« PreviousNext »

CHAPTER 2: Definition and Overview

2.1 Background and Definition

First introduced in 1947 in Illinois in the form of a tap-in fee, DIFs became widely accepted in the 1950s and 1960s primarily as a means to recover capital expenditures for water and sewer facilities. In the 1970s, with the decline of Federal and State grants, the use of DIFs expanded to nonutility-related needs, including roads, parks, schools, and other public services. Starting in the 1980s, DIFs have been universally accepted as a critical funding source for municipal facilities.

With the increasing use of DIFs, additional court litigations at the local level (see chapter 4 for more information) led many States to enact laws that authorized local jurisdictions to use DIFs. As of 2015, 29 States have established enabling legislation for DIFs (Federal Highway Administration [FHWA] 2019, 34). Public agencies now commonly use DIFs to pay for parks, schools, roads, sewer systems, water treatment, utilities, libraries, and public safety facilities and services in newly developed areas. DIFs are now known by many different names, a system development charge (SDC) being a common term used for transportation facilities specifically. A transportation-related DIF is also variously referred to as intersection development charge, road impact fee, traffic impact fee, or mobility fee.

In addition to revenue generation, DIFs are a form of land use regulation designed to ensure that communities maintain adequate levels of public facilities in the face of growth. DIFs support the notion that development should pay its own way. Some communities consider DIFs a pro-growth tool because of their ability to defuse rising no-growth sentiments, ensure facility adequacy, and facilitate development approval (HUD 2008, 27). Although the use of DIFs is widespread, there are four basic community characteristics common to jurisdictions that use DIFs (Carrión and Libby 2000, 2). These community characteristics generally are the following:

1. Having a large population base with foundational public facilities already in place.
2. Experiencing moderate to rapid growth but having the desire to maintain a constant level of public services.
3. Facing high property taxes to support growth and maintain service levels.
4. Being burdened with large, sunken capital investments that are becoming more expensive to replace and maintain.

DIF is a monetary exaction that differs from a tax or a special assessment that a local governmental agency charges a developer in connection with approval of a development project. The fee offsets some or all of the cost of new or expanded public facility needs located outside the new development boundaries that benefit the development project. Also, because they are typically used as a replacement for negotiated exactions, DIFs generally add speed and predictability to the development process, are more equitable, and are likely to generate considerably more revenues than informal systems of negotiated exactions (more discussions follow in section 2.2). The fee was originally intended to fund capital expenditures only, but some public agencies now use them for operations, maintenance, and administrative expenses (Mathur and Smith 2013, 20).

DIF is also a one-time, up-front cash payment made in advance of the completion of the development project—usually at the time of approval of building permits or issuance of certificates of occupancy, although some jurisdictions allow extended payments over a period of years. Based on the landmark Nollan/Dolan court rulings (see chapter 4 for more information), an imposition of DIF on a development project must pass the essential nexus and rough proportionality tests; that is, a direct cause–effect relationship must be proven between the proposed project and the fee imposed on the developer, and the fee imposed must be roughly proportional to the impact created by the project (see chapter 4 for more details).⁴

To meet the nexus/proportionality requirements, public agencies typically conduct nexus, or fee, studies. Many different methodologies are used in these studies to determine overall fee structure and appropriate fee levels (see chapter 5 for more details). In general, both the cost of the public facilities and the nature and size of the development project determines what the DIF will be. The resulting fee schedules typically set forth the DIF charges per residential dwelling unit (DU) or per 1,000 ft2 of nonresidential floor space.

The DIF structure, however, can be quite complex and multilayered. Different fee schedules are often established for different land uses (e.g., residential, nonresidential), different facility types (e.g., water/sewer, transportation, school, open space, etc.), and different geographic districts within a local jurisdiction (e.g., infill vs. greenfield areas; see chapter 5 for more details). There are also many exceptions—such as exemptions, exclusions, waivers, deferments—to accommodate larger public policy objectives such as affordable housing.

Beyond fulfilling the nexus/proportionality tests, the complexity level is often driven by the level of accuracy needed to achieve horizontal equity (i.e., those who benefit pay) as well as vertical equity (i.e., those who are able pay; see chapter 3 for more details). It is also important to recognize that developers are not necessarily the ultimate bearer of DIFs. Depending on circumstances, others may instead bear the fee, including the landowner, the builder, or the buyer.

