REDEVELOPING THE MUNICIPALITY —
PREPARING FOR THE FUTURE

By PAUL D. SPEER, JR.

Illinois taxing bodies — Counties, townships, cities, villages (the previous four jointly called 'municipalities' or 'municipal governments), schools, sanitary districts and others — originally relied on the property tax as the source of general revenue. Over time as the demand for services increased, the state provided relief through the distribution of state revenues — income taxes, motor fuel taxes and direct aid — and through legislation permitting local sales taxes and utility taxes. Cities or villages which had concentrations of retail businesses were especially benefitted by the flow of sales taxes, which their municipal governments used to lower and even eliminate the property tax rate.

Even without regional shopping centers, Illinois taxing bodies in which the costs of services escalated in tandem with increased property values saw no relative increase in property taxes. The demand for property tax caps was muted as long as personal income also increased.

In municipalities with populations at the upper end of the income ladder and property values to match, there remained a relatively high level of disposable income and personal wealth. Higher tax rates were 'bearable' in view of the amenities of location and top level services. The employment profile reflected entrepreneurial, managerial, or financial services careers. Until the 1990s, these jobs were relatively stable and provided a path for upward mobility.

At the other end of the spectrum were communities which were formed by workers living out the American dream, moving to rental and single family self owned properties and stretching their budget to do so. In some sense these people were an extension of the contract buyers under earlier FHA programs.

The employment base of these communities was in large measure blue collar. As industrial firms went out of business and the twelve dollar an hour jobs disappeared, replacement jobs did not provide the income necessary to support essential family services, mortgage payment, increasing maintenance costs on the property. Property taxes on residences rose because of the loss of the industrial property tax base and the shrinking downtown retail base, which itself fell prey to the location of malls in nearby municipalities.

The supply of new buyers was hurt by the employment situation. The demand for housing in certain blue collar areas was muted by the increase in vacant or unkept property. As mortgages on properties fell into default and buildings were vacated, taxes on many properties went unpaid and the taxing bodies were forced to levy higher taxes on the remaining properties.

The property tax system in Cook County has provisions to obtain these unpaid taxes. However, as will be demonstrated below, the system failed and its net effect was to lower the amount of taxes available to the taxing bodies, increasing the burden on the actual taxpayers, at the margin causing more tax defaults, and lowering the quantity of municipal services. The latter of course then adds to the downward cycle.

Review of the Property Tax System

The property tax system, at least in Illinois, works in the following manner.

a. First the taxing body establishes a budget and directs the County Clerk to levy property taxes for particular portions of the budget. (The taxing body accounts within its budget for other sources of revenue, including Federal and State Aid.) The levy is divided into funding categories. For instance, for a school district each of the three principal categories — Corporate; Operations, Building and Maintenance; Transportation — are restricted as to size of the levy by a maximum tax rate. The maximum tax rate for each is set by state law and modified by referendum. Non-home rule taxing bodies are further restricted outside Cook County by levy limits as well. Home rule municipalities have no such restreiction.

b. Next, the County Clerk checks to determine if the category levy requested can be collected by applying the maximum tax rate against the total taxable assessed valuation. If it cannot, the levy requested by the district is reduced to that which can legally be collected. The County Clerk has the option of permitting a levy of up to one hundred five percent of that which

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could be collected by applying the permitted tax rate to the assessed valuation. This decision is based on expected collection shorfalls.

c. The County Clerk then extends the derived tax rate for each category and sums the individual rate. It delivers the total rate for each of the taxing bodies to the County Treasurer. The latter then sends out the tax bills to the listed owner of each parcel of property.

d. The County Treasurer collects the tax payments and distributes them to the district.

The Sale of Unpaid Property Taxes

To stimulate timely payment of property taxes, the County places penalties (currently in Cook County 1.50% per month) for late payments. As a further incentive, the County permits the sale of unpaid taxes during the following year. Bidders are permitted to pay the taxes and penalties in full and assign a rate of interest which the owner would be forced to pay in addition to redeem the property. If the owner failed to pay and the bidder continued to pay the property taxes the County would after a period of time issue a deed to the property to the bidder. The taxes collected by the County Treasurer as a result of these annual tax sales were delivered to the district and other taxing bodies.

The Scavenger Tax Sale

Certain properties received no bids. For those properties on which no bids had been received for two years, the County held periodic 'scavenger sales'. Bidders at the scavenger sales were permitted to pay less than the full amount of taxes due, even as low as one dollar. Similar procedures were established for the delivery of a deed.

