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Monday
Mar302009

The Cost of Development, One Example

Most development that takes place in small towns ultimately weakens the town. This is because most development costs the community more money to maintain than is ever brought in through additional tax revenue generated by the development. This is true even when the development is successful and builds-out right away. It is almost always a losing proposition.

Most small towns in Minnesota are funded primarily through property taxes. My own property tax statement arrived this week indicating that my family's share of the city's revenues will be $252 this year. That has been a pretty consistent number for some time now, and it provides an opportunity to provide readers of TPB.com a concrete example of the Small Town Ponzi Scheme.

We purchased our property in 1996 and built a house that same year. We have your standard, "new" small-town lot - 5 acres on a cul-de-sac. We bought it because of the location, the thick woods and, most of all, because it was the lowest price lot we looked at.

At the time we purchased the lot, the road in front of it was gravel (Class 5 for you rural folk, aggregate for you engineers). The year after we built, the city improved the road to an asphalt surface (tar or bituminous, respectively). The city graciously picked up half the cost of this road and assessed the rest back to us. This was a good deal and we gladly paid the $3,300 assessment (financing provided by the city to boot).

So our share of the road was initially subsidized $3,300. Let's assume my taxes have not increased since 1997 (they have, but it helps makes the point). Let's also assume that the city has spent the same amount - roughly 35% of the budget - on road improvements each year (that is also not true - it has been increasing, but it also makes the point). Based on these assumptions, it will take the city more than 37 years just to repay the initial subsidy.

$252/year tax contribution  x  35% portion dedicated to roads  =  $88/year contribution to roads

$3,300 initial road subsidy  /  $88/year contribution  =  37.4 years

Now consider the obvious fact that by the time the city "breaks even" on this "investment", the road will have been maintained for 37 years, including at least one major maintenance project (resurfacing). Not so obvious is that Minnesota law would prevent the city from legally assessing for the cost of the maintenance since I would see no increase in property value (they may assess anyway - many cities do, despite the fact that it is not technically legal). You can also add to the analysis the fact that I skewed the numbers to shorten the repayment. My taxes have increased since 1997 and the percentage of the city budget that went to roads was less, so my contribution is actually even lower than this scenario represents.

The time to "break even" is essentially never - my road will always cost my neighbors more to maintain for me than I will ever contribute to the effort.

Now let's examine another scenario, because I can just hear people screaming that their city would never be so stupid and would require the developer to build the road before the city would take it over. Actually, my city is not so stupid because they now require this as well. So does the development pay if the developer fronts the cost of the improvements?

Nope. Not even close.

Let's start with some more assumptions. Assume that my taxes hold steady at 2009 levels during the 20-year estimated life of the roadway. Let's also assume that the cost of replacement is the same as the initial cost of construction. While my taxes won't hold steady, they won't vary nearly as much as the cost of road improvements, which will be many times higher in 2017 than the 1997 cost of $6,600.

(Note: I could run present and future worth analysis for all of this, but these basic numbers demonstrate the absurdity of the situation so clearly that this extra effort on my behalf is not necessary. Especially when the extra effort would only make the situation more absurd - my estimate here is actually better than reality.)

$88/year contribution to roads  x  20 years  =  $1,764 total 20-year contribution to rebuilding my road

$6,600 cost of rebuilding  -  $1,764 contribution  =  $4,836 city subsidy in the year 2017

So my neighbors are going to pay nearly three-fourths of the cost of maintaining my road for me. I'll make sure and wave to my neighbors. Perhaps host a block party or something.

Readers should know that the numbers for sewer, water, storm sewer and other major infrastructure is even more skewed.

I can now hear readers asking me how, if the numbers are this absurd, do small towns stay in business? The hard reality is that they are not. Small towns survive and cash flow using four different mechanisms: 

  • Subsidy from federal, state and regional governments.
  • Taking on debt.
  • The Small Town Ponzi Scheme (taking revenue from new development to fix old development).
  • Transfers from net-positive tax-paying properties to subsidized properties.

We'll talk about these four mechanisms some other time, but I'll conclude by pointing out that only one of these is a stable, long-term strategy (hint: not the first three listed).

Will federal, state and regional subsidies continue? Can small towns continue to take on debt? How much longer until ponzi schemes start failing?

The time to start building Strong Towns is now.

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