In the DIF implementation phase, increased transparency is critical for developers to identify all fee-related project costs early on to assess their projects’ feasibility (see chapter 6 for more details). Recognizing that developers are generally more sensitive to fee transparency than specific fee levels, one of the challenges facing public agencies has been to present clear and cohesive fee structure and fee schedules that are transparent, up-to-date, and readily accessible.

2.2 DIF vs. Developer Exaction

According to the U.S. Department of Housing and Urban Development (HUD), DIFs are different from, and should not be confused with, developer exactions.⁵ DIFs are formally established one-time charges applied to new developments to pay for additional off-site public improvement capacity needed by the new developments. The charges can cover a wide variety of public services (primarily off-site) and are based on a general formula that applies equally to all new developments proportional to their incremental capacity needs. Lacking proportionality and predictability in comparison, developer exactions are typically site-specific, dealing primarily with on-site internal improvement needs within and close to the development project boundaries and negotiated on a case-by-case basis. The following paragraphs describe several ways that DIFs can be different from developer exactions.

In general, developer exactions fall into two broad categories: (1) mandatory land dedication requirements and (2) negotiated exactions. A major limitation common to both types of exactions is that they tend to address only those public improvements that are either on-site or in close proximity to the development. Such needs as roadway systems to relieve congestion or water treatment plants to relieve the overloads are generally beyond the power of an individual developer to address through the exaction process (HUD 2008, 23).

In most communities, developers are already required to construct, at their own expense (and dedicate to the local government), all public improvements within a subdivision that are designed to serve only that subdivision. These internal improvements, which must be constructed to standards set by the local government, typically include local streets, sidewalks, water distribution lines, wastewater collection mains, and storm sewers.

More generally, typical exactions include the dedication of parkland, school sites, and road rights-of-way. In addition, developers may be required to construct public facilities, such as widening the portion of a substandard street on which the development has frontage or installing a traffic signal at a congested intersection nearby. Exactions may also take the form of monetary contributions, such as fees in lieu of dedication or developer participation in a pro rata share of the cost of installing a traffic signal (HUD 2008, 22).

Monetary exactions are generally the result of open-ended negotiations between the developer and the local government. These exactions may be imposed at any stage of the development process that local governments have broad discretionary authority, particularly when regulatory approvals, such as zoning, special permits, or planned unit developments, are required. Although negotiated exactions are standard procedure in many communities, they are tightly regulated in some States, such as North Carolina and Virginia (HUD 2008, 23).

Monetary exactions are superficially similar to DIFs and fees in lieu of dedication and may be considered a direct precursor of DIFs. In-lieu fees, however, are usually based on land costs only and are ill-suited for public services not requiring extensive amounts of land. DIFs, on the other hand, are meant to cover a proportionate share of the capital facility costs (primarily off-site) and may apply to a wider variety of services. In addition, monetary exactions are typically site-specific and often negotiated on a case-by-case basis, whereas DIFs are based on a general formula that applies equally to all developments.

One of the major drawbacks of negotiated exactions is that they lack predictability and proportionality (HUD 2008, 23–24). For example, the amount of the exaction is unpredictable because it may depend on the accident of geography or on the political or bargaining skill of the developer. In addition, small developments—which may cumulatively result in significant capital improvement needs—often escape such exaction requirements because, individually, they are not capable of making significant contributions. Regarding proportionality, regardless of project size, negotiations can be equally time-consuming and expensive for both the developer and the local permitting authority. Past experience also indicates that the need for exaction to be proportional to impact created on public facility needs is often a secondary concern in negotiated exactions (HUD 2008, 29).⁶

2.3 Other Development Charges

In some States, there are fees that fall under the broad umbrella of development fees or charges that carry some characteristics of DIFs and/or monetary exactions, such as utility connection fees and permit processing fees, which are subject to different legislative requirements than those specific to DIF.⁷ As an example, table 1 provides, in addition to DIFs, various in-lieu and development fees that exist in California for different uses that are subject to different legislation. Along with DIFs, some or all of these fees are levied against new development projects as applicable and, when combined, can have material impact on the project’s overall feasibility. With these different fee types, it may be challenging for developers or others to fully understand all fee-related cost implications of their development projects upfront. Regardless of how they are categorized and differentiated, the final combined fee could be at the level that may potentially disincentivize real estate investments needed for growth.

