Minadeo, Timmons, & Morris 2009

Does Growth Pay?
A Measure of the Impact of Growth in the
Residential Housing Sector

Executive Summary
When a community experiences growth, there are many associated benefits. An increase in the population of a community translates into increases in the demand for the existent housing and increases in housing starts in the area. The appreciation of residential properties along with the new development provides the community with benefits such as increases in property tax revenues and fee based incomes from required building permits provided by the growth. Increases in population bring in a greater amount of shared state and federal revenues and increases in consumption tax revenues to the communities among other benefits. Though many have focused on the benefits, there are also costs that are associated with growth. A unique aspect of our article is the application of capital budgeting analysis as used by corporations. This methodology takes the time value of money into consideration, a process we do not find in other models devoted to the analysis of residential growth. This study uses cost-benefit analysis to question whether the benefits associated with growth outweigh the costs or do current residents become the net losers. In the event that costs exceed benefits, the excess costs should be used to determine an appropriate impact fee.

Introduction
This study uses cost-benefit analysis based on a methodology which takes the time value of money into consideration to determine whether new residential growth pays its own way. The model outlined in this article applies the corporate technique used to evaluate investment projects – capital budgeting analysis. The cost-benefit analysis involves identifying and allocating an array of tax flows, capital costs, and operating costs which are collected on either a per capita or a per household unit basis. The allocation approach is performed to determine if the discounted aggregated costs are covered by the discounted benefits attributable to new residential growth. Alternatively stated, what is the net present value or net effect of new residential growth (the present value of development benefits less the present value of development costs)?

There are three possible outcomes in this examination. First, the net effect of new residential growth could be found to be zero, this would mean that total discounted benefits from the inflow of fees, taxes, and revenues equal to total discounted costs. New residential growth funds its own way. Second, the net effect of new residential growth could be positive meaning new residential growth is beneficial paying more than its fair share. Finally, new residential growth could have negative net effects. If so, the shortfall of benefits to costs means new residential growth is either subsidized by current residents who as a result of the growth are subject to higher taxation, diminished services, or reduced quality of life. This may suggest the need for an appropriate impact fee to be levied by the municipality.

Zoning, administrative, and fiscal decisions based on a quantifiable cost-benefit methodology should be fair, unbiased, accurate, and defensible. Residential growth costs are of particular interest when affixing fees and establishing property tax rates. Reliable measurements of the cost of new residential growth should be of value to governmental agencies, urban planners, tax payers, and developers, as well as current residents.

Cities and regions grow because they have various competitive advantages over other areas (Floyd and Allen 2005, p. 322.). These advantages create employment opportunities that attract migration. However, growth does not occur without impetus from many players. Government officials at the state and local levels have to establish a climate for growth and opportunities for investors to earn a fair return on their investments. Planning commissions often establish a master plan for their jurisdiction via zoning, designating land for various usages including both commercial and residential use. Developers analyze the costs, political climate, incentives, and return on investments before deciding to undertake construction, whether it is a residential community, an office, or an industrial park.

There are many benefits associated with growth. Benefits of growth could include the influx of capital providing for startup expenses and/or construction activity for new office or industrial facilities, and increases in employment to satisfy additional labor requirements. Increased consumer spending and an expanded tax base occur when additions are made to the labor force. An increase in county population requires more residential housing and new residences bring further benefits to the county coffers. Residential property taxes account for a large percentage of a county’s annual receipts. A county will also receive funding from state and federal revenue-sharing programs that are population driven.

Growth, residential growth in particular, does not occur without costs. An increase in a county’s population may mandate upgrades in road networks and require additional schools to handle the influx of new students. Residential growth will ultimately require that water and sewage facilities be constructed or their capacities expanded to handle new residents. Additional police, fire fighting, and other county facilities and services may need to be enhanced to meet increased demands associated with growth.

Unless new development provides economies of scale in the delivery of public services and/or the provision of public infrastructure it will be the current taxpayers who subsidize growth. These subsidies could be in the form of higher taxes, additional bond obligations, or the detrimental affects of under-funded, growth-crowded schools, diminished services, and congested thoroughfares. In this study, no attempt has been made to account for the quality of life issues associated with the detrimental affects associated with growth. Only the fiscal costs and benefits are taken into consideration, and studies such as Axelrad (1998) and Burchell (1997) show that the costs and benefits can differ based on the amount of sprawl associated with the residential development.

