With the budget crunch this year, many people are asking legitimate questions about when and how tax increment financing (TIF) is used. Some of those conversations are getting bogged down in trying to understand exactly how TIF dollars flow. This post is not about the important questions of how and when to use TIF. This is a technical description of the flow of money in an effort to relieve some of the side questions about how it works.
What happens when MDHA provides tax increment financing? There are two key starting points to know. First, a baseline amount of property tax is established. If a property pays $10,000 per year in property taxes before the new development, that $10,000 is the baseline. When the new building is done, it will generate more taxes — say, $30,000 per year. The difference between the post-development tax bill and the pre-development bill is the “tax increment.” In my example, the tax increment would be $20,000 per year. Second, with TIF, it is MDHA that borrows money from a bank. MDHA then provides the loan proceeds to the developer. The developer will typically use the MDHA loan proceeds as part of its equity in financing a project.
Next, the project is built. The new building then gets its new, final property tax assessment. And then the owner pays the full amount of those property taxes to Metro just like everyone else. However, Metro and MDHA will have made a note of the baseline tax ($10,000) and knows to think about the baseline ($10,000) and the tax increment ($20,000) differently. More about that in a second.
Whenever Metro receives any property tax revenue, it automatically allocates the money to its several Funds — including the General Fund, the School Fund, and the School Debt Service Fund. This bears repeating — every dollar received including the tax increment dollars gets automatically allocated in certain fixed percentages to Metro’s various accounting Funds. When you pay your property taxes, about 41% gets allocated to the School Fund and the School Debt Service Fund, for example. And a TIF project works the same way — about 41% of its property tax payments get allocated to those same two of Metro’s Funds.
Then each year in the budget, each of the Funds has an expense line item where its share of the tax increment from TIF properties is deducted out and given to MDHA. Then MDHA uses this money to pay back the TIF loans.
This technical accounting flow of money among Metro and MDHA does not match up with the conventional perception of TIF loans. The common understanding is that Metro has decided to keep property taxes for TIF properties artificially low and that Metro never sees the money. While the end result that the tax increment is not available for typical government services is the same, the actual mechanism is different. Metro does collect the full property taxes on each TIF property, allocates the tax increment to its various Funds just like all other property tax revenue, then debits the tax increment money out of the Funds and over to MDHA, and then MDHA pays the loans.
As we wade into a budget season where people are looking for money, I know that some are seeing the budget line items for payments to MDHA and asking about it. Again, the sole goal here is to explain the mechanism. The more important long term question is about how and when to use TIF.