Costs and Benefits of New Residential Development*

August 1999

Elena Irwin and Dave Kraybill

Department of Agricultural, Environmental, and Development Economics

The Ohio State University

* Presented at the "Better Ways to Develop Ohio" conference, sponsored by the Ohio State University Extension, Columbus, OH, June 24-25, 1999.

Residents and local officials often request estimates of the taxation and fiscal effects of proposed development projects. Special interests tend to focus exclusively on costs or exclusively on benefits of land use change. This short-circuits public deliberation and confuses residents who are concerned about how development might affect the taxes they pay and the quality and quantity of public services they receive. Various methods have been advanced for evaluating the costs and benefits of proposed development, including the cost of community service studies and fiscal impact analysis.  In what follows, we summarize each of these methods and explain why fiscal impact analysis is a more comprehensive approach to evaluating the local fiscal impacts of development. In addition, we discuss non-market costs and benefits that may affect the well-being of residents living in a community that witnesses new development. Lastly, we offer some remarks regarding the policy usefulness of fiscal impact analysis for regional land use planning and community development in Ohio.

What’s Missing in Cost of Community Services (COCS) Studies?

COCS studies have become a popular method of examining the fiscal impacts of different land uses on local governments. These studies attempt to identify current local governmental revenues and expenditures that are associated with broad categories of land use (for example, residential, commercial, industrial, and farmland/open space). In other words, this approach considers the direct fiscal impacts that are attributable to each land use (e.g., the impact of residential land use would include the amount of property tax revenues that are generated by existing residents and the amount of expenditures that are required to services these residents). Results from COCS studies are summarized in terms of a ratio of expenditures to revenues for each land use. A ratio greater than one indicates that expenditures outweigh revenues for that particular land use. A number of COCS studies have been performed across the U.S. and have consistently shown that expenditures outweigh revenues for residential land use, leading to the conclusion that residential development does not pay for itself.

The simplicity of this approach is both its greatest strength and weakness. Because they do not require in-depth analysis, these ratios are relatively easy to calculate and straightforward to explain to community residents and local officials. However, this approach only considers the direct fiscal effects of residential development and ignores many of the indirect fiscal benefits that accompany development. As a consequence, the COCS studies provide insufficient information and are often misleading as a guide for decision-making regarding the desirability of new residential growth within a community.

Fiscal Impact Analysis

Fiscal impact analysis provides a more comprehensive view of both the direct and indirect fiscal costs and benefits of development. This is because this approach also considers the "economic multiplier" effects of residential development. New residents moving into a community will increase the available labor force within a community, leading to an increase in the total amount of income generated by households living in the community. Because part of this increase in aggregate income will be spent locally, local business sales and opportunities will increase, leading to additional employment opportunities in local sales and services. Such multiplier effects can generate significant revenues in the form of additional income taxes and business property taxes. If the new residents are employed in new jobs located in the community, this expansion in local employment is often associated with substantial business property tax revenues.

The net surplus or deficit that is generated by additional residential development will depend not only on the inclusion of these indirect fiscal benefits, but also on the current level and available capacity of existing community services. For example, if the existing schools are not at full capacity, then additional residential development may require very little additional capital expenditures to provide school services to new school-aged children. However, if the schools are at full capacity, additional residential development may require large capital outlays to build additional school facilities. The implication is that the costs of providing public services are not constant, but rather will vary depending on the existing population and public service capacity in the community. Such capacity effects are also found with roads and other public infrastructure and services that can become congested as residential demand for services increases.

In addition to the level of population and public service capacity, other characteristics of the population and residential development can impact the costs of providing public services. For example, the pattern of residential development can increase or decrease the costs of providing services to a fixed number of residents. All else equal, the per capita costs of servicing a population that is more dispersed (vs. concentrated) will be higher because more miles of streets and public utilities will be required to reach them. Other cost factors include the characteristics (e.g. age, income, and preferences) of the incoming residents and how they may alter the overall demand for the type or quality of services. The rate of growth can also affect the cost of providing services. Communities that experience very rapid population increases will face higher per capita public service costs if governments are unable to take the time required to identify and finance the least-cost service option.

Finally, new residential development may lead to increases in property values, which will have benefits for both the local government and current residents. This is true because the supply of total land within a given community is fixed so that, as population and demand for housing increase, the price of residential land will also increase. In addition, if the quantity and quality of services improves with increases in population, land values may increase due to a "capitalization effect." Because land is a fixed asset, many (and potentially all) costs and benefits associated with a land parcel in a particular use will be capitalized into the value of that land. For this reason, additional benefits to residents in the form of increased public services will be reflected in higher residential property values. For the same reason, negative impacts of additional residential development will also be capitalized into land values. For example, in areas that are already built to capacity, additional growth leads to traffic congestion and visible loss of open space. These effects will also be capitalized into land values and could lead to lower property values.

Because fiscal impact analysis draws on existing patterns of development and public finance to predict what will happen in any particular locality, such variations in per capita costs can be taken into account. As a result, fiscal impact analysis can comprehensively answer such questions as: are taxes of existing residents likely to change if development occurs? Will the quality of public services change? At what level would developer impact fees have to be set to avoid tax increases for existing residents? How does the density of development affect the fiscal position of local government and hence the tax bill of existing and new residents? What public service facilities would soon reach capacity in any given locality and require additional construction?

Non-Market Costs and Benefits

While fiscal impact analysis is a more comprehensive approach, it does not capture the non-market effects that may accompany residential development. This term refers to a broad category of costs and benefits that may occur as a result of development, but are not reflected in changes in government expenditures and revenues. Non-market benefit may not even be fully reflected in land values or any other market price signals. Such affects may be positive or negative and will occur if residential development affects goods or services that are not normally purchased through markets – for example, environmental amenities, such as water and air quality; a community’s sense of place and cultural traditions; and the diversity of the local population. If such attributes of a community are valued by residents and if additional development changes the quality of these attributes, then the costs and benefits of these changes should also be accounted for. For example, as a community grows and population increases, the sense of place associated with the community may be lost or in some ways diminished. For a complete accounting of the impacts of additional development, the cost of these changes would also be included in the cost/benefit analysis. The spatial pattern of development, as well as the socio-demographic changes in the community's population, can play an important role in determining these impacts. Economists have developed a variety of approaches for quantifying such changes and estimating their associated costs and/or benefits, some of which rely on survey methods that elicit a stated preference from respondents for these non-market services.

A Regional Perspective

The costs and benefits of development are often unevenly distributed over a region. Industrial development alone (that is, without residential development) usually generates large fiscal surpluses (in the sense that the additional tax revenues exceed the additional public service costs) while residential development alone often generates fiscal deficits. If one community has most of the businesses and another community has most of the residents in a region, residential property tax rates are likely to be low in the community with most of businesses and high in the largely residential community. When the number of residents who commute out of a community exceeds the number of workers who commute into a community by a large margin, existing residents are likely to be concerned that additional residential development may lead to increases in their property tax rates. It is no surprise that local leaders and residents of bedroom communities frequently oppose additional residential development!

Regional planning and revenue sharing by local governments can resolve many of the problems of development. First, it is easier to implement land-use controls and incentives in large regions involving many parcels over tens or hundreds of miles than in small regions the size of individual communities. Second, the fiscal imbalances related to the spatial mismatch between the location of residents and the location of businesses can be overcome by regional revenue sharing. In effect, revenue sharing transfers tax revenues from communities with a disproportionate number of businesses to communities that have a disproportionate number of residents. Fiscal impact analysis is an important tool in regional land use planning. It can help regional land use agencies and local governments to choose the best location for particular types of development, to evaluate the fiscal effects of alternative densities of development, and to design revenue sharing mechanisms that equalize the benefits and costs of development.

Conclusion

In many cases the debate over development has become polarized. Too often local residents and community leaders feel pressured into having to support or oppose residential development before estimates of the likely costs and benefits are available. Promoting or opposing development without regard to its type, location, or pattern and without consideration of the existing community characteristics misses the point. In most cases, the outcome of fiscal impact analysis is likely to neither completely support nor completely oppose development. Rather, it is likely to influence the amount and pattern of development. Therefore, the issue is not whether development is "good" or "bad," but rather what the net effects (the balance between the benefits and costs) are of any given development within a particular community.

At this point, it is too early to make any meaningful generalizations about the fiscal surplus or deficit of residential development in Ohio. The net fiscal effect of any given development project may vary greatly from one community to another because of differences in commuting patterns, the demographic characteristics of the population, existing public service capacity, and other factors. Remarkably few fiscal impact studies have been conducted on proposed residential development projects in Ohio. We recommend that a thorough fiscal impact study be done in every case where residential development is proposed for the next 3-5 years. In addition, we recommend that a study of non-market costs and benefits be carried out for several case studies of development projects in Ohio. Eventually, it should be possible to generalize from these fiscal impact and non-market valuation studies, but only after a sufficient number of development projects have been carefully analyzed.

References

Frank, J. The Costs of Alternative Development Patterns. A Review of the Literature, Washington, DC: The Urban Land Institute, 1989.

Kelsey, T. "The Fiscal Impacts of Alternative Land Uses: What do Cost of Community Service Studies Really Tell Us?" Journal of the Community Development Society,27,1, 78-89, 1996.

Ladd, H. "Fiscal Impacts of Local Population Growth: A Conceptual and Empirical Analysis," Regional Science and Urban Economics, 24,661-686,1994.

Prindle, A. and T. Blaine, "Costs of Community Services," The Ohio State University Extension Fact Sheet, CDFS-1260-98, 1998.