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A Guide to Impact Fees and Housing Affordability
By Arthur C. Nelson, Liza K. Bowles, Julian C. Juergensmeyer, James C. Nicholas ISLAND PRESS
Copyright © 2008 Island Press
All rights reserved.
ISBN: 978-1-61091-084-2
CHAPTER 1
Impact Fees—Past, Present, and Future
This chapter serves as a background on impact fees and how they have evolved over time. It also includes data on how impact fees are being assessed today, with tables summarizing national data and several useful local examples illustrating specific impact fee structures. It concludes by introducing the concept of equity as applied to impact fees and their effect on affordable housing.
The Need for Infrastructure Financing Tools
Financing basic community infrastructure in the United States has become more complex and more expensive with each passing year. It has become more complex because we are continually expanding our urbanized areas and thereby requiring increased infrastructure. Table 1.1 shows some basic trends for the United States. The urbanization of the nation's population has continued, and with continued urbanization comes increasing numbers of people and households looking to government for services, including the provision of infrastructure. The population continues its shift to metropolitan areas. However, this shift has been at a lower rate than in the past. Both the number and the populations of all urban areas have continued to grow, most notably in medium-sized cities. In both the medium-sized and large cities, the population per city declined, simply indicating that the cities added to that size grouping would be at the lower end of the size range, thus reducing the average size.
But noting increased numbers of people in cities alone understates the demand. As incomes have increased, the public's expectations of and demand for public facilities have also grown. Schools are no longer aggregations of classrooms but have become multimedia learning and social-cultural centers. The transition has greatly increased the cost of providing educational facilities. The same is true for park and recreational facilities. Gone are the days when a ball field was simply an otherwise vacant area where ball was played. Now they are stadiums with all the accoutrements, including red dirt. A fire department no longer simply puts out fires; today it offers advanced life support. These evolutions are responses to public demands. Few would doubt that the quality of modern public services is greatly improved. And few would doubt that the cost of these services has greatly increased.
The federal government has long since reached its peak as a growth source of revenue to state and local governments. Since 1972, the federal portion of state and local revenues has remained constant at about 20 percent. This has left state and local governments to rely on their own revenue-generating abilities to meet the demands of the public. Some suggest that the federal government is responsible for many of the increased costs being borne by local governments through the use of unfunded and partially funded mandates.
As urbanization and public demands grew, inflation became an important political and economic fact of life. For most of U.S. history, inflation had not been an issue. During the 1970s and 1980s, however, this was not the case. One pernicious aspect of inflation is that it significantly weakens the revenue from fixed-base taxes, such as the motor fuel taxes. Inflation increases the cost that fixed-base revenue sources are to cover without increasing the means to pay those costs. Inflation increases the cost of road construction and maintenance but does nothing to the proceeds derived from a levy of 6 or 8 cents per gallon. In the face of such a problem, the logical thing to do is to raise the fixed-base tax. Property taxes, while not fixed base, require action to be increased. The action required is an increase in the assessed or taxable value of the property.
Figure 1.1 shows annual rates of inflation from 1970 to 2004. During that time period, the average rate was 4.95 percent per year, about twice the long-term rate of inflation. Annual inflation during 1980 was 13.5 percent, and the year-over-year rate peaked during 1980 at more than 17 percent. Such rates of price growth meant that the purchasing power of fixed-base taxes, such as the motor fuels tax, declined by 13.5 percent during 1980. One commodity most responsive to inflation is real estate, including development property. In fact, real property inflation tends to proceed faster than general inflation. General inflation increased public facility operating and capital costs, but it also increased the prices of both new and existing homes, thereby increasing the property taxes on those properties. It should not be surprising that California's Proposition 13 was enacted in 1978, during a period of unprecedented inflation. Proposition 13 rolled back property taxable values to 1975 and capped their rate of increase.
Massachusetts soon followed in 1980 with Proposition 2½, which took its name from the limit on property taxes being no more than 2.5 percent of taxable value. Since the referendum enactment of these two limits, all states have taken some action on limiting property taxes. Thus, property taxes tend to act like fixed-base taxes because of the limitations imposed by legislation or constitutional amendment.