Government policies, incentives, and the quality of life in the community nurture increased economic activity. The current analysis considers the various factors of residential growth in order to determine how the benefits of growth compare to the costs. Results from this analysis can provide the information government officials, developers, and planning commissions deem necessary to make informed decisions when analyzing the impacts of residential growth in their own communities. Elected officials can use the guidelines used in this analysis to evaluate the costs of growth. Implementation of the modeling technique used in this analysis by regional planners or government agencies should prove useful in determining an efficient and equitable structure for residential-related permits, impact fees, and taxes.

Literature Review
Examination of the economic and urban planning research reveals many articles and studies in which cost-benefit analysis has been used. Most of these studies, particularly in the field of economics, have only identified the impact on the economy based on population growth and the additional demands for taxpayer funded services associated with a growing community. Irwin and Kraybill (1999) argue that the net effects of development are important and will differ with the demographics and planning of each particular community. There is a vast literature on the application of cost-benefit analysis including: Freeman, Niemi, and Wilson (2001); Fuguitt and Wilcox (1999); Gramlich (2002 1990); Nas (1996); among others. This study contributes to the fundamental theory of cost-benefit analysis by applying the time value of money to the issue. Discounting the anticipated costs and benefits associated with growth to obtain a net present value approximation, this study’s estimate of the net effects of residential growth is done in order to address the appropriateness of impact fees.

Careful consideration should be taken before impact fees on new development are put in place. Impact fees are known to inhibit development and have a larger impact on lower cost residential development. Skidmore and Peddle (1998) argue impact fees lead to a 25 percent reduction in the rate of residential development. However, other findings refute their argument.

Numerous articles (Burchell 1997; Burchell et al. 1998) focus on the costs and benefits of development as they differ with land use and sprawl. In these articles, as well as Calavita, Grimes, and Mallach (1997), the effects of regulations including the implementation of impact fees are addressed. Calavita et al. (1997) argue that development impact fees which increase the cost of development are typically ultimately borne by land sellers in the form of reduced price rather than having an effect on market prices or production. Whereas, Burge and Ihlanfeldt (2006a, 2006b) find that while impact fees do not have a significant impact on construction rates in rural or urban areas in suburban areas they do significantly increase the stock of housing. Burge, Nelson, and Matthews (2007) conclude impact fees in suburban areas can help to meet growing housing needs, help to increase the availability of more affordable housing, and facilitate infrastructure improvements needed to sustain economic growth.

Several other studies have examined implications of impact fees on new development or projects, some of these include: Frank and Downing (1996), Kolo and Dicker (1993), and Levine (1994). As noted by the literature, there are a variety of stances on the appropriateness of impact fees and the impacts on communities considering the adoption of such policies when faced with projects that stem from residential growth.

Projects are defined as any government action, including a law or regulation that causes a change in the status quo. A project could also be the construction of a new highway, repair of an existing bridge, new development, or any action that changes the productive capacities of an economy or the distribution of resources. To evaluate a project, a comparison is made of the future or ‘the world with the project’ versus the world without the project or ‘status quo’ (Freeman 2001).

In 1988 the American Planning Association published the widely used book, Development Impact Fees: Policy Rationale, Practice, Theory, and Issues. This book contains a chapter titled “The Rational Nexus Test and Appropriate Development Impact Fees” by Nicholas and Nelson that addresses cost and benefit analysis used to determine an impact fee sufficient to fund new growth (Nicholas and Nelson 1988). The impact fees are based on new construction and focus on the difference between the costs which are directly attributable to new residential growth and the benefits associated with that same growth. The key phrase is “directly attributable”, such as additional facilities, infrastructure, or services required to support these additional residential units.

Wolfson (2001) describes true cost-benefit analysis as a narrow class of procedures that evaluates policies in terms of net benefits provided to individuals. Ideally, benefits and costs of a particular project or policy measure can be listed and valued, eliminating all double counting. Benefits are usually defined solely in terms of the change in individual well-being the policy induces, and costs are generally measured in terms of monetary costs of resources required to implement the project. One performing this sort of cost-benefit analysis arrays the benefits of a project or policy change against the costs, with everything valued in a common metric, and makes a decision about the change based on the difference.

