Growth and Change

Vol. 29 (Winter 1998), pp. 90-110

A Model of Tax Increment Financing

Adoption Incentives
RICHARD F. DYE AND JEFFREY O. SUNDBERG

ABSTRACT With tax increment financing (TIF) a municipality pays for economic
development expenditures out of future increases in tax collections. If the
development expenditures are the sole cause of the increased tax collections, TIF is a
fair and reasonable policy. If not, TIF can distort choices and redistribute resources.
This paper develops an economic model of TIF as a choice by the sponsoring
municipality with an impact on an overlying government. The analytic framework
isolates the impact of key variables, permits analysis of the payoff from TIF to each
government, and helps inform discussions about equity. The model clearly shows
that while the special nature of TIF causes it to favor projects that generate
significant tax revenue, that revenue need not be truly incremental with respect to the
project alone, and projects therefore need not be efficient to be financially viable to
municipalities. In fact, the projects that best fit the goals of TIF legislation may be
impossible to finance through TIF. Alternative government programs may be
required to help towns develop areas most in need.

Introduction
ax increment financing (TIF) is a policy tool that allows a municipality to
T designate an area for improvement and then earmark any future growth in
property tax revenues to pay for economic development expenditures. If all of
the future growth in property taxes within the district is clearly and fully caused
by the TIF-funded improvements, then TIF is simply an accounting device
wherein projects pay for themselves over time. TIF is controversial because that

Richard F. Dye is the Ernest Johnson Professor of Economics at Lake

Forest College and an adjunct professor at the Institute of Government and
Public Affairs at the University of Illinois. Jeffrey O. Sundberg is an associate
professor of economics at Lake Forest College. The authors would like to thank
the editors and referees of this journal and participants in seminars at Lake
Forest College, the Illinois Economic Association, and Northwestern University
for valuable comments. The authors would also like to thank the James S.
Kemper Foundation and the Civic Federation for financial support.

Submitted Dec. 1996; revised Mar., Nov. 1997.

© 1998. Center for Business and Economic Research, University of Kentucky.
Published by Blackwell Publishers, 350 Main Street., Malden MA 02148 US,
and 108 Cowley Road, Oxford, OX4 IJF, UK
 TAX INCREMENT FINANCING 91

condition of clear and full causation is seldom met. If some future growth in
property taxes would occur even without the TIF expenditures, the use of tax
increment financing can result in both inefficient expenditure choices and the
redistribution of tax revenues. The purpose of this paper is to provide an
analytical framework for TIF to examine those efficiency and equity concerns.
We begin with a more detailed look at the context and content of TIF laws.
Over the last several decades, the number of municipalities adopting tax
increment financing as a development tool has increased, as the number of states
authorizing the use of TIF has risen to forty-four (Forgey 1993). At the same
time, the relative importance of TIF has been increased by the decline in federal
and state funding of other local economic development incentives. TIF
requirements vary from state to state, but the basic features are similar. A
municipality designates an area as a TIF district. To qualify, an area often must
be considered “blighted.” Public improvement expenditures are undertaken,
usually bond-financed and often linked to additional improvements funded by
private developers. The tax base is frozen at its nominal value as of the
inception of the district, and local jurisdictions receive tax revenue determined
by the tax rate applied to the inception value. The TIF district’s debt service and
other costs are paid with revenues from the tax rates of all local jurisdictions—
the town, the school district, the county, and special districts—applied to any
increment to the district’s tax base over the inception value.1
In some states, a condition for the establishment of a TIF district is the
assertion by the municipality that the development would not happen “but for”
the TIF expenditures. If indeed all of the increment to property value is
attributable to the development expenditure, then TIF merely compels the non-
municipal jurisdictions to share in the financing of improvements in the same
proportion that they share the tax revenues generated by those improvements.
If, however, any increment to the property tax base (new development,
improvements, real appreciation, or even merely inflationary increases in the
value of existing properties) would occur independent of the TIF project, or if
the project relocates development that would otherwise occur elsewhere in the
jurisdiction, then TIF raises a variety of incentive and equity concerns.
Political perceptions of TIF often concentrate at these “pure attribution” or
“pure capture” extremes of the possible outcomes; proponents frequently see
TIF revenues as fully attributable to the project, while opponents commonly
characterize tax increment financing as a cynical device to capture from other
governments revenues associated with increases in property value that would
have occurred even without the use of TIF. In order to examine those concerns,
an integrated theory of TIF is presented as a financial decision. By examining
the interactions among the many variables involved in a TIF, the incentives at
work and how they impact development can be better understood.
92 GROWTH AND CHANGE, WINTER 1997

