When the words ‘deficit' and ‘cuts' are among the most commonly used phrases by the government, and the shadow cast by the Comprehensive Spending Review (CSR) looms large, it seems a surprising time to hear about a new mechanism for borrowing. The plans for Tax Increment Financing (or ‘TIF') unveiled by Nick Clegg at the Liberal Democrat Party Conference and confirmed in the CSR by George Osborne, are, however, just that.
Local Authorities are currently permitted to borrow against their overall revenue stream, but business rates are not included within that overall revenue stream as they are not a guaranteed source of income. The introduction of TIF will change this.
TIF gives Local Authorities the option of borrowing against future increases in local business rates to fund key infrastructure projects. The rationale is that improvements to local infrastructure will attract growth in the area and enable business rates to be increased to service the loans. The onus will be on the Local Authority to show that the projected increase is additional to any uplift due to businesses relocating to the area from other Local Authorities.
The changes to the current system will require legislation to implement them. As such, current thinking is that it will be between 18 months to three years before TIF becomes live. Fuller details of proposals are awaited in the forthcoming white paper on sub-national growth, expected later in the year. Until the white paper is published, there are some sizable gaps in the proposals. That said, there are some clear opportunities and, inevitably, risks that are already visible.
Strong support for the proposals
TIF has been hailed by many as an opportunity to prevent investment in city communities stalling. It enjoys support from both the investment community and from Local Authorities.
Property investors have been clear that they see TIF as a valuable opportunity to maintain regeneration and key infrastructure projects during the era of cuts. TIF allows private investors wishing to acquire public debt greater choice as to where to put their funds. Local Authorities have indicated that the decentralisation element of TIF is particularly welcome, in addition to providing for investment in strategic projects at a time when more speculative investment is dwindling. TIF is viewed as a strong incentive for Local Authorities to invest in projects set to benefit local communities.
A golden opportunity?
The concept of TIF sounds very promising; however, some risks should be borne in mind.
TIF has been in place for over 50 years in the United States during which time it has become clear that the model is not without risks or setbacks. The most common criticism is that some projections of future growth in an area may not be realised, leaving the Local Authority liable for payments without an increased income. While local government in the UK has withstood the recession better than central government, incidents such as the collapse of Iceland provide a salient reminder of the reality of the risks involved for investors. In addition, volatility in commercial real estate prices increases the risk associated with projects suitable for TIF. TIF is by no means a sure bet.
Questions have been raised about the possibility of central government acting as a guarantor for Local Authorities entering TIF arrangements. Such a provision could reduce both the cost of the debt, and the extent of the risk. Without this, the level of risk involved for the investor remains substantial, but it is yet to be seen if this will be part of the requirements for TIF.
The USA TIF model provides a tax exemption for interest received from a TIF funded project. It is not yet clear whether this will be a feature of a UK TIF. Such an exemption would provide substantial further incentive for investors and go some way towards offsetting the risks.
It has been suggested that the current framework of planning law will act to reduce the advantages of TIF. Both the length of time needed to obtain planning approval, and the cost of doing so will dilute the potential benefits of TIF. Early indications are that there will be strong central regulation of applications for TIF which stands both to protect investors but TIF is an attractive light on the horizon for both the investment community and Local Authorities. However, it is important for investors not to be wooed by the initial attraction without taking a full stock of the implications.