2.4 DIF vs. Special Assessments and Other Alternative Funding Sources

Public finance criteria indicate that DIFs are better suited for certain public facilities than others. Table 2 summarizes the basic economic characteristics of different public facility categories and the preferred funding mechanism, whether it be impact fees, special assessments, user fees, general taxes, or dedicated taxes (HUD 2008, 21). The economic characteristics that table 2 presents are as follows:

• Marginal cost characteristics—that is, whether infrastructure capacity increases can be accommodated gradually in small increments (“smooth”) or intermittently with major investment needs in large increments (“lumpy”; see chapter 3 for more information).
• Scale economy—that is, whether the unit cost savings of providing additional infrastructure capacity increases significantly or moderately with increasing investments (“large” or “moderate,” respectively) or the unit cost remains constant regardless of the size of the investments (“small”).
• Exclusivity (or “excludability”)—that is, the degree to which infrastructure provisions can be limited
  to only paying customers or the degree to which a government can prevent “free riders”
  (i.e., nonpaying customers).
• Demand elasticity—that is, whether the demand for infrastructure is highly or moderately sensitive to the price charged (“high” or “moderate,” respectively) or price has little bearing on the demand (“low”).

In terms of VC techniques specifically, public agencies throughout the United States are increasingly using DIFs and SADs to shift more of the costs of financing public facilities from the general taxpayer to the beneficiaries of those new facilities. DIFs can fund a wider variety of services and types of facilities than is possible with SADs. DIFs are also better suited for incremental improvements, such as, local access roads or water/sewer lines, for which marginal cost pricing, with minimal incremental costs, is possible (see chapter 3 for more information). On the other hand, SADs are better suited for lumpy investments (e.g., major highways or water/sewer plants) that have low demand elasticity for which achieving significant economies of scale is possible.

From a budgetary perspective, SAD assessments represent a much more secure source of revenue than DIFs and are better suited to secure debt, allowing for more flexibility in financing options. In addition, SADs can be used for both existing and new developments, although financing off-site facilities can be challenging. DIFs, however, are applicable only for new developments and are geared specifically to finance off-site facility needs. Finally, one unique advantage of DIFs is that they can be structured to require new developments to buy into existing excess capacity, thus recouping prior public investments made in anticipation of growth demands. Recoupment of prior investments is generally not possible with SADs (HUD 2008, 27).

As an alternative infrastructure funding source, DIFs differ from user fees in that they represent a reservation capacity fee; that is, they provide the facility capacity whether or not those who pay actually use that capacity at any given point in time. Also, unlike user fees, DIFs are directly tied to local planning processes and to the financing of local CIPs. Thus, DIFs are geared toward helping achieve overall community planning objectives.

Finally, DIFs may not be the best way to finance certain public facilities, in comparison to taxes from public finance perspectives.⁸ For example, facilities such as those for public safety (e.g., police, fire), parks, libraries, and schools may be better financed through general funds from taxes (and debt retired through general obligation [GO] bonds). Similarly, roads can be better financed from dedicated taxes and user fees. Relatively speaking, DIFs may be most appropriate for water and sewer facilities, which was their most common initial use. However, when elected officials find themselves without the legal or political ability to raise taxes but want to maintain the level-of-service quality in their communities, they are increasingly considering DIFs as a pragmatic alternative and critical funding source for their infrastructure needs, including transportation facilities (HUD 2008, i).

Footnotes

⁴ If DIF does not relate to the impact created by the development project or exceeds the reasonable cost of providing the public facilities, then the fee may be declared a special tax subject to voter approval (LCC 2003, 2).

⁵ According to HUD, DIFs are not considered a developer exaction per se but instead fall under the “impact assessment” category, which represents various scheduled charges made against new developments for the purpose of financing public facilities (HUD 2008, 22).

⁶ A variant to negotiated exaction is the development agreement (DA) that is based on a negotiated contract between the developer and the local government. Unlike negotiated exactions, DAs can cover a broad range of facilities and, once in place, can provide certainty to both the developer and local government. DAs are widely used throughout California and Florida, and are increasingly seen in other States.

⁷ In addition to these fees, in some States, there are other scheduled charges that developers pay under the broad umbrella of impact assessments that are made against new developments for purposes of financing public facilities. Examples include general impact tax in California, transportation impact tax in Oregon, and public facilities tax in Tennessee.

⁸ From financial and administrative perspectives in general, property taxes provide a relatively easy-to-administer, reliable stream of revenue to finance infrastructure. Property tax funds can also back general obligation (GO) bonds, which provide the lowest cost financing available to public agencies.

« PreviousNext »