Question

Rocket Beach is a rapidly growing city near a space program facility with a current population of 200,000. The rapid growth is outgrowing current infrastructure, including streets, sidewalks, lighting, and sewer systems. City council members have considered a variety of options to fund infrastructure expansion, including (1) a term bond issue maturing in 20 years, or (2) a one-half cent sales tax increase, or (3) an impact fee of $1.00 per square foot for new residential and commercial buildings.

Evaluate the advantages and disadvantages for each of the potential financing options from the viewpoint of (1) the city council, (2) current homeowners and business owners, and (3) building contractors.

Answer 1

A. City Council

Option 1

->Advantages

1. City council can easily raise the money for infrastructural development via bond issue as the same would be considered as government bonds with a risk-free rate of return in which the investors will be eager to invest. Also, the investor will earn interest by investing in the said bonds.

2. There will be no pressure on city council for increasing the sales tax.

3. There will be no pressure on city council by making the contractors charge impact fees from the home and business owners and increasing the real estate prices.

-> Disadvantages

1. City council will have a financial liability to pay the interest expenses on the bonds issued as per the terms of the bonds.

Option 2

-->Advantages

1. The major advantage of choosing the said option would be an increase in sales tax revenue.

2. City council will have no financial liability such as interest expense

3. There will be no pressure on city council to make the contractors charge impact fees from the home and business owners and increase the real estate prices.

-->Disadvantages

1. The cost of expansion of infrastructure of the city would be a huge cost and hence city council will not be able to raise such huge amount of money in a short time via increasing the sales tax rate by 1.5%. The same will take time and slow down the infrastructural growth in comparison to option 1.

2. The people in the city might not like the new increase in the sales tax rate, as the same will increase the prices of basic commodities that an individual purchase on a routine basis. Hence, there may be protests against the increased tax rate.

Option 3

-->Advantages

1. City council will be able to increase its overall revenue by a new stream of revenue i.e. Impact fee.

2. City council will have no financial liability such as interest expense

3. There will be no pressure on city council for increasing the sales tax, as the same might result into public protests.

--> Disadvantages

1. The cost of expansion of infrastructure of the city would be a huge cost and hence city council will not be able to raise such huge amount of money in a short time via charging the impact fee of $1 per square foot. They'll have to analyse or survey the future infrastructural projects in the city and estimate cash inflow of the impact fee, the time when they'll be able to raise the total amount required and its present value. This might also slowdown the infrastructural growth.

2. The impact fee is charged on the new infrastructural projects. Hence, there might not be enough projects ongoing or planned in the city to recover the impact fee required for the said expansion.

3. Also, the impact fee would increase the real-estate prices and can also be protested by building contractors and new investors.

B. Building owners & Home Owners

Option 1

-->Advantages

1. Building and Home owners can purchase the bonds issued by City council, as the same will provide them a risk-free rate of return and they'll be able to invest their money in a safe option.

2. As the city council will be able to raise all money required for the expansion in a very short time, the development of infrastructure (such as streets, sidewalks, lighting, and sewer systems) would be faster and will ultimately benefit the home and business owners.

3. The home and business owners would not be burdened with increased sales tax or the new impact fee(for potential investors in Home and business owners), if the said option is selected.

-->Disadvantages

1. As the government issued bonds provide a risk-free rate of return, the same would be lower than the other potential investment options available to the home and business owners.

Option 2

-->Advantages

1. Building and Home owners will be able enjoy the faster rate of growth in infrastructure in the said option as everyone will have to contribute by paying the said indirect tax. The city council will be able to collect the money needed for expansion quicker in comparison to the option of charging the impact fee and hence, the fast rate of growth will benefit the general public eventually.

-->Disadvantages

1. The increase in the sales tax will ultimately increase the prices of the commodities consumed by general public and hence, will increase the routine expenses.

Option 3

-->Advantages

1. Only the home and business owners who plans to invest or buy new property will have to pay the impact fee, the rest will be not be charged anything, unlike the option where sales tax was increased by 1.5% for all.

-->Disadvantages

1. As the impact fee will be paid by the potential buyers or investors of property, hence, the cash inflow might not be for the required expansion, which will slow down the infrastructural growth and in turn the general public will not be able to enjoy the new infrastructural facilities soon.

2. The real estate prices will rise on account of introduction of the new impact fee, which in turn will make the properties costlier for the potential investors amongst the current home and business owners.

C. Building Contractors

Option 1

-->Advantages

1. Building contractors will be benefited by the new contracts which, they might get on account of the planned expansion in the city, as the city council will be able to raise the money quicker in the said option in comparison to the other two.

2. Under the said option, building contractors can also invest their excess funds in the bonds and earn interest income on the same.

3. Building contractors are too a part of general public and hence, they will not have to pay the excess sales tax on the commodities in a scenario where option 2 is selected by city council instead of the current option.

4. Also, if option 3 was chosen, the real estate prices would increase and hence, will reduce the demand of properties and in turn will negatively affect the revenue of the building contractors. However, no such scenario would be created if option 1 is chosen.

-->Disadvantages

1. The investments, if any, made by building contractors in the bonds issued by city council, will not give them the rate of return as other investing options might provide them.

Option 2

-->Advantages

1. Under the said option, as everyone will have to contribute for the infrastructural development, by way of paying increased sales tax. The collection of the funds required for the expansion will be faster than option 3, and the building contractors might also get the contracts from city council quickly.

--> Disadvantages

1. Building contractors are too a part of general public, and hence, they will also have to pay the excess sales tax on the commodities.

2. The increase in sales tax will also increase the prices of the raw materials the building contractors use, which will ultimately increase the real estate prices, in cases where they are not able to get the credit of the excess sales tax paid by them.

3. On account of increase in the real estate prices, the demand for making investments or buying new properties will reduce and will affect the building contractors' revenue in a negative manner.

Option 3

-->Advantages

1. Choosing the said option will not result in increase in raw material prices and hence, there will be no increase in sales price of property on account increased prices of raw materials.

-->Disadvantages

1. The impact might have to be collected by the contractors from the buyers and they might be made responsible to pay the same to city council (similar to other indirect taxes). This will increase the procedural requirement of the contractors and they might have to incur addition consultancy charges for the same.

2. Charging the impact fee to raise the money for expansion seems to be the slowest way of collecting the money required for expansion by city council. This in turn will reduce the rate of distribution of new contracts by city council to the building contractors.

3. Charging the impact fee will increase the real estate prices and the demand for making investments or buying new properties will reduce and will affect the building contractors' revenue in a negative manner.