Monday, April 6, 2009

Making growth pay for itself

Dan Telvock of the Free-Lance Star writes in his blog about an op-ed written by Clark Lemings, a land-use attorney and founding member of the Stafford Council for Progress. Mr. Lemings has an idea that residences above a certain value do pay for themselves without need for subsidies from local government.

It is a common refrain that growth should pay for itself. But what does that mean? What is the cost of growth? How is it paid for now (if it is in fact completely paid for ever)? Who pays for it?

The existing county residents don't want to pay additional taxes to cover new (or expanded) roads, utilities, schools, libraries, etc., that are necessary to support new residents. New residents (and the developers who seem to do the building for most of them) don't want to pay high impact fees just to gain access to those same roads, utilities, schools, libraries, etc. How should local government untie this Gordian knot?

It occurred very quickly to me after reading this that the answer lies in accounting. Not the cash-based accounting in which government budgets are usually presented. No, the answer lies in accrual-based accounting. If you will pardon the pun, accrual-based accounting uncovers the lies politicians tell us when they present the budget. I'm not sure these are intentional lies, but rather are lies borne of ignorance to the nuances of accrual-based accounting.

So, without explaining accrual-based accounting in this post, let me explain how it helps us solve the cost allocation problem for new growth. Unfortunately, I do not have the figures I need to show this quantitatively, so I must confine myself to a qualitative discussion of the process.

First, the expenses of the county on an accrual basis include depreciation and exclude capital purchases and principal repayment on debt. You cannot talk about the cost of new assets (or of improving existing assets) without including depreciation.

Consider for this argument a limited situation. Only residences use public utilities and services, and the real estate tax is the only tax. (The concept is easily extendible to businesses. I leave that to the reader.)

If you divide this total expense figure by the number of existing residences, you get the average cost per residence of public utilities and services. This is the minimum average real estate tax that you must place on each residence. (You have to charge more if there are principal repayments on existing debt or capital purchases not funded by debt issuance.) As Mr. Lemings asserts, under these limited circumstances residences that are taxed above the average amount pay for themselves.

Assuming that all existing public assets have remaining capacity, you can add new residences at will without incurring additional cost. The advantage to existing residences is greater sharing of the costs, which means a lower average cost per residence, which should mean lower taxes per household. It is reasonable to expect new residences under these circumstances to "buy into" the existing public assets.

But what happens when existing public assets do not have sufficient remaining capacity--i.e., the water treatment facility must be expanded, or a new well is needed, or a new school must be built, etc.? Who pays for the new assets, how much, and why?

In reality, most new or expanded facilities benefit existing residences as well as new residences. The solution is to allocate the cost fairly among these two groups.

Public facilities have a design goal of supporting a planned number of residents, who arrive to occupy new residences or else accumulate the usual way in existing residences. The cost of the facility construction or expansion then is allocable in an estimatable way before it is even constructed!

It is not difficult to compute the cost allocable to existing residences versus new residences. If a facility supports 10,000 residences, and 8,000 are currently using it, then 20% of the cost of the facility should be paid for by the next 2000 new residences that will use the facility.

Start with basic principles.

1) New residents should compensate existing residents for any capital loss due to early retirement of existing facilities due to replacement.

2) New residents should pay their portion of capital costs (including financing) for new or expanded facilities (assuming that the facilities were adequate for existing residents beforehand).

3) If the new residences will not be built all at once, then the real cost (accounting for inflation) of (1) and (2) must be recovered over time, with the outstanding balance being adjusted upward for inflation each year. In nominal terms, more cash will be recovered than initially layed out for the public facilities; but in real terms, the recovery will approximately equal the initial outlay.

4) If growth stops, then existing residences must finish paying for the new or expanded facilities, and future new residences must "buy into" the facilities.

5) Implicitly, every existing residence represents ownership of existing assets. Treat them the way you would treat owners of assets held by shareholders of a non-profit corporation.

There are two ways of recovering the costs. The first is through impact fees on new residences. The second is through a cost recovery district that levies a special real estate tax on new residences.

First, the impact fees. This fee sums up the new residence's cost all at once and up front as it is approved for construction. Depending on the costs being allocated, this could be a large and unwieldy sum. The fee would necessarily be increased annually to keep the real value of the cost recovery neutral with the initial outlay. If the number of new residences does not meet the planned amount, then the full cost will not be recovered.

Enter the cost recovery district. Approved lots are placed in the district. Costs for new or expanded facilities are allocated to the district. No matter how few or how many residences are built, no matter how long it takes to build out the residences, the district pays an additional tax to recover the initial outlay. The tax ends when the costs are paid. At that point, these new residences become "existing residences" and are subject to compensation by new residences who add their use to existing facilities.

There are additional benefits to a cost recovery district. Take for instance a senior community. These residences do not demand schools, and therefore should not have to "buy into" existing schools, nor share in the capital cost of new schools. The allocation for these residences can be lessened, leading to a faster satisfaction of costs, and lower annual costs of living for retirees.

Costs can be allocated narrowly to parts of the county (like specific subdivisions), or broadly by applying a county-wide cost recovery district. These districts should be layerable, so that each recovery goal is separate and time-limited (that is, it has a finite life). Each incremental investment decision can be weighed on its own merits, and the costs can be recovered more easily from those who enjoy its benefits.

Finally, debt issuance and service can be tied to specific cost recovery districts, dedicating revenue streams to repayment. Transfers from the general fund to cover cash flow shortages due to slower than planned growth can be properly accounted and repaid to the general fund when applying principles (3) and (4). This can improve the likelihood of receiving favorable financing terms.

In conclusion, it is possible to estimate and allocate the costs of growth. Furthermore, there are means to recover these costs fairly from the existing and new users of public assets. With a little financing assistance from the general fund, even long-duration development costs can be recovered fairly. The idea is to ascribe ownership to existing residents, and to make new residents smartly "buy into" existing assets, and pay their portion of investment in new or expanded assets.

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