by James A. Bacon
Changes in fiscal analytics have the potential to transform modern municipalities. First is the notion of looking at zoning and real-estate development through a lens of revenue-per-acre rather than the traditional revenue-per-project. Second, in order to bolster fiscal solvency, local government should consider prioritizing investment by Return on Investment (ROI) or comparable metrics such as years of payback. Tracking infrastructure depreciation and calculating project ROI will encourage elected officials to make more fiscally responsible decisions.
Local governments seemingly face a grim long-term prognosis. Employee health care costs are rising with no let-up in sight. Maintenance costs are mounting as roads, buildings and pipes wear out. Pension obligations are surging as near-zero interest rates depress financial returns on retirement-fund investments.
There is no one to come to the rescue. The gridlocked federal government is challenged with its own national debt and annual deficits. The states, collectively speaking, are in little better shape. Other than instances in which the first name of the state happens to be “North” and the last “Dakota,” local governments cannot count on an economic resurgence to bail them out.
For the foreseeable future, local governments are on their own. But as surprising as it may sound, that’s actually a good thing. Necessity, as the old saw goes, is the mother of invention. Local government is ripe for reinvention – and planners have a key role to play.
Local governments in the United States and around the world stand at the edge of a golden age of innovation. Two game-changing developments are creating possibilities unimagined a decade ago: the digital revolution (Internet, wireless communications, data warehousing) and conceptual breakthroughs arising from the smart growth movement. For localities that break free from conventional thinking, the potential exists to drive down costs, improve the quality of services and foster a pattern of growth and development that more than pays its own way.
Innovators are using online technology to create new models for education and deploying sensors, actuators and algorithms to optimize everything from parking and highway utilization to sewer-pipe maintenance and street light illumination. But nothing, in my estimation, has more potential to transform the modern municipality than the nascent discipline of fiscal analytics.
Broadly speaking, two new approaches are emerging. First is the notion of looking at zoning and real-estate development through a lens of revenue-per-acre rather than the traditional revenue-per-project. Thanks to the work of Joseph Minicozzi, the principal of Urban3, and Peter Katz, former planning director of Sarasota, Fla., municipal planners are rethinking old zoning axioms. The blazing insight of Minicozzi and Katz is that walkable, mixed-use development can yield several multiples more revenue per acre in property tax revenue than conventional development in low-density, auto-centric suburbs. Minicozzi recently replicated those findings in a study for the Sonoran Institute of nine Western cities and towns: Downtown mixed-use development brings in five times more revenue per acre than conventional, single-use establishments on the outskirts.
Yet, as documented in Smart Growth America’s meta-study, “Building Better Budgets,” mixed-use development actually reduces the cost per acre of installing and maintaining infrastructure and public services.
Smart growth is not just more responsive to the burgeoning consumer demand for “walkable urbanism,” as Christopher Leinberger terms it, and it doesn’t just support congestion-mitigating transportation options such as walking, biking and mass transit. It is the holy grail of planning -it is growth that pays for itself. By determining what Katz calls a real estate project’s “fiscal quotient,” local elected officials can side-step the no-win dilemma of whether to enact debilitating tax increases or preside over the slow degradation of infrastructure.
Both Minicozzi and Katz have made the point well, and I need not elaborate upon it here. Rather, I will focus on a second approach to bolstering fiscal solvency, and that is a logical corollary of their work: prioritizing local government investment by Return on Investment or comparable metrics such as years of payback.
The Property Tax Yardstick
Government investment in infrastructure and amenities creates tangible economic value that can be measured in the form of rising real estate property assessments. That’s common sense. What’s not so intuitive is the idea that not all government investment is created equal. Politicians blather about “investing” in education, infrastructure or various pet projects. But elected officials do so without the discipline of their private-sector counterparts who measure profit, calculate Return on Investment (ROI) and steer capital to investments offering the highest ROI.
Building a highway interchange or mass-transit rail station, to pick but two uncontestable examples, create economic value, as measured by the increase in property values around the public improvement. Conversely, some government investment destroys economic wealth. Charles Marohn with the Strong Towns group, makes the case that “stroads” – a multi-laned street-road hybrid designed to move large volumes of traffic – are expensive to build and maintain, drive away pedestrians and bicyclists and depress adjacent property values. It seems that people don’t like living or doing business on wide, unwalkable transportation arteries.
Spending local money to undermine the tax base, he argues, amounts to fiscal hari kari.
Clearly, government investments vary greatly in the degree to which they create wealth or destroy it. As a guiding principle, local governing bodies should strive to invest in infrastructure projects that create the most wealth over time. At present, however, few municipalities possess the analytical tools to make informed and rational investment decisions. Developing such tools, I submit, is the great challenge of municipal finance.
I would start the conversation this way - Private enterprises have a very clear bottom line – profit, a concept that the accounting profession has honed over the centuries. Profit is meaningless to local governments, which are expected to do no more financially than balance their books. The closest thing to a municipal bottom line is the assessed value of real estate. Virtually everything that a local government does – building roads, designing streetscapes, running schools, grooming parks, patrolling streets, putting out fires, operating utilities – has a direct or indirect effect on the desirability of living and doing business in that community. The marketplace assigns higher property values to more desirable communities and lower property values to undesirable communities.