Ross and Thorpe (1992) quantified impact fee calculation processes. Two methodologies for calculating impact fees—inductive and deductive—were discussed. The inductive methodology process, similar to the methodology used by Nicholas and Nelson (1988), utilized calculations based on the cost and capacity of an existing facility such as a water sewage treatment plant or a roadway, and used that facility as a model to determine the fees for future facilities mandated by growth. The deductive calculation method involved calculating the impact cost by determining the additional demand on a facility or infrastructure such as a road, sewage facility, or school caused by additional population.

In theory, impact fee determination identifies where a shortfall exists between benefits and costs. In reality many municipalities assign impact fees in perception of the cost of new growth. The assignment of the fees may be somewhat arbitrary in nature. The cost-benefit analysis performed in this study will determine the appropriateness of an impact fee.

The legal aspects of cost-benefit analysis-derived impact fees are outlined in the rational nexus test. This test necessitates that there must be a reasonable connection between community growth that new development generates and the need for additional facilities to serve that growth. State courts increasingly base the validity of impact fees on this type of analysis. Cost and benefit analysis identifies these parameters and any shortfall in benefits over costs is the resulting and legally defensible impact fee.

The approach taken in this study does not deal specifically with impact fees; however, the impact fee is relevant in determining what costs and benefits are associated with new residential development. This paper consolidates methodologies used to determine capital costs and operational costs in order to conduct a cost-benefit analysis of new residential growth. This is done to determine whether or not an impact fee is necessary to compensate for the cost-benefit differential attributable to new residential growth. Existing residents will in essence subsidize new development if the discounted cost of growth is greater than the discounted benefits. Otherwise, an impact fee is unnecessary. Growth pays its own way.

Determining Cost-Benefit Factors Associated with Growth
Cost and benefit analysis in finance is one of the major tools used to analyze competitive projects, and the process can be adapted to compare the costs and benefits associated with residential growth. This article will modify and improve the analytical process by concentrating on the cost and benefit determinants of residential growth and by treating this growth as a competitive condition.

To determine whether growth pays its own way, both the additional benefits of new residential growth and the additional costs necessary to support the new growth must be identified and measured. The costs and benefits should then be discounted to take into account the time value of money. Finally, these discounted costs and benefits are compared.

The cost associated with, or required to support, new development can be broadly categorized as capital costs and operating costs. Typical capital costs would include additional infrastructure required by growth (sewage plants and water facilities), governmental and educational facilities, as well as obligations necessitated by the expansion of existing infrastructure to handle the increases in population. New feeder or linkage roads not funded at the state or national level and upgrading existing roads to handle increased usage would be another example of a capital expenditure.

School construction costs are derived using per-student costs based on the latest county school construction costs and student capacity, or the per capita debt obligation for school capital projects in the most current county budget. Capital costs for road usage attributable to new development are determined based on average single-family usage standards established by the Institute of Traffic Engineers. Additional requirements for public safety and county facilities will be determined by setting average costs per capita equal to marginal costs per capita and deriving facility costs shares.

Operating costs include funding day-to-day operations of the government, maintenance and upkeep of facilities, augmentation of public safety and educational services needed to support new development, as well as interest expenses on borrowed funds used to pay for capital items necessitated by growth.

Benefits are derived from revenues generated from the construction of the developments such as the additional tax flow resulting from the development’s property taxes, which increase the tax base. Residential property tax revenue from the developments, to include privately owned single- and multi-family residences, will be received annually and many times can be expected to increase due to real property appreciation in cases where growth brings with it an increase in the quality of life (Heimlich and Anderson 2001, pg. 29), or increases in the tax rate. Estimates of property appreciation should be based upon recent history and future expectations, and tested over a plausible range of projections as the analysis is sensitive to appreciation rates.

In addition, greater population and the resulting increase in consumer spending within a municipality will expand the allocation of various state tax collections to the localities, such as the state sales tax and gasoline taxes when these new residents purchase products and services within their municipality. Thus, new residential growth provides the municipality with an increased share of population-based revenue, e.g., sales tax and wheel tax. Economic benefits associated with residential growth are best measured in terms of tax revenue generated from new housing units.