Previous examinations of TIF in the literature have been descriptive,

evaluative, and sometimes empirical, but only one develops a formal model
(Lawrence and Stephenson 1995). Much of the literature is in the fields of
planning or applied economic development. Huddleston (1986, 1984, 1982, and
1981) provides an excellent description of TIF; he pays particular attention to
variations in the share of TIF taxes that municipalities capture from non-
municipal governments and examines those differences with data from
Wisconsin. Others (Williams 1996; Royse 1992; Voss 1991; and Bland 1989)
attempt to delineate the circumstances when TIF projects will be an effective
tool for local economic development, or present case studies (Carlson 1992;
Hood 1992; Davis 1989; Grimm 1997; and Silverman 1997). Stinson (1992)
and Huddleston (1982) calculate the financial viability of specific projects by
assuming different future induced rates of growth in property value. Klemanski
(1990) assesses the political and legal consequences of TIF in addition to the
fiscal aspects.
Anderson (1990) provides an econometric examination of TIF districts
using data from Michigan. Much of his attention is directed to the econometric
problem caused by the simultaneous determination of growth in property values
and the decision whether to adopt TIF financing; independent but anticipated
growth may lead to increased use of TIF to capture revenues from other
governments, while successful TIF development projects will lead to increased
growth. Anderson finds a positive association between property value growth
and TIF adoption, but is unable to determine the direction of causation. Using
data from Indiana, Man and Rosentraub (1994) also find a positive association
between property value growth and TIF adoption, but, although they assert the
conclusion that TIF causes growth, they do not use statistical techniques that
appropriately test for the direction of causation.
Lawrence and Stephenson (1995) present a model of TIF that allows
calculation of the distributional impacts on multiple overlapping jurisdictions.
They assume that as the tax base changes in a year each jurisdiction’s tax rate is
adjusted to yield a target levy. Their model gets at the crucial attribution/capture
issue by using a measure of the “natural” fraction of a year’s growth in tax base
that would have occurred without the TIF project. The other key parameter of
their model is the portion of a year’s incremental tax revenues that is released to
the overlying governments and not used to pay TIF project costs. They apply
their model to a case study of a TIF district in Des Moines, Iowa and estimate
the annual impact of the TIF on tax revenues compared to what they would have
been in the absence of the project.
Much of the existing literature merely lists critical factors for using tax
increment financing and discusses the probable impact of different variables on
the likely success of projects. Lawrence and Stephenson have advanced our
understanding of TIF with a multi-jurisdictional model that specifies the
 TAX INCREMENT FINANCING 93

interrelationships among several of those factors. Their model presents the

impact of TIF for an individual year and emphasizes distributional issues.
In what follows, a model is offered that presents the impact of TIF in a
multi-year context and emphasizes the dynamic issue of net present value. The
model is used to explore the sensitivity to, and interrelationships among, many
of the factors that impact TIF projects. It is hoped that such a model can provide
specification guidance to future empirical examinations of TIF impacts. The
model allows an examination of a range of equity and efficiency issues in the
use of TIF, such as the types of municipalities and projects favored, the return to
overlying governments, and the possibility of locally efficient but globally
inefficient uses of TIF. The model serves as the basis for simulations that are
used to examine the relationships among the variables of interest.

