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(NOTE: Dana Radcliffe is a former Senior Consultant with Deloitte & Touche, specializing in real estate economics. Currently, he teaches philosophy and applied ethics at Syracuse University and Le Moyne College)

 

Date: September 22, 2000

 

To: Jim Mahaney

 

From: Dana Radcliffe

 

Re: ERA fiscal impact calculations

 

 

As you know, SIDA commissioned a study by Economics Research Associates (ERA) to assess the fiscal and economic impact of the proposed Carousel Mall expansion and to determine the economic basis of a new PILOT agreement to finance infrastructure and improvements required by the expansion. In its June 8 report, ERA provided data indicating that the fiscal and economic impact would be positive and that it would be beneficial for the City and County to enter into a PILOT agreement with the developer.

 

Since Pyramid maintains that the expansion is not feasible without a PILOT, attention has focused on whether or not the City and County should approve a PILOT agreement. In arguing for a PILOT, proponents of the expansion have based their case on the ERA data. Consequently, it is important that City and County legislators be assured that the ERA data in fact support their entering into a PILOT agreement with Pyramid.

 

In this memo, I consider ERA's calculations regarding the fiscal impact of a PILOT agreement. As you will see, ERA's numbers and methodology have some surprising and problematic implications.

 

ERA's data seem to show that, with a 30-year PILOT, local governments will receive considerably more in sales taxes generated by the expanded mall than they will lose in forgone property taxes on the mall. These data appear in the tables on p. 3 of the ERA report's executive summary and are explained on pp. 29-34 of the report itself. In the first table, "Annual Tax Payment Comparison (in millions)," note the figures for "Median of Typical Mall Taxes (@$1.51 psf in 2000)" and compare them to the dollar-amounts in the "Total Local" columns of the second and third tables, which give sales tax estimates. We find that, currently, the City and County are forgoing $2.2 million in property taxes that would be paid on the existing mall in return for sales taxes of $11.6 million. At the end of Phase I, those figures will be $3.9 million and $17.4 million, respectively. And at build-out, the amounts will be $9.7 million and $32.4 million. The report notes that, if the County proceeds with a proposed apparel exemption for sales taxes, the City and County could lose annual sales tax revenues of $3.8 million on the existing mall and $12.4 million on the expanded mall. ERA states that "[t]hese figures are notable, but a fraction of the total sales tax impacts of the project" (p. 4).

 

The sales tax estimates, on which the data favoring a PILOT depend, are controversial and have been challenged. For present purposes, though, I will accept them as reliable. ERA does make a mistake, however, in its use of these sales tax estimates. The report observes, "As shown, the local sales tax revenues total some $32 million from the Project, far above any amount of real estate taxes forgone in the PILOT agreement" (p. 3). Clearly, ERA is comparing the forgone property taxes with the total sales tax revenues generated by the mall. This is a methodological error. The existing mall now generates and will continue to generate sales taxes, whether or not a PILOT is approved and the mall is expanded. Hence, assuming a comparison makes sense (a point I will take up in a moment), the comparison must be between the forgone property taxes and the increase in sales tax revenues generated by the expanded mall. The "Total Local" figures include the sales taxes that will come from the existing mall, with or without the expansion. So, in evaluating how much local governments gain from the PILOT agreement in additional sales taxes, the sales taxes from the existing mall must be subtracted from the "Total Local" amounts. Thus, given ERA's data, Phase I will produce a sales tax increment of $5.8 million (in 1999 dollars) and the fully expanded mall will yield an annual sales tax increment of $20.8 million--significantly less than the $32 million total figure ERA cites in comparing the prospective fiscal gains and losses from the PILOT. I will return later to these estimates, showing that they are less than any credible estimates of the forgone property taxes--assuming that it makes sense to draw such a comparison. (In fact, it doesn't make sense, as we will see below.)

