TABLE OF CONTENTS
LIST OF FIGURES
LIST OF TABLES
Efficiency and equity concerns are likely to be important considerations in determining basic DIF structure and appropriate fee levels (see chapter 5 for more information).
Transportation agencies evaluating the efficiency of a proposed VC technique as an infrastructure financing mechanism may want to consider the following three factors:
In terms of sufficiency, for local agencies providing public services, there is a general acknowledgment that new developments frequently create infrastructure costs that are greater than the revenues generated from DIFs (Carrión and Libby 2000, 11). On the other hand, empirical evidence also shows that DIFs generally raise property prices more than the amount of the fees (Mathur and Smith 2013,15). Taken together, these seem to indicate that although the currently collected DIF revenues are not sufficient to cover the costs of public improvements, there may be excess values generated from new developments that could potentially reduce the DIF revenue shortages.
One way to remedy the DIF revenue shortage situation is to integrate the DIF program into the local planning process. There is significant variation among States on how, and the extent with which, to use DIF techniques, both in terms of the fee structure and the methodology for determining fee levels. DIFs are often project specific and likely to be negotiated on a case-by-case basis, an approach that is more vulnerable to legal challenge and more staff intensive to administer. Public agencies are increasingly choosing to legislate their impact fee structure and standardize fee schedules for more transparency.
When legislated, DIFs become directly tied to local planning processes and to local general plans (GPs) and specific plans (SPs). For each long-term capital improvement project identified in GPs and SPs (see chapter 5 for more information), nexus studies are often used to allocate project costs between the existing and new developments. Local governments then develop the basic DIF structure and standard fee schedules based on the additional capital improvement needs attributable only to new developments. When linked directly to local comprehensive plans in this way, DIFs can work as an instrument to guide future developments efficiently. They allow public agencies to carry out capital improvements with a funding schedule, ensuring that the improvements are in place to serve the new developments. DIFs can thus be an effective tool for guaranteeing adequate infrastructure that accommodates new development and facilitates growth in areas identified in localities’ long-term growth and land-use plans.
Proportionality is the connection among the demands that new developments place for public facilities, the costs involved in meeting those demands, and how local governments allocate these costs to beneficiaries of the private developments and users of the public facilities. One of the central themes in structuring and implementing DIFs of all types has been this concept of proportionate share (i.e., horizontal equity) that has been generally accepted, dating back to at least the 1970s. This means local governments allocate costs to those who benefit and in accordance with their use of the facilities. From a legal standpoint, DIFs are prohibited from charging new developments more than a proportionate share of the cost of new public facilities. This is closely related to the very definition of impact fees, which are distinguished from taxes or general charges and required to be based on actual or projected expenditures.
Chapter 5 will present the complexity in methodologies used to determine basic DIF structures and resulting fee levels are in large part driven by the desire to achieve horizontal equity (Raetz, Garcia, and Decker 2019). This is manifested in a multilayered DIF structure that often varies with land use (e.g., residential vs. nonresidential), facility type (single vs. multifamily), facility size (e.g., square footage or number of bedrooms), density (e.g., high- vs. low-density areas with different growth potential), location (e.g., proximity to public transit), and configuration (e.g., single use vs. mixed use).
Because they are inherently based on the horizontal equity principle, DIFs have survived proportionality challenges well over the years compared to other VC techniques, except in one major respect. As presented earlier, empirical evidence has shown that impact fees raise the price of properties by more than the amount of the fees. For example, a dollar increase in an impact fee raises housing prices by $1.66 for new housing and by $0.83 for existing housing (Mathur and Smith 2013, 15). Because existing homeowners do not pay impact fees, these findings demonstrate that DIFs negatively affect horizontal equity by favoring existing developments at the expense of future developments. Existing property owners may see a windfall gain from increases in property values when infrastructure improvements are capitalized in real estate markets (Strathman and Simmons 2010, 41).
If this proportionality imbalance issue becomes critical, one remedy for transportation agencies may be to make a policy decision about whether the cost of new public facilities is charged directly to the new residents only or shared with current residents—for example, via higher taxes, some type of reimbursement mechanism from the general fund, or even by creating a TIF district with wider footprints that include existing developments. This could be a sensitive issue because current residents can refuse to pay for new facilities serving new residents. Charging all the costs to only new residents, however, would create an undesirable free-rider situation, when current residents benefit from new facilities without paying for them.
