Tax Increment Financing (TIF) FAQ

This is a guest post by our summer Fiscal Program intern Cameron Ewine

Tax Increment Financing (TIF) is one of the most widely used local economic development tools in the United States—with over 10,000 active TIF districts across 49 states—yet it receives surprisingly little public attention. TIF is used as a financing mechanism to help provide public infrastructure and incentivize the redevelopment of declining downtowns, aging shopping centers, and economically blighted areas in general. In hopes of bringing more attention to this widely used but little understood policy, this guide explains what TIF is, how it works, the main arguments for it, and why the policy has garnered many critics.

What Is TIF?

Tax Increment Financing (TIF) was first authorized in California in 1952 as a redevelopment financing tool designed to encourage investment in economically distressed or blighted areas, such as abandoned factories or dilapidated housing. The idea was straightforward: Use increases in property tax revenue generated by the redeveloped property over time to help pay for the costs of redevelopment today.

Mechanically, a city or county establishes a TIF district by designating a specific geographic area for redevelopment. At the time the district is created, the existing level of property tax revenue it generates becomes the “base” value. The base property tax revenue continues flowing to the existing taxing jurisdictions, while any increase in property tax revenue—the tax increment—is redirected to repay the debt incurred to finance the redevelopment.

Because those incremental tax revenues would otherwise have been available to schools, counties, libraries, fire districts, or other local governments once property values increased, critics point out that TIF diverts revenue away from public services.

TIF is authorized under state law, so every state has its own rules governing how the program operates. Individual state statutes differ on issues such as how long districts may remain in place, whether eminent domain may be used, and what types of projects may receive TIF funding. Arizona is the only state without a traditional TIF statute after its own version of the redevelopment financing mechanism was ruled unconstitutional.

How Does TIF Work?

An example helps illustrate the basic concept.

Suppose an abandoned factory currently generates $100,000 per year in property taxes. After the factory is redeveloped into a mixed-use commercial property, annual property tax collections rise to $400,000. The original $100,000 continues flowing to the existing taxing jurisdictions, while the additional $300,000—the tax increment—is redirected to finance redevelopment costs within the TIF district.

Municipalities generally finance TIF projects in one of three ways. Which one of them is used depends on multiple factors such as the local municipalities’ rules, the tolerance for risk, and the individual states’ TIF statute. The three methods are as follows:

Debt-financed TIF districts are the most common. This financing method involves issuing municipal bonds to provide developers with funding upfront. The city issues bonds backed by anticipated future tax increments and uses the proceeds to finance redevelopment. Once the project begins, tax increments go toward repaying the debt. This approach allows large projects to begin immediately but exposes local governments to financial risk if future property tax growth falls short of projections. If the TIF district doesn’t generate enough revenue to repay the initial debt, it is called an underwater TIF.

Pay-as-you-go TIFs are less risky because redevelopment occurs first. Rather than borrowing against future revenues, the municipality reimburses the developer over time using tax increments as they are collected. Note that states and municipalities have different stipulations on what specific costs TIF money can be used for.

Tax-rebate TIFs, which are used much less frequently, require property owners to pay their taxes normally before the municipality rebates the incremental portion back to the developer. In practice, this arrangement resembles a property tax abatement more than a traditional TIF. The main difference between this and a pay-as-you-go TIF is that the local government doesn’t require the same oversight of how the increments are spent.

Who Actually Pays for TIFs?

Existing property owners within a TIF district continue paying the same property tax rates they otherwise would have. TIF does not involve directly increasing tax rates. Instead, the expectation is that redevelopment will increase property values and, in doing so, property tax revenues.

Rather than flowing to schools or other local governments, the incremental tax revenue is redirected toward redevelopment costs within the district. In the case of debt-financed TIF districts, the increment goes toward repaying incurred bond debt.

What Can TIF Money Be Used For?

