This is a long post. The conclusion I eventually reach (somewhat reluctantly, truth be told) is that it is not financially prudent for the School District to support the proposed amendment of TID #32 to include the Edgewater project.
Because the School District is one of the taxing authorities in Madison, it is represented on the Joint Review Board (JRB), which must approve the creation of or amendment to Tax Incremental Districts (TIDs). Lucy Mathiak is our representative on JRB.
The Madison Common Council has approved amending existing TID #32, which was created in 2003 and includes the upper State Street area, to add the Edgewater hotel project to the TID as a way of providing assistance in the funding of the project. The proposed amendment now will go before the JRB. At our School Board meeting on Monday (September 27), the Board will provide formal direction to Lucy as to how to vote on the proposed amendment of TIF #32 at the JRB.
The Superintendent has recommended that the Board direct Lucy to vote no on the Edgewater amendment. This recommendation is based in part on an analysis prepared by Erik Kass, our Assistant Superintendent for Business Services, and Brian Brewer, our financial advisor from Robert W. Baird, who prepared tables showing how long it will be before the projected increased property tax revenues to be generated as a result of the Edgewater project will be sufficient to offset the property tax revenues foregone as a result of amending the TID to include the project and so delaying the time when the TID could be closed. Those materials can be found here.
I have found this break-even analysis informative and useful. But, standing alone, it doesn’t provide a clear answer as to whether or not amending the TID to include the Edgewater project would be a prudent investment. I have undertaken my own analysis to try to answer that question for my own benefit. In trying to structure my analysis, I have received helpful assistance from Erik Kass, Brian Brewer, and City Comptroller Dean Brasser, who all took the time on Friday to talk to me and answer my questions.
Regardless of what my personal views might be, I have no interest in attempting to second-guess the decision of the Common Council to approve the Edgewater project. I take it as a given that the City has decided that the project is worth pursuing. I’m also not interested in second-guessing the financial data that the City has developed and provided to us that bears upon the project. I accept the City’s projections as reasonable for these purposes.
As a general rule, I prefer to be supportive of City projects. I think TIF can be a valuable tool for economic development. For purposes of voting on how to direct our representative to the JRB to vote, I think that I’d nearly always support the establishment of a new TID district, if the proposal had passed the various tests applicable to the establishment of such a district. That would mean that the tax increment would not have been generated in the absence of the TID, and so the School District is not losing anything by supporting the application of that increment toward the cost of the project pursuant to the terms of the agreement.
Things are different when the proposal is that an existing TID be amended or extended. In this case, it can sometimes seem that the City can look at the accumulated increment in the TID as a piggybank that it is free to draw upon. I view it more as an accumulated amount of deferred property tax revenues that the City holds in trust for the School District and other taxing agencies and it shouldn’t be drawn upon unless it is to be used for an additional investment in the TID that makes financial sense on its own terms.
That brings us to Edgewater. In brief, my position is that I respect the decisions the City makes with respect to the use of a TID, but just don’t ask the School District to subsidize a project. To my mind, the School District would be subsidizing a project if, using appropriate valuation techniques, we conclude that the value of potential property tax revenue foregone as a result of investment in a project exceeds the value of potential additional property tax revenue the project is expected to generate.
In other words, for a project like Edgewater, there is a City investment. This investment can be measured in terms of property tax revenues foregone. Using an appropriate discount rate, we can place a present value on that stream of foregone property tax revenues. Let’s call that present value X.
A project like Edgewater will result in increased property values and so in increased future property tax revenues. We can also place a present value on the projected future stream of increased property tax revenues the project generates. Let’s call that present value Y.
If Y > X, then the project makes financial sense and, generally, there is no reason for the School District to complain about it. However, if X > Y, then the deal is a financial loser, and the School District would in effect be called upon to subsidize the shortfall in revenues.
So, for Edgewater, is X > Y, or Y > X? Fortunately, City Comptroller Dean Brasser and his staff have provided helpful data that allow us to address that question.
The City says that without the Edgewater amendment, TID #32 is projected to close in 2017. With the closure, the increment in value in the properties included within the TID would be restored to the property tax rolls. This addition would result in a broader base of property value from which to collect property taxes, and so would result in a property tax decrease for all other property owners, all else equal. The City calculates that, in the absence of the Edgewater amendment, the closure of TID # 32 in 2017 would result in a property tax savings on the average Madison home of about $35, beginning in 2018.