Proportionality concerns also arise when dealing with lumpy investments, which are linked to facilities that are built infrequently and cannot be expanded incrementally. According to HUD, highway projects may fall into this category (HUD 2008, 21). The demand for public facilities generally increases incrementally over time because of population growth and changes in community preferences. However, if public facility expansion needed by new developments involves a lumpy asset—for example, major roads, water/sewer plants, schools, and parks, as opposed to local roads, neighborhood parks, or emergency response services—some loss in proportionality may occur. When capital investments are lumpy, the current costs of constructing public facilities needed in the future could be spread among all future users, rather than just among those in new developments.
As presented in section 2.1, nexus studies generally help to separate out the portion of the lumpy investments attributable only to new developments. Public agencies sometimes use recoupment or reimbursement mechanisms to improve the proportionality concerns. As presented earlier, when existing infrastructure has excess capacity from previous lumpy investments, local governments can structure DIFs to allow new developments to buy into the existing capacity, enabling public agencies to recoup prior investments made in anticipation of growth. In addition, if local governments use DIFs for new developments (that are occurring in the present time) to build public facilities that are lumpy, they can structure DIFs such that the current developers can receive reimbursement from future development projects that stand to benefit from any excess capacity in lumpy assets provided as part of the current developments.9
DIFs are one-time upfront charges applied to new developments that allow public facilities to be provided roughly concurrent with the new developments. Although pay-as-you-go potential and concurrency are of benefit, DIFs do not offer the ability to use the revenues as supplemental security (like other VC techniques, such as TIFs and SADs sometimes do) for GO and revenue bonds needed to finance large-scale capital projects. DIF revenues are generally required to be spent within a reasonable period following fee payment, which imposes an additional constraint.
The choice of an infrastructure financing method can affect the pattern of land developments, and efficient pricing of infrastructure can make the land-use patterns more efficient (HUD 2008, 17). To determine the cost of any developments, there are, in general, two approaches: (1) average cost pricing, which considers the total costs of producing infrastructure services; or (2) marginal cost pricing, which accounts only for the incremental costs needed to produce an additional unit of services.10 A basic premise behind DIFs is that new developments should pay the marginal cost of providing public facilities necessary to accommodate the growth (Carrión and Libby 2000, 3). Under the marginal pricing method, public officials would first need to determine the location of the central facilities (e.g., major highways or water/sewage plants) and then price the services accordingly. The market would then dictate appropriate and efficient land-use patterns.
Based on this marginal pricing approach, the issue of geographic equity becomes a factor, in that some areas may be more costly to serve than others (HUD 2008, 29). Following this theory, in areas where central facilities already exist in close proximity, the marginal costs would be lower, and if the service areas are densely populated, then the costs would be shared by many and may be even lower. In areas where there are no central facilities in close proximity and the service areas are sparsely populated, the marginal costs could be significantly higher.11 By adopting DIFs and their marginal pricing approach, especially when significant foundational infrastructure is already in place, the current residents are, in effect, helping to ease the burden of future infrastructure provisions by shifting only the incremental infrastructure costs onto new residents; that is, new residents are essentially buying their way into the community (Carrión and Libby 2000, 3).12
An element of geographic equity is related to infill and redevelopment because older areas may have excess infrastructure capacity that is underutilized. Even in places where the infrastructure needs upgrading, the cost can be less per unit of development if infill and redevelopment is encouraged. DIFs might help offset many of the subsidies of new developments that produce a leapfrog urban sprawl pattern that allows developments to skip over land closer to the urban area. In this context, DIFs could be one area where marginal cost pricing could become an issue of local policymaking. More generally, research has found that DIFs may affect the location decisions of residents or businesses if these decisions are highly sensitive to price (i.e., elastic demand; Burge 2012, Carrión and Libby 2000). Businesses may choose to locate in a community without impact fees (mostly in rural settings), which can slow urban growth. DIFs may also reduce the price of undeveloped land because DIFs act as a deterrent to develop open land (Carrión and Libby 2000).13 The irony is that in low-density, growth-hungry rural areas where the marginal costs of providing infrastructure are high, DIFs have generally remained minimal, whereas in high-density, fast-growing urban areas where the marginal costs are low, DIFs have at times reached as high as 20 percent of the property sales prices (Dresch and Sheffrin 1997). This may be the reason why DIF revenues have proven to be an important funding source for capital-intensive public transit facilities in urban areas.14
Social or vertical equity is based on the ability-to-payprinciple, rooted in welfare economics, in which only those who are able and can afford it should pay for public infrastructure. In public finance, the vertical equity consideration calls for the wealthy to pay more than the poor for government provided goods and services. Vertical equity concerns about DIFs pertain to the negative impact of fees on lower income households and property owners. Commentators have noticed that under DIF, vertical inequities can occur in two respects: (1) a flat-fee structure that does not take into consideration the affordability factor and (2) an increase in property prices resulting from DIFs that can price out low-income property buyers.
