A University of Iowa study on the effect of tax increment financing (TIF) on educational expenditures in the state of Iowa may have policy implications for local governments, especially those with low-income school districts.

Phuong Nguyen-Hoang, assistant professor in the School of Urban and Regional Planning at the University of Iowa, finds that greater TIF use is generally associated with reduced educational spending by local taxpayers.  He adds that a decline in education spending created by TIF is less noticeable for higher-income school districts compared to lower-income districts. 

His findings were published in Education Finance and Policy (2014, 9(4): 515-540).

“The decline, though small, in expenditures of school districts in the lowest-income group would have been larger if they had not increased their property tax rates and if state aid had not partially offset their potential tax-base losses from TIF,” says Nguyen-Hoang, faculty in the UI’s Public Policy Center. “The study findings imply that local governments associated with school districts at the lowest end of the income/wealth spectrum should exercise prudence before adopting TIF for economic development purposes.”

He suggests that school districts should be allowed to opt in, or opt out, of TIF plans initiated by cities. In addition, he calls for the “but for” test to be used as a condition for TIF approval. In other words, the proposed development would not happen unless financial support is available from TIF.

How TIF works

TIF is an economic development tool in which local governments reinvest added tax revenue from public improvement projects back into the area where it originated. The goal is to stimulate new private investment and thereby increase real estate values.

When a TIF district is established, the assessor evaluates the value of that district in the first year and uses that figure as the tax base for the life of the district. Any incremental increases in assessed values during the life of TIF district will be diverted from overlapping taxing jurisdictions to a TIF fund. Overlapping taxing jurisdictions include school districts and counties.

TIF in Iowa

In 2011, Iowa had more than 2,200 TIF districts. Nearly 86 percent (or 297) of the state’s school districts contained one or more TIF districts for at least one year during the study’s sample period from 2001 to 2011.

Two reports (Fisher 2011; Fisher and Lipsman 2012) detail how TIF in Johnson and Polk counties has been abused, resulting in negative consequences for overlapping jurisdictions, including school districts.

For instance, the merged Iowa River Landing/Coral Ridge Mall Urban Renewal Area in Johnson County diverted $4.99 million in property taxes from the Clear Creek Amana and Iowa City Community school districts, causing them to increase property tax rates by $2.83 and $0.56 per $1,000 of taxable value, respectively.

Iowa school districts are financed primarily by property taxes and state aid.

Under state law, school districts are required to spend a certain amount per pupil ($6,001 in FY2013). A state aid formula makes up the difference between what the district can raise in property tax revenue and 87.5 percent of the allowed per pupil spending. The school district is on its own for the remaining 12.5 percent. Nguyen-Hoang says Iowa is among four states (including Kentucky, Ohio, and Pennsylvania) that authorize school districts to levy local income taxes to help finance specific education programs.

TIF’s impact on education

During a TIF project, a school district may benefit financially when the project produces positive spillover effects on property in neighboring districts. These unexpected repercussions enlarge the property tax base available for the district and lower what voters pay in property taxes, thus enhancing their demand to finance education expenditures.

Opponents contend that negative spillover effects and frozen tax bases that would have trended upward in value even without TIF lead to higher tax prices for educational services, which in turn lower voters’ demand for education spending.

Nguyen-Hoang measures TIF use by assessed property value above the frozen tax base (or, the incremental value). He found evidence that greater use of TIF was generally associated with a small decline in per pupil education spending for Iowa communities. Specifically, a one-standard deviation increase in the mean incremental value per pupil from $10,750 to $28,000 is associated with a reduction of 0.29 percent in school district operating expenditures.

The effect could have been larger if the state had not partially financed TIF by using only school districts’ non-TIF tax bases to determine state education aid. In other words, TIF shifts costs to state taxpayers through state aid to local schools.

Nguyen-Hoang’s research offers little evidence to support the commonly held proposition that school districts benefit from TIF when TIF districts come to an end. This finding may reflect voters’ fear of the “ratchet” effect, meaning once school spending is increased, it keeps going up.  

TIF’s negative impact on education spending is more noticeable for school districts in lower wealth or income groups compared to higher wealth or income groups. This price effect for the lowest income districts is approximately twice as large as for the average effect reported earlier.

Nguyen-Hoang says that TIF’s negative, though small, effect on education spending, coupled with no gain from the often-claimed long-run benefits of TIF, justifies establishing policy measures to protect school districts from TIF.

Article written by John Riehl, Writer/Editor, University of Iowa Graduate College