Authors: Aleks Granchalek, Managing Director, Public Finance and Kenneth Holub, Senior Vice President, Commercial Executive
While most city officials are aware of traditional incentive programs to attract new projects, they must get creative if they want to attract the kind of high-opportunity projects that can bring continued success to their local municipalities. Knowing all options out there, and getting creative with putting together packages, is key.
Tax increment financing programs (TIFs), tax subsidies and opportunity zones, among others, can create attractive packages for business owners to expand and invest in local communities.
Incentives Toolbox for Attracting High-Opportunity Development:
With TIF programs, municipalities direct future property tax revenue increases from a defined area or district toward an economic development project or public improvement project in the community. The money can go to publicly-subsidized economic development, such as redeveloping blighted properties. Or it can help pay for public projects, such as parks, schools or libraries.
The pledged security for the TIF expenses or debt is the incremental gain in property tax revenues realized after the infrastructure is developed.
Synthetic TIF Programs
In the mechanism of synthetic TIFs, a local government finances a public improvement or partners with a developer. The project or borrowed funds are then repaid from revenue derived from taxes on increased property values in the vicinity of the public improvements, or from other revenue garnered from increased private sector economic activity in the vicinity.
Improvements can be paid for with debt or pay-as-you-go financing where the party who puts in the improvements is repaid over time.
Although the expected increase in property tax revenue may represent the crucial element of the repayment plan, there is always a different security pledged to the financing. The financing could be a bond, a loan or developer funds.
A TIF program in Salt Lake City has designated 119 areas as redevelopment areas, each managed by a redevelopment agency, according to a Brookings Institution report.
A synthetic TIF lacks the formal designations needed for the conventional TIF described above. As a result, it has fewer procedural steps than a normal TIF and generally doesn’t face the same size restriction for the designated district that a traditional TIF does.
Tax Subsidies and Abatements
Tax subsidies represent another incentive. Tax exemptions and reductions are granted by both state and local governments. They can be entitlement subsidies enacted by law and available to any company that meets program requirements, or they can be discretionary subsidies negotiated individually in a deal between a company and public officials.
Tax abatements cut a firm’s taxes below standard rates for a defined time period. Abatements are particularly common for real estate projects, but can include sales, income or other taxes that a prospective company might be especially sensitive to (see General Business Tax Reductions). They can be used to convince a major local company to locate in a specific area or to attract a real estate developer to a specific community.
Indianapolis offers companies tax abatements to create new jobs, expand the tax base, and diversify the economy, according to the Brookings report. Meanwhile, Cincinnati provides property tax abatements to companies and developers building or renovating a residential, commercial, industrial, or mixed-use facility if the new or renovated facilities create jobs, the report says.
General Business Tax Reductions
Another tax abatement option is temporarily reducing general business taxes. For example, to help a manufacturing company purchase equipment, a city can stipulate that the company pays no taxes on the equipment in the first year, and is responsible for the total tax amount only after a period of several years. In return, the company might add jobs. Abatements also can be provided for corporate income taxes.
States and localities also can offer sales tax exemptions for targeted activities, such as new pollution-reduction equipment or for targeted industries, such as high-tech businesses.
States frequently provide tax credits for new jobs created or money invested in salaries. Job creation tax credits are a way for states to influence corporate relocations, expansions and retentions.
Opportunity zones are now a popular way to spur investment in distressed (and some non-distressed) areas. The program lets investors defer and reduce capital gains taxes in exchange for investing the money in designated low-income neighborhood development projects.
Governors in all 50 states have designated areas in their states as opportunity zones, and investment funds have been created to finance new business and real estate projects in these areas. Investors in the funds receive tax breaks. And for developers, the program is expected to create a steady stream of long-term liquidity, including for affordable housing projects, commercial real estate and local businesses. Participating in Opportunity Zone financing does not automatically preclude the use of other project incentives.
Performance-based incentives are another way to attract development. Wisconsin, for example, offered technology hardware maker Foxconn Technology $3 billion in tax and performance-based incentives. Those incentives include hiring, wage and investment targets with deadlines.
Only if Foxconn spends the capital and creates the jobs that they have promised will they will receive the full incentive. The program’s structure and compliance reporting requirements are designed to protect taxpayers from companies and projects that overpromise and under-deliver.
New Market Tax Credit
The New Market Tax Credit (NMTC) is offered by the federal government to businesses that invest in low-income communities, growing their operations and creating jobs. NMTC investors provide capital to community development entities, and in exchange are awarded credits against their federal tax obligations. Investors can claim their allotted tax credits in as little as seven years.
Solar Energy Benefits
Some local governments are opting to provide incentives to enterprises that rely on alternative energy like solar. For instance, Illinois has implemented the Adjustable Block Program, which offers tax credits for real estate owners using solar energy. The program offers a set price for purchase of Renewable Energy Credits (RECs) through 15-year contracts between a utility and an approved vendor representing one or more solar projects.
Property Assessed Clean Energy (PACE) Financing
PACE loans help finance energy efficiency upgrades or the installation of renewable energy sources for all types of properties. The program, overseen by the Department of Energy, allows state and local governments to offer funding for energy improvements. Property owners then repay the money over time. The payments come through property assessments, and the properties serve as collateral for the loans.
The Capital Stack
Of course, local officials should be aware of the capital stack for projects involving public finance. The capital stack refers to the organization of all funding contributed to finance a project or company. The capital stack defines who has rights and in what order to the income and profits generated by the project. It also determines who has rights to a piece of the actual asset in case of default.
At the top of the stack is equity, which can be held by developers and investors. Equity holders have the potential for the biggest gains, because as owners they are entitled to any profits after debts are settled. But they also face the biggest risk, because in the event of failure, their equity can become worthless.
The Debt Element
Beneath equity sits debt, which generally includes bonds and loans. For public infrastructure projects, tax-exempt bonds are the primary financing mechanism for states, counties and localities. Revenue bonds can be used to finance specific projects, as opposed to general obligation bonds, which are floated to fund municipalities’ general needs.
Debt holders have better protection than equity holders in case of failure, but their upside is limited, because they aren’t entitled to a share of profits or capital gains. Debt holders are compensated by the interest rate they receive.
Local officials have plenty of incentives at their disposal to attract and enable development and public improvement projects in their area. From TIF programs, to tax subsidies, to opportunity zones, officials have a lot of room to get creative with these incentives. Deploying the right mix of incentives can bring development to local areas, which serves as a win-win for both city leaders and businesses.