Although the courts have made it clear that lawful impact fees must reflect proportionate shares, they have also accepted very relaxed approaches, including the common use of flat fees set at average levels applied to every case in the community (HUD 2008, ii). An impact fee can be legally accepted as long as the process for establishing the fee achieves an overall, general correspondence between costs and fees. Unlike real property taxes, however, flat fees tend to have a regressive effect; that is, they fall disproportionately on people with lower incomes than those with higher incomes. Especially when DIFs are set at high levels, they tend to be more regressive.
DIFs based on a flat-fee structure can be horizontally equitable but vertically inequitable. For example, local jurisdictions often assess the same impact fee per unit for parks for all residential dwellings in a given service area based on horizontal equity. If DUs differ by the number of people living in them based on type or size of dwelling, then they do not achieve vertical equity.15 Charging each unit the same flat fee could negatively influence vertical equity, with smaller units overpaying with respect to their occupancy and income levels, and the larger units underpaying.
As was the case with horizontal equity (see chapter 5 for more information), problems with the flat-fee structure can be fixed using a more layered approach; that is, by designing the DIF schedule to vary with land use, facility type, facility size, density, location, and/or configuration. The basic trade-off in fee structuring is between the administrative ease that comes with simplicity in methodology and more accurate and equitable fee structure offered by more complex multilayered approach that can be challenging administratively. One way to deal with the complexity is to integrate DIF structuring into the planning process and to establish multilayered but standardized fee schedules that are transparent and updated on a regular basis. Chapter 6 will present further local jurisdictions can streamline the overall DIF implementation process by legislating the fees into local ordinances.
As presented earlier, DIFs generally raise prices of both new and existing properties more than the amount of the fees. With these price increases, DIFs also negatively affect vertical equity by making properties less affordable, especially for renters who are generally of lower income. The cost burden of properties as a proportion of household income also increases more for lower income households than higher income households (Mathur and Smith 2013, 15). In a competitive market and in the short term, developers would also attempt to pass the DIF costs onto buyers, exacerbating the vertical inequity situation even more.
To remedy vertical inequity, local jurisdictions often establish exceptions to DIF payments in the form of exemptions, exclusions, waivers, deferments, and other financial incentives (HUD 2008, 66—69). Localities give (1) exemptions when new developments do not create new impacts (e.g., converting nonresidential units into residential units with fewer resulting impacts) and (2) exclusions (or reductions) when alternative revenues are available to finance the facilities (e.g., fees are excluded or reduced when Federal and/or State funds are used or when other financing mechanisms—such as community or business improvement districts, empowerment zones, or enterprise zones—are available).
Local jurisdictions also give waivers for all or part of the impact fees on certain, qualifying developments, such as for affordable housing. A growing number of local jurisdictions also offer buyers of affordable housing forgivable loans to use as down payment as an indirect way to waive impact fees (HUD 2008, 68). Because empirical studies overwhelmingly show that developers pass impact fees onto homebuyers or renters,16 such waivers would help lower the housing price or rent for lower income households (Carrión and Libby 2000, 4). In general, smaller properties, such as small offices and commercial establishments, can receive waivers because the owners of such properties are less likely to be able to pay than the owners of larger properties. Finally, impact fees can also be paid in installments as opposed to in a lump sum or at a later stage in the development process. In some jurisdictions, developers of low-income housing are given deferments for as long as 10 to 15 years (HUD 2008, 69).