Those using the model will be required to determine an appropriate time period to analyze residential growth, and this growth involves costs and benefits occurring at different times. One of the processes used in cost and benefit analysis is the comparison of factors valued in a common metric. The values of these costs and benefits should be expressed in terms of ‘constant dollars’, which represents the present purchasing power of dollars without building in inflation. Using present value, or constant, dollars ensures that all costs and benefits are measured in dollars with the same purchasing power.

In order to obtain a constant dollar value, present value computations are used with present value defined as: the value of the factors in today’s dollars of future payments or expenditures discounted back to present using a specified or derived rate of return. Because costs and benefits occur over a number of years, present value computations are necessary to perform comparative analysis. Before these analyses can be undertaken, a discount rate and time period must be determined.

Selection of a discount rate can have a decisive impact on whether the cost and benefit analysis favors current residents or new growth. When discounting occurs, the future benefits decline in comparison to present costs. A large discount rate lowers the value of future benefits, and with future benefits producing smaller results the onus of growth could fall on current residents. Conversely, a lower discount rate creates a higher present value of benefits possibly unfairly favoring new growth. Thus, a sensitivity analysis may be needed to fully understand the impact of residential growth.

Since capital projects necessitated by growth within a municipality could be funded with long-term general obligation debt (bonded debt and notes), taxation or a combination of both, this article considers a discount rate equal to the Federal Office of Management and Budget estimated cost of public funds of 7 percent (OMB, No. A-94, 2002). Even though 7 percent appears to be a reasonable rate, the model is tested over a range of discount rates.

An appropriate time period must be specified and this time period is usually the number of years that funds are borrowed or the life cycle of a capital project or facility. One way of choosing a time frame for evaluation is to pick a time interval that is closely related to the long-term general obligation debt (bonded debt and notes) that are used to finance infrastructure growth and improvements OMB, No. A-94, 2002).

Determining the discounted present value of a stream of annual cash flows from taxes paid and income generated from new development provides the benefits obtained from new development – an approach unique to this study. Offsetting these benefits will be the discounted costs, both capital and operational. Table 1 provides a list of the growth related costs (both capital and operating) as well as benefits to be addressed in this analysis. This model should have universal application to any growth-oriented community.

Cost-Benefit Analysis
The hypothesis offered for this article is that current residents subsidize new residential growth. After identifying the costs associated with residential growth and the benefits gained from it, the hypothesis will be tested using a variety of discount rates in conjunction with an estimated and nominal property appreciation rate. If the results from the model show that benefits equal or exceed costs, then the hypothesis is rejected as growth pays its own way. If costs exceed benefits, then the hypothesis will be accepted as true.

The discounted costs and benefits are calculated in order to estimate the net effects of new residential growth. The estimated cost, X, expressed as a present value (PV) is derived in the following manner:

If the hypothesis is rejected, then the benefits of new residential development exceed the costs and growth is deemed beneficial. This suggests that there is no need for impact fees to be imposed. If the hypothesis is accepted, then the benefits of new residential growth are less than the costs, leaving existing residents to subsidize new growth or providing an appropriate determination of an impact fee.

Rutherford County Example
To demonstrate how our model might be used to determine whether residential growth pays for itself, the model is tested on a fast growing county in Tennessee. Rutherford County is a county in the Middle Tennessee area that has experienced a vast amount of growth over the past couple of decades. During the 1990-2000 decade, the county population grew 53.5 percent and ranked as the 73rd fastest growing county in the entire country. Along with the population growth, total personal income measures in Rutherford County have grown from $158,723,000 in 1970 to $4,761,390,000 in 2000. Thus, per capita income increased from $2,704 to $25,953 over this thirty year period. When adjusting per capita income for inflation, annual real per capita income measures are obtained. A linear trendline fitted to the inflation adjusted per capita income measures from 1970 to 2000 shows real per capita income has increased by approximately $234.54 per year.⁽¹⁾

Population projections from the University of Tennessee, Knoxville estimates Rutherford County population at 263,701 in 2020 (CBER 1999). Interestingly enough, another study from the University of Tennessee projects population by 2025 to be 318,583, representing 75 percent growth from 2000 – 2025 (Hensley 2003).

