The lack of liquidity in funding markets has had a profound effect on delivery of new private sector development. While the effects of the financial crisis have, to date, been felt less acutely in the public sector, it is unlikely that the level of funding available to local authorities will be sustained over the next two to three years. Increases to the national debt and cuts announced in this year's Budget will mean that local authorities will find it more difficult to fund large-scale infrastructure.
Although new funding mechanisms, such as the Community Infrastructure Levy and the Business Rate Supplement, are being introduced in England and Wales, it is not anticipated that these will be sufficient to fund infrastructure in areas where it is most needed. Reports have indicated that as private sector developments slow down, local planning authority revenues from planning applications and planning gain contributions have fallen in the past year by up to £700 million in Scotland alone. The UK national deficit in planning gain investment in infrastructure will be significantly higher.
However delivery of infrastructure remains critical to economic development. As conventional sources of funding dry up, the Government needs to look at alternative ways of generating resources for projects, including infrastructure required to both enable and encourage future development.
Alistair Darling hinted in the Budget at the introduction of Tax Increment Financing (TIF) pilot schemes in the UK. The Scottish Government and Scottish Futures Trust have also expressed some interest in exploring the use of TIFs. The model has been widely used in the US for some time. In the UK, developers have already begun talks aimed at using TIFs to fund projects, and Local Government Minister John Healey has invited local authorities to submit nominations for a TIF pilot scheme to fund regeneration projects. Grosvenor and Hammerson are seeking to use TIFs to progress their respective shopping centre developments in Sussex and South Yorkshire while Transport for London and the Treasury are considering the viability of TIFs to fund the extension of the Northern Line to Battersea Power Station.
Parliamentary and industry interest in the introduction of TIFs is growing. A recent All Party Urban Development Group report called on the government to introduce them as a new model of development funding. The British Property Federation, already in discussions with the government in relation to TIF pilots, support TIFs as a model to maximise the resources availably to developers.
TIFs are a form of local tax re-investment. Under the scheme, anticipated future increases in tax revenues are used to finance the creation of infrastructure to serve the development which will generate those tax revenues. The local authorities will issue development bonds – essentially borrowing to invest in infrastructure to enable development within a specified area. Those borrowings are serviced by greater tax revenues arising from increases in the level of development and rising property values, resulting from the benefits that the new infrastructure brings to the area. As a forward-funding model, the concept is relatively simple.
Following the designation of Accelerated Development Zones (ADZs), property taxes within that area are divided into two categories; one based on the original value of the property before the infrastructure or TIF development provision, and the other on the increase in value associated with the development. The former tax stream is allocated in the usual way. The latter is paid to the local authority, where those funds are hypothecated to finance the bonds.
As with any forward funding model, the principal question to be addressed is the allocation of risk. If development bonds are issued and funds obtained on the basis of projected development rates that prove to be overly optimistic a clear structure must be in place for allocating the risk of that income deficit between the local authority and fund provider. That risk structure must balance the cost of public borrowing (both in political and financial terms), against maintenance of the value of bonds to be issued in future TIF schemes.
Legislation conferring tax raising powers on local authorities will be required to operate TIFs. It will need to prescribe the circumstances in which TIFs could be used and either define those areas to be classified as ADZs or confer authority for that decision to be taken at a local level. This represents a real opportunity for the development industry to shape the model to meet the demands of the UK market.
At present, confidence levels in both the public and private sector are low. There is a danger that the current pessimism concerning public sector borrowing could lead local authorities to put this initiative to the bottom of the pile. The reality, however, is that without innovative thinking and bold decisions many important schemes across the country will sit mothballed for many years to come because the private sector is unable to fund the infrastructure necessary to deliver buildings. Developers and Local Authorities are discussing use of TIFs for particular schemes. Swift action from the Government is now needed to put in place the legislation necessary to ensure that talking stops and the building begins.
Ewan MacLeod is a partner specialising in planning and environmental law with leading UK law firm Shepherd and Wedderburn LLP.