The Model
The decision to undertake a TIF project is made by a local government
body, town X. Town X decides whether or not to adopt a TIF by comparing the
expected streams of fiscal and other benefits and costs with and without the
project. Town X is located within school district S, as is another town, Y. The
revenue received by the school district is based on the school tax rate and the
property value in towns X and Y. In the event that town X chooses a TIF
project, the school district is compelled to participate as well.2
In order to determine the impact of a TIF project, the model provides an
equation for the present value of property tax revenues. The present value of
revenues is modeled, first without and then with the TIF project, for both the
municipal government X and the overlying government S. The net present
value of the TIF is then calculated as the present value of the difference in tax
revenues with and without the TIF minus the cost of the TIF project. The net
present value to each government is defined separately to allow an examination
of equity issues. The full derivation of the model is presented in the Appendix
and only key steps useful for the exposition are shown here.
The initial assumptions for the non-TIF case are as follows. The revenue
collected by town X is calculated by multiplying the property value, Vx, by the
municipal tax rate, tx. Town X consists of two districts, one of which is the
blighted area under consideration for the TIF. The blighted area is a fraction f of
the total value of X, so that the total property value in the area is fVx. Property
values in the blighted area are expected to grow at rate gb, and the value of the
remainder of town X is expected to grow at rate gx. With a discount rate of r, the
present value of the revenue collections by town X in the absence of a TIF is
therefore
f (1 − f )
PV (Tx ) = t xV x [ + ]. (1)
r − gb r − g x
94 GROWTH AND CHANGE, WINTER 1997

TIF and other local economic development projects cause not just one-time
increases in improvements, but, at least potentially, boost blighted areas onto a
higher growth path of annual increases in nominal property value (g'b ). The
project may also affect the growth path of nominal property value in portions of
town X not included in the TIF district (g'x ), or even in the neighboring town Y
(g'y ). The model thus allows each of the three growth rates to change if a
project occurs. The amount spent on the project is cfVx. Each dollar spent on
the project increases property values in the district immediately by A, so that the
one-time boost in property value in the first year is AcfVx.3 The present value of
tax collections by the town in the presence of a TIF is thus equal to
t (1 − f )V x t x ( fV x + AcfVx )
PV (Tx ) = x + . (2)
r − g ′x (1 + g b′ )(r − g b′ )

The second term represents the present value of future tax collections from the
blighted area. Economic efficiency requires that the incremental benefit from
the project must exceed the cost.4 The net present value of the project to town X
is therefore equal to the expected tax revenues with TIF less the expected tax
revenues without TIF and the town’s share of the cost. Thus,

t x (1 − f )Vx ( g ′x − g x ) t x ( fVx + AcfVx ) t t

NPV (Tx ) = + − x fV x − x cfVx . (3)
′
(r − g x )(r − g x ) ′ ′
(1 + g b )(r − g b ) r − g b tx + ts
As a last step, the impact of factors that affect the town beyond the amount of
property tax revenue collected must be included in the equation. The term NBx
signifies the present value of the net benefit the project creates for town X other
than the changes in property tax revenues. The net benefit may include either
costs or benefits and thus may be positive or negative. The final equation for
addressing the efficiency of a TIF project to town X is therefore
(1 − f )V x ( g ′x − g x ) fVx + AcfVx t
NPV (Tx ) = tx + t x − x fVx
(r − g ′x )(r − g x ) (1 + g b′ )(r − g ′b) r − gb
tx
− cfVx + NBx . (4)
tx + ts
With parallel set of definitions and assumptions, the equation for school district S is
(1 − f )V x ( g ′x − g x ) fVx + AcfVx t
NPV (Ts ) = ts + t s − s fV x
(r − g ′x )(r − g x ) (1 + g b′ )(r − g b′ ) r − gb
V y ( g ′y − g y ) t
+ t s − s cfVx + NBs . (5)
(r − g ′y )(r − g y ) tx + ts
 TAX INCREMENT FINANCING 95

The next two sections of the paper use this model to generate some insights
about tax increment financing. The third section concentrates on just the
property tax flows from TIF and emphasizes efficiency issues. The fourth
section adds complexity and introduces equity issues.

