The use of pilot financing to develop Manhattan's Far West Side.

• Author: Cerciello, Amy F.
• Position: New York

INTRODUCTION

On January 19, 2005, the Bloomberg Administration revealed the details of a plan to transform Manhattan's Far West Side. (1) The plan authorizes the extension of the Number Seven subway line and the construction of new office space, housing, streets, and parks. (2) The Bloomberg Administration intends to finance these public improvements outside of New York City's capital budget. A newly created local development corporation called the Hudson Yards Infrastructure Corporation will issue bonds backed by revenues that the new development is expected to generate. (3) The largest anticipated revenue source for bond repayment is commercial payments in lieu of taxes ("PILOTs") made by private developers who build within the development zone. (4)

PILOT-backed bonds are a unique and little used mode of financing. New York City has never issued PILOT-backed bonds before, (5) and they are a rare structure in the municipal debt markets. (6) Yet, PILOT financing has a close analog: tax increment financing ("TIF"). TIF is a popular local redevelopment financing mechanism. (7) Since its inception in California in 1952, all fifty states have implemented legislation authorizing the use of TIF. (8) This Comment discusses TIF and its legal and financial drawbacks, and then applies the lessons learned from TIF to PILOT financing. Part I describes TIF's general structure and underlying rationale and then examines New York State's TIF statute. Part II considers the legal challenges that have been raised against TIF and predicts their likely outcome in a New York court. Part III explores the risks and policy considerations surrounding the use of TIF. It also considers whether TIF really is a self-financing redevelopment mechanism, as its proponents argue. Finally, Part IV examines the limited use of TIF in New York and proposes an explanation for its scarcity. It also outlines the similarities between TIF and PILOT financing, and explains how the legal issues, risks, and policy considerations surrounding the use of TIF apply with equal force to PILOTs. It concludes by recommending some changes to the Far West Side's PILOT financing plan, based on the lessons learned from TIF.

1. TAX INCREMENT FINANCING: THE BASICS

   This section begins by explaining the basic structure of TIF--in particular, how tax revenues get allocated during the life of a TIF project. It then describes TIF's basic assumptions and underlying rationale. Finally, it examines New York State's TIF statute.

   1. Tax Increment Financing's Structure und Rationale

      TIF allows local governments to finance redevelopment projects with the increased tax revenue generated by the redeveloped property. (9) The initial property tax base of the redevelopment zone (the "TIF district") is "frozen" on the tax roll. (10) As the redevelopment progresses, property values and property tax collections should increase. (11) The taxing authorities continue to receive tax revenue based on the frozen base value, (12) while the excess tax collections (the "tax increment") flow into a special fund that is used to make interest and principal payments on the TIF bonds. (13) The original taxing authorities do not get any of the tax increment until the TIF bonds are repaid. (14)

      Two central assumptions underlie the use of TIF. The first assumption is that property values would remain constant without the stimulation provided by TIF. (15) The second assumption is that the redevelopment causes the increase in property values and the corresponding increase in tax revenue. (16)

      Because TIF projects are financed from the incremental tax revenue generated by the redevelopment, TIF proponents argue that TIF is a self-financing mechanism. (17) In theory, the municipality does not have to pledge funds from its capital budget or increase taxes to fund the redevelopment. (18) This characteristic of TIF helps explain its increasing popularity. (19)

   2. New York State's Tax Increment Financing Statute

      TIF originated in California in 1952 as a way to provide local matching funds for federal urban renewal grants. (20) Now all fifty states have legislation authorizing the use of TIF. (21) New York authorized the use of TIF in 1984 with the passage of the Municipal Redevelopment Law ("TIF statute"). (22)

      1. The Blight and "Cannot be Accomplished by Private Enterprise Alone" Requirements

         Under New York's TIF statute, two criteria must be met before a municipality can implement a TIF project. First, TIF can only be used to redevelop "blighted areas." (23) Second, TIF can only be used when "the redevelopment of such areas cannot be accomplished by private enterprise alone." (24) Most states' TIF statutes contain similar requirements. (25)

