Redevelopment Financing Gets an Overhaul in California

The governor eliminated the state’s redevelopment agencies -- and the way it funds urban revitalization. Now the Golden State must find new money sources.
by | March 2011

The current battle over redevelopment in California highlights an important question for economic developers throughout the nation: Can tax-increment financing (TIF) survive the current downturn in the economy, or has TIF become a luxury that general funds can no longer afford?

The idea behind tax-increment financing is simple: In an urban area that needs investment, any increase in property tax revenues in that district -- the property tax increment -- should be plowed back into the district to fund infrastructure or to subsidize private development. In theory, this is good for everyone, because property tax revenues wouldn’t go up without the tax-increment investment. But in practice, property tax revenues go up for a whole variety of reasons, including simple inflation in the real estate market, which means schools, counties and other agencies that receive a share of property tax revenues perceive themselves as losers.

Many states severely restrict access to TIF, letting local governments use it only for specific purposes. But in California -- where TIF was invented 60 years ago as part of the state’s urban renewal effort -- there are few state restrictions, and TIF is the single most important financing tool available to the state’s 480 cities. Access to TIF requires a finding of blight, and cities that have recently formed TIF districts must share their property tax increment with schools and counties.

Nevertheless, TIF has been one of the few ways cities in California can unilaterally gain more control over the property tax flow. (Under Proposition 13, local governments don’t set their own rate; the state sets the rate and allocates the revenue.) TIF is so widely used in California that in recent years, the tax-increment flow to redevelopment agencies has been around $6 billion -- some 12 percent of the entire property tax revenue in the state. Because of complicated school equalization requirements in California, the state must backfill every dollar that school districts lose to TIF. Since schools get 50 percent of the property tax, that means the state is subsidizing redevelopment to the tune of $3 billion a year. When you’re staring at a $25 billion budget deficit, that’s real money. That’s why California Gov. Jerry Brown -- a former big city mayor who used TIF effectively in Oakland -- eliminated it. Even without the budget deficit, there’s a reasonable point to be made here: Should California really be spending $3 billion in state general fund revenue per year on urban revitalization and economic development?

The legal wrangling that followed is complicated and not worth going into detail here. Suffice it to say that just before the New Year, the California Supreme Court upheld the complete elimination of redevelopment agencies and TIF along with it. Cities and redevelopment agencies wanted to negotiate a compromise, but Brown held firm and the redevelopment agencies went out of business on Feb. 1.

The silver lining is that the end of redevelopment has opened up a fresh discussion in California about how to finance urban revitalization and economic development. One idea put forth by Darrell Steinberg, the leader of the state Senate, is to give the tax increment to the schools and counties but allow the cities to keep the real estate assets accumulated by redevelopment, creating a kind of local economic development endowment. Others have proposed sharply limiting the use of TIF to specific purposes, such as brownfields, transit-oriented development and inner-city retail. Still others have suggested making it easier for local governments to issues bonds for economic development purposes.

City officials in California have been both angry and terrified about the end of TIF. It’s part of a longstanding feud with the state -- dating back more than 30 years to Proposition 13 -- as to who controls the property tax. Underneath the rancor, however, is a healthy discussion both in California and nationwide about how to finance urban revitalization. In California, the liberal TIF law meant that everything looked like a nail, because TIF was the only hammer. TIF has an important role to play, but it’s not the only tool.

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