Costs and benefits will ultimately be translated into per-household measures. In some instances per capita measures must be converted to per-household measures. This is where average household estimates play an important role. The 2000 census average household size estimate for Rutherford County is 2.65; however this measure may be somewhat underestimated to portray the effects of new residential growth. Established neighborhoods typically are composed of older residents with fewer school age children. However, new residential development, in most instances, is composed of couples with a family size larger than the 2.65 estimate or couples who plan on having children. Therefore, this analysis’ per household measure of 3.5 is based on an estimated 1.5 students per new household. ⁽²⁾ It is important to note the per-household cost and benefit calculations are sensitive to the household size measure used in the example.

In conducting the cost/benefit analysis for Rutherford County, the capital and operational costs as well as the associated benefits of residential growth identified in the theoretical model are taken into consideration. The present value of the costs and benefits vary based on the specification of the discount rate and household sizes used in the derivation of said costs and benefits. Thus, after spelling out the derivation of the capital costs, operational costs, and benefits a short sensitivity analysis will be conducted.

Capital Costs
Cost and benefit comparisons for growth analysis start with cost estimates for capital projects required to support new developments. Perhaps the best determinant of future capital costs are today’s capital costs, if the cost of the last similar capital project was recent. Capital costs included in this study include schools, water treatment, roads, and public safety.

School Capital Costs

School capital costs are based on the educational capital projects initiated by the Rutherford County Board of Education as detailed in the 2003-2004 budget.⁽³⁾ Additional costs attributable to school facilities are renovations and improvements and these items are treated by Rutherford County as capital projects. This study uses the schools capital cost budget less renovations and improvements since maintenance on existing facilities is not directly tied to new residential growth per se.

The 2003-2004 amounts budgeted for educational capital projects, excluding renovations and improvements, were $25,800,900. The assumption made in this analysis is that school capital expenditures take in to account only projected growth and that schools are currently operating at capacity. If any of the budgeted expenditures are to rectify currently inadequate facilities, it will lead to an overestimate of the school capital costs associated to new growth. The population increase for Rutherford County from 2002 to 2003 as reported by the Census was 6,562. The household size estimate associated with new growth used previously by Rhody (1995), 3.5 persons per household, is used to obtain an estimated per-household school capital cost of $13,761.53. The school capital costs can be financed through the use of 20 year municipal bonds, if so; an average annual cost of growth attributable to school capital expenditures is $688.08.

Water and Wastewater

Water and wastewater costs are allocated on a per household basis. Per household water and waste treatment facility costs are broken down into three broad categories as shown on Table 2. Total capital improvements costs for water and waste treatment facilities are estimated to be $6,069.84 per household. Again, the capital expenditure is assumed to be funded through the use of 20 year municipal bonds at an annual cost per household of $303.50.

Roads

Another major capital expenditure is for roads mandated by new residential growth. These roads are commonly referred to as linkage roads because their construction or expansions are necessary to link a new development site into an existing thoroughfare that does not require upgrading. The State of Tennessee, Department of Transportation, Mapping and Statistics Office, puts the cost of a two-lane urban highway, used as a linkage road to a main access roadway with a capacity of 18,700 vehicles per day, at approximately $1.5 - $1.9 million per mile. Additional costs associated with this urban construction would include $100,000 per mile right away costs, $100,000 per mile utility adjustments, and $300,000 for each two-lane bridge constructed.⁽⁴⁾

Of course, requirements for new roads to support residential development vary from county to county. Sparsely populated counties could require the construction of longer linkage roads than would a metropolitan county. The Department of Transportation estimated the average linkage road in Rutherford County would be 1.7 miles long. Accordingly, the estimated cost per mile is approximately $1,285,294 or $243.43 per lane foot.

The Institute for Transportation Engineers (ITE) reports that the typical single-family home generates 10 trips per day, with an average length of approximately 5 miles. The lane feet of road used per household is used to determine the cost per household of building roads necessary to serve growth. This yields an estimate of 14.12 lane feet of roadway per household having a cost of $3,436.66.⁽⁵⁾ Twenty year long-term general obligation debt (bonded debt and notes) are used by Rutherford County to finance capital infrastructure growth and improvements. Thus, dividing the per-household costs by 20 results in an average yearly capital road cost estimate of $171.83 per household.

Public Safety and Services

The last capital cost measures in the model encompass the additional police car and ambulance needs that arise in support of new residential growth. The demand for police cars and ambulances are based on county population measures.

