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Three Core Understandings

It has been suggested here by a local government official that cities need to spend money to make money. Will it work? "Don't know" was the answer, which is true. Public officials at the local level rarely, if ever, even bother to measure whether or not something is working before they proceed confidently to the next big thing.

This mentality has infected local governments across the country, where gambling with other people's money is seen as good stewardship, particularly if it is being done in service of the "right thing to do". This often pits different factions of society into arguments over what the "right thing to do is" -- is it another highway lane or perhaps a streetcar line or maybe a subsidy to a new business or an emissions reduction program -- without any objective understanding of what is actually working or what the trajectory of the public balance sheet actually is.

I've promised to describe how a local government can have growth without risk -- can experience the upside of growth without the downside -- and opt out of the gambling, Ponzi scheme approach. Before I do that, we need a common understanding of how to know whether or not a local government investment is "actually working".

I've developed three short videos that explain how this would be done. The first is called the REAL Return on Investment and it explains the difference, as measured by a local unit of government, between investing in economic activity and investing in a project that pays an actual return for the taxpayer.

The next video, Costs and Benefits, gets into additional detail on how to calculate the actual return. It explains the difference between benefits that might be desirable, yet generate no capturable revenue, and those benefits that directly manifest in the revenue stream of a local government. We have many reasons to pursue the former, but can only do so after sufficient pursuit of the latter. (And while I didn't make the case, this points out another effect of orderly but dumb policies that limit the flexibility of local governments -- California's Prop 13 being Exhibit A).

The third video then extends the conversation of costs to ensure that we are getting beyond cash flow and actually talking about the long term costs (ie. the second life cycle). There needs to be a direct correlation between the long term liabilities we are taking on and the new revenue streams we are creating. If those don't balance, the project can cash flow just fine but, long term, it is a failure.

I realize these are nuts and bolts kind of conversations, but it is important to note that I'm not suggesting that local government must always have a positive return on investment on everything it does. I'm also not suggesting that local government should stay completely out of any endeavor that would be altruistic. All I'm pointing out is that, whatever goals or desires a local government may have, the prerequisite to accomplishing those goals is financial solvency. The higher the return on public investments a community has and the greater its financial solvency, the more capacity it has to take on other endeavors.

That's actually not a difficult concept to comprehend.

And in reality, none of this is difficult. In fact, there were times when I was putting these videos together that the sheer obvious nature of them caused me some private embarrassment. That was, until I stepped back and noted that no local government that I've ever seen operates in anywhere near this fashion. I shared them with a few friends last week and the consistent feedback I got was one word: radical.

That these basic concepts are radical in America, circa 2013, says more about us than anything I could write.

Next Monday we'll delve into the high upside, limited downside, approach for local governments.


If you'd like more from Chuck Marohn, you should really get a copy of his recent book, Thoughts on Building Strong Towns (Volume 1). It is a primer on thr Strong Towns movement and an essential read for those wanting to get up to speed quickly.

You can also chat with Chuck, Nate Hood, Andrew Burleson, Justin Burslie and many others over at the Strong Towns Network. Join the conversation on how to make yours a strong town.

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Reader Comments (11)

Not to be shallow, but what was the music used in the background of the videos?

I thought that the first video ended too soon. You brought us right to the brink of the explanation of tax revenues generated needing to match outlays but then just stopped.

March 25, 2013 | Unregistered CommenterToast2042

The music is something I put together for the ST podcast. Just background tracks.

I believe the second video answers your comment from the first....at least that was the intention. There was a decision made on whether to make this one long video or three short ones. Went with the latter.

March 25, 2013 | Registered CommenterCharles Marohn

The three short videos are effective. Even though this seems simple to you (and some of your readers), each 2min video unpacks a ton of conversation. I could see local governments watching a single video and then spending an hour talking about how it applies to their policies and budgets. I see a tendency to bite too much off into a single conversation, and then the entire thing collapses and goes nowhere. By breaking down the content into smaller chunks, it is more easily digestible (and sharable) by the masses. I'm interested to see where you take this conversation next!

March 26, 2013 | Unregistered CommenterLawrence Andre

Lawrence -- you made my day. That is the exact vision I had in my head too....a committee or council working on these issues listening to one video and then discussing for a LONG time.

Thank you.

March 26, 2013 | Registered CommenterCharles Marohn

I burst out laughing on seeing Mayor Quimby in the last video, that made my day.

