January 19, 2018

SPECIAL REPORT

SB 58 – Revise certain provisions regarding tax increment financing districts.

Housing as part of Tax Increment Financing

Building factories, warehouses even retail stores creates jobs and expands a community’s tax base.  Does housing do the same thing?  After the construction of a house is completed, it doesn’t involve any jobs for anyone other than perhaps a yard mowing service, the occasional visit by a plumber or Merry Maids.

One thing is certain; housing is essential to workers (research shows they like to live indoors); workers are essential to business; and there are many businesses where workers are in short supply. 

SB 58 makes it clear that developing affordable housing is part of economic development for a community and is an appropriate use of tax increment financing (TIFs) in the same manner as projects that are classified as “industrial” or “economic development”.  Under SB 58, “Affordable Housing” becomes eligible to have the funds that a TIF allocates to bond payments - meaning those funds that would otherwise go to school general funds - will become part of the statewide calculation of the state-aid formula rather than coming from the school district taxpayers.

If you actually understand what this bill does from reading the paragraphs above, wow, your next task will be solving the mysteries of the Big Bang Theory.  For everyone else, this report will guide readers to an explanation of how TIFs work in general, how tax money flows from a TIF district to pay off infrastructure bonds, how schools get the same amount of general fund and special education fund money that the TIF property would have paid and where that money comes from, since it won’t come from the tax increment district’s tax payments. 

Finally, learn how the money that goes to the schools is raised from the local tax base of the school district or is raised as part of the state-aid formula from taxpayers across the state.  Whew.

First, some background on how tax increment districts work in general.  Note: For those familiar with TIF financing and ready for the advanced material on SB 58, go directly to “affordable housing” below in Section 2.

Section One - What is a Tax Increment Finance District (TIF)? 

The small town of Two Dot has an opportunity for a new manufacturer to come to town that will create a bunch of new jobs – high paying jobs with full benefits and snazzy uniforms.  This is good news; the kind of good news that comes with a bunch of questions.

To begin – the empty field where the new factory is going to be built doesn’t have any streets, water lines, water/sewer lines or street lights.  How do those things get built when Two Dot’s city budget has trouble paying a part-time police officer and buying three goats that “mow” the city park?  Answer – use tax increment financing.

How it works – The value of the section of land where the factory will be built is $500,000 before anything is built on it.  The value of the land plus the factory after it’s built will be $5,500,000.  The increased value is known as the increment.  A TIF district takes the tax revenue from the increment to pay off bonds that Two Dot sold to raise the money for the infrastructure.  This “reassignment of tax revenue” can be done for no more than 20 years.

Example using made up numbers.

Here are the property tax levies for Two Dot which is in Four Dot County

Note:  Property taxes are levied in “Mils” – each mil = $1 of taxes for each $1,000 of taxable value.

The total for the field before the factory is built

Total mils levied in Two Dot = 25/1000.  Here is the breakdown:

• 12 mils for schools (9 of which is general fund/special education levy)
•  5 mils for the county
• 5 mils for the city (well, a field would never be in the city limits, but this stuff is hard enough to explain – so this field in the city)
• 1 mil for township (there are more than 900 townships in South Dakota)
• 1 mil for the mosquito control district
• 1 mil for bond payments that built the waterpark.

So the empty field was paying taxes of $12,500 – (25 mils x 500) - each mil is applied to $1,000   of value.  Applying each mil levy above to the taxable value “per thousand dollars” gives revenue as follows:

• $6,000 for schools ($4,000 of which is for general fund/special education
• $2,500 for county taxes
• $2,500 for city taxes
• $500 for township
• $500 for mosquito control district
• $500 for waterpark bond

The Increment - After the manufacturing plant is humming away, the value of the property has skyrocketed to $5,500,000.  The taxes paid by this property will now be $137,500 – which (according to Chamber of Commerce math) is way more than the $12,500 that the property paid before the factory was built. 

