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Capital Facility Financing Article

Capital Facility Financing

By Rich Yukubousky, Municipal Research & Services Center

Introduction: The following materials are talking notes of a presentation to the APA Washington Chapter Annual Conference, October 22, 1996.

Purpose: Provide an overview of the options available at the local level to finance public facilities. Give a summary of pros and cons of each approach, with some guidelines about where each approach might be useful.

Caveats: This information was prepared for cities and towns. Much of it may not apply to counties and special districts.

Some Overarching Issues:

I assume that you have already completed your comprehensive plan in conformance with the GMA, that you have completed your capital facilities element. Further, I assume that you have involved the community in defining acceptable service level standards. True, you may have to revisit this issue if you find out that the community is unwilling to pay once they find out what the cost is. And finally I assume that you have done an excellent job of meaningful community participation so that everyone is bought into your capital facilities plan. Since you are probably going to end up with a plan that uses multiple sources of funds, each interest will want to insure that they are not being asked to pay more than their fair share.

Now all you have to worry about is how you are going to pay for the plan. Can you generate enough money to pay for the plan? And can you convince those who will pay for the plan that the distribution of costs is equitable. In other words, who will pay for the plan?

1. Current versus future beneficiaries (Pay Now versus Pay Later )

Pay as you go - There are some advantages of not incurring debt:

Interest savings - could leave more money for the actual project

flexibility - can stop work on projects if there is an economic downturn. No fixed debt service payments to make.

Fiscal responsibility - less likely to issue too much debt

legacy for future generation - paid up infrastructure will be in place for the next generation

low administrative costs - no costs to issue bonds or administer debt service

Pay as you use - There are also some strong arguments in favor of debt financing:

equity - Those who use the facility after it is built will bear some of the costs. (Under pay as you go current users provide future users with free facilities)

reserve fund raiding - Less temptation to raid reserves because reserves will be small and debt service must be paid.

Effect of inflation - if there is any inflation, debt will be paid off with cheaper dollars.

Lower tax rates - Rates will be lower because costs are spread over a longer time period and, in a growing economy, over more people and a higher assessed valuation

acquire as needed - Projects can be built as needed, usually now, without waiting for funds to accumulate

For more detail see A Debt Primer for Washington Cities and Towns, Report Number 30, MRSC, August 1994.

2. Current residents versus newcomers

This is a major issue in the debate over growth management. In many communities, residents do not want to raise their taxes to pay for growth - growth that they do not want in the first place. Some argue that if it were not for unwanted growth, the demand and the pressures for new or expanded facilities would not exist. These folks might argue that developers, and/or residents of new development ought to pay their own way.

Long term residents of a community may be more willing to support bond measures to pay for new facilities if there are impact fees. Others would argue that the whole community should share in at least part of the cost since this new development presumably brings positive benefits - even to current residents.. Also, a lot of growth is from within our communities - not all are exiles from California - it includes our sons and daughters.

3. Local versus regional or state financing

Some argue that the burden of responsibility should rest with those who benefit. If the beneficiaries are local, then the cost should be borne locally. If the beneficiaries are located outside of the local community, then perhaps there ought to be at least partial regional or state funding responsibility. However, it is not always easy (or even possible) to isolate benefits in this manner. If a new commercial development adds additional traffic to a transportation facility to degrade level of service from LOS E to LOS F, should that development bear the entire cost of remedy? Or shouldthe cost of a solution be spread over all users of the facility?

Finance Methods:

Following are descriptions of some of the major financing options along with a discussion of important issues related to each.

1. General Obligation Bonds - Backed by the full faith and credit of the city . Bondholders have legal claim on general income of the city if default occurs. There are two types:

A. Councilmanic Bonds (Limited Tax General Obligation Bonds)

May be issued by a vote of city council. Backed by general fund revenues because voters have not been asked to pay increased property taxes. May be used for any city purpose. Does not have to be capital.

B. Unlimited General Obligation Bonds

Backed by the full faith and credit of the local government.