As the previous paragraphs have suggested, a recurring theme with TIF is state variation. Most states restrict TIF revenues to public infrastructure projects such as roads, water systems, sewer lines, and sidewalks. Other states permit TIF revenues to finance certain private development costs as well.

In both cases, instead of requiring a developer to pay for the necessary infrastructure improvements that accompany a large project, TIF subsidizes these costs. As a result, developers bear fewer redevelopment costs while future property tax growth is redirected away from other local taxing jurisdictions. In cases of true economic blight, this may be a necessary tradeoff to create real growth opportunities. But the reality is that there are many examples of TIF districts in areas that are far from blighted—areas that have been experiencing consistent property value growth.

Which States Use TIF the Most?

Although TIF is a state-level policy, the Midwest is a relative hotspot for TIF districts. There are some theories for why this is the case, such as the region’s older industrial infrastructure, strict state laws that give municipalities localized control, and a heavy reliance on local property taxes to fund urban renewal. However, a current and comprehensive study is necessary to discern the real drivers of TIF adoption. Beyond the two available state reports from Iowa and Nebraska, comparing TIF use across states becomes difficult.

According to the most recent available state report, Iowa has approximately 4,194 TIF districts. This is by far the largest number of any state. In that same report, Iowa local governments reported a total of $4.68 billion in outstanding debt that they expect to repay with future TIF revenue.

The lack of transparency surrounding TIF is one of the major criticisms the policy faces at the local level. When a sizeable portion of future property taxes that would otherwise go to schools and public services is diverted, taxpayers understandably want to know where it is being spent. Unfortunately, reporting requirements vary widely across states, making it difficult for taxpayers to determine exactly how TIF revenues are being spent.

What Are the Main Arguments for TIF?

• Correcting Market Failures: Some areas remain underdeveloped because redevelopment costs exceed expected private returns. Contaminated land, demolition costs, and infrastructure requirements can all limit private demand for development. Government subsidies may help bridge that financing gap.

• Meeting the “But For” Requirement: This is the idea that if it weren’t for the government subsidy, the project would never happen. Many state statutes require municipalities to make this finding before approving a TIF district.

• Self-Financing Economic Development: Supporters argue that TIF is essentially free because it does not raise taxes. Instead, it redirects future tax growth that they argue would not exist without redevelopment.

• Promoting Redevelopment and Equity: TIF can direct investment toward neighborhoods suffering from decades of disinvestment. Areas that have been historically blighted, for whatever reason, can be given a fair shot at redevelopment.

What Are the Main Criticisms of TIF?

• Difficulty Verifying the “But-For” Requirement: Verifying that development would not take place but for subsidies is extremely difficult because governments cannot directly observe what would have happened in the absence of the subsidy.

• Encouraging Cronyism and Political Favoritism: Critics argue that TIF can encourage rent-seeking by giving developers an incentive to lobby local officials for subsidies rather than competing on market fundamentals.

• Failing to Materialize or Cover Costs: If local governments use municipal bonds to finance TIF districts, there is a chance the bonds will fail to generate sufficient tax increments to repay the debt. TIFs that do not raise the necessary tax revenue to repay their debt are called underwater TIFs.

• Diverting Tax Revenue That Would Have Been Generated Anyway: When TIFs are used in areas that are not truly blighted, TIF captures tax increments that would have occurred anyway, effectively pulling funding from public services for unjustified reasons.

• Displacing Rather Than Creating Economic Activity: This is a major criticism of retail-based TIFs. If TIF is used to fund a new mall in one area of town, nearby shopping centers may see lower demand at their own stores. Consumer spending is often shifted rather than expanded, with online shopping also creating constant competition. All of this leads to a cannibalization effect in which little or no new economic activity is created and instead is shifted from other areas at taxpayers’ expense.

In my next article, I’ll examine Iowa’s FY25 annual urban renewal reports to see whether TIF is achieving its original goals of revitalizing blighted areas, self-financing, and correcting market failures.