While there is no national consensus on a standard for the number of patrol cars, the International Association of Chiefs of Police (IACP) recommends coverage of one vehicle per 1,000 residents. Rutherford county police coverage closely approximates this IACP recommended coverage rate. The average patrol car has a 3 year life, costs $23,000, and has a salvage value of $4,600.⁽⁶⁾ The cost of the vehicle, less the salvage value, has to be amortized over the three-year life of the vehicle yielding a yearly per capita cost projection of $6.13 or $21.46 per household.

Ambulance coverage is based on either population density or, in sparsely populated areas, response time. Ambulance coverage within Rutherford County is one vehicle per 20,000 residents. The average ambulance has a 5-year usable life, costs $95,000⁽⁷⁾, and has a salvage value of $42,600. The cost of the vehicle, less the salvage value, will be amortized over the vehicle’s 5-year life. The yearly per capita cost for ambulances is $2.62 or $9.17 per household.

Operating Costs
There are operating costs associated with residential growth. These costs are categorized as school, non-school, and public safety costs. The public safety costs include the costs of operating police cars and ambulances. In this example capital and operating costs are considered separately, therefore, the operating costs exclude funds earmarked for capital outlay.

Schools

Rutherford County’s budgeted education expenditures for fiscal year 2003-2004⁽⁸⁾ were $152,502,139. The combined Federal (2 percent), State (52 percent), and County (46 percent) revenues allocated for schools make up the budgeted expenditures. In the determination of operating expenses, the amount earmarked by the county for capital outlay, $133,000, must be subtracted. Subtracting this amount from the county’s portion of the school budget gives the amount of school operating expenses to be funded by the county, $69,781,454.

The marginal per-household cost for school operating expenses will be set equal to the average cost per household resulting in an extremely conservative estimate of the per-household marginal cost for education operating expenses.⁽⁹⁾ For the purposes of this study, we will assume that all students are taking advantage of the county’s public school system. The county’s portion of school operating expenses divided by the estimated number of households (66,443) yields a per-household average education operating cost of $1,050.25.

Operating Costs Other than Schools

There are seven other operational categories separately funded under the Rutherford County, 2003-2004 budget. The funding for each operational category is listed on Table 3. The total budgeted funds less Federal and state revenues leaves the county’s share of budgeted expenditures at $83,646,723. The annual average per-household cost (based on the 2003 household estimate of 66,443 households) for the non-school operating expenses was $1,258.92.

Public Safety Equipment

The operating costs associated with police and ambulance service required to support population increases due to development have to be determined. The average police car has an annual fuel and maintenance cost of $3,895 while supporting 1,000 new residents.⁽¹⁰⁾ Thus, the resultant annual operating cost associated to police cars was $3.895 per person or $13.63 on a per-household basis. The operating costs for an ambulance to provide services to 20,000 residents are $1,782. This yields an annual operating cost of $0.09 per person or $0.31 per household. This yields a total of $13.94 for operating costs as related to public safety equipment calculated on a per household basis.

Benefits
Rutherford County’s annual budget addresses a number of revenue inflows (benefits). Some of these inflows are addressed directly by growth; some benefits must be extrapolated from the revenue stream. Extrapolation will be determined by setting per-household marginal benefits equal to average benefits (revenue stream divided by county population times family size). Revenues include: local property taxes; license and permit fees; fines, forfeitures, and penalties; charges for current services; other local revenues; fees from county officials; state revenue; federal revenue; other government and citizen groups.

Taxation Rate and Appreciation Schedule for Rutherford County

In 2002, the Rutherford County commission levied the certified tax rate of $2.51 per $100 of assessed value, down from the pre-reappraisal rate of $2.78 per $100 of assessed value. The county subsequently raised the property tax rate $0.29 to the current rate for 2003-2004 of $2.80 per $100 of assessed value. Additionally, there have been 14 instances in the last 29 years where property tax rates in excess of the certified rate have occurred, resulting in an average annual increase of $ 0.135/100 dollars of assessed value. For this article, the tax rate will be assumed to increase $ 0.135/100 dollars annually, though this is a historical average and is subject to change as property values increase.