Determining who ultimately pays the DIFs is needed because, under certain circumstances, developers may be motivated to pass the fees onto others. In a robust real estate market, for example, developers and builders may pass the fees onto property buyers, whereas in a down cycle, developers and builders may be willing to assume some of the costs to lower the price and remain competitive. According to the National Association of Home Builders, it is easier to pass DIFs forward from developers to buyers than backward from developers to landowners. If this is true, then there is the assumption that buyers of new properties will pay the fees through higher prices due to impact fees. On the other hand, if the fee is imposed before developers have had a chance to account for them, developers will have to pay the fee out of their profits.
The strength of housing demand and the availability of similar developable land in nearby localities may affect who will ultimately bear the burden of an impact fee. In general, the relative share of the impact fee that sellers and buyers pay depends on demand elasticities. If buyers of new homes are not price sensitive (i.e., demand is inelastic), they will pay a greater portion of the impact fee. In the short term, both buyers and developers bear part of the burden unless developers offset their share of the fee by reducing lot or dwelling size, quality, and/or amenities (see figure 1).
If the housing demand is strong and not price sensitive (which means the demand is “inelastic” and does not change significantly with the price, as shown by a steep demand curve in figure 1-A), and if there are no substitutable sites in similar markets with a lower fee, then developers will likely still have opportunities to achieve the return necessary to attract institutional financing by passing the impact fee to buyers of the new homes (shown as the larger blue shaded area in figure 1-A), shouldering less of the burden of the fee themselves (shown as the smaller gray area in figure 1-A).
In markets where the housing demand is weak and sensitive to price (which means the demand is “elastic” and changes significantly depending on the price, as shown by a relatively flat demand curve in figure 1-B) and that have substitutable sites in nearby localities without fees, developers and landowners will likely pay more of the impact fee from their profit margin (shown as the gray shaded area in figure 1-B, which is much larger than the blue shaded area borne by buyers) or see a short-term drop in building as few or no developable sites meet the return requirements of developers and investors.
Over time, it is generally believed that owners of developable land will adjust to the fee and accept lower prices, allowing for more housing production. Empirical data show that buyers of both new and existing housing often bear DIFs, particularly those who bought homes in strong economic markets or shortly after implementation of the DIF, with landowners also bearing a portion of the fee in some cases (Raetz, Garcia, and Decker 2019, 21). The share of fees that developers bear and the factors that affect this share are unclear, in part because of a lack of data about developers’ financial circumstances.
Figure 1. Graphs. DIF Burden vs. Demand Elasticity.
9 In Oregon and California, for example, reimbursement districts are often used for this purpose.
10 Public finance economists advocate marginal pricing based on a three-tier charging system that includes (1) a charge for the capital costs of producing the main infrastructure assets (e.g., major highways or water/sewage plants); (2) a charge for the local connections to the main assets (e.g., local access roads or water/sewer lines), which may vary depending on density and distance from the main assets (e.g., residential density and distance from a major highway influence the costs of local access roads); and (3) a charge for actual use based on the short-term costs of producing the infrastructure services (e.g., water meter charges).
11 In San Diego, for example, impact fees in sparsely populated areas can be more than 10-fold higher than those in densely populated areas.
12 This may be one way to justify the windfall value appreciation benefit enjoyed by current residents, as presented earlier.
13 A more recent study found that impact fees paid by commercial developers lower the value of commercially zoned undeveloped land, whereas impact fees associated with utility systems that apply more universally are found to have a uniformly negative influence on land values in general (Burge 2012).
14 For example, the City of San Francisco’s DIF program for the transportation sector, in the form of transportation sustainability fees, is dedicated primarily to improving the city’s public transit facilities.
15 Federal data in 2003, for example, showed that the average household size of units less than 500 ft2 was nearly 2.0, whereas it was more than 3.0 for units more than 2,500ft2. Furthermore, households with higher incomes were more likely to own larger houses. The same 2003 Federal data showed that per capita household income for the smaller unit was $9,950/person but was well over $25,000/person for the larger unit (HUD 2008, 105).
16 By way of higher property prices or rents.