Efficiency and Financial Viability Simulations

From the standpoint of local government, a project can be defined as
efficiency enhancing if it has a positive net present value for equation (4)—the
benefit it creates, beyond what would have been collected from the area without
the project, is at least sufficient to cover the cost of the project. A project can be
defined as financially viable if the net cash flow is positive—the revenue
collected must at least cover the cost of the project. The difference between the
efficiency calculation and the financial viability calculation is that efficiency
includes a subtraction for the opportunity cost of would-be tax collections.
In order to develop an understanding of efficiency and financial viability
and to examine the impact of key variables, the model is used to perform
simulations. To build some intuition about the model, initially two restrictive
assumptions are made: that all of the impact of the TIF project is on property
values; and that only the value of property within the district is affected. By
ignoring any non-tax benefits (NB=0) and any impact on growth rates outside
the blighted area (gx=g′x and gy=g′y ) the model collapses to:5
t x ( fVx + AcfVx ) t t
NPV ( X ) = − x fVx − x cfVx (4′)
(1 + gb′ )(r − gb′ ) r − gb t x + ts
Three of the variables—the one-time improvement in property values (A),
the subsequent growth rate in the blighted area (g′b ), and the cost of the project
(cfVx)—are affected by the TIF project. The value of the TIF project to the
decision-making municipality is, however, also affected by the other variables:
the municipal tax rate (tx), the school district tax rate (ts), the interest rate (r), and
the would-be growth rate of the blighted area (gb). Perhaps the single most
important thing to notice about this model is the impact of that last variable:
increases in tax revenues that would have occurred even without the project are
an opportunity cost subtraction from efficiency calculations, but are included in
the financial cash flow available to pay project costs.
The following simulations, based on equation 4′ examine the value of TIF
projects under a range of assumed values for the growth rates and the tax rates.
In each case the net present value of spending one dollar of government money
in the district is calculated, taking into account the one-time boost in assessed
value caused by the spending and the improvement in future growth rates of
96 GROWTH AND CHANGE, WINTER 1997

property values as a result of the project. The model simulations first set values
for the parameters, then solve the model for the net present value and net cash
flow value6 of the TIF project to the town using a variety of assumed pre-TIF
growth rates, post-TIF growth rates, and tax rates.7
Figure 1 shows the present values obtained by solving the model for a range
of post-TIF growth rates (g′b ) and two different municipal tax rates (tx) . To
remove, for now, the distinction between efficiency and financial viability, these
simulations assume that the potential TIF district has property values that are
expected to remain stagnant (gb=0). The first result shown in the figure is
obvious—higher post-TIF growth rates have a positive and increasing effect on
the net present value of the project. The second result—higher municipal tax
rates increase the value of the project—may be less obvious. Much of the
earlier literature stressed the importance of the share of the project costs paid by
overlying governments; Huddleston’s (1984) “subsidy rate” is equivalent to
ts/(tx+ts) in our notation.8 While higher municipal tax rates do increase the
relative share of costs borne by town X, that is more than offset by the higher
tax collections received.
Non-zero pre-TIF growth rates lead to a divergence between economic
efficiency and financial viability. As a consequence, some efficiency-improving
projects will not be financially viable and some financially viable projects will
not be economically efficient.
The simulations shown in Figure 2 are the present values obtained by
solving equation (4′) and the corresponding expression for net cash flow for a
positive pre-TIF growth rate (gb=3%), a range of post-TIF growth rates (g'b ),
one municipal tax rate (tx=1%), and the same fixed values for the other model
parameters. The net cash flow value calculations in Figure 2 show that any
project that results in a post-TIF growth rate of at least 0.5 percent can be
successfully financed. The net present value calculations in Figure 2 show that
when the opportunity cost rate of growth (gb) is high, the project is inefficient for
a wide range of ex post growth rates. The project is financially viable, but
inefficient, for g'b between 0.5 and 2.8 percent. Only when g'b exceeds 2.8
percent is the project efficiency improving. 9 With a positive pre-TIF rate of
growth, the district is able to “capture” that portion of the growth in property
value for use in TIF financing.
This points out what we consider to be one of the gravest flaws in TIF. If
property values would grow at a high rate in the absence of TIF, even a project
that results in a permanent reduction in the growth rate would be easy to finance.
Policy makers unused to the concept of opportunity cost might be susceptible to
making a poor decision if financial viability is confused with efficiency.10
The notion of “blight” might reasonably be associated with the assumption
of declining property values in the would-be TIF district. Figure 3 shows the
present values calculated by assuming a negative pre-TIF growth rate (gb= -3%)
 TAX INCREMENT FINANCING 97