Systemic Problems

Generally, the system works as designed. Property taxes are paid or made up, the taxing body receives the money from late payments and continues to operate. The system presumes that the tax sale buyer is a temporary investor, interested in the financial returns from the interest rate assigned; it also presumes that the failure of the owner to pay is temporary and that the risks of such failure are completely known to the owner. These presumptions are or should be correct.

Finally, it presumes that the tax sale or scavenger sale buyer, should the owner ultimately forfeit the property, will return it to the tax rolls at its prior, highest and best use. This presumption is not correct. The acquisition of the property through tax or scavenger sales is viewed by a large percentage of such buyers as low cost speculation leading to a profitable re-sale.

The normal sales transaction with willing seller and willing buyer with knowledge takes place at true market value. Full consideration is realized. The buyer must normally put up at least twenty percent of that market value and pledge the property or other resources as security for a loan.

On the other hand, the tax sale buyer must pay only the property taxes. The tax rate is usually at or under ten percent of the assessed valuation. That assessed valuation is around one third of the market value. The tax sale buyer can achieve an interest in the property for payment of less than three and one half percent of the market value, without having to mortgage the asset or pledge other assets. He can carry the property for less than the cost of a commercial loan — and be paid back his investment plus a market rate of return on his investment, if the owner eventually pays his back taxes.

The tax sale buyer is motivated by more than a speculative interest in obtaining a real asset, as opposed to a rate of return on a financial asset. The receipt of a quit claim deed after the specified time enables him to pyramid his return. Such a buyer is usually uninterested in developing the real asset but is prepared to make a quick sale of that asset at a fire sale price.

The scavenger sale buyer obtains the same interest in the property at even less cost. At the time the speculator acquires the deed to the property, the prior tax liens are forgiven. The speculator has two choices. He may actually pay property taxes each year, after attempting to and in many cases succeeding to have the assessed valuation lowered — reducing in effect his cost of carry. He may choose, on the other hand not to pay the taxes until the next tax sale cycle begins. At this point he can decide whether he can make a profitable sale. If not, he can walk away and invest in other properties on the same basis.

The Effect of Speculation on the Taxing Body

The effect on the municipality (as well as the other taxing bodies) is cumulative. To raise tax dollars as fewer and fewer properties pay current taxes, it must levy to the maximum rate and the County Clerk must approve the over-levy. The higher tax rate discourages the remainder of the taxpayers. At the margin, they succumb and rid themselves of the property at a lower price which includes the effect of higher tax rates.

The lower market value imbedded in the lower sales price is then reflected in a lower assessed value. The taxing body can raise fewer tax dollars. Funding becomes insufficient for legitimate purposes. For municipalities, police and general government functions suffer causing the perception of a loss of safety. For schools, students apparently receive less of an education, discouraging parent-homeowners. Tax rate increases where passed by referendum further encumber

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property owners. More property passes into tax sales. Governance and the educational process suffer.

The symptoms are clear. Tax collections fall below ninety five percent of the extension. Even with the five percent over-levy, the taxing bodies cannot collect sufficient money to fill the levy and the downward cycle begins.

Reversing the cycle is perhaps the most important task facing municipal governments. The other taxing bodies do not have the ability to effect development and redevelopment and must rely on the efforts of the municipality. At the same time, the latter must clearly obtain the trust and confidence of those taxing bodies that it is acting in the best interest of all.

A New Look at Municipal Resources —
The Property Tax Base

Each municipality differs in the property resources within and adjacent to its incorporated borders. The presence of vacant or improved land adjacent to the present boundaries is also a resource which might permit expansion of its property tax base and the lowering of that burden upon its present taxpayers. We assume in this discussion that the municipality is landlocked and must put to best use what is within its present borders. What must happen next is an inventory of the properties coincident with both a comprehensive zoning plan and a development plan in conformance with the zoning.

The first component of the base is land. Municipalities with large tracts of undeveloped land have a scarce and potentially valuable resource which, other things being equal, can be improved and yield additional taxes. The first question to be asked by the municipality is why such improvement has not taken place. The usual answer is that undeveloped land is the cheapest way of holding or 'banking' property. Valuations, and thus property taxes, are at the lowest level. The amount of capital tied up in the land will be low. On the other hand, there may be no active market for the property. As real estate brokers are fond of saying, the three key elements regarding the desirability of a piece of property are: Location; Location; Location.

Location implies not only the site and the surrounding area, but also the quality of the municipal services — its safety, the utilities available — and the level of property taxes, utility taxes, state unemployment insurance, state worker's compensation burdening any new development.

Property taxes in Cook County on various developments are estimated to be in the range of $2.70 per square foot. For adjacent counties the tax will be at least $1.50 per square foot lower. This is a considerable disincentive to locating in Cook County.