 

Rather than questioning ERA's total sales tax estimates, I will examine the reasonableness of the other set of figures on which the data favoring the PILOT depend--i.e., the estimates of property taxes forgone by the City and County under the current and new PILOT agreements. Again, these numbers appear in the first table on p. 3 of the executive summary, on the line for "Median of Typical Mall Taxes (@$1.51 psf in 2000)." ERA assumes that estimates of forgone property taxes using the current assessed value as the basis are unrealistic. Hence, although the table includes a line for "RE Taxes Using Current Assessment," the figures ($10.8 million, $19.2 million, $48.3 million) are not used in computing the fiscal impact of the PILOTs. In the following remarks, I will take up each of the forgone property tax estimates separately.

 

ERA estimates that, without the current PILOT, Pyramid's property taxes on the existing Carousel Mall would be $2.2 million in the year 2000.

 

- The property tax rate is 3% of assessed value. The assessed value of the existing mall is $324.8 million. Pyramid management has said publicly that it would challenge this figure, and some City officials have publicly concurred that it is too high. City Auditor Minch Lewis, for example, in his report on the proposed PILOT agreement, estimates that $2.1 million is a realistic figure for the property taxes Pyramid would pay on the existing mall.

 

- If Pyramid would be paying $2.2 million in property taxes on the existing mall, then by a simple calculation we can compute the implied assessed value:

 

Assessed Value x .03 = $2.2 million

 

Assessed Value = $73.3 million

 

If we take the assessed value implied by a "realistic" property tax estimate to approximate the fair market value of the property, it follows that the fair market value of the existing Carousel Mall is far lower than the current assessed value. In fact, at $73.3 million, its fair market value is less than a fourth of the present assessed value of $324.8 million!

 

- The summary sheet distributed with the proposed PILOT agreement states that redevelopment bonds issued by SIDA will be secured "with the tax payments from the mall--and nothing else." This means that, for Phase I, redevelopment bonds in the amount of $110 million will be secured by property taxes on a mall worth $73 million. Obviously, this is impossible. Given that the fair market value of a property is the capitalized value of its income, not even the income, let alone the property taxes, on a $73 million mall could secure $110 million in bond debt. If the (diverted) property taxes are $2.2 million, then, since $2.2 million is only 2% of $110 million, the property taxes would not come close to covering the annual debt service on the Phase I bonds.

 

ERA estimates that, without the new PILOT, Pyramid's property taxes on Carousel Mall at the end of Phase I construction would be $3.9 million in 2002.

 

- If, as Pyramid insists, the mall expansion is not feasible without the PILOT, then it is pointless to estimate what the property taxes would be upon the completion of Phase I in the absence of the PILOT. Consequently, if the project is not feasible without the PILOT, then ERA's $3.9 million figure here is meaningless. It follows that it is meaningless to compare this amount of forgone property taxes to the estimated increase in sales tax revenues expected when Phase I is completed. (We have already seen that the total sales tax estimate cannot be used in a comparison of the fiscal costs and benefits of a PILOT.)

 

- If, on the other hand, the project is feasible without the PILOT, then there is no need for SIDA to issue redevelopment bonds to facilitate the expansion and the City and County should not enter into a PILOT agreement.

 

- Since ERA (erroneously) assumes that the $3.9 million figure here is a meaningful number, let us go along with the assumption, for the sake of argument. If the property taxes were $3.9 million when Phase I is completed, then, given a property tax rate of 3%, the implied "realistic" assessed value would be $130.0 million. This is obviously absurd. Pyramid will spend, conservatively, $250 million in equity investment on Phase I, in addition to $110 million in bond funding. What developer would spend $360 million to expand an existing mall (even one whose "realistic" market value is $73 million), in the expectation that the market value of the expanded mall will be $130 million? If ERA's estimated forgone property tax amount that Pyramid would pay when Phase I is completed, $3.9 million, were a meaningful figure, it would entail that the Phase I expansion project is not feasible--indeed, that it is nowhere close to being feasible.

 

ERA estimates that, without the new PILOT, Pyramid's property taxes on Carousel Mall at build-out would be $9.7 million in 2006.

 

- As with the previous assumption, if the mall expansion is not feasible without the PILOT, then there can be no meaningful estimate of what the property taxes would be at build-out in the absence of a PILOT. Thus, once again, if the project is not feasible without the PILOT, then ERA's $9.7 million figure here is meaningless. It follows that it is meaningless to compare this amount of forgone property taxes to the estimated increase in sales tax revenues expected when the entire expansion plan is completed. (Again, the estimated total annual sales tax has already been excluded from such a comparison.)