Must be approved by a 60% majority of the voters, turnout must be 40 percent of those voting in the last general election. Raises property tax to pay for projects. Only used for capital purposes. Limits to amount of debt that can be issued.

Debt limits:

Three pots of 2 1/2% of assessed valuation each: (1) general government purposes, (2) municipally owned water, sewer and electric utilities, and (3) open space and parks. Pots two and three are voted, must be 60% yes, 40 percent turnout.

Pot 1 is a mixture of voted and non voted. 1 1/2% is limit of non voted, or councilmanic bonds.

Most cities probably have more debt capacity that they can use. Political limits are often tougher - willingness to pay may be greater than ability to pay. Also Moody's and Standard and Poor's will rate bonds. If a rating agency thinks you are borrowing too much, you will pay higher interest rates. Most communities do not issue debt to their full legal capacity.

Enhance chance of passage of bond measures by:

  • Time the election. Not after a presidential election where there is high voter turnout. May be difficult to validate the election.
  • Be aware of what else is up for vote, e.g. school district bonds. Voters may reject the cumulative impact of several bond measures. Or choose the one that is most important to them, and reject others.
  • Prepare a factual question and answer brochure. Know and address citizen concerns
  • Talk to news media
  • Know campaign finance laws. Can't use public facilities or staff to convince voters to vote for bonds. May have to speak as a citizen outside of work hours. Talk to the public disclosure commission.

Many cities across the state have successfully used general obligation bonds to fund city wide street improvement and major maintenance projects. The most important element is to have a well-thought out plan, with good cost estimates and solid justifications for the improvements contemplated.

2. Revenue Bonds - Used to finance projects for an enterprise that is self supporting. Examples include water and wastewater projects, airports, golf courses, parking garages, toll roads and bridges.

Payment of debt service comes from user fees generated by the capital facility that is being built. Interest rates are higher than in GO bonds since these bonds are not backed by the full faith and credit of the city. Not subject to statutory debt limits. However the bond market provides an effective limit to the amount of bonds issued. May place covenants on the bonds, e.g. do not issue additional bonds for a water utility unless there is sufficient revenue to pay additional debt service. Anticipate income may have to be 1.25 times the debt service requirement (debt coverage ratio).

3. Local Improvement Districts - When a capital project is going to provide a benefit that primarily or wholly benefits only a subset of citizenry, a LID can be formed as part of the project. Commonly used for projects such as street improvements, street lights, sidewalks, water and sewer systems, and underground power lines.

Property owners may petition to form an LID, or council can pass a resolution of intent to form an LID - which may be blocked by property owners paying 60% of the cost. Property owners can pay their share up front, but normally LID bonds are issued to pay at least part of the project cost. Each property owners assessment is equal to the special benefit received by that property.

Property owners make a yearly payment into an LID fund which is used to pay the principal and interest on debt. If a property owner fails to make two property assessments in a full and timely manner, the city must commence foreclosure proceedings. The city's LID guaranty fund is used to cover bond payments; this fund is replenished through foreclosures. Under no circumstances can bondholders collect from the city's general fund revenues, unless the city so stipulates. LID bonds are not general obligation bonds that are backed by the full faith and credit of the city.

4. Grants and Loans - Historically grants were an extremely important source of revenue for capital facilities. However attempts to reduce the federal deficit has resulted in a dramatic reduction in the availability of grants to fund capital projects.

The criteria for the award of grants tend to accent a need derived from preexisting conditions. Projects needed to support new growth are more difficult to secure.

There are a number of grant and loan programs available. Following is a list of agencies you may wish to contact:

A. Public Works Trust Fund (loans) - Provides low interest loans to local governments for repairing and replacing deteriorating infrastructure. Over the past decade this program has offered about a half billion dollars in financial assistance to local government. Contact Pete Butkus - 360-586-7186.

