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Why Do Local Governments Award Business Tax Incentives?

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Richard Funderburg and Joshua Drucker
March 11, 2022

The question posed in the title of this article has a variety of possible answers, each supported by academic theories: local governments award tax incentives in order to maximize revenue, vie with other cities by countering their competitive offers to local businesses or are captured sycophants of business interests.

In our research, “Do local governments use business tax incentives to compensate for high business property taxes?” coauthored with David Merriman and Rachel Weber, we consider other distinct and strategic explanations.

Local governments might reduce taxes selectively, through incentives, to benefit preferred businesses in targeted districts. The motive might also be to promote redevelopment in key neighborhoods or to offset uncompetitive tax burdens, such as where overlapping governments—city, county, school district, special districts, etc.—combine to produce high consolidated property tax rates.

Finally, local governments might act to alleviate disparities in taxes across property types. Thirty-seven states and the District of Columbia allow higher effective property tax rates for businesses than for primary residences. For this incentives strategy to escape substantial municipal revenue losses, cities must simultaneously charge artificially high taxes to nonsubsidized businesses and/or residents.

In our work, we tested the hypothesis that general-purpose local governments use property tax incentives selectively to compensate for high property taxes. Imposing high initial taxes on businesses gives local governments discretion to reduce tax burdens via incentives for preferred uses at specific locations.

We found evidence supporting our hypothesis in Cook County, Illinois (encompassing Chicago and 133 smaller municipalities), where cities award property tax incentives to offset their own uncompetitive tax rates. Tax Increment Financing (TIF) districts, in contrast, appear to be used by cities to divert revenue from other local governments with overlapping taxing jurisdiction.

The legal authority in Cook County, to tax business properties on a greater share of market value than residential uses, officially dates back to the 1970 Illinois Constitutional Convention. That compact enshrined in law the previously unauthorized practice of “classification”—taxing different property uses at different effective rates—that dates as far back as the 1920s in Chicago. Although any Illinois county with at least 200,000 residents can authorize classification, only Cook County currently chooses to exercise this authority. Elsewhere in Illinois, property is assessed at 33 1/3 percent of market value for real estate taxation purposes, whether a business or a primary residence.

The sole purpose of classification is to shift some tax burden from one class of property to another. For example, Cook County businesses, in general, are assessed at 25 percent of their market value, 2 1/2 times the assessment share of residences (the maximum difference permitted by the state Constitution).

A patchwork of overlapping governments and districts adds to spatial disparities across Cook County; consolidated property tax rates range from 6.81 to 38.45 percent of assessed value. After accounting for the multiplier, required by the state to increase the average Cook County assessed value to 33 1/3 percent of market value (2.72 at the time of our study), business properties in the highest tax rate districts are effectively taxed at over a quarter of their market value (2.72 x 0.3845 x 0.25).

Through classification, the City of Chicago is able to keep its residential property tax rates relatively low compared to other Cook County municipalities, shifting higher effective tax rates to businesses and taking advantage of the concentration of commercial and industrial properties in the urban city. Where business properties comprise a substantial share of the tax base, classification enables local governments to raise the same amount of revenue with a lower property tax rate by transferring the burden to business properties and increasing the total assessed value.

Incentive classes, administered through the Cook County Assessor’s Office, are available for Cook County municipalities to reduce the assessment ratio for designated businesses from the general rate of 25 percent to a competitive 10 percent of market value.

Our research found that an estimated 11 percent of Cook County’s assessed value in industrial property is subject to abatement through incentive classes, whereas about one percent of commercial assessed value receives abatement. For 2014, we estimated that approximately $250 million in countywide tax collections (5.3 percent of the $4.7 billion total) was foregone from commercial and industrial property taxes through the use of incentive classes.

A staggering 45 percent of all business parcels in Cook County are located within a TIF district; $644 million in property taxes is redirected annually from local taxing authorities to city-controlled TIF districts.

We found that business tax incentives are concentrated, as we anticipated, in Cook County taxing districts with higher consolidated property tax rates. Yet we did not observe cities using incentives to equalize rates within their own borders. This suggests that cities use the incentive classes to offset their own uncompetitive rates in competition with other municipalities. In contrast, cities concentrate TIF districts in locations where the consolidated tax rates across multiple taxing authorities are higher, signaling that they use TIF to capture tax revenues from overlapping governments.

Author: By Richard Funderburg, Associate Professor of Public Management and Policy at the University of Illinois Springfield, and Joshua Drucker, Associate Professor of Urban Planning and Policy at the University of Illinois Chicago.

This article was written under the auspices of the Government Finance Research Center at the University of Illinois Chicago

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