 

- If, on the other hand, the project is feasible without the PILOT, then there is no need for SIDA to issue redevelopment bonds to facilitate the expansion and the City and County should not enter into a PILOT agreement.

 

- As before: Since ERA (erroneously) assumes that the $9.7 million figure is a meaningful number, let us go along with the assumption, for the sake of argument. If the property taxes were $9.7 million when all phases of the expansion are completed, then, given a property tax rate of 3%, the implied "realistic" assessed value would be $323.3 million. Once again, ERA's assumption yields a patently absurd result. Pyramid proposes to invest $900 million in expanding the existing mall--$650 million in equity investment and $250 million in bond funding. Again, what developer would spend $900 million to expand an existing mall (even one whose "realistic" market value is $73 million), in the expectation that the market value of the fully expanded mall will be $323 million? This would be analogous to spending $90,000 on an existing house worth $7,000, in the expectation that the market value of the improved property will be $32,000. If ERA's estimated forgone property tax amount that Pyramid would pay when the entire project is completed, $9.7 million, were a meaningful figure, it would entail that the project is not feasible--by a wide margin.

 

Now let us turn to the comparison that is supposed to demonstrate the positive fiscal impact of the PILOT. That is the comparison of (i) ERA estimates of what Pyramid would pay in property taxes if the mall were expanded, to (ii) ERA sales tax estimates. As we have seen, because Pyramid regards expansion as infeasible without a new PILOT, it is meaningless to estimate forgone property taxes on an expanded mall. But, since ERA's methodology assumes such numbers are meaningful, what results would we get if we accepted this assumption, for the sake of argument, and we used forgone property tax figures implied by property market values that would be required in order for expansion to be feasible?

 

- Let's consider Phase I. Suppose that equity investment is $200 million and bond funding is $110 million. Suppose, too, that the existing mall has a market value of only half of its assessed value of $324 million--i.e., $162 million. This means that, for the Phase I expansion to be feasible, the market value of the mall at the end of Phase I would have to be at least $472 million (= $200M + $110M + $162M). At a rate of 3%, the property tax on a $472 million property would be $14.2 million. This is the amount Pyramid would pay on the Phase I mall after 2005, when the current PILOT expires. Now compare this forgone property tax amount to the increase in Carousel sales taxes generated by the Phase I expansion. Looking at the "Total Local" data on the second table on p. 3 of the executive summary, we can calculate that the Phase I sales tax increment effected by the PILOT will be $5.4 million annually. If the City and County agree to a new PILOT for Phase I, they will thereby agree to forgo (after 2005) $14.2 million annually in mall property taxes in return for an increase in mall sales tax revenues of $5.4 million. (This calculation doesn't even take into account the negative impact on sales taxes of an apparel exemption, which ERA says could cost local governments $3.8 million annually on the existing mall alone.) Obviously, this would be a foolish public investment and bad fiscal policy.

 

- Now let's consider the relevant comparison at build-out. Assume that the existing mall has a market value of $162 million and that Pyramid, as planned, will invest $900 million in the expansion. For the project to be feasible, then, the market value of the fully expanded mall would have to be at least $l.062 billion. The property taxes, at 3%, on a property of that value would be $31.9 million. This is the amount of the property tax revenue local governments will be forgoing annually on the mall when its expansion is completed. ERA estimates that the mall at that point will generate $32.4 million annually in total sales taxes, which is a $20.8 million increase over the sales taxes from the existing mall. If the City and County agree to PILOTs on all phases of the expansion, they will thereby agree to forgo $31.9 million annually in mall property taxes in return for an increase in mall sales tax revenues of $20.8 million. (Again, this calculation leaves out the potential $12.4 million annual cost of an apparel exemption, if it is approved.) As with Phase I, this would be a fiscally indefensible public investment.

 

 

CONCLUSION: The case in favor of the City and County approving the proposed PILOT agreement rests on the reasonableness of ERA's data and its methodology. However, ERA's fiscal impact data and methodology are fatally flawed and, thus, cannot support the City's and County's approving the proposed PILOT agreement.

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