman, 2000). The municipal of Los Angeles will assess the municipality if these needs arise in the region. Every TIF regulation requires a threshold to be met prior to the adoption of TIF. This threshold is normally referred to as “but for” test (Kerth & Baxandall, 2011).
1.3 Research Structure
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This section provides the overview of the covered chapters by the study. The introduction chapter provides the background knowledge, aims and objectives and the significance of the study. The literature review chapter, second chapter, will review previous , current and empirical researches that have tried to discuss the efficiency of Tax Increment Financing in Los Angeles. The chapter will first provide a brief overview of the adoption and basic structure of TFI. Secondly, it will examine legal issues concerning TFI: state constitutional and statutory issues. Thirdly, the study discusses TIF and the local government system and deals with economy by discussing how this all fosters economic development in Los Angeles. Lastly, the chapter will discuss the fiscalization of development policy and the challenges of adopting TIF in Los Angeles.
The third chapter, which is methodology chapter, offers a detailed insight into the research methods. This chapter discusses the research designs and their justification in association to fulfilling the objectives of the research. It provides a general idea of the methods of data collection and their respective justification. The research methodology chapter ensures the validity and reliability of the data collected. In addition, the chapter will also discuss the approaches of data analyses and the limitations of the research methods used by the study.
The fourth chapter analyses and presents the data collected from the research. Besides this, the chapter interprets the data based on the research questions and objectives. The last chapter, referred to as conclusions and recommendations, sums up the conclusions based on the findings presented in the previous chapter. It also makes necessary recommendations on how to adopt Tax Increment Financing in order to foster economic development.
This research focuses on a certain type of EDI, known as Tax Increment Financing and it refers to a tool for economic development available to municipalities and local governments. What differentiates TIF from other EDI tools is that it lacks direct subsidy from higher government levels. The research will determine if TIF is an effective EDI tool for the municipal of Los Angeles County, especially in the city of Los Angeles. Tax Increment Financing (TIF) appropriates property tax revenues resulting from the growth in evaluated valuation. Many states including California use EDIs to correct certain market failures in the development processes. The deployment of EDIs to promote economic growth necessitates the government to withstand the temptations to curry favor by subsidizing powerful industries. These reasons for the implementation of EDIs have various implications for the growth of property values. A government aid to rectify a market failure should elevate the rate of growth of property values in the area of target depending on whether or not there are spillover effects. There is a consensus that the effective function of Tax Increment Financing fosters economic development among economic analysts. Consequently, there is a need to ascertain that economic development incentive tool used in Los Angeles contributes considerably to the economic development of the region. The various persons and institutions that will benefit from the study include investors and residents of Los Angeles city and other states.
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