FIGURE 1. IMPACT OF TAX AND POST TIF GROWTH RATES ON NET PRESENT VALUE
(Pre-TIF Growth Rate=0)

FIGURE 2. IMPACT OF POST-TIF GROWTH RATES ON NET PRESENT VALUE AND NET
CASH FLOW WITH POSITIVE PRE-TIF GROWTH RATE (gb=+3%)
(AND MUNICIPAL TAX RATE = 1%)
98 GROWTH AND CHANGE, WINTER 1997

FIGURE 3. IMPACT OF TAX AND POST-TIF GROWTH RATES ON NET PRESENT VALUE AND
NET CASH FLOW WITH NEGATIVE PRE-TIF GROWTH RATE (gb=-3%)
(AND MUNICIPAL TAX RATE = 1%)

with the same other assumptions as the previous simulations. The lower
opportunity cost means that there is a much wider range of positive net present
values than in the previous case. If pre-TIF growth is negative, the project need
not result in high ex post growth rates to be valuable—merely arresting
declining growth rates is an efficiency-improving result. The net cash flow
values are, however, the same as for the previous case and the breakeven level
of post-TIF growth for financial viability is still +0.5 percent. Because the
frozen tax base amount actually overstates the revenue the town would be
receiving from the district in the absence of TIF, there is a range of post-TIF
growth rates where the project is efficiency improving but not financially viable.
These simulations have demonstrated four things. First, there is the obvious
result that benefit to the town of the TIF project depends positively on both the
value of new property and the increment to the growth rate. Second, projects
with a positive net present value are more beneficial when the municipal tax rate
is higher, in spite of the reduced relative subsidy from overlying governments.
Third, even projects that result in no improvement in efficiency can be
financially viable if underlying growth rates are sufficiently high. Fourth,
projects that meet the stated goals of TIF legislation in arresting blight may not
 TAX INCREMENT FINANCING 99

be financially viable, since the growth in property value over the inception
value, and therefore the net increment to tax revenues, may be too low.

Modeling Equity Problems

To develop the efficiency versus financial viability distinction, the
simulations based on equation 4′ employ very limiting assumptions, notably that
the only benefit from the project comes from higher property tax revenues.11
This, in effect, assumes away conflict between the decision-making municipality
and the contributing overlying government because they share proportionately in
property tax revenues. More realistic scenarios would not require such
conditions to hold, and therefore could create imbalances in the benefits
received by various governments. There are a variety of ways this might occur,
which can be illustrated by referring to the full model of equations 4 and 5.
First, suppose that town X is able to take an item that normally would be
paid from its municipal budget, perhaps road maintenance, and reduce the
budgeted expense by shifting costs onto the TIF project. Town X then receives
a net benefit from the project in the form of lower municipal expenses. This can
be incorporated in the model through a positive NBx term in equation 4. The
school district receives no such reduction in its expenses, so it does not
participate in that benefit. This drives a wedge between the incentives of town
X and of school district S. Suppose the project shows a positive net present
value to town X only because a negative tax-revenue effect (the net value of the
first four terms in equation 4) is offset by a larger positive cost-shifting effect
(NBx). The project will have a negative net present value to school district S,
since it has a proportional negative tax-revenue effect but does not receive the
benefit of cost-shifting (NBs=0 in equation 5). Town X will wish to pursue the
project, and school district S may be compelled to participate. The taxpayers in
school district S will be worse off either by receiving lower services for the
same school tax rate (ts) or by having to pay a higher tax rate to maintain the
same level of services. School taxpayers who reside in town X will receive a
more than offsetting benefit (NBx), while school taxpayers who reside in town Y
receive no such benefit.
An even more dramatic case occurs if the development of the TIF district in
town X changes private investment decisions so that improvements that would
have been made in town Y are now made in town X. The future growth of
property value in town Y is now reduced (g′y<gy), and the future growth in town
X is enhanced (g′b>gb). This reallocation of investment has no impact on school
district S, since the property is moved within the district, but is of value to town
X.12 In addition, the residents of town Y will be harmed because of either a
reduction in future tax revenues received by their municipality or an increase in
the rate needed to make up the lost revenue.
100 GROWTH AND CHANGE, WINTER 1997