Local governments were faced with conflicting demands:
• Increase the supply of facilities, especially infrastructure, to larger populations
• Increase the quality of public facilities, also to larger populations
• Avoid tax increases in meeting these demands
As these events unfolded, the philosophy of taxation moved more toward the use of the "Benefit Principle" and away from the "Ability to Pay Principle." This shift, combined with continuing urbanization and inflation eroding the tax base, set the stage for "alternative" sources of revenues.
As a result of new federal environmental mandates, local jurisdictions were also being directed to make massive investments in water pollution control facilities. These investments originally were funded up to 85 percent by federal grants. They are now funded by federal loans amounting to 45 percent. The highway system that was to be primarily funded by federal sources has fallen into disrepair with increasing congestion because of inadequate federal funding. States elected not to assume the primary role that the federal government was abandoning for precisely the same reason that the federal government was abandoning it: cost. The responsibility for highway maintenance and other major public investments has fallen to local jurisdictions by default. Where local governments attempted to assume these responsibilities, they were met with the "taxpayers' revolt," a reaction to the increase in property taxes that resulted from increasing local absorption of these responsibilities as well as a more general unwillingness to pay the costs for home buyers that did not yet live in their communities. Clearly, other means of funding were needed. When the power to tax proved unsuccessful, local jurisdictions looked to their police powers as a means to address the problem.
American local jurisdictions have great discretion in the exercise of their power to protect the public's health, safety, and general welfare. By contrast, they have almost no independent discretion in the exercise of their power to tax without voter approval. It was natural then that the police powers would be turned to as an alternative. Local communities found that growth and development meant more traffic, more wastewater, and more schoolchildren, all of which somehow had to be accommodated. Absent the funds to make physical improvements, congestion resulted, and with congestion also came citizen outrage. Increasingly, local elected officials faced a public demand to reduce taxes and maintain or even increase services. In such an environment, growth and development came to be viewed as detrimental rather than beneficial. The detrimental aspects of urban growth provided the basis to invoke the police powers and protect the public against the congestion and loss of "quality of life" that further growth and development would entail.
The impact fee arose not out of any great thought or plan but simply from desperation resulting from conflicting demands placed on local officials. Citizens demanded quality public services, and taxpayers insisted on lower taxes. Builders demanded that they be allowed to serve a clearly apparent market for their products, and those that earned their living from development fought for their jobs. Local governments were vested with the authority to impose reasonable conditions on new development that were consistent with protecting the public's health, safety, and general welfare in all of its manifestations. The impact fee filled this role. As a result, the use of impact fees spread rapidly, with Florida at the forefront.
To understand the evolution of the impact fee, it may help to first understand the state of urban infrastructure through considering a representative example. The small community of Key West, Florida, a former private enclave that still maintains those traditions today, is an island jutting into the Straits of Florida. The city had been dumping its untreated sewage into the Straits. In order for the City of Key West to fund an Environmental Protection Agency–mandated sewage treatment system, it would have had to raise the monthly bill for each homeowner by $65 to fund the expansion with revenue bonds. An increase of $65 per month was considered outrageous, and the citizens turned it down, thus creating an environmental and funding crisis. This crisis ultimately became an issue in the further development of the city in that the City was barred from making new sewer connections and thus new construction could not proceed. A cost-sharing agreement was struck between the City and the development interests that included a monthly bill increase of $15, which, combined with an impact fee, funded the sewage treatment system. Development was thus allowed to proceed. As a result, the city stopped pumping its raw sewage into the Gulf Stream.
Education presented another area in which impact fees have filled a funding gap. Like sanitary and road infrastructure, school construction tended to be financed from inelastic revenue sources, and these too failed to keep pace with need in areas of rapid growth, with more and more schools becoming overcrowded.
Large-scale, fast-paced growth is not nationwide or even statewide. In rapidly growing Florida, the actual growth areas are confined to no more than 10 percent of the geographic area of the state. Significant state funding support could not be expected, for that would mean taxing both the growing and the nongrowing (and therefore poorer) areas—thereby taxing the poor to subsidize the more affluent. The state's legislatures joined the federal government in holding the position that if the needs were great enough, the prosperous growth areas had the ability to fund the improvements needed to serve growth. What they lacked was the willingness to raise the funds.
Now, given this situation, what realistic alternatives were available to local governments? Although some communities did agree to raise local taxes, as a general rule this approach did not get very far. Even in areas that increased taxes, the increases were generally insufficient to respond to the magnitude of the needs. Some communities sought to restrict growth to a level consistent with existing infrastructure. As could be expected, this "solution" has been hotly opposed by the building industry. Impact fees were the alternative to further congestion and a shutdown of building. Impact fees charged new construction and generated revenue that the community could use to expand the physical infrastructure needed to accommodate that growth.