B. Community Development Block Grant Program - Funds local housing, public and community facilities, economic development, and planning projects which principally benefit low income households. Eligible applicants include cities and towns under 50,000 population and counties less than 200,000 populations. Larger jurisdictions receive direct distributions. Contact Charmaine Stouder at (360) 586-1243.

C. Community Economic Revitalization Board - Provides low interest loans and grants to help finance public infrastructure required by business and industry. Supports industrial development, job retention and creation. GO bonds, lease, other local funds used to payback loans. Contact Kathleen Engle (360) 586-0657.

D. Transportation Improvement Board - Bob Moorhead/Rod Diemert -360-705-7593

E. WSDOT - TransAid Engineer - Brent Rasmussen - 509-324-6080

F. WSDOE - Wastewater grants - (360) 407-6760

Water quality financial assistance - (360) 407-6500

Storm water pollution prevention grant - Kitty Gillespie (206) 407-6540

WSDOE's public information section at (360) 407-6145 could direct you to the appropriate staff.

5. Mitigation and Development Fees - A fundamental shift in policy. During most of its history the US has stimulated growth and development by transferring resources out of the general tax base, from millions of citizens, to those who developed waterways, railroads, farms, industries and neighborhoods.

Public is no longer willing to shoulder this burden. Development sometimes does not improve quality of life. Rather it generates pollution, congestion and lower quality of life. - imposes costs community.

Increasing cost of public infrastructure coupled with decline of support for taxation alternatives, has forced local governments to seek alternatives.

Definition of impact fees: Charges applied to new development to generate revenue for the construction or expansion of capital facilities located outside the boundaries of new development (off site) that benefit the contributing development.

Impact fees fall within the general system of land development regulation. It is not a revenue raising or taxation programs. Rather the objective is to insure adequate capital facilities. Must be able to demonstrate a rational nexus - a close fit between the fee and the problem it will be used to solve. This makes it similar to a user fee based upon the benefits received.

Arguments made by advocates of impact fees:

  • Ensures that new development will pay its fair share (or at least a share) of infrastructure development costs. Be aware that impact fees will probably not pay the total cost of new or expanded facilities. One study found that impact fees covered only about one-third of the costs of providing services. Two-thirds of the cost is met by property taxes, user fees, sales taxes and other sources.
  • Eases pressure on the community's other financial resources.
  • Provides a politically acceptable alternative to property taxes. Growth may be more politically acceptable when impact fees are imposed because residents perceive that new home buyers will pay for their own services.
  • Avoids de facto moratoria on development that result from tax and debt limits on local government.
  • Provides revenue exclusively earmarked for infrastructure. Where there are concurrency requirements, may allow developers to proceed with projects instead of waiting for public facilities to be constructed at some future date.
  • Correctly calculated impact fees assess the developer only for the cost of providinginfrastructure for the new development. Developer will know the cost up front, and have a better chance of obtaining financing.
  • Allows local government to commit to constructing public facilities in a planned and systematic manner since a CIP is required for fee imposition. In Washington state this is more a function of the GMA.

Arguments made by Opponents of Impact Fees:

  • Infrastructure is the responsibility of the community as a whole, not new development alone.
  • Because impact fees are based on the costs of improvements, and not ability to pay, they are inherently regressive. Some argue that we are moving towards a society where those who can pay will receive societal benefits, and those who cannot pay will gradually be shut out.
  • Adverse impact on housing affordability. Drives up the market price of both new and existing housing.
  • Impact fees may be used to further no-growth objectives.
  • By earmarking impact fees revenue, local governments lose flexibility in financing capital and other expenditures. Legally, however, there is not much choice.
  • Impact fees have potential for abuse by government unless limited by carefully crafted legislation.
  • If one jurisdiction has impact fees and adjoining areas do not, development may be displaced from one area to another.
  • The administration of impact fees (calculation, assessment, collection, tracking, refunding, etc.) may be expensive. Gets very complicated and technical.