A TIF project may also alter tax collections from sources other than the
property tax. For example, a project designed to revitalize a shopping area may
create higher municipal sales tax revenues (which could be modeled in the NBx
term). Such revenues would be beneficial to town X and its residents, but would
not create any additional revenue for the overlying school district S. In fact,
they may make certain taxpayers in the same school district worse off if the tax
revenue is a reallocation from money that would have been received by town Y.
The net benefit term can also be used to take into account benefits (or costs)
that are not reflected in changing tax revenues. For example, a TIF project
might alter local traffic congestion, environmental conditions, or labor markets.
These benefits or costs should be used in considering the full economic value of
the project. The TIF project could increase service demands on overlying
governments as, for example, with additional pupils residing in the newly
developed property. Since these effects are unlikely to have identical impact on
town X and on school district S, there is again an imbalance between the share
of benefits received and the share of cost allocated to the governments.
The existence of such localized benefits and costs helps explain the concern
with the transfer of revenues from overlying governments whose residents will
not share in these benefits. It might also explain the observation that a number
of TIF projects will probably not generate sufficient incremental revenues to pay
debt service and will require general fund contributions from the guarantor
municipalities. (See, for example, Stinson 1992 and Redfield 1988). If the non-
tax-revenue benefits are substantial, projects that are not financially viable under
the rules of TIF may in fact be welfare improving for at least one of the
governments.
A related case is where other revenue sources are affected by the TIF
project. An important example of this is the school aid formula that in many
states makes grants inverse to the value of the local property tax base. If a TIF
decision freezes the tax base below what it otherwise would be, then an
equalizing state aid formula would raise school district revenues above what
they otherwise would be. Indeed, in the case of an aid formula with a “state
guaranteed tax base,” and where that guaranteed base also grows at rate g'b , a
school district would be made whole by the state. The degree of state subsidy
depends, of course, on the school aid formula in the state and where the affected
school district falls in that formula.13
The capture of benefits from outside the local area will obviously affect the
efficiency of local choices. Continuing the school aid example, there can be
projects that have a positive present value for local decision makers (in both
town X and school district S), who receive a pecuniary transfer from non-local
state taxpayers, but a negative present value to the state as a whole.14
Another example of TIF triggering access to increased state revenues is
Illinois’ ill-considered experiment with sales tax TIF in 1986. Projects that
 TAX INCREMENT FINANCING 101

qualified under this plan were able to capture the increment to state sales tax
revenues within the district. Local decision makers accordingly had strong
incentives to draw TIF district boundaries to include existing retail sales tax
sources that would rise with inflation or real growth regardless of the payoff to
any TIF development.15
The issues identified in the model simulations and model extensions suggest
a number of concerns for the design of TIF programs as part of overall
development policy. The concluding section raises some of these concerns.