What can be done about it? There are vaious direct programs — tax abatement and tax increment financing — which used alone or in combination with self help programs such as special service area financing can be used to assist development. The municipality needs first to know its landowners and what inducements or incentive can be used to cause the development it desires.

If it is industrial land, jobs will be brought to the community as well as the other components included by the Census Bureau term 'Value Added by Manufacture'. More important, the export of product from the community does not usually affect the contribution of other industrial companies — does not, therefore, beggar them.

If it is shopping center land, the municipality must look at the benefits from development and weigh them against the costs if any from the loss of other retail stores caused by new competition.

If it is residential land, the municipality must estimate the costs of providing services by all of the taxing bodies as opposed to the increased taxes which become available.

Developing a Strategy

For existing developed properties which continue to pay property taxes the municipality must choose from among several strategies: retention, expansion, replacement, and acquisition. It is important for the municipality to understand that commercial businesses as well as industrial companies have life cycles and within each area firms age well or badly. Competition, changes in manufacturing or commercial layout, the cost of raw materials, the relative price of transportation, new product development and many other factors affect the viability of an enterprise.

The municipality must have available some indication of the costs of service versus the revenue received from each of its large businesses and remember that for those revenues represent a cost of doing business for that firm. A municipality is in fact in partnership with that firm. In some sense, the revenues received above the costs of municipal services represent dividends from an equity position in a local enterprise. The loss of that enterprise brings dividends to a halt.

The strategy of retention is like preventative medicine. It is led by the municipality, but assisted by the other taxing bodies. The municipality has the obligation to its taxpayers as partner in the enterprise to protect its dividends. This means that it must establish good relations and conduct periodic surveillance which will enable the collection of information relative to its ongoing operations, employee relations and plans. Clearly, such activities must be passive in nature. They must provide the municipal government with the basis for possible

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future assistance in many different areas, actions which will keep the private enterprise in place.

The strategy of expansion will involve the municipality being aware of an using those tools, old and new, which will provide incentives for the expansion in place of an enterprise. Businesses grow and there is a high level of competition for relocation. Tax based incentives for the construction of improvements are one method by which an enterprise can be induced to remain rather than to relocate.

The strategy of replacement will be used to locate new enterprise to replace an entity moving out. Sometimes it is not possible for a municipality to retain an enterprise. It must then focus on the true reasons for leaving and determine if municipal action or inaction on any matter might have affected that decision. Next it must realistically plan for the replacement of that entity. The municipality should work with the property owner in attracting a buyer or a user. It should treat the property as if it were vacant land and use the tactics described above.

The strategy of acquisition will be used to secure the location of new enterprise within the municipality. As implied above, there is a great deal of competition for the siting of new facilities. Successful location of large enterprises creates not only new jobs but also an income multiplier. Many of the incentives which affect the location of enterprises come from the state capital. It is essential that municipalities lobby for and obtain incentive based legislation. The success of such legislation in attracting new facilities is well documented. Local governments rely to a certain extent on the distribution of moneys from the State. If super-marginal local revenues can be raised, as a result of such siting, the burden on state revenues can be decreased.

A Tactical Approach to Revitalization

At the same time as the strategies above are considered, there are certain contrarian approaches to development which may be of use.

The first of these deals with the situation found in the downtown of many older municipalities. Ownership of such properties is fragmented. The properties are usually fully depreciated and off mortgage. Assessed valuations have been appealed, usually without contest. Upper stories have been declared economically obsolete. The property taxes on the property have been minimized. As a result, the owners, usually absentee, require minimum rents to achieve an acceptable return. Vacancies and low income businesses abound.

There is usually a cry for municipal 'investment' — streetscaping, pedestrian malls, special taxing districts. It usually does not work. Pedestrian mails complete the decline started by parking meters in the 1960s. Municipal investment is the last piece to be placed in this puzzle. The first piece is updating the municipal code with code enforcement following. The municipality should actively contest any proposed reductions in assessment and support reassessment values. Property owners should shape up or ship out. The new buyers will have mortgages to pay, a higher level of valuation and will actively seek better tenants.

It is generally true that the economic condition of the doughnut surrounding older downtowns is in the most deplorable condition. These were the structures which originally made the downtown commercial area viable. The doughnut provided, with the jobs available downtown, the critical mass necessary for the economic health of the central city. The revitalization of that area with its mix of obsolete industrial, underutilized rail yards, and substandard housing will require the full range of economic development tools. New ownership and job creation need to be actively encouraged. In particular, public transportation and public safety issues need to be addressed. The traditional view of surface transportation being a monopoly needs to be reexamined with a view towards increasing access and lowering costs.