The proposed amendment to TID #32 to bring in the Edgewater project is likely to delay the closure of the TID by four years. However, with the expanded scope of the TID, there would be more incremental property value restored to the property tax rolls at the time of closure in 2021. The City calculates that, with the Edgewater amendment, the closure of TID #32 in 2021 would result in a property tax savings on the average Madison home of about $46, beginning in 2022.
So, for purposes of analyzing the Edgewater project, we can view the cost of the project to the average homeowner as four years of $35 annual property tax savings. These savings, from 2018 through 2021, would be foregone as a consequence of amending TID #32 to include Edgewater because the amendment will delay closure of the TID from 2017 until 2021. This value represents X.
The payoff for the average taxpayer is that, beginning in 2022 and continuing indefinitely, the average annual property tax savings attributable to the TID would be $46 rather than $35. The property tax revenue benefit attributable to the Edgewater project would amount to an $11 ($46 – $35) annual annuity that commences payment in five years. This value represents Y.
Next, we have to calculate the present value of X and Y and compare the two. Again, in present value terms, if Y is greater than X, it’s a good investment. If X is greater than Y, it’s a poor investment.
A key step in calculating present value is determining an appropriate discount rate. The discount rate is meant to reflect the fact that $1 received today is worth more than $1 received in ten years. An appropriate discount rate take into account both the time-value of money, as well as the degree of risk associated with the future payment. If a transaction is completely risk-free, then the conventional approach is to utilize a discount rate based upon 10-year or 30-year T-bills, which are viewed as the safest investment possible. This would result in a discount rate between 2% (a bit less than the current interest rate on 10-year T-bills) and 4% (a little bit more than the current interest rate on 30-year T-bills).
If a potential investment is not risk-free, then the use of a higher discount rate is appropriate. There is no single “correct” answer to the question of what discount rate is appropriate for a specific set of circumstances.
There is certainly risk associated with the Edgewater project. In order for property taxpayers to receive the $11 benefit promised in 2022 and future years, the project would have to unfold as anticipated (or hoped) and would have to result in enhanced Edgewater and associated properties whose increased economic value would be reflected in sufficiently high assessments to support the projected $11 incremental annual decrease in property taxes paid by the typical Madison homeowner.
So, what’s the appropriate discount rate to reflect this risk? I don’t know. I suspect that it could be anywhere from about 5% on the very low end to about 12% on the higher end. The best approach seems to be to calculate the values of X and Y using a range of discount rates and then make some sort of judgment based on the results.
I’ll calculate the two values using the following discount rates: 2%, 5%, 7%, and 10%. The first calculation places a range of present values on the receipt of $35 annually for four years. This is X and represents the value to the typical homeowner of the projected property tax benefit foregone by the delay in the closing of TID #32 as a result of the addition of the Edgewater project.
The second calculation measures a range of present values for the receipt of an $11 annual annuity beginning in five years, which reflects the decrease in property tax liability and hence benefit the typical homeowner is projected to receive as a result of the addition of the Edgewater and associated properties back to the tax rolls when the amended TID #32 closes. This is Y.
There are two wrinkles to this second calculation. For how many years is it appropriate to take into account the annual $11 benefit? I am told that the convention in TIF analysis is to use a 20-year timeframe. So, we should place values on the benefit of receiving $11 a year beginning in five years and ending in 20 years. The second wrinkle is how do we do that? I think it makes sense to calculate the value of receiving annual payments of $11 for twenty years, and separately calculate the value of receiving annual payments of $11 for four years. The difference between these two results should represent the value of receiving $11 annual payments beginning in five years and ending in 20 years.
Without further ado, here are the results:
|Discount Rate||Present Value- No-Edgewater Option||Present Value- Edgewater Option||Payoff for Edgewater Option|
What conclusions can we draw? The Edgewater option only makes financial sense if one believes the appropriate discount rate to use is less than 3%. Since I think the appropriate discount rate is certainly greater than 5%, and more likely at least in the 7% to 12% range, it looks to me like the proposed Edgewater project does not make financial sense, based on my analysis of the figures that the City has provided. In light of this, it doesn’t seem as if it would be prudent for me to recommend that the School Board’s representative to the Joint Review Board vote in favor of amending TID #32 to include the Edgewater project.
What do you think? Does this analysis make sense? Am I missing something?