Fiscal Impact Analysis - Evaluating benefits of economic development

(from Maine Townsman, June 1995)
by Mark Eyerman, President of Planning Decisions, Inc.

In the mid 1980's, meeting rooms in Municipalities across southern and coastal Maine echoed with calls for growth controls and restrictions on new development. And while the boom washed over these areas of the state, towns and cities in northern and eastern Maine waited hopefully for the economic boom to come to their community.

By the early 1990's, the boom had withered and Maine's economy had sunk into a recession. The calls for growth control turned to calls for economic development as communities struggled to pay for the growth of the 1980's. In community after community, economic development became the battle cry. The land use regulations developed during the boom became the target of streamlining. Economic development committees and development corporations sprouted like dandelions across the landscape. Town planners became economic developers.

This renewed interest in economic development was driven primarily by a common belief that commercial and industrial development is a profit generator for towns and cities. Conventional wisdom says that these kinds of uses pay more in property taxes than the costs they generate for public services, resulting in a surplus or "profit." This "profit" can then be used to hold down property taxes for the residential taxpayers of the community.

But like the Yankees we are, some folks were skeptical of this common wisdom. They asked the tough question, "Does this economic development really generate a revenue surplus for a community?" This same question was being asked in other areas of the country as well. This article looks at how Maine communities can answer that question for themselves.

THE NATIONAL EXPERIENCE

This question is not a new one. For the past 25-30 years, the issue of economic benefit from development activities has been raised in many different forums. Fiscal Impact Analysis emerged as an organized discipline in the 1960's and 70's primarily in association with a focus on so-called "cost-benefit analysis" as a way of addressing this question. Environmental impact statements, program budgeting, and other analysis techniques called for an analysis of the likely benefits of a proposed activity together with an analysis of the proposed costs to determine if there was a net positive impact from the proposed activity or project. Fiscal impact analysis developed as a way of looking at the financial benefits (revenues) and costs (service expenditures) of proposed projects.

Traditional fiscal impact analysis, as developed primarily by Robert Burchell and David Listokin of Rutgers University, quantifies the direct revenues derived from a proposed development or planning scenario and the direct costs associated with providing public services to that development or community. The direct revenues and costs are then compared to determine the fiscal impact on the community. In writing about this approach to fiscal impact analysis (The Fiscal Impact of Commercial Development, Land Development, Spring-Summer 1993), Wim Wiewel from the Center for Urban Economic Development at the University of Illinois at Chicago observed:

"Traditional fiscal impact analysis, developed primarily by Robert Burchell and David Listokin of Rutgers University and practiced by many others, has come to some fairly well-established conclusions. While the exact magnitudes of fiscal impact vary from case to case, certain types of development consistently generate more revenues than costs. In rough sequence, office buildings, industrial uses, warehouses, retail operations, and high-density apartment buildings with small units generate net revenues, while lower-density apartments, townhouses, and single-family homes impose net costs. Obviously, the demand for schools and other residential services is relatively more expensive than the traffic and protective services required for nonresidential development."

Over the past decade, there has been a growing recognition of and professional discussion about the limitation of "traditional" fiscal impact analysis. These fall into two broad categories, methodological concerns about what is or isn't included in the analysis and how costs are determined and systemic concerns about how to account for secondary and long-term impacts.

As a result of these concerns, and a perception that "traditional" fiscal impact analysis may not accurately reflect the fiscal implications of non-residential development, a number of attempts have been made over the past few years to look at fiscal impact analysis from a broader perspective. These studies have tried to answer the question: "Do communities with a larger amount of commercial and industrial development have lower taxes as would be expected from traditional fiscal impact theory?"

In 1991, DuPage County, Illinois undertook such a study and concluded that areas in the county with higher levels of nonresidential development had higher levels of public expenditures. It is important to note that this study did not look at tax rates, only at gross expenditure levels. This study was widely viewed as supporting a position that nonresidential development has a net negative fiscal impact.

Other studies on this issue have been conducted since the DuPage study. A study of Virginia communities conducted by the Urban Land Institute found that the level of local government spending correlated positively with the relative ease with which the community could generate property tax revenue. In communities in which larger percentages of the local tax base are in nonresidential property, the ease of generating revenue is greater and the level of spending is higher. Closer to home, this correlation probably exists in communities with large, nonresidential tax bases such as Yarmouth, Wiscasset, or Bath. As with the DuPage study, this analysis did not look directly at tax rate implications.