The No Cash Bid and Development

Essential to this revitalization effort is the municipal acquisition of property and organizing it for development. Tax increment financing as a redevelopment tool anticipated the purchase of property at market rates with a transfer to a designated developer. A better method has been developed involving the non-tax generating scavenger sale property indicated above.

Currently, Cook County, Illinois, has permitted municipalities on behalf of private developers to issue no cash bids for scavenger sale property. The municipalities are responsible for establishing with the developer a redevelopment program for the property. The no cash bid supersedes any cash bid by the private sector for the property. The municipality qualifies a developer for the parcel, the County Board then approves the municipal application and certificates of purchase are issued. The property is delivered to the developer approximately eleven months after the certificate of purchase is issued. The majority of the time between issuance and transfer is taken up by the statutory period during which the property can be redeemed.

Called a 'Tax Reactivation Program' this process anticipates early redevelopment by the municipally selected developer. One advantage to this program is that the property is placed in the hands of an entity interested in development of the real asset and not a speculator. The program also anticipates no municipal ownership of all or part of the development project. This is unfortunate. As has been indicated above, scavenger

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sale property remains generally delinquent even after the sale. There is no net loss for municipalities to hold property for development as part of the use of municipal equity.

Municipal Equity

Of all the resources available to the public sector, municipal equity is the least used. Equity is in one sense the residual value of an asset after payment of debt for which the asset has served as security. A Municipality selling, say, its water utility to a private sector company realizes the value of that asset after payment of the outstanding utility debt. The investment in that utility by the municipality was done solely from the proceeds of municipal borrowings, grants from other levels of government, and the revenue left over each year after the payment of operating and maintenance expenses and debt service.

The grants represent a form of equity investment on the system balance sheet. The leftover revenues represent system retained earnings, such earnings are a form of equity.

The land granted by the township at the time the school districts were originally established was a form of municipal equity. It formed an original endowment against future expenditures. In certain localities the Board of Education has retained an interest in the land and leased it to the private sector, obtaining rents. Unfortunately, in most cases it has been spent.

As local governments are now caught between the Scylla of greater demand for public service and the Charbydis of revenue constraints, the concept of municipal equity is being revived. The idea of a municipality directly investing in private sector activities as a shareholder or a partner is, however, still foreign to the experience of most local governments.

Such investment does occur — overtly in the ground leases of township school property, more subtly in every tax abatement or tax increment granted by local governments to the private sector. There is a need for additional revenue sources. We propose that one evident source lies in scavenger sale property on which a no cash bid can be made. The property to be acquired need not be ready for development immediately; it should form an endowment to be used as the municipality sees fit.

The endowment property could lie fallow for a set period — say, ten years — before the taxing district would be required to return it to the tax rolls in one form or another. By that time the district would have sold it or leased it, or entered into an income generating venture with the private sector. Key to this concept is the idea that such revenues as are available will offset additional direct taxes on the taxpayers and residents in the District.

The establishment of a property endowment mechanism would re-energize the abilities of taxing districts to manage themselves. Instead of the passive management system prevalent among districts, in which the schools, for instance, rely on property taxes and state and federal aid, a new resource would be assigned which would require active management and the participation a wider spectrum of district residents and taxpayers.

It is clear also that the application of a mechanism similar to the no cash bid mechanism of the present scavenger sales would occur more often in the poorer districts. The value of the endowment could equalize to a certain extent the disparity in wealth between richer and poorer districts. While the initial intent of the program is to acquire property within the boundaries of the district, smart managers and prudent proselyters would solicit out of district properties from graduates and friends. Endowment property once obtained could be held, traded or developed.

The mechanism would work in the following manner.

a. The municipality and its real estate advisor would obtain from the County the list of scavenger sale properties within its boundaries.

b. It would next evaluate various properties and candidates for its endowment portfolio. The portfolio would be separated into three categories:

1. Properties held for future appreciation;

2. Properties to be co-developed with the private sector; and

3. Properties to be used in immediate sale or trade.

Of the three categories, only the first represents property which would remain off the tax rolls for other than the first two years after acquisition. To the extent that the property was income producing, property taxes would be paid. There probably would have to be a valuation cap on such properties acquired. Perhaps ten percent of the total valuation of the District might be permitted.

The concept of municipal equity blends in well with current thinking regarding public-private partnerships as well as the use by local governments of taxable as well as tax exempt financing. It underscores the ability of a taxing body to raise money from other than the taxpayers or other units of government. For school districts, such re-endowment of their balance sheets represents an historically validated tool, useful in assisting them to obtain a stronger fiscal basis.

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