Tax Increment Financing: Interpretation

The tax increment spreadsheet is particularly useful for trying different financing scenarios for a project. The spreadsheet format allows you to change one or more of the input statements and observe the effect over the life of the bond issue. Since input and calculations are physically separated, you need have no fear of accidentally overwriting a formula. Financing a project is particularly sensitive to interest rates and repayment schedules. The spreadsheet allows you to develop a family of financing schemes based on variations in those two inputs.

The tax increment spreadsheet is also useful for making a first estimate of the feasibility of financing a project with tax increment funds. The spreadsheet will not eliminate the need for a bond consultant: You will probably ask their advice on likely coupon rates, and you will certainly need their help in selling your bond issue for the lowest rate possible. But it will allow to you "ballpark" a project and work out many of the details before you have to call in the consultant.

In working out the tax increment analysis, you want to make conservative estimates of the revenue the project will generate. If you underestimate revenue, it is always possible to retire a bond early; if you overestimate revenue, the shortfall will have to come from general revenue and may lead to a tax increase. The most conservative estimate, of course, would result in never undertaking the project; but that would also mean a loss of the benefits (economic and other) the project might have generated. The trick is to estimate costs and revenues as realistically as possible, and when it is necessary to guess (and only then), guess on the conservative side.

Finally, if you capitalized some of the interest on the project, when you examine the totals at the bottom of the Analysis Table you will find that the debt service payments are larger than the revenues from tax increments. Put another way, your actual payments on the bond issue will be less than the debt that was serviced. This paradox arises because part of the principal was borrowed to pay some of the early interest payments. If you subtract the capitalized interest from the total loan and run the analysis again, you will find that the debt service will be a little less than tax increment revenues. In other words, you paid a little more than you would have if you had borrowed only the cost of the project (and not borrowed any money to pay the interest). You will also notice that you would not have enough money to service the debt in the early years of the project. Rather than asking the city to put in its own money ("equity") to cover the early expenses, you ask the investors to finance that part of the project, too. The investors agree, but charge the city interest on the interest payments made from the loan (i.e., the capitalized interest), and that accounts for the "little more" paid back when the interest is capitalized.

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