Just as it would be unthinkable for a corporate CEO not to know how profitable his company is, and whether profits are growing or shrinking, it should be unthinkable for government leaders not to know the total assessed value of property within their jurisdictional borders, and whether it is growing or shrinking. Just as it would be a dereliction of duty for a CEO not to know the profitability of various divisions and subsidiaries, it should be deemed equally negligent for government leaders not to know the total assessed value of the different districts and neighborhoods of their county, city or town. But those figures, if reported at all, are buried deep within lengthy documents.
A CEO does not control all the factors that affect his company’s profitability, which can vary depending upon economic conditions, the actions of competitors and the rise of new technologies. But there are many factors that he (or she) can control, and shareholders hold him accountable for those. Similarly, there are many factors that influence property values, some of which a governing body can influence and some of which it cannot. Elected officials should focus on those factors that they can control, and voters should hold them accountable.
Corporations calculate the “rate of return” or “return on investment” of potential investments when deciding where to allocate capital, and local governments should adopt a comparable discipline.
To show how such thinking might work in practice, let us take a humble example. Bike lanes and trails, it is commonly said, create economic value in the form of higher property prices. Studies have shown that access to a biking amenity can increase nearby property values by a percentage point or so. Let’s walk through the logic using an example from my home town in Richmond, Va., where the City Council proposes to spend some $350,000 to convert a 27-block residential street into a “bicycle boulevard” that prioritizes bikes over cars.
Let’s say the initiative adds 1 percent assessed value to properties along the route. A $300,000 house would gain $3,000 in assessed value. With a real estate tax rate of $1.20 per $100 in assessed value, Richmond would generate an additional $30 per dwelling in tax revenue yearly. The roughly 500 properties along the street, to use rough numbers, would generate $15,000 per year in added tax revenue. If the city financed the improvement via a 20-year general obligation bond, currently paying 4.2 percent interest, the city essentially would break even over the 20 year payback period, using the increased tax revenues to cover interest and principle. After that, the annual return on investment would be 4.3 percent. In this particular case, the city of Richmond hopes to get 80 percent federal funding for the project, which means the project would generate a 21 percent return on local investment. That would be a very profitable application of local resources.
Likewise, advocates of different stripes assert that parks, libraries and schools increase the value of adjacent and nearby properties. In cases like these, it is crucial to remember that the impact on property value hinges largely on the quality of urban design. Schools, parks and libraries that are accessible only by car will have a far less positive impact on nearby property values than those that are stitched into a walkable urban fabric. Families will not pay a premium to live next door to an elementary school cordoned off by a fence where kids have to ride the bus to get to their classroom. Conversely, families often will pay a premium if children can walk or ride their bikes to school. ROI calculations need to take such nuances into account.
Real estate developers understand that the art of place making pays big dividends. In real estate markets everywhere, people are willing to pay a premium (as measured by the price per foot of floor space) to live in walkable neighborhoods with convenient access to amenities. A modest investment in streetscapes and public spaces can provide a big payoff in the price of housing sales prices. Local governments need to adopt a similar mindset. The payoff from creating great places is a long-term annuity that pays an income stream in tax revenue over time.
Avoiding the Fiscal Ponzi Scheme
Politicians can justify virtually any project with airy talk of its benefits. But they rarely look past the ribbon-cutting. State and local governments do not commonly report “depreciation,” as private businesses do to account for the erosion of asset values over time. Nor do most state and local governments set aside money to replace those assets. They fund everything on a pay-as-you-go basis.
The result has been a fiscal Ponzi scheme, to quote Marohn, in which the federal government picks up 80 percent or so of the up-front capital cost. Localities, lured by the prospect of “free” money, commit to the project with little heed to long-term consequences. Thus, for example, the Interstate Highway System, funded primarily by Uncle Sam when it was built five decades ago, is wearing out. States face multibillion-dollar liabilities for restorative work. Congress doesn’t have the money to pay to rebuild the system. That obligation has fallen to the states. Trouble is, they don’t have the money either.
Mass transit has the same problem. The federal government pays most of the cost of new construction but devolves maintenance and replacement to others. The Washington Metro, now about 40 years old, is falling apart, as its governing body refused to set aside reserves years ago to cover depreciation. Today, the Metro says it needs to invest $1.5 billion a year over the next decade just to maintain current levels of service. No one has identified a source of money.
Thus, it is essential for any calculation of ROI to consider full life-cycle costs. Adjusting for maintenance and replacement, an ROI calculation of the Richmond bicycle boulevard might look somewhat less alluring. On the other hand, one also could assign an economic value to taking cyclists off other roads where they slow traffic and put themselves at greater risk of accidents and injuries. As case studies and best practices spread over time, ROI calculations will become increasingly sophisticated about incorporating hard data regarding social and economic costs and benefits.
Tracking infrastructure depreciation and calculating project ROI will encourage elected officials to make more fiscally responsible decisions. It’s harder for municipal leaders to justify over-investing in infrastructure when they understand the long-term costs associated with their decisions. It’s more difficult to fund unproductive projects if objective analysis shows that the investment will shrink the tax base or generate an ROI less than the cost of capital (the interest rate on municipal debt).
Admittedly, the benefits of more rigorous fiscal analytics won’t be felt right away. Adopting a disciplined approach to allocating its investment capital won’t bail a locality out of a financial crisis. It won’t pull a Detroit or similar city back from the brink. But the slide from eroding competitiveness to Detroit-style insolvency is a decades-long process. Start now, get disciplined, start maximizing wealth creation, and planners can help boost the revenue yield for generations to come.
James A. Bacon, a Virginia-based journalist, publishes the Bacon’s Rebellion blog at www.baconsrebellion.com.
Published in the December 2013/January 2014 Issue