Implications for Policy and Conclusions

In order to evaluate TIF programs, we must understand what type of
development they encourage and look at the incentives of each level of
government involved in the program. It is clear that TIF can be used to improve
blighted areas in many different towns; however, TIF is most attractive to
municipalities with high expected growth rates, and can be profitably used in
such towns in areas that are not blighted in any usual meaning of the term. On
the other hand, as the underlying growth rate of the area decreases, it becomes
more and more difficult for TIF projects to pay off, even if they have a very
positive impact on future growth. The local government’s focus must be on
whether or not the project generates revenues which exceed its share of costs.
The “pure attribution” case, where all of the benefits take the form of an
increased tax base shared by both the municipality and the overlying
government, is the basic or reference case in our model. Here, participation in
financing by the overlying government is fair in that costs are borne in exact
proportion to their participation in future revenues. But if this is the nature of
most TIF projects, then there should be no problem with allowing overlying
governments to participate in the decision of whether or not to adopt a TIF
project.
TIF also has elements of “capture,” in that it encourages towns to undertake
projects that may be beneficial to the town itself largely because of transfers
from other towns in the same overlying government, resulting in a net loss to
those areas. An overlying government should not concentrate on the subsidy
rate as its main source of concern, but should instead consider two issues. First,
it should determine whether gains are created that would not occur “but for” the
presence of TIF. Second, it should carefully examine the project’s proposed
gains and determine the fraction of gains that are actual inflows to, rather than
pecuniary transfers within, its boundaries.
A variety of issues need to be examined from a state policy standpoint.
First, states should carefully consider what types of projects and types of
communities they wish to stimulate. TIF involves state funds in subsidizing
local development and, as has been noted, TIF has the largest payoff for
communities with the highest expected rate of growth rather than the greatest
102 GROWTH AND CHANGE, WINTER 1997

need for development. A strict definition of blighted might result in TIF only
being made available to towns with declining property values, so that the
program as it currently exists would not be financially viable; a different
program would be needed to allow towns to at least stabilize areas of declining
property values.
Second, the determination that growth would not occur “but for” the public
subsidy via TIF is in some states merely a pro forma assertion made by the
municipality. The “but for” determination might be constrained by more
rigorous statutory tests, subjected to direct state oversight, or opened up to
easier challenge by overlying governments or taxpayers. One straightforward
policy change that might be appropriate is to require an annual adjustment in the
frozen tax base for the general rate of inflation in property values.
Third, even if the “but for” test can be met in one location, states need to
determine the extent that the gains from TIF projects are really pecuniary
transfers from other areas within the state, and also what specific types of
improvements should be allowed. It is easy to see that if every town uses TIF to
develop a strip mall and attract shoppers from the neighboring town, the
overlying governments and the state will not see any net benefit.
These observations suggest that states reexamine the role of TIF in
development policy. Overlying governments should be given greater
participation in the decision. The types of areas and communities allowed to
qualify for TIF should be defined carefully, as should the types of improvements
allowed under the program. Finally, alternative forms of subsidy are needed if
the state wishes to encourage development in the poorest areas of the poorest
communities.

NOTES
1. Variations across states in TIF procedures include: the conditions that must be met for
an area to qualify for the program; the types of projects or public expenditures
permitted; the degree of public participation in decision-making; the degree of
participation of non-municipal governments in decision-making; inflation-adjustment
of the property value base; partial sharing of the increment with the other
governments; limits on the size of districts; rules for any distribution of revenues in
excess of debt service and other allowable costs; time limits for the life of district or
for the term of the bonds. Even the name, Tax Increment Financing, is not universally
assigned to this type of program. (Bland 1989; Calia 1997; Forgey 1993; Paetsch and
Dahlstrom 1990; Redfield 1995).
2. More realistically a TIF project would impact the future revenues of a number of
overlying governments, each with different boundaries (see Lawrence and Stephenson
1995), but for purposes here the essence of the distributional issue is captured in the
simple case of one overlying government.
3. The multiplier term A could be linear or nonlinear. The more general nonlinear form
is presented in the Appendix.
4. We are using the term efficiency in the second-best sense of welfare improving, not the
first- best sense of optimality.
 TAX INCREMENT FINANCING 103