However, impact fees have significant drawbacks. Capital improvements and infrastructure are needed up front, but impact fees trickle in. Roads, schools, parks, and utilities are all needed ahead of development. The problem is that funding is not available up front unless it is put up by the developer or borrowed by the host local government. Developers and local governments assiduously avoid both actions. Impact fees, while becoming an important component of local government finance, do not address the timing problem. Impact fees, as they are commonly implemented, charge new development when the construction is actually permitted. Thus, the impact fee receipts trickle in as construction occurs. While jurisdictions prefer any revenues to no revenues at all, they would prefer up-front revenues so that facilities can be constructed and be available as new development occurs.
The key to resolving the "trickle in" problem is bonding, but bonding requires a secure source of revenue that can be pledged. Impact fees are not considered to be secure because their receipt will rise and fall with the level of construction in a community. The solution is to create some type of security, borrow against that security, and then use impact fees to make the required payments.
The Proliferation of Impact Fees
Table 1.2 shows the national average impact fees for 2003–2004 for detached, single-family dwellings by type. It also illustrates the wide range of fees, with school impact fees being the most expensive and libraries the least. These norms are derived from a sample of 152 local governments, including 44 in California, 51 in Florida, and 57 in other states. These data are for jurisdictions that charge impact fees of various types. Not all of the 152 local governments charge each type listed in the table, so the number per impact fees varies. The method of sampling is not scientific. Rather, the sampling was done by opportunity, meaning that when the opportunity presented itself, data were included in the sample. Even with the caveats on sam-pling methodology, the table is useful in illustrating the types of fees and relative costs.
Just as interesting as the cost of impact fees is the rate of growth in such fees. Table 1.3 shows the average nonutility (not including water and sewer) impact fee amount and the annual growth rate from 1988 to 2004.
The data shown in table 1.3, the results of a national survey conducted by Duncan Associates, are the averages for the jurisdictions included in this survey. The average has grown at an annual rate of 4.07 percent. This may be contrasted with a rate of inflation (CPI) of 2.7 percent during the same period, and a construction cost index of about 2.9 percent. It is apparent that the rate of increase has not been steady over the period. The trend line shown in figure 1.2 is simply the annual rate of growth over the sixteen-year period rather than the year-to-year rate seen in table 1.3.
The data shown in table 1.3 are the averages for all jurisdictions included in the sample. Over time, many more jurisdictions have been added and some have been removed (usually for nonresponse). Given that the sample is not scientifically drawn, any conclusions based on it must be tempered. Table 1.4 presents a constant sample of impact fees.
The amounts in table 1.4 are substantially less than those of tables 1.2 or 1.3 because not all fees were included in the constant sample. When the sample was begun in 1988, only a few types of impact fees were included. Those impact fees for the named jurisdictions have been followed over the sixteen years, and these results are shown in table 1.4. Interestingly, the rate of increase of residential impact fees for the constant sample is in general accord with the variable sample; also, the data in table 1.4 (depicted graphically in figure 1.3) show that nonresidential fees, especially industrial fees, have been growing more rapidly than residential fees. One explanation might be the lack of developer opposition in commercial versus residential construction.
Impact fees began as minor supplements to traditional sources of capital improvement finance. The water and sewer impact fees that were at issue in the 1975 case Contractors and Builders Association of Pinellas County v. City of Dunedin were $325 for water and $475 for sewer. These 1975 amounts are below the $2,131 and $1,963 of today. Similarly, the "transportation" fee litigated in Broward County v. Janis Development Corp. was $100, which even adjusted for inflation is very much less than the average road impact fee of $1,679 today. The amounts of impact fees adjusted for inflation thus began small and became much larger. The role of impact fees began as supplemental and is now primary. But the impact fee debate continues. That debate has evolved, however, from whether impact fees should be assessed at all to how they should be assessed.
(Continues...)
Excerpted from A Guide to Impact Fees and Housing Affordability by Arthur C. Nelson, Liza K. Bowles, Julian C. Juergensmeyer, James C. Nicholas. Copyright © 2008 Island Press. Excerpted by permission of ISLAND PRESS.
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