Question

A new subdivision was recently built within the city limits of Providence, Rhode Island. The City Government has taken on the project of building and installing streetlights and benches within the subdivision. The City Government will issue five-year bonds in order to finance the project. According to the city’s laws and homeowner’s agreement, the provision of lighting the sidewalks is the responsibility of the homeowners. An excerpt from the bond agreement is provided below:

The aforementioned bonds are issued and held by the City Government. Provisions for repayment of the bonds will flow from the special assessment (property tax) that is levied against the homeowners. Failure by a home owner to pay the tax will result in the foreclosure of the homeowner’s property. The property will then be resold at public auction, and the proceeds will be used to finance repayment of the bonds. If a property is not sold at auction, City Government is not required to purchase the property. The City Government is not required to use proceeds from other funds to cover delinquencies while the foreclosure process is occurring, but does maintain the power to create a separate fund for the purpose of redeeming the bonds.

Given the facts provided, what type of fund should the City Government use to account for the debt service transactions?

During the construction phase, how should the source of funds be identified within the appropriate fund?

Is the type of assessment being used by the City Government a service-type special assessment or a capital improvement special assessment?

Explain your analysis and document your conclusion fully, including specific references for relevant technical literature section(s) within the GASB Codification that were utilized in reaching your decisions.

Answer 1

Based primarily on the qualitative data, four primary uses or purposes of SSAs and SAs can be identifi ed, which corresponds to whether the fi nancing methods are pay-as-you-go or borrowing. Th ese purposes are explained in detail here. Table 1 shows examples of these uses for each primary purpose.

PRIMARY PURPOSE 1

SSAs (ad valorem) are used to maintain common areas in residential subdivisions (most oft en) and commercial and industrial areas, especially for stormwater maintenance and drainage, and may only become active when the residents or business owners fail to maintain the common areas. Such uses are oft en established prior to development and in conjunction with annexation of land as part of a planned unit development (PUD) agreement between a developer and municipality. Th e agreement requires the eventual property or business owners maintain the common areas aft er the development is complete, but when property and business owners do not fulfi ll this obligation, the municipality steps in to implement the SSA. Although it is much more diffi cult to establish SSAs aft er the fact, several jurisdictions encountered situations where SSAs were set up aft er development was completed and all properties sold to individual owners. Several other municipal governments were examined in which some property and business owners preferred to have the common areas maintained by the government rather than the home or business owners’ association, and most of the land area in several municipalities where covered entirely by SSAs (mostly dormant)5 .

TABLE 1 Examples of Special Service Areas and Special Assessments For Each of Four Primary Purposes PURPOSE EXAMPLE