5. In this special case of the model, both governments gain in direct proportion to their
share of the cost of the project and the return to school district S is
t s ( fV x + AcfVx ) t t
NPV (S ) = − s fVx − s cfVx . (5′)
(1 + g b′ )(r − g b′ ) r − g b tx + ts
Note that this is simply NPV(X)*(ts/tx). Because of this strict proportionality between
the gains to town X and to school district S, if the revenue from town X’s tax rate is
sufficient to cover the fraction of cost attributed to town X, the same will be true of
school district S. Accordingly, only the net present value to town X is calculated in the
simulations of this section.
6. The net cash flow value is the present value of future benefits and costs ignoring the
would-be increment to tax collections. This is calculated by evaluating equation 4' at a
value of gb = 0.
7. The parameters held constant across the simulations are assigned the following values:
tx = school district tax rate = 2.5% of assessed value;
Vx = assessed value of property in town X = $1,000;
f = fraction of Vx included in the TIF district = .10;
r = discount rate = 6%;
c = cost decision variable (per $1 of assessed value) = 0.2;
A = growth multiplier = 1.25.
The growth multiplier of 1.25 dictates that $1.00 of government spending creates a
$1.25 increment to property value in the first year. Such an increment could occur for
many reasons. For example, government spending may be tied to private investment
designed to further boost property values.
8. Obviously a higher subsidy rate that is caused by a higher school district tax rate (ts)
will benefit the municipality. See the Appendix.
9. It should be noted that while this breakeven post-TIF growth rate is lower than the pre-
TIF growth rate, it is being applied to a higher initial value due to the one-time boost
from development (AcfVx >0).
10. As noted earlier, Anderson (1990) finds a positive correlation between growth and
TIF adoption but is unable to disentangle the direction of causation. He does find,
however, that prior population growth is a strong positive predictor of TIF adoption
and his interpretation of this result is consistent with a prediction of our model—that
local officials may be trying to capture high expected rates of increase in local property
values. This corresponds to the simulation results in Figure 2; projects in areas with
high underlying growth rates are easy to pay for, through such capture, though they
may or may not be efficient.
11. Perfect capital markets would be necessary for the future revenues to have the full
impact on present-day residents. The absence of such borrowing ability may result,
as shown by Lawrence and Stephenson (1995), in tax rates going up, at least
temporarily, because of the constraint the TIF project places on taxing bodies.
12. Redfield (1995) cites the case of one TIF district designed to relocate a grocery store
several blocks away from the existing location in a neighboring town.
13. Anderson’s (1990) empirical study includes a measure for replacement revenues via
Michigan's school aid formula but finds no significant impact on TIF adoption
decisions. Hinz (1997) estimates “the state [of Illinois] replaced $8.7 million of the
$18.3 million diverted from [Chicago] city schools by TIF districts in 1995.”
14. Morse and Farmer (1986) found this result to hold for a particular Ohio property tax
abatement program.
104 GROWTH AND CHANGE, WINTER 1997

15. See Redfield (1988) for a devastating and thorough critique of the policy or Klemens
(1990) for a summary.

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Calia, Roland. 1997. Introduction. In Assessing the impact of tax increment financing in
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———. 1982. Local financial dimensions of tax increment financing: A cost-revenue
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———. 1984. Tax increment financing as a state development policy. Growth and
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———. 1986. Distribution of development costs under tax increment financing. Journal
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Klemens, Michael D. 1990. TIFs: What cost to state treasury? Illinois Issues 16 (June):
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Redfield, Kent D. 1988. Tax increment financing: Legislative issue. Springfield,

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APPENDIX
MODEL DERIVATION AND COMPARATIVE STATICS
The decision to undertake a TIF project is made by a local government
body, town X. The decision affects the property tax base for an overlying
government, school district S. The first step in developing the model is to define
the tax revenues collected in any given year, first in terms of the property value
in any given year and then in terms of the property values of the initial year. The
present values of the infinite series of expected property tax revenues, first
without and then with TIF, are calculated. Next, the net present value of the TIF
project is calculated as the present value of the difference in tax revenues with
and without the TIF minus the cost of the TIF project.
The assumptions for the non-TIF case of the model are as follows:
(1) There are two municipalities, X and Y, that together form one school
district, S. Each has a property tax at rate t applied to the total value of property,
V, so that the revenue collected in any year is T = tV.
(2) Town X consists of two areas. The value of the blighted area, which is a
fraction f of the total property value of X, is growing at rate gb. Property values
in the remainder of town X, with a total value of (1-f)Vx, are growing at rate gx.
Property values in town Y are growing at an annual rate of gy.
The tax revenue collected by town X in year i without any TIF project is
defined to be
Tx i = txi Vxi . (A1)

The revenue collected by the school district in year i is similarly defined to be

Tsi = ts i (Vx i + Vyi ) . (A2)