      2. The Planning Phase

         After the local legislature identifies a blighted area, it must conduct a study to determine the feasibility of the proposed redevelopment. (26) If the legislative body concludes that the project is feasible, the next step is to prepare a preliminary plan that justifies the project. (27) The plan must describe the project and its likely impact on the surrounding neighborhoods and the environment. (28) It also must explain why redevelopment would not occur without TIF. (29)

         If the legislative body approves the preliminary plan, it then must prepare a redevelopment plan. (30) In addition to confirming the information provided in the preliminary plan, the redevelopment plan must describe the proposed method of financing. (31) If the redevelopment will be funded with TIF bonds, then the plan must indicate the amount and term of the bonds that will be issued. (32) The legislature then must submit the redevelopment plan to the planning agency for review. (33) The planning agency is expected to file its comments within thirty days of receiving the plan. (34)

      3. Public Hearing Requirement

         Before adopting the redevelopment plan, the legislative body must present the plan at a public hearing. (35) It must post notice of the hearing in a local newspaper and in at least four prominent public locations in the affected area at least three weeks prior to the hearing. (36) The notice must include a legal description of the boundaries of the project area and a summary of the plan. (37)

         Anyone who objects to the proposed plan may challenge it at the public hearing. (38) The TIF statute requires the legislative body to "hear and consider" all objections. (39) After the hearing, the legislative body may officially adopt the redevelopment plan. (40)

         The legislative body may amend the redevelopment plan at any time after it is adopted. (41) But the amendments must go through the aforementioned public notice and hearing process before the legislature can adopt them. (42)

      4. Implementation

         After the legislature adopts the redevelopment plan, the municipality has the authority to acquire property, relocate displaced individuals, demolish or move buildings, and prepare the site for redevelopment. (43) The statute permits the municipality to assign these administrative powers to a local government agency. (44)

      5. Tax Increment Bonds

         To carry out the redevelopment plan, the TIF statute authorizes the municipality to issue bonds payable from and secured by real property taxes ("TIF bonds"). (45) The municipality can only issue TIF bonds for certain public purposes, however, including the acquisition of land, the demolition and removal of structures, and the construction of streets, walkways, public utilities, parks, and playgrounds. (46) The statute expressly provides that TIF bonds may not be secured by the "faith and credit" of the local government (47) and that they will not count toward the issuing municipality's constitutional debt limitation. (48)

2. SUCCESSFUL LEGAL CHALLENGES TO TIF STATUTES

   Although no one has challenged New York's TIF statute thus far, a number of constitutional arguments have been raised against other states' TIF statutes. (49) Of those, three have prevailed. (50) This section examines those three arguments and predicts the likely outcome if they are ever raised in a New York court.

   1. TIF Bonds and Constitutional Debt Limits

      1. Generally

         Ali state constitutions limit the amount of public debt that municipalities can incur. (51) Courts are divided over whether TIF debt counts toward these limits.

         Courts in the following states have considered the issue and concluded that TIF debt is subject to constitutional debt limitations: Arizona, Iowa, Kentucky, Oklahoma, South Dakota, West Virginia, and Wisconsin. (52) With the exception of South Dakota, each of these states' TIF statutes expressly provides that TIF debt does not count toward constitutional debt limitations. (53) Yet, such provisions are not controlling. According to the Oklahoma Supreme Court, "[s]tatutory declarations alone will not alter the nature of indebtedness when circumstances make it clear that an obligation has been incurred." (54) Courts in the aforementioned states reasoned that, because TIF bonds are repaid from property tax revenue, they implicate the credit of the underlying municipality. For example, in Richards v. Muscatine, (55) the Iowa Supreme Court held that "ultimately the 'credit' of a city is its power to levy general taxes. When it pledges all or part of that power, it pledges its credit and in a realistic sense incurs an obligation." (56) Similarly, the Supreme Court of Wisconsin determined that TIF bonds count against constitutional debt limits because "they are payable solely from general property tax revenue." (57) The court noted that it did not matter that the tax increment might not have existed without the use of TIF. (58)

         Courts in the following states have taken the opposite view, instead finding that TIF debt is not subject to constitutional debt limitations: Colorado, Florida, Indiana, Missouri, South Carolina, and Utah. (59) In making this determination, these courts relied on the special fund doctrine. (60) Under the special fund doctrine, when bonds...