Legal Guidelines

U.S. Supreme Court (Nollan and Dollan) coupled with Washington gives some guidance:

1. There must be a rational nexus - there must be a close fit between the exaction and the problem created by the development ( Nollan, 1987)

2. Rough proportionality - quantitative relationship between the exaction and the impact of the proposed development (Dolan, 1994) While not requiring a precise mathematical calculation, city must perform an individual determination that degree of relief sought is commensurate with the impacts. Washington courts have upheld impact fees where the fees were based on a detailed park study (Trimen Development Co. V. King County) that included factors such as zoning, projected population and assessed value. By contrast in Henderson Homes, Inc. V. City of Bothell, the Washington Supreme Court rejected a predetermined fee of $400 per lot to help pay for city parks. The court held that the city failed to show a direct impact of the proposed development on the park system. In other words, need to make a site specific determination. Need to consider the type of development, and the size (in dwelling units for residential, and square footage for commercial).

3. Washington GMA provides additional limitations. Local governments that are required to or choose to plan under the GMA can impose impact fees. In addition to the tests above, the fees must:

  • be used for system improvements that "reasonably" benefit the new development. This is actually more restrictive than the "rough proportionality" test. There needs to be some benefit to the development. Expected use of the facility is the best indicator. For example, a park fee should not be used on a park across town that the residents of the subdivision would rarely use.
  • must be refunded if not spent within 6 years on public facilities intended to benefit the development
  • Under the Growth Management Act, impact fees may be collected and spent on four types of public facilities: (1) public streets and roads; (2) public parks, open space, and recreational facilities; (3) school facilities; and (4) fire protection facilities in jurisdictions not part of a fire district. The impact fees must be addressed by a capital facilities plan element of an adopted comprehensive plan. See RCW 82.02.050 - 82.02.100.

4. Washington's Local transportation Act authorizes transportation impact fees to offset the demands of growth and new development by mitigating off site transportation impacts.

  • A development's transportation impacts must be measured for their "pro rata" share of the improvement being funded.
  • Fees must be" reasonably necessary as a direct result of the proposed development." Need to identify a limited geographic area
  • Fees must be spent within 6 years or refunded. If not able to raise the necessary public share, in effect cannot charge developers.

5. Be careful about physical taking. Any physical intrusion is likely to be suspect, such as an easement for public access. You could be required to pay compensation.

Impact fees depend upon land use plans for defensibility. Comprehensive land use plans allocate land for particular activities. Includes master facility plan that programs facilities at the time, place and size to accommodate development in accordance with the land use plan. The CIP specifies those facilities that will be constructed over the next few years - typically five or six. Impact fees are used to finance the CIP.

Most common use of impact fees across the US are for water and sewer facilities. According to one study, utilities accounted for more than 40% of all impact fees collected in 1990. (This figure includes hook-up or connection charges - technically not impact fees in Washington).

After utilities, highways are the next most common charge. Almost a quarter of all impact fees collected in 1990.

Schools are third - almost 20% of fees collected in 1990.

Utilities, roads and schools accounted for about 85% of average impact fees in 1990.

There is a substantial range in the fees assessed. One study found that the national average in 1990 was about $6413 for a 2000 square foot single family house. Costs would be 20-25% higher in 1996 due to inflation. Washington practice is more conservative, and fees tend to be lower.

Other uses less common but include: parks, libraries, police and fire facilities, general government buildings, emergency medical facilities, hospitals, solid waste facilities and even public cemeteries. However, local governments can only use impact fees for those uses specifically authorized in Washington statute.

6. Transportation Benefit District - Pursuant to RCW 35.21.225, cities are authorized to establish transportation benefit districts to fund the capital improvement of city streets within the district.

The improvements must be: (1) consistent with state, regional and local transportation plans; (2) necessitated by congestion levels attributable to economic growth; and (3) partially funded by local government and/or private developer contributions. Transportation benefit districts are quasi-municipal corporations with independent taxing authority. RCW 36.73.040. Transportation benefit districts are given authority to levy a property tax (36.73.060), issue general obligation bonds (RCW 36.73.070), establish LIDs (RCW 36.73.080), and impose impact fees (RCW 36.73.120) to fund transportation improvements.