In all seriousness, I'd be curious to know what you think of the analysis of the Cincinnati Streetcar project: http://www.cincinnati-oh.gov/streetcar/linkservid/17D4E8BF-EE36-4924-94AAFBB630857475/showMeta/0/

They go into a lot of detail over many aspects of the financial return, including the usual dubious time savings and other more esoteric factors, but here's the key points that I found. And yes, I realize that this is all based on projections, so maybe that's a fail right there, but it is based on experiences in other cities with similar systems, and this project is entirely within downtown and the nearest adjacent urban neighborhood where value capture is already highest. Anyway...

They project that over 30 years property values along the streetcar corridor will increase by $379 million. However, when you factor in the amount of vacant and underutilized land and buildings, they expect $1.5 billion in private investment to occur over the next 15 years due to increased desirability, access, etc. If we look only at property taxes, taking just the $379 million number will yield $123 million total additionally property taxes after 30 years at the current 2.1% rate (this is assuming the increased value goes up linearly over that timeframe, from $0 at the start to $189.5 million at 15 years, etc.). So that's just enough to cover the estimated construction cost of $120 million, but not much else. Keep in mind though that this is just from increased property value, not from any expected new development.

Now, if you apply that same math to the $1.5 billion in increased property values and new building that's expected over 15 years, the numbers get much more interesting. That yields a total of $252 million in new property taxes over 15 years, and assuming no new growth after that time, that's still an additional $31.5 million in property taxes per year. That's more than enough to pay back the initial construction, the $2.5 million per year of expected operating costs, and since streetcar infrastructure is expected to last 30-50 years before needing major rehabilitation (the lower end of that range for the cars, higher for the track, and probably somewhere in the middle for the electrical overhead), it seems like a big win to me.

I figure this is the sort of analysis they did to get their benefit-cost ratio of 2.7 for the project, which appears to be the return to the city government itself (if you just took the $1.5 billion and $120 million you'd get a ratio of 12.5). Nevertheless, this is only looking at property tax implications. Cincinnati and many cities in Ohio get the bulk of their revenue from local income taxes, in this case 2.1% much like the property tax rate. There's also sales taxes as well, though levied by the county and redistributed accordingly. That means the revenue back to the city will be even higher than I calculated above. So is this a win, or am I missing something?

March 26, 2013 | Unregistered CommenterJeffrey Jakucyk

Jeffrey, I have not gone through it in detail, but as you describe it my alarms go off. Two issues:

1. Projections. Everything looks rosy in the land of project-advocate projections.
2. Correlation. It is impossible to say that "attractive" on a city-wide basis is attributable to a streetcar or if it would make the community more attractive to invest in schools, parks or highways. Seemed very dubious.

As you'll see next week, I'm inclined to be very conservative with the bulk of my money and highly speculative with a tiny portion. This seems more like that latter and, if so, feels like too much money.

March 26, 2013 | Registered CommenterCharles Marohn

Well regarding the correlation point, there's a handful of businesses that are opening up in Over-the-Rhine specifically in anticipation of the streetcar going in. Overall that entire neighborhood, being as densely built as it is, right now is not attractive for development because a lot of it is too far to walk to downtown, or to Findlay Market and back, and there's nowhere to put parking. What has been done so far has generally needed additional financing to provide for garages, leading to other problems associated with them.

All that said, when compared to other planned or already built streetcar projects, this one is routinely regarded as being the most viable in that it serves the most people in the best neighborhoods with the shortest route. The results seen in other cities that built streetcars roughly 10 years ago have been more successful than expected even in neighborhoods that don't have nearly as good bones we do.

I certainly understand and share a lot of your skepticism, but this project has received a lot more scrutiny (officially and unofficially) than highway projects costing 10x as much, and which get greenlit despite coming out way worse in their own analyses. I bet a lot more of your alarms would go off for those projects. There's definitely a double-standard at hand, and yet even if the projections are overly rosy they'd have to fall pretty darn short to not come out ahead for the city. The benefits just seem a lot more capturable to me than many projects where most of the supposed benefits are subjective (all of which I specifically left out). At least as far as I can see anyway.

March 26, 2013 | Unregistered CommenterJeffrey Jakucyk

I wouldn't argue with any of that, particularly the statement about lack of scrutiny on highway projects that are much costlier.

March 26, 2013 | Registered CommenterCharles Marohn

Maybe I am missing something Jeffrey, but your detailed analysis of the Cincinnati project misses two key points.

