Special Assessments Are Not Dead
By DAVID H. PADDEN, President, Padden & Company, Inc.

Let me state upfront one important fact: Special Service Areas are not a substitute for Special Assessments. Each method of financing has its own place and purpose. The decision to use one form of financing municipal improvements over the other should not ride on costs or even convenience. The pivotal question is one of fairness to the property owners. There are those situations where, cost considerations aside, a special service area (S/S/A) provides the fairer means of financing a needed improvement. But to be sure, there are also those situations where, regardless of cost, a special assessment (S/A) provides the fairer means.

If all properties within a jurisdiction were of exactly the same size and condition; if all such properties had equal access to transportation, schools, shopping and other amenities; if there were no vacant properties awaiting development; and if the time value of money was not a consideration — local improvements could easily be socialized by an equal assessment to every citizen within the jurisdiction. Such is not the real world. Recognizing that local improvements enhance property values and that certain properties are benefited more than others, the Illinois General Assembly, in 1897, passed the Local Improvement Act (65ILCS 5/9-2-1 et seq.} which sets out a procedure for making municipal improvements and for levying the costs of such improvements in a manner proportionate to the enhanced property value accruing to each property owner. Mostly, the Local Improvement Act contemplates improvements to residential areas of the community and in fact this is where the Act has been most widely used.

In 1973, the Illinois General Assembly passed the Special Service Area Tax Act (35ILCS 235/0.01 et seq.), which provided for the creation of special service areas to finance special improvements and services. In an S/S/A the costs are not spread on a benefit basis, but rather on an equalized assessed valuation (EAV) basis, with each property being taxed based on its proportionate share of the entire equalized assessed valuation of the entire area encompassed by the S/S/A. The two acts are not in conflict. They are meant as alternatives to be used in a manner that provides the fairest and most appropriate method of financing for the property owners involved in the specific improvement.

Some authors have indicated that S/A financing is no longer the most favored method of financing local improvements. But to think this way is a mistake. There are simply many local improvements which do not lend themselves to financing based on EAV. This is particularly the case in residential areas where, despite differing EAV's, each home benefits from the particular improvement in the same manner/amount as every other home.

The theory of S/A financing is that the property owner should pay for the enhanced value to his/her own property which the improvement provides. Assessing each property owner for said enhanced value can be accomplished in an unlimited number of ways (i.e. by front foot abutting the improvement; by square footage of the property; on a per tap basis; or based on the estimated use of the improvement by the property). Financing by S/S/A, on the other hand, should only be used where all properties are equal in EAV and will each benefit the same from the improvement, or where spreading the costs of the improvement on an EAV basis is truly a fair way to spread the costs of the services/improvements being provided.

The classical use of the S/S/A method is a downtown area wherein high-rise properties benefit disproportionately more than low-rise properties and a cost spread based on the EAV's of the properties will equitably address the disproportionality. In contrast, vacant property in a residential neighborhood would get a virtual free ride when EAV is used to spread the costs. In other words, an S/S/A seeks to equalize services to all properties within the area without reference to the enhanced value of said properties. The rationale behind a S/A specifically addresses the problem of enhanced valuation of property and assesses improvements accordingly.

The opportunity to use S/S/A financing should be welcomed as a largesse. But despite the promises of decreased costs and administrative convenience, this procedure should not be forced into usages for which it is not appropriate. And, by the way, the cost differential is not nearly as great as most proponents of S/S/A financing would have you think. It depends upon whether the cost is an actual cash outlay or is a matter of time and inconvenience. It also depends upon whether

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a municipal official looks at costs from the municipal government point of view or whether he puts himself in the position of a property owner and sees costs as a burden of property ownership. Special service areas have fixed terms, usually 10 to 20 years, and the property owner is stuck with interest payments for the entire life of the bond issue. Special assessments on the other hand can be paid in advance at any time. As interest rates fluctuate over a period of time, it is often advantageous to a property owner to pay his assessment in full. In addition, where the ability to obtain a second mortgage or equity line of credit is available to the property owner, said funds can be used to pay the assessment in full and obtain an additional interest deduction tax benefit.

