In its Spending Review, the Coalition Government again signalled that it is looking to introduce tax increment financing (TIF) into the United Kingdom. TIF - together with other measures - is aimed at encouraging local authorities to support economic growth in their areas, with particular emphasis on property-led urban regeneration.

Why is TIF needed?

New development attracts new businesses. New businesses provide new jobs and opportunities. Regeneration promotes benefits for the developer, for new occupiers, for the local authority and for the wider community.

Regeneration projects need new roads, sewers, schools, open spaces and other services necessary to enable and support development. This infrastructure is critical to viability. If the necessary infrastructure does not exist, then a developer must include the cost of providing those works in his appraisals. This results in negative residual land values and/or insufficient developer's profit - rendering such schemes unviable.

Market forces, then, are insufficient for private sector participation. But for additional support from the public sector, the private sector cannot address the issue of regeneration.

This failure of market forces has long been recognised. Historically, various grants have been awarded to support and encourage infrastructure works and wider urban regeneration projects.

Strict public spending controls now mean that alternatives to grants have to be looked at.

Tax increment financing is a potential model to help bridge the viability gap. It is a means of providing funds from local taxation to contribute to start-up and infrastructure costs.

The model originated in the United States, and has been used to capture funding for regeneration. It is not without its issues, and the US experience will inform the debate and influence the shape and style of the UK's TIF.

What's a "tax increment"?

An increment is an increase; but an increase in what, and how? Take the example of business rates in a run-down inner-city area.

  • A "base" level of tax will already be generated from businesses active in the area. Such tax is likely to be modest and typically will generate even smaller sums as the area degenerates further.
  • It is anticipated that income from business rates will be enhanced once the area is regenerated. This is because: regenerated property values will increase, so increasing rating assessments; and new and bigger businesses will be attracted to the better environment created by the regeneration scheme, and will add to the tax base.

It is the difference between the base tax and the enhanced tax achieved through regeneration that makes up the "increment". That additional slice of tax can then be hypothecated to (say) infrastructure works.

In the short term, HM Treasury is giving up tax revenue but - in the longer term - it benefits from the additional employment, corporate and transfer taxes that result from regeneration.

How is the tax increment used to finance enabling works?

The tax increment is a revenue stream, and there are various ways in which this might be used to pay for or subsidise enabling works.

  • A sponsoring local authority already has the power (under the Local Government Act 2003) to borrow on prudential terms to fund capital works and investment in assets. The tax increment might be used by that authority as an additional source of income to repay such borrowing over time, so satisfying prudential criteria.
  • Alternatively, developers might agree to meet the initial costs but then be reimbursed by the sponsoring local authority over time (with the sponsor diverting the increment to the developer) - a "pay-as-you-go" arrangement.
  • Finally, the revenue stream represented by the tax increment might be packaged up and used to raise a lump sum of cash (in the form of a "local bond" issued by the sponsoring local authority). The revenue stream repays principal and interest over its life (say, 25-30 years).

What happens next?

The previous government invited expressions of interest in setting up "accelerated development zones", in which TIF might be piloted. The response from local authorities was very positive. The City of Birmingham's Big City Plan already anticipates creating "accelerated development zones" with infrastructure funding from increases in future business rates income streams.

Taking forward that original work, Deputy Prime Minister Nick Clegg announced on 20 September the Coalition Government's intention to give new powers to local authorities in order to allow them to raise money to sponsor TIF in their areas.

In his Spending Review on 20 October, Chancellor of the Exchequer George Osborne announced that a White Paper on TIFs (and other measures to support sub-regional/local growth) would be provided later this year. We anticipate that this will be issued before the Pre-Budget Report (late November/early December).

It is to be hoped that the White Paper will provide a new model TIF for the United Kingdom, addressing some of the issues arising from the US experience; delivering flexibility with simplicity; and proposing a number of pilot schemes to kick-start urban regeneration across the country.