Monday, July 6, 2009

Financing infrastructure in cities

One of the most important, but least discussed, anomalies with Indian federalism is the devolution of financial powers to urban local bodies. Apart from the property taxes and small state government grants, they are not entitled to any share of the huge direct and indirect taxes that originate in these cities. Thus, the famous anecdotal grouse of Mumbai's residents generating the lions share of the nation's direct tax revenues but not getting to enjoy even a fraction of it! The economic slowdown (especially the lull in real estate sector) has only exacerbated the resource crunch facing local governments.

When the real estate boom was at its peak, governments could parcel out areas for development either by selling it outright or by taking in substantial upfront "developer contributions" and annual lease fees. Now, with the economy limping and the halcyon days of real estate boom not likely to return anytime soon, developers are refusing to commit upfront contributions, leaving governments to search for alternative sources to cobble up resources to finance infrastructure investments.

This is especially a problem in newly developed areas and city suburbs where break-neck pace of development in recent years have left people living in areas with little or no basic infrastructure. Now, the slowdown has forced developers to soft-pedal and delay or cancel all projects under construction/development, thereby robbing local bodies of huge revenues from such developments. Further, many developers have dropped their commitments to develop community assets in their areas, leaving the local governments to bear that burden. In the circumstances, the local bodies are left to raise resources on their own to develop infrastructure in these areas.

Local governments are forced to look for alternative revenue generation sources like borrowing against their existing assets or future revenue streams to meet their capital expenditures. Tax-increment financing (TIF) is one of the more popular means of borrowing against future revenue streams, used for decades now in many parts of the US, to finance urban infrastructure development. The idea is to draw a boundary round an area, borrow to pay for basic infrastructure and repay the loan from the increase in property-tax revenues inside the redeveloped zone as private firms start building. The cash flow stream of property tax provides an excellent match for funding such long-term infrastructure assets. This approach can be ideal for financing urban renewal projects and new developments like satellite townships.

In the US, Chicago has 158 such zones, covering 29% of its land and 13% of its property by value. TIF plans have been credited with reviving many declining districts of Chicago in the early eighties. Now, the Economist reports, cities like Edinburgh, Newcastle, Leeds and Birmingham are toying with adopting TIF for funding instrastructure in re-developed areas.

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