City of Lawrence

City Commission

MEMORANDUM

DATE:               November 29, 2007

TO:                   Dave Corliss – City Manager

                        City Commissioners

FROM:               Rob Chestnut

PUBLIC INCENTIVES

The City has been presented with a number of projects requiring public investment in recent months.  It is clear that the City Commission has a significant challenge in evaluating these projects due to a lack of process for the diverse types of investments now under consideration.

This memo attempts to identify the different types of projects, and to provide direction to staff in development of a process that should be required for approval.  

Cost/Benefit

Currently, the tax abatement is the only form of public incentive that requires a cost/benefit analysis.  This is dictated by state statute (K.S.A. 79-251), but the State of Kansas does not provide a formula for determining the cost/benefit ratio. 

A cost/benefit analysis should be completed for any public incentive approved by the City Commission.  However, it is important to note that the analysis should be designed for the type of incentive under consideration.  It is not possible to analyze these projects in one type of analysis.

The important decisions for the City Commission to make regarding policy are as follows:

§ Should costs be defined as abated/refunded taxes or the actual public project investment?

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§ What are the economic benefits that should be considered in the calculation?

§ What time horizon should be used to evaluate the projects?

§ What types of projects should be reviewed?  Suggestions are as follows:

o Tax abatements

o Tax increment financing (TIF)

o Transportation development districts

o Infrastructure investments for industrial development

o Other projects requiring direct public investment

Cost/benefit determination may be difficult in projects such as a TIF, because the public investment may not be determinable at project inception.  In these instances the public may be the final guarantor on the project (as was the case in Downtown 2000), but these risks may be mitigated or eliminated by agreement.  Regardless, it is still important to develop a method for evaluation in order to provide information about economic benefits and determine risks in the project.

Abated taxes versus actual public project investment

Taxes that are abated are typically created by the project itself.  A primary policy question surrounds the “but for” test related to the project.  Would the project not go forward but for the public incentive? 

If the answer is no, then it is relevant to analyze the benefits of the project versus the actual project costs that would be defined as the public investment.   If the project surrounds an existing tax paying entity, and net loss in tax revenue due to abatement should reduce the economic benefits as compared to the actual project costs.

If the answer is yes, then it is relevant to analyze the benefits of the project versus the total abated taxes over a time horizon.  The abated taxes are considered the public investment in the project versus the actual project costs.

The method uses by our current tax abatement policy regards abated taxes as the public investment.  The “but for” policy question must be answered by the governing body.  If we answer no to the question, then the analysis should look at the actual project costs versus the economic benefits to the City of the project.  It should be done on a present value basis that discounts future benefits against the public investment typically made up front in such projects.  It is important to take into consideration the borrowing costs required by the City

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to bond such investments and the project economic benefits should provide a return over-and-above the interest costs incurred by the City.

Economic Benefits

The standard economic benefit assumptions should be reviewed and approved by the City Commission. These assumptions are crucial to the outcome produced by the analysis, and knowledge of the variables is important.  Asking the right questions about the project is as important as the answer produced by the analysis. 

An example from our current modeling surrounds job creation.  In the current cost/benefit analysis the City treats job creation as a negative in some circumstances.  It is important to define clearly the estimated fiscal effect from job creation.  It may need to be variable based on the project circumstances.

Economic benefits will vary based on the type of public incentive under review.  Infrastructure investments for industrial development, tax increment financing

projects and traditional tax abatement projects will all producing different economic benefits. 

Time horizon

Time horizons may vary by type of project.  However, they should stay as consistent as possible within each classification.  Without this constant, it will be difficult to measure project quality relative to other projects.  Circumstances may dictate an extended time horizon to measure economic benefits, but it should be understood that extended time horizons will introduce more variation in projections.  It will inherently increase the risk in the project.

Specifically, it may make sense to look at a 10-year versus 15-year time horizon for evaluating potential public incentive projects.  Focus must be placed on the length of time on the performance agreement between the City and the applicant.  Understanding the benefits and these milestones is useful to define potential risks of the applicant leaving after the initial expiration of the abatement period.

Role of the Planning Commission

The Planning Commission is required to review any public incentive projects that required land use action.  A review of their responsibilities in this area should be discussed in light of their responsibilities by state statute (K.S.A. 12-741 et seq.). 

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What involvement should the Planning Commission have in reviewing cost/benefit analysis of public incentives?  This is an important question to answer to understand roles and provide adequate understanding from the applicant of requirements for the process.

Process Alternative

The only existing group that has been tasked with the review of any public incentives is the Public Incentive Review Committee (PIRC).  They have reviewed tax abatements and performance of companies after abatements have been granted.  This group should be reconstituted to review all public incentives under the following criteria:

• The committee must meet more frequently to review projects.  Currently, they meet formally only once per year to review data from abated companies. 
• The committee needs more formal direction from the City Commission on their scope and charter.  The establishment of performance criteria for abated companies was never formally approved by the City Commission.  It is incumbent upon the City Commission to establish and monitor the performance of entities receiving public incentives. 
• The committee needs to be available for review of projects on an ad hoc basis as opportunities present themselves for the community.  If this is not practical, the review will fall to the City Commission.

Need for balance

The challenge in working with private sector projects is the need for public process in a competitive marketplace.  That is why defined process is essential.  This will assist the applicant in knowing about expectations and planning accordingly.  The public review is enhanced by this understanding as well. 

Understanding and redefining public incentive policy will need to be an ongoing exercise as new City Commission members are elected.  The ability to respond to changing market conditions is important to establishment of a dynamic economic development philosophy that is essential for Lawrence in the coming years.

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Next Steps

A regular agenda item should be scheduled for discussion of the details in this memorandum.  The City Commission needs to define the following issues:

• Review of state statues to understand the parameters.
• Requirements for tax abatements.
• Requirements for the Planning Commission.
• What scope should we apply outside of state requirements?
• What types of projects fall under the process?
• What should be the process (PIRC or other)?
• Definition of the general guidelines defining costs to be measured.
• Staff needs to present the current method of evaluation for abatements.
• General guidelines on economic benefits to be measured.
• Staff needs to present the current method of evaluation for abatements.

This review may take several sessions, and it will require staff time for preparation and research.  It would be beneficial look at models done in other communities if available. 

The City Commission must move forward with existing projects as this process is being defined.  As we approach a consensus about new process, it will be important to define implementation in fairness to applicants with existing proposals.

I want to thank Commissioner Highberger for his contributions to the document.  He provided the legal citations, valuable insight into our current cost/benefit modeling and feedback on the framework of the presentation.