If the certified rate were the only property tax rate used, there would be no need to include property appreciation in this analysis. The addition of the incremental advances caused by a tax rate in excess of the certified rate necessitates the inclusion of the appreciated property valuation in present value computations. However, the model is tested to determine how sensitive the results are to the inclusion of property appreciation.

Property Taxes

Property values are reappraised on a 4 year cycle in Rutherford County. The average price of a new home used to compute residential property taxes was $137,999, with an estimated annual appreciation rate of 3.21 percent. The current county property tax rate was $2.80 per $100 of assessed value, with assessed valuation based on 25 percent of appraised value. An increase of $0.135 was added annually, reflecting the average increase in the residential tax rate in excess of the certified rate.⁽¹¹⁾

Shared Revenues

Taxes received from Federal and State governments include revenue earmarked, for the most part, for education. Shared revenue includes the county’s share of state sales tax, wheel vehicle taxes, and other revenue. These four categories of taxes will increase as the population increases and are, therefore, a benefit attributable to new residential growth. Rutherford County’s revenue projections for Fiscal year 2004 and their associated per capita revenue measures are presented in Table 4. Based on the new growth household size estimate of 3.5 used in this example, the shared revenue measure totals $2,714.18 per-household.

Rutherford County Schedule of Permit and Inspection Fees

The following fee schedule applies for Rutherford County and will be used in the computational process for the benefits portion of the cost/benefit analysis. These fees are not a flow of dollars; rather, they are only paid one time. Fees are based on the average home price of $137,999, the price used as the base price of housings.⁽¹²⁾ Though it is understood that impact fees are charged in Rutherford County, the goal of this paper is to determine whether an impact fee is indicated. Thus, the impact fee is not included in the average fee revenue estimates on Table 5.

Results
After analyzing the costs and benefits associated with new residential growth, the present value computations associated with each must be made. Present value are computed based on the Office of Management and Budget estimated cost of public funds of 7 percent for the discount rate, and the present value of all costs and recurrent benefits will be calculated over a 20-year period. Obviously, discount rates may vary. In order to test the model’s sensitivity to the discount rate, alternate discount rates are considered. Table 6 displays the resultant measures.

The results presented on Table 6 suggest that residential growth in Rutherford County pays for itself.⁽¹³⁾ That is the cost-benefit analysis shows that the benefits of growth such as the shared revenues, property tax revenues, and one time fees realized by the county due to the growth outweigh the costs associated with the growth. There are many assumptions that were made in this study that could potentially reverse this outcome such as smaller average household size, smaller average property appreciation rates, etc. If it were determined that growth did not pay for itself, an analysis of this nature could provide a basis for the determination of an appropriate impact fee.

Note: The results of this analysis are sensitive to the average household size and the property appreciation rate used. Thus, a sensitivity analysis adjusting these measures has been included in the Appendix.

For the interested reader, a sensitivity analysis has been included in the Appendix. On Table A6.1, the estimates are based on the 3.5 person average household size with no property tax appreciation and continue to yield positive net impacts associated with new residential growth. However, when using the household measure of 2.65 as reported by the Census, differences are seen in Tables A6.2 and A6.3 where estimates are based on a property tax appreciation rate of 3.21% and 0%, respectively. On Table A6.2, the net impact of growth is indeterminate alternating from positive to negative as the discount rate used in the estimation is increased. On Table A6.3, net impacts of growth are negative for all discount rates considered.⁽¹⁴⁾

Conclusions
The hypothesis tested is that current residents subsidize new residential growth is rejected for the Rutherford County example. This study builds upon traditional cost – benefit analysis by offering a methodology which employs time value of money concepts in order to approximate the net effect of residential growth. In the Rutherford County example, the comparison of capital and operation costs versus the benefits associated with new residential growth has benefits exceeding costs. If costs had exceeded benefits, new growth would be supported by current residents either paying higher taxes, experiencing reduced services, or a combination of both.

The types of taxes levied, the amount of taxation, as well as the reduction or elimination of county services are political decisions. This article was not designed to develop courses of action; rather, it was designed to present a methodology to address the need for impact fees. The Rutherford County example employs this methodology providing results indicating the benefits of growth outweighed the cost. It is understood and shown through sensitivity analysis that results could differ as area specific economic conditions change. The model presented in this paper can provide cities and counties a rational approach for evaluating whether residential growth pays for itself.