It should also be noted that an S/S/A appears on the property owners' tax bills, and as real estate taxes are collected a year in arrears, S/S/A financings must provide for capitalized interest to cover the time period between the issuance of the bonds and the actual collection of the first S/S/A tax payment. Capitalized interest is not required in S/A financing.

Finally, it can be argued that a local improvement, even though local in nature, enhances living conditions as well as outright property values for the entire community. In recognition of this fact, S/A proceedings allow a portion of the cost of the improvement to be borne by the entire community as a public benefit. Again, this further assures that costs will be spread equitably, whereas, in an S/S/A, no public benefit is provided for and the entire cost of the improvement falls upon the property defined within the special service area boundary.

There are other advantages to the use of special assessments that seem to have been forgotten. Whereas an S/S/A can be voted down by 51% of the owners and electors in the targeted area, an S/A can be levied regardless of objections by the property owners. In areas of safety and health this is an important consideration. Consider sewerage improvements. Nowadays, there is a tendency for municipalities to seek low-cost EPA loans for doing such improvements. They are lured by the low interest rates on these loans. However, it can be fools' gold. While waiting to get on the approved list (or waiting for someone to fall off that list),

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construction may be dangerously delayed while costs of construction escalate and eat up all the advantages of the low interest loan. And right now, with budgetary restraints abounding at all levels of government, the question of waiting for an EPA loan approval might prove to be costly and time consuming indeed. Additionally, it should be noted that, despite the ability of the municipality to move forward with an S/A even if the property owners object, under S/A financing each individual property owner will have the opportunity to have his/her "day in Court." This opportunity is unavailable to property owners in an S/S/A unless they can convince 51% of their neighbors to join with them.

Frequently, the ability to deduct assessments on personal tax returns is cited as an advantage of S/S/A over S/A. This advantage too may prove illusory. As far as I know, the IRS has never made a formal ruling on the deductibility of special service area payments, and, in any case, the only advantage is the immediate write-off of taxes paid vs. a deferred write-off under an S/A. In the latter case, the principal amount of an S/A is added to the cost basis of a property, which lowers the eventual capital-gains tax upon a sale.

Presently, the overriding issue with municipal administrators is the question of cost and convenience, while the fairness question is overlooked. But the fairness question cannot be swept under a rug, particularly in the present climate of mounting taxpayer anger. S/S/A's which apply "benefit" rather than the assessed valuation as the basis for the levy raise serious constitutional questions in the minds of most bond counsels with whom this writer has dealt. There will be more said on the subject as this series on financing techniques continues in subsequent issues.

I started this essay by raising the question of fairness. Theoretically, though impracticably, each property owner could construct at his/her own expense that

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portion of an improvement which directly benefits his/her property. Though eminently fair, this would be foolishly expensive. In an effort to eliminate such cumbersome procedures, S/A's were provided for by the State. The procedures involved with an S/A are consonant with the democratic process, and property owners by and large have accepted S/A's as an equitable manner of providing needed improvements. Importantly, S/A's have almost a 100-year-old track record in Illinois. The provisions of the Local Improvement Act have been thoroughly adjudicated and are now comfortably predictable. The same cannot be said of the Special Service Area Tax Act. As I suggested earlier, current usages may not withstand court challenges, particularly those attempting to levy on a benefit basis rather than by EAV.

Yes, the S/A method of financing local improvements places a certain burden on municipal governments, though that burden has been greatly eased in modern times with the use of computers. But, no matter; if governments are there to serve the people, then the benefits to the citizenry should be above the inconvenience to its public servants. Surely, fairness to the citizen property owners in assessing the costs of a local improvement is worth the extra effort.

I end by repeating: special service areas should not be seen as a substitute for special assessments. In making their decision as to which form of financing to use, municipal authorities should be admonished to do the right thing.

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