The old amount of taxes ($12,500) is now called the “base” and those taxes continue to go to the school, city and county, et al, as they did before the factory was built.

The “increment” amount of taxes - $125,000 will not go the city, county, schools, township, mosquito district and waterpark bonds.  Note – The Chamber will point out that these funds are not being “taken” from those governing bodies because it is money that they never received.  Plus other tax control methods limit cities and counties to budget increases by dollar amount.

Now for the tricky part – The school general fund/special education fund WILL get the amount of money that the incremental increase in taxable value would pay.  In this example, the new manufacturer will pay $125,000 in new taxes, of which $45,000 would go the school general/special education fund.

Key question – where does the $45,000 come from if the taxes from the factory are being used to pay off bonds (loans) used to build streets, water/sewer lines and other infrastructure?

Answer – since this project is an “industrial” project as defined in the school funding law, the revenue comes from the calculations that are used to set the general fund levy for all school districts general and special education funds.  In blunt terms, it comes from a microscopic increase in the general fund and special education fund levy.  These levies are set by the state as part of the state-aid formula. That process can be explained but takes about as many pages as War and Peace.

How much of an increase?  For this project, the state is spreading $45,000 among a statewide taxable value in commercial property values of approximately $18,000,000,000 ($18 billion).  That is a mil levy of 0.0024, which is less than one cent per thousand of taxable value.

If you own a house with a taxable value of $500,000 – congratulations!  Your tax increase to pay for Two Dot’s school’s general/special education fund is roughly $1.20 on a total tax bill in Two Dot of $12,500 or, expressed as a percent of the tax bill, 0.001%.    

Wasn’t this supposed to be about affordable housing?  What happened to that?

Section Two – SB 58 – Affordable Housing as an Economic Development TIF

As exciting as the new manufacturer is for the citizens of Two Dot, there is a problem.  Where in the heck are all the new workers supposed to live?  Two Dot needs houses, like a housing development.  In many communities the developers will build houses but the expenses for infrastructure will drive the price of the houses above what entry level workers in the new factory can afford.  This leads to the next question. 

How the heck do you get the streets or street lights, storm sewers and water mains to the location of the new housing development?  How does a budget strapped community take advantage of the opportunity to create jobs if they can’t put in the public services to the homes that will be needed by the people that will work in those new jobs?

The answer has been tax increment financing which, as seen above, uses the new taxes from the new building to pay off loans (or bonds) that can be used to put in the infrastructure so the new enterprise can be built.  In this new scenario, the increased value from the homes that are built.    

It is an idea that works.  So what does SB 58 do that is different from current law?

It changes the source of the money that goes to the school general/special education funds, even though the increased tax revenue is paying off the bonds that put in the infrastructure.  Current law allows TIFs to be used for housing development, but the money for school general/special education fund must come from the taxpayers in the school district and cannot be put into the state-aid levy.

SB 58 will allow housing developments that are created to meet the demand for affordable housing to be part of the school funding, state-aid formula just like industrial projects (Two Dot’s new factory) and economic development projects.  There is a condition for the spreading of the school revenue as part of the state-aid formula – the houses have to be originally sold at or below the price level for the first time homebuyer program of the South Dakota Housing Authority ($270,000).  There is also a provision that sets limits for monthly rents for apartments.

New example – a housing development of 30 new homes.

Let’s examine a development that seeks to create 30 new affordable houses and see the impact of SB 58 in real terms.  A note:  This is a very basic example that is imperfect – it is offered to keep the issue of replacing school general/special education funds in context. 

To begin - The Project – 30 homes (6 homes to the acre) on total land of 5 acres.  Price for each home is the first time home buyer limit of $270,000.  Total value of the development equals $8,100,000.  To be accurate and to keep this issue from being simple, the taxable value of the development is $6,885,000 (85% of full and true value).  For the rest of this example, the taxable value will be rounded up to $7,000,000.