1 The Core CPI measures used to calculate the real per capita income measures over the 1970 to 2000 period was all items less food and energy available from the Bureau of Labor Statistics. Using the CPI data, the per capita measures were converted to 1982-1984 dollars.

2 The household size measure was previously used by Rhody (1995).

3 Rutherford County, Tennessee, Department of Budget and Finance (2003).

4 Tennessee Mapping and Statistics, Allen (2002).

5 The lane feet per household per day is calculated by multiplying the number of trips per day by the average trip distance (measured in feet) with the resulting value divided by the road capacity expressed as vehicles per day, 18700.

6 The average cost measure and salvage values are taken from Rutherford County Department of Finance (2003) and Hopkins (2003), respectively.

7 Hopkins (2003).

8 Rutherford County Tennessee Budget (2003).

9 If the county’s school system is already operating at capacity, setting the marginal cost equal to the average cost per household would tend to understate the capital costs and operating costs associated with schools. Conversely, if schools are not operating at full capacity, the cost per additional household are minimal as is the case with roads and other public services (Irwin and Kraybill 1999).

10 Rutherford County, Tennessee, Department of Finance (2003).

11 Using the Office of Management and Budget estimated cost of public funds of 7 percent for the discount rate in the 20-year present value computations, gives a discounted cash flow of $17,508.48 per single family home.

12 Rutherford County Tennessee Codes (2004).

13 Additional costs and/or benefits may be found suitable for the completion of a thorough cost benefit analysis. This paper lends an example of a methodology that could help in addressing the appropriateness of levying an impact fee and if so the magnitude of the imposed fee.

14 Although prior research suggested the use of 3.5 as the average household size in new development, recent evidence from the American Community Survey reveals that new residents have lowered the average slightly, underscoring the importance of population assumptions to the analysis

Appendix
A sensitivity analysis has been performed altering the household size and property tax appreciation rates used in the Rutherford County example. The results presented on Tables A6.1, A6.2 and A6.3 show that the results are sensitive to the assumptions of property appreciation and household size. This further highlights the sensitivity of the estimates to the discount rate.

Note: The results are based on an average household size measure of 3.5 and no property appreciation.

Re-estimation of Tables 2 and 4 is needed as household size measures assumptions are changed from the 3.5 value to the 2.65 Census estimate. The results are presented in Tables A2 and A4 and are used to get the average annual values presented in Tables A6.2 and A6.3.

Note: The results based on an average household size of 2.65 and a rolling 4 year 3.21% property appreciation rate.

Note: The results are based on an average household size of 2.65 and no property appreciation.

References

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______. 2006b. “Impact Fees and Single-Family Home Construction.” Journal of Urban Economics 60: 284–306.

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Dr. Dominic F. (Nick) Minadeo is 2nd Vice President and Director of Research for the Nashville office of Colliers Turley Martin Tucker. He retired from the armed forces in 1993 after 25 ½ years of service; serving 8 ½ years as a Navy enlisted man and 17 years as an Army officer. Nick earned a Doctorate in Economics from Middle Tennessee State University and is a consultant for the US Department of Labor, Bureau of Labor Statistics Short-Term Forecasting Consortium. He is also an adjunct professor for the Sorrell College of Business, Troy University, Troy Alabama; additionally, he is an Area Business Chair at the University of Phoenix, Nashville Campus. Contact Nick at nminadeo@ctmt.com or 615.301.2839

Douglas Timmons is an Associate Professor of Finance at Middles Tennessee State University. He received his Ph.D. in Real Estate and Urban Land Studies
from the University of Florida and teaches real estate finance and real estate
investment classes. He has published numerous articles in various real estate
journals. Dr. Timmons can be reached at MTSU, P.O. Box 27, Dept. of Economics and Finance, Murfreesboro, TN 37132. (615) 898-5750; jtimmons@mtsu.edu.

Dr. Pamela D. Morris joined the faculty of Middle Tennessee State University in August 2007. She is presently assistant professor of economics and finance. Her teaching and research interests are monetary economics, corporate finance, and financial institutions and markets. She received a PhD from Middle Tennessee State University, and a BS and MS from Auburn University. Contact information: (615) 494-8678; pmorris@mtsu.edu.