The Metropolitan Planning Council of Chicago recently conducted a study of 115 municipalities in northeastern Illinois with populations greater than 10,000 to understand the relationship between commercial-industrial growth and property tax rates. From a March, 1995 article, "Does Business Development Raise Taxes?: A Commentary," by Deborah Stone in the American Planning Association's Public Investment magazine, the following conclusions were reached regarding the results of the study's regression analysis:

Business development (as measured by increases in assessed value) tended to be associated with lower real effective residential tax rates that would otherwise have occurred. It is generally rational for local officials to seek economic development.

Population growth, on the other hand, was generally associated with increased residential tax burden measured as a percent of residential personal income. This finding supports the common wisdom that population growth often increases the tax burden by increasing the demand for services, such as schools.

Population growth was associated with employment growth in the home and nearby communities. In this study, a community's population growth was nearly 4 times more strongly associated with employment growth in nearby communities than with its own employment growth. Therefore, economic development in one community may mean population growth and higher tax rates for nearby communities that do not experience the residential property tax benefit of the business development.

High tax rates seemed to deter development (holding other factors constant).

IMPLICATIONS FOR MAINE COMMUNITIES

So what does this all mean for the Maine communities? Obviously, the most important message is that there isn't a simple answer that is applicable in all situations. Rather, there appears to be a set of relationships that influence the fiscal impact of commercial and industrial development on the community. These include:

The secondary impacts of nonresidential development are probably key to the long term fiscal impact of that activity but are not easily accounted for in "traditional" methods of analysis.

The scale of the activity with respect to the existing community may influence the net fiscal impact. Larger projects are more likely to have significant cost implications.

Projects that contribute to a change in the character of the community to a more urbanized form are more likely to have negative impacts.

Projects that change the type of public services a community must provide or the fundamental way in which services are delivered are more likely to have negative fiscal impacts.

The capacity of the community's infrastructure (roads, sewers, water system, schools) to accommodate the growth without investment in new/expanded capital facilities appears to be a major factor in the fiscal impact of nonresidential development. This is particularly true in the early years of a project.

Projects that increase the income levels of the residents of the community are more likely to create increased demand for more and/or higher quality public services.

The cost of servicing nonresidential development tends to increase with the employment density of the development.

Development that attracts new residents to the labor market area or community is more likely to have a reduced or negative fiscal impact because of the need to provide services to the new residents.

Communities that have a lower effective tax rate, but offer services comparable to surrounding communities, are likely to attract higher levels of growth.

The type of development (relocations to the region vs. intra-regional relocations vs. growth of existing business) impacts the level of in-migration and service demands and therefore the fiscal impact of those activities.

ASSESSING THE FISCAL IMPLICATIONS FOR YOUR COMMUNITY

As suggested above, the fiscal impact of economic development varies depending on the nature of the development, the capacity of the community to absorb the growth, and the secondary impact resulting from the commercial and industrial activity. Planning Decisions has developed a methodology for assessing the fiscal impact of economic development on Maine communities to help them understand if economic development (and what types of development) is economically beneficial for their city or town.

The analysis consists of four steps:

Step 1. Determine the Potential Net Income Resulting from Commercial/Industrial Development

This step involves estimating the potential revenues generated from property and excise taxes paid by the new development. These revenues are then discounted by estimated changes in state aid to education and county tax resulting from the increased tax valuation. This results in the net increase in revenues to the municipality.

Step 2. Determine the Potential Increase in Service Costs Resulting from Commercial/lndustrial Development

This step involves assessing the demands on municipal services created by commercial/industrial development and the costs of providing these additional services. This analysis should be done department by department with a focus on any special demands created by new development and the capability to provide those services.

Step 3. Determine the Direct Fiscal Impacts of Economic Development

By comparing the net revenue estimate developed in Step 1 with the service cost estimate generated in Step 2, the direct fiscal impacts of proposed economic development can be assessed.

Step 4. Evaluate the Indirect or Secondary Revenue and Service Implications of Economic Development

Once the direct impacts are understood and quantified, the key step is evaluating the likely impact of the economic development on residential growth. This involves understanding the regional labor, job, and housing markets; commuter patterns; the type and level of employment likely to result from the development; and the costs of servicing residential development. This step is somewhat less "scientific" than the first 3 steps but most communities can develop a reasonable assessment of the potential secondary impacts.

With this information, a community is then in a reasonable position to know if economic development pays in their community and what types of development have the most potential fiscal benefit for the community.

Planning Decisions, Inc. is a research and planning firm with offices in South Portland and Hallowell. The firm provides public and private sector clients with services in the areas of community planning, public policy research, fiscal impact analysis, market feasibility analysis, and economic research.