Current taxes – using the same levies as the manufacturing facility (reduced by 4 mils because the general fund levy is lower on homes than businesses), the homes in this development would pay a combined total of $147,000 ($4,900/home) with the following breakdown:

• $56,000 for schools ($36,000 for general/special education fund)
• $35,000 for the city
• $35,000 for the county
• $7,000 for the township
• $7,000 for the mosquito district
• $7,000 for the waterpark bonds

The question at hand – since the school district will still get the $36,000 for the general/special education fund even though the taxes from the houses will be reassigned to pay for the bonds that installed the infrastructure, where the heck is that money coming from?

Current law gets those funds from an increase in the tax levy for taxpayers in the school district.  How big a hit is that?  For this scenario, assume that the school district is the same as the county of Four Dot and the taxable value is the same as Brown County at $4,000,000,000 ($4 billion).

To get $36,000 from the $4 billion taxable value takes an increased mil levy of 0.009 mils ($0.009/$1,000 taxable value).  If you own a $500,000 home (again, well done) your tax increase would be $4.50 on a tax bill of $10,500.  More to the point, the tax increase for the owners of the new home would be $2.43 on a tax bill of $5,670.

 

Finally – What does SB 58 do???

 

SB 58 says that affordable housing developments can use tax increment financing for installing infrastructure and those TIFs will be treated just like “industrial” projects and “economic development” projects when it comes to the school financing law and the state aid formula.  The money that goes to the local school district, even though the taxes paid by the houses in the project are being reassigned to pay off bonds (loans) for the infrastructure.

This means that the money being put into the state-aid formula will microscopically increase the school general fund and special education fund levies.  For the example above, the housing development in Two Dot, the increased mil levy when spread statewide would be spread among the statewide total taxable value for owner occupied housing which is $30 billion.

To get $36,000 from a tax base of $30 billion requires an increased mil levy of .12 of a penny or expressed as a mil levy $0.0012/$1000 taxable value.  Using the $500,000 home that would be an additional tax of 60-cents.

The Combined Effect.  Of course, if the analysis is only done for one community, the impact on taxes will be tiny.  But the state aid formula will be raising money for more than 100 TIF districts throughout the state.  How much of an increase results from the combined total?

The Department of Revenue estimates that there is a total of $1 billion dollars of taxable value that is included in the TIFs in South Dakota.  Since that total is entirely made up of commercial property, the total revenue for school general funds would be $7,000,000 (slightly more if the special education levy is included).  The actual general fund levy for commercial property is $6.978/$1000 of value (rounded up to $7).  Commercial property generated $376,062,906 for schools.  The $7 million that are spread to all commercial property is about 1% of the total.

Not Perfect

Several of the economic development professionals across the state have pointed out that some provisions of SB 58 may limit its effectiveness and their ability to use the new law in their communities.

Chief among the concerns is the fact that the first time home buyer price point isn’t allowed to increase and, in fact, has not increased for more than a decade.  Should the real estate market shift in a community before a development deemed to be for “affordable housing” could be completed, the stagnate price point could end up selling homes below cost – a real problem.

Under the provisions of SB 58 as written, all of the houses in a development that recovers school funding from the state-aid formula, will have to be sold at the first time home buyer price point.  The developers point out that a more stable approach might be to offer 70% of the homes at the first time home buyers price and allow the others to be sold at a higher price. 

SB 58 also controls the amount apartments can charge for rents, again using guidelines that some consider unneeded.

Conclusion

Acknowledging the validity of the concerns expressed by a few of the economic development specialists, the South Dakota Chamber of Commerce and Industry believes the Daugaard Administration has taken a significant step of recognizing that affordable housing is part of economic development of South Dakota and supports passage of SB 58.  Along with that support, the Chamber will seek to address the concerns expressed above in future legislative sessions.

Thank you for your support of the South Dakota Chamber of Commerce and Industry.