#1: SSA to maintain common areas Mettawa’s Woodland Falls residential subdivision (SSA #3, $22,000 proposed budget) has an assessment to maintain and repair water transmission mains, sanitary sewer trunk lines and lift stations (including force mains), storm sewer mains, street, curb, gutter, traffi c signal, street lights, stormwater management consisting of detention and/or retention basins, bicycle and equestrian trails and public sidewalks. Mettawa also has SSAs in several business parks for this purpose. St. Charles’ SSA #5 and SSA #7 are manufacturing districts in which assessments are established to maintain common areas and storm water detention areas including maintenance and repair of the storm sewer. Requested extension for #7 that has no storm sewer responsibilities. St. Charles also has residential SSAs for this purpose. \ #2a:SA or SSA on developed property without annexation Elmwood Park residents can request to establish an SSA to have their alleys improved. The improvements consist of the installation of a concrete alley and storm sewers (for drainage), new concrete garage aprons, with the option of using permeable pavers (green alley). The village covers the cost of initial engineering and 50% Evanston has an alley repaving program in which residents pay 50 percent of the costs but uses SAs. Riverwoods uses SSAs to install municipal water systems to provide Lake Michigan water to residents. #2b: SSA on developed property with annexation Glen Ellyn annexed the Lambert Farms subdivision in 1999 and received a loan from the Illinois EPA for $1,508,839 to extend sanitary sewer lines to homes in the subdivision. This loan is being repaid with SSAs levied on residents until 2022. #3: Developer incentive Lincolnshire issued $15 million in SSA bonds in 2004 to construct the infrastructure for Sedgebrook retirement and nursing home. This is an example of using SSAs for one property owner. Streamwood also lists SSAs as part of their tax incentives and development assistance programs. All public infrastructure improvements to support the Timber Trails subdivision in Western Springs were fi nanced with bonds that are being retired through SSAs. #4: BIDs Highland Park has an SSA, in conjunction with a TIF, in the Ravinia Business District to help fi nance marketing and special events within the district. Specifi c services provided by municipalities under this broad purpose and within the PUD agreement focus on maintenance, repair, and replacement of “open space, common areas, landscaped areas, and natural areas” rather than the maintenance, repair, and replacement of infrastructure such as sidewalks, streets, and lighting. It is also interesting that maintenance and management of stormwater facilities is the most common specifi c use among the 18 governments in the sample that use SSAs for this primary purpose. Compared to other uses of SSAs, the benefi ts of good stormwater management oft en spill over to areas outside of the SSA and possibly to the entire jurisdiction and region. In other words, the benefi ts of stormwater maintenance and management are not always special to the property owners who are paying the SSA. Th e Chicago region has a particular geography and weather pattern that requires good stormwater management. Flooding and poor stormwater management have been a signifi cant threat to governments and many property owners in the region (Hendrick, 2011), and these threats are increasing as a result of climate change (Chicago Metropolitan Agency for Planning, 2008). Th e common and shared benefi ts of good stormwater management were apparent from legislation passed by the Illinois General Assembly in 1988 that gave the fi ve non-home rule counties in the region the authority to implement countywide stormwater ordinances.6 Th e Kane County Stormwater Ordinance (1997), for instance, requires all municipalities in the county to set up dormant SSAs for new development and may partially explain the relatively high number of governments in this county with at least one active SSA. Although the region’s planning agency and other regional experts advocate the use of utility enterprises (similar to water and sewer funds) rather than SSAs for stormwater management, the trend towards using SSAs for this purpose continues (DuPage County, IL 2007; Chicago Metropolitan Agency for Planning, 2008). In this case, reliance on SSAs for this purpose may be based more on historic “English ditch law” that required farmers to pay for drainage of their land hundreds of years ago than considerations of whether this method of fi nancing is appropriate for stormwater management. Evidence shows that use of SSAs for this purpose is the most common among the four purposes, and is most prevalent in jurisdictions that developed aft er 1980 and are not serviced by municipal storm sewers. Th e fi nancing of services and benefi ts for this use is primarily pay-as-you-go. In other words, the property taxes collected fi nance the maintenance of operations in the SSA rather than to pay off debt for infrastructure improvements. Several municipalities, in fact, discussed having to establish miniature budgets for each SSA that they manage for this primary purpose. Th e amount taxed on most properties for this purpose, however, is not very great. In the Village of Elburn in Kane County, homes in the Prairie Valley subdivision paid $0.06 per $100.00 of EAV (about $60 for a $300,000 home) in 2013 to maintain common areas in the subdivision.7 PRIMARY PURPOSE 2 SSAs and SAs (non ad valorem) are used with and without annexation to fi nance new or signifi cantly upgraded infrastructure. Th is can include water and sewer systems (to eliminate private wells and septic tanks), lighting, paving of alleys, parking facilities, stormwater facilities, and even roads in existing residential (usually) or commercial areas in which land use has been established previously. Th is purpose diff ers from the fi rst purpose primarily in that land use within the STD was well-established prior to the creation of the STD. Th e improvements fi nanced by these tools are expected to be capitalized back into the property values of properties and even profi ts of enterprises that are aff ected (Shoup, 2014, 414). Th is purpose would include building facilities that increase stormwater capacity and reduce fl ooding, which enhances the properties rather than simply maintaining them as with the fi rst purpose. Many governments will also issue bonds for all, or a portion of the improvements if they are costly in order to spread out the payments for property owners over a long period of time. Similar to the other purposes, the liability for repayment of bonds within the STD lay with the property owner and not the municipality. Th is situation oft en creates a great deal of confusion for property owners who must contend with separate tax liabilities that can hinder and complicate the sale of property. This primary purpose can also be divided into use with annexation and use without annexation. Of the 17 sampled governments that use SSAs or SAs for this purpose, six used it with annexation. In many cases, the annexation was driven by the desire of residents in nearby unincorporated areas to discontinue their wells and receive water provided by city wells or from Lake Michigan. When an area is annexed, all properties must be brought up to the codes and standards of the annexing government and can include improvements to streets, stormwater maintenance, and other infrastructure in addition to water and sewer systems. Evidence showed that, without annexation, SSAs and SAs for this primary purpose have been used mostly in residential areas for installation of new water and sewer lines followed by upgrade of alleys, street lighting, and street improvements. Many governments with SSAs or SAs for this purpose fi nanced a portion of the improvements through general revenues. Government subsidies ranged from 25% in Beach Park, to 60% in Clarendon Hills, and the improvements can be requested and agreed upon by property owners, or they can be a government-initiated (e.g., the Park Ridge Alley Paving / Reconstruction Program and the Brookfi eld Alley Paving Program). Of the 37 governments sampled, only seven governments had used or were currently using SAs for this purpose, and several of them talked about replacing their SAs with SSAs. Th e greater cost of implementing SAs compared to SSAs, especially in the case of non-payment of the property tax levy or charge, was documented in six of the sampled governments. Th is raises the question of why a government would use an SA rather than SSA. Th e investigation also revealed an important rule of thumb about when to use one or the other: Ad valorem SSAs should be used when the properties within the STD are similar and for ongoing goods and services; non ad valorem SAs should be used when the properties are dissimilar and there are diff erent land uses within the STD. More generally the evidence shows that it is easier to identify the proprietary benefi ts that accrue to a set of properties that have clear boundaries, similar land use, and comparable property values compared to areas without clear boundaries, mixed land use, and a wide range of property values. Jurisdictions with more recent growth and development have more of the former characteristics due to the prevalence of residential subdivisions, shopping centers, and business parks. By comparison, older jurisdictions are more likely to be laid out on a grid and have residential, commercial, and industrial uses mixed within the same block. Th ree governments were also observed where offi cials were concerned about the need to consider what level and quality of goods and services have been provided using either SAs or SSAs versus general taxes in the past in order to judge whether the use of these tools is fair in particular cases. For this reason, debates about whether tools are fair seem to occur quite oft en over improvements to areas that are already developed and where land use has been established. Th ese debates seem to be particularly contentious in jurisdictions that have been developed at diff erent times and, therefore, have varying qualities of infrastructure. In these cases, questions about what constitutes a unique benefi t for properties in an STD relative to the rest of the jurisdiction and even past time periods are more diffi cult to resolve to everyone’s satisfaction. PRIMARY PURPOSE 3:

SSAs are used to repay bonds the municipality issues to build basic infrastructure (e.g., streets, water, sewer) to support new commercial and / or residential development. Th ese SSAs are primarily a tool for attracting development or redevelopment to an area within the jurisdiction compared to the prior purpose in which major improvements are not expected to increase the number of residents or businesses in the area. Similar to purpose two, bonds for which the government is not liable are oft en issued in conjunction with this purpose, but - similar to purpose one - the SSA is established with only a few liable property owners initially. As the primary property owner, the developer is responsible for paying principal and interest on the bonds initially, but that responsibility will transfer to new property owners as individual parcels are sold. When new development or major redevelopment occurs that is privately motivated, there are three primary alternatives for fi nancing the basic infrastructure to support the development (Ayers et. al, 2014): 1) the developer pays out of personal funds and secures borrowed money for which only the developer is obligated; 2) the municipality fi nances the infrastructure and assumes obligation for the borrowed money; 3) use of land-secured fi nancing in which all property owners in the development become obligated to pay some portion of the infrastructure (Misczynski, 2012). Prior research on suburban Chicago municipalities shows that many governments have a policy that public improvements that support development and redevelopment pay for itself, which eliminates option two for these governments (Hendrick, 2011). Option two is the riskiest for the government if the development fails because the government is obligated to repay the debt in this case. Option one is the next riskiest for the government because, although they are not liable for any debt associated with the development, they may have little control over what happens to a failed development in the future. With option three, however, the government can resort to tax the sale of the property to secure new ownership if the developers fail to pay the property taxes that secure the debt. Developers are also attracted to these tools because they reduce upfront capital and interest costs, which improves cash fl ow, and reduces liability and debt on their balance sheets aft er the properties are sold (see Orrick & Datch, 2008; Scutelnicu, 2014, and Scutelnicu & Ganapati, 2012). Several governments observed also presented these types of SSAs as examples of public-private partnerships. For instance, there is the Metra Station Development project that is a collaboration between Park Forest, Olympia Fields, and Matteson. Also, the Lake Villa Downtown Plan, and the Westmont Redevelopment Plan and Program all involve SSAs that are presented as public-private partnerships in the proposals that are available online. It is also not uncommon for such SSAs to be used with other economic development and development incentive tools such as tax incremental fi nancing districts and sales tax abatements, tax credits, and business improvement districts (BIDs) in commercial areas. 8 Evidence shows, however, that use of ad valorem SSAs for this primary purpose is sometimes unpopular with the public, realtors, governments, and even developers. Online information shows advertisements from developers that their homes are not built with SSAs, and several government offi cials claimed proudly that their homes are not sold with SSAs. