What Is Tax Increment Financing and How Does It Work?

Tax Increment Financing (TIF) is a public financing tool utilized by local governments to support redevelopment and community improvement projects. This mechanism enables municipalities to fund initiatives by capturing the future growth in tax revenue generated within a specifically designated area. The objective is to stimulate economic development in areas that might otherwise remain underdeveloped or stagnant. TIF is not a new tax; rather, it strategically redirects future tax revenue increases to invest directly into the growth of a defined district.

The Mechanics of Tax Increment Financing

Tax Increment Financing operates by establishing a baseline property tax value for a designated area before development begins. This “base value” represents the total assessed value of all taxable real property within the proposed district at its creation. Property taxes generated from this base value continue to flow to existing taxing bodies, such as school districts, libraries, and fire departments, as they did before the TIF district was formed.

TIF captures the “increment,” which is the increase in property tax revenue above this established base value. As new development, rehabilitation, or other improvements occur within the TIF district, the assessed value of properties within that area rises. The additional property tax revenue from this increased value, beyond the original base, is the increment. This increment is then diverted into a special fund managed by the municipality or a designated redevelopment agency.

These captured funds are used to finance eligible redevelopment project costs within the TIF district. One common method is to secure bonds issued to cover the upfront costs of development. The future tax increment serves as the dedicated revenue stream to repay the principal and interest on these bonds over time. This approach allows for significant upfront investment in projects that might not otherwise be financially feasible.

Alternatively, TIF funds can be used on a “pay-as-you-go” basis, applying the incremental revenue directly to eligible project costs as they are incurred or to reimburse developers for their investments. This method ensures that funds are expended only when the tax increment has been generated. Regardless of the financing structure, the intent is for the diverted taxes to pay for improvements that would not have occurred otherwise.

The duration of a TIF district is limited, usually 15 to 30 years. Once the TIF district reaches its expiration date or the bonds are repaid, the entire property tax revenue, including the previously captured increment, flows to all traditional taxing bodies. This allows the broader community to benefit from the expanded tax base created by successful development within the former TIF district.

The increment is calculated by multiplying the increase in assessed value above the base by the prevailing tax rates within the district. This means that while TIF captures revenue growth, it does not increase the individual property owner’s tax bill. Instead, it reallocates where a portion of existing tax dollars, specifically the growth component, are directed.

Establishing a Tax Increment Financing District

The establishment of a Tax Increment Financing district involves a structured process, initiated by a municipality or local government. The first step is identifying an area considered blighted, underdeveloped, or in need of economic revitalization. This identification involves conducting analyses, such as blight studies, to confirm the area meets statutory criteria for TIF designation.

Feasibility studies are also conducted to determine if the proposed redevelopment will generate sufficient future tax increment to cover the project costs. These studies include an economic impact analysis to project development benefits and assess whether the project would occur “but for” the TIF assistance. This “but for” test is a common requirement, ensuring TIF funds are used for catalytic projects.

Following these studies, a comprehensive TIF redevelopment plan is developed. This plan outlines the objectives, proposed projects, estimated costs, and a future land use strategy for the district. It also defines the boundaries of the TIF district and establishes the “base value” of the property taxes within that area.

Public engagement is important to the TIF establishment process. Municipalities are required to hold public hearings to inform residents and affected taxing bodies about the proposed TIF district and redevelopment plan. Notice of these hearings, often with a map of the proposed district, is published in local newspapers before the hearing. Affected taxing districts, such as school boards and counties, are given an opportunity to review and comment on the proposed plan.

After public input and review, the local governing body, such as the city council, must approve the TIF redevelopment plan and designate the area as a TIF district through ordinances. Once approved, the county auditor or clerk certifies the base value, and the mechanism for capturing the tax increment is put into place. This procedural framework ensures transparency and compliance with state and local regulations for TIF implementation.

Common Applications of Tax Increment Financing

Tax Increment Financing funds are applied to projects aimed at revitalizing and developing designated areas. A primary application is to finance public infrastructure improvements within the TIF district. This includes construction or upgrading of roads, sidewalks, water and sewer lines, and other essential utilities. These enhancements lay the groundwork for private investment and improve community functionality.

Funds are also used for site preparation, particularly in blighted or underutilized areas. This may involve demolishing dilapidated structures, environmental remediation of contaminated land, and site clearing and grading. These steps make the land more attractive and ready for new construction or redevelopment.

Public facilities and amenities within the district can also be supported by TIF. This includes developing parks, community centers, and other public spaces that enhance the quality of life for residents and attract businesses. Funds may also improve downtown business districts or rehabilitate historic properties, preserving local character while fostering economic growth.

TIF is also used to assist private development projects that align with the redevelopment goals of the district. This can involve offsetting extraordinary costs of urban construction or incentivizing projects that would otherwise be too financially risky. Eligible costs include property acquisition, rehabilitation of existing buildings, and certain financing costs.

TIF funds are restricted to projects and improvements within the designated TIF district boundaries. The expenditures must directly contribute to the redevelopment and increased property values within that area. This ensures the captured increment is reinvested directly into the area that generates it, fostering targeted economic development.