First, a lot of people in this country believes government exists to provide services that the private sector can't/won't provide because the profit isn't there. For those that subscribe to that belief, when should the government do anything "for a profit"? I would argue it shouldn't and thus these conversations take us off track.

Second, while the streetcar numbers may show that the city collects more direct tax revenue than it pays to build the project, what about the other services that the city needs to provide in the corridor? These conversations tend to forget those. Tax dollars are not meant to just pay for a single infrastructure project. What about the other infrastructure projects needed to support the district? And what about the services the city needs to pay for the district? When the tax money is allocated for a singular project, how do the other needs/wants get funded?

No matter how we slice these conversations, I keep finding myself back at square one with the Ponzi Scheme discussion at the heart of Strong Towns. The math doesn't add up. We don't see the total picture of what it takes to operate a community. We are upside down financially. Our dependence on one-time, outside money to build things isn't sustainable. Our bonding strategies aren't sustainable. I feel that we are overextended. I am concerned for what that means for my children's quality of life.

March 27, 2013 | Unregistered CommenterLawrence Andre

The thing about it Lawrence is that it's an attempt to get the neighborhood back to some level of density that it had in the past, and which the rest of the infrastructure that's already in place was built for. Looking at just Over-the-Rhine by itself, this is a neighborhood that in its heyday 100 years ago (when there were multiple streetcar lines crisscrossing it) had a population of nearly 50,000 but which today has only on the order of 6,000-8,000. The amount of abandonment and blight means that it has a disproportionate amount of crime and needs a lot of other social services that would cancel out some of the additional services needed for a more populous neighborhood. Either way, we're talking about a situation where the "carrying capacity" of the neighborhood is much higher than its actual use, but of course the infrastructure and services still need to be maintained. I'd also say that my analysis above assumes the whole construction cost is born by the city, which in reality it isn't (it's about half), so it puts the city ahead in terms of saving additional tax revenue for future maintenance needs.

The question of whether the government should be doing anything for a profit is a good one, something that's worth further discussion. Here's how I look at it though. The government should be taking on things that yield a profit overall, but which aren't directly captured and may appear to be unprofitable when viewed in isolation. For instance, municipal water and sewer systems, as well as garbage collection. They aren't generally profitable by themselves, so they don't make business sense as private operations, but the public health benefits lead to fewer people being sick, less need for hospitals, more productive work, and more taxes. Education as well leads to smarter people who get better jobs that pay more taxes and don't turn to crime. These are all benefits, profit if you will, but which don't accrue back to the original services directly.

That's where it gets risky of course. When "the system" gets as big as it is today, it's impossible to look anywhere and see what places are or aren't solvent. There's just too much going on and so many things are interdependent that it's next to impossible to step back and see just what's benefitting what else, and if it's working. Obviously it's not working, but we can't point to any one thing to say why or why not. Of course a lot of these are very long-term value capture propositions, which makes short-term cuts look better than they are since the effects won't be felt for years or decades to come.

March 27, 2013 | Unregistered CommenterJeffrey Jakucyk

The issue with Over-the-Rhine is that it is built in a way that isn't desirable for people who want and/or need to own cars. And in most cases cities in North America require people to own cars.

The neighborhood is already built and well-served by city services and infrastructure in general. The problem is not the lack of infrastructure or the lack of services, but rather the lack of the right kind of infrastructure. By building better transit options it will allow this neighborhood that was built prior to the advent of the automobile to fill some of its many vacant structures that are currently in demand but are cost prohibitive to redevelop due in part to the costly need to provide parking.

You can see this with the development that is currently taking place. Developers have recently spent nearly $100M on parking structures alone to support the growing number of residents and visitors to Over-the-Rhine. When you factor in the investment in parking facilities in Downtown, the financial tally skyrockets. Since policymakers have already passed zoning regulations that allow for developers to reduce the amount of parking they provide along the streetcar line, it's really just a question of whether you want to invest in a public asset like a streetcar, or subsidize private amenities like parking garages.

Since the City already provides services and infrastructure to this neighborhood, it makes the streetcar a clearly unique opportunity to get more people living in an area that is already "paid for" with regards to those services and pieces of infrastructure. It becomes even more valuable a proposition when you consider that only a portion of the streetcar project cost is coming from local sources.

March 28, 2013 | Unregistered CommenterRandy A. Simes
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