To our knowledge only one or two have even come close to being formed. None are in existence. As far as we know, the City of Centralia has come the closest to forming a TBD. Potential TBD formation was used to leverage about $12 M in federal and state grants, but that the Council backed off at the last moment. The cities of Bellevue and Anacortes have formed transportation benefit districts and have developed formulas for the assessment of new developments for their share of off-site transportation improvements (verify?) Snohomish County is preparing to form a transportation benefit district in the vicinity of Paine Airfield (verify?)

There appears to be unresolved legal issue. King County Bond Counsels have had the following problems associated with the formation of TBD's:

  • They question the authority of a city or county to levy taxes upon a portion of either the city or county to finance the TBD bonds - does this increase the overall taxation limit of the authority?
  • They also question the authority of either a city or county council to also be the TBD commission.
  • In multi-jurisdictional TBD's, they further questioned whether the TBD taxation reduces the over the taxation capability of the participating municipalities.

    • Apparently some of these concerns have been resolved through recent legislation but they have resulted in the delay of implementation of TBD's in the state of Washington.

Revenue Sources

See A Revenue Guide for Washington Cities and Towns, published by MRSC, June 1992 for information on the revenue sources available to Washington cities and towns, and their allowable uses. There is too much material to address in this kind of presentation. A few sources have been highlighted below since they are particularly applicable to capital financing.

1. Real Estate Excise tax - Provides a revenue stream that can be used to back bonds. This is important because it is part of the state GMA statutory package. Note that general obligation bonds cannot be backed solely by the real estate excise tax. The bonds must be backed by the full faith and credit of the city. If REET receipts are not sufficient some year, the money will have to come out of the general fund.

Levied on the sale of all real estate, measured by the full selling price. State levies at the rate of 1.28% .

First quarter percent -

Cities and towns not planning under the GMA and those planning under the GMA but having a population under 5000.

- May spend their REET 1 revenues for any capital purpose identified in a capital improvement plan (CIP) and local capital improvements, including those listed in RCW 35.43.040. This includes LID-type projects such as streets, parks, sewers and water mains, swimming pools and gymnasiums (RCW). It also includes non LID-type projects such as city halls, fire stations and libraries as long as they are listed in a CIP.

Cities and towns larger than 5000 population and planning under the GMA - must spend first quarter solely on projects in CIP. RCW Defines capital projects very broadly

Second quarter of one percent - Only levied by cites and towns that are required to plan or choose to plan under the GMA, whether above or below 5000. More limited uses than REET 1 - streets, water, sewers and parks but not land acquisition for parks.

To be eligible for Public Works Trust Fund, a city must be imposing the optional 1/4 percent real estate excise tax for capital purposes. The Public Works Trust Fund is used for repair, replacement or improvement to public works projects, such as streets, bridges, and water, sewer, and storm sewer systems.

2. Business and Occupation tax - There are a number of cities in Washington that currently do not impose this tax, particularly in eastern Washington where this tax is politically unpopular. At leastone city has imposed this tax solely to pay for a specific capital facility, and then rescinded the tax once that facility was paid for.

3. Utility Business and Occupation Tax - This tax is levied on the gross operating revenues that public and private utilities earn from operations within the boundaries of a city or town. Taxes may be levied on electric, water, sewer, solid waste, storm water, gas, telephone, cable TV and steam. The maximum rate is limited to 6 percent unless voters approve a higher rate. At least three cities have done so for public safety purposes. In Kennewick this revenue will be used for fire department capital purposes.

4. Street Fund - This is in reality a collection of revenue sources.

The street fund accounts for the City's annual gasoline tax revenue, which can be used for street maintenance, repairs or construction (arterial street fund). As these funds are generally limited, most smaller cities use the street fund for minor repair and maintenance. The City could supplement the street fund with sales tax or property tax revenue from its general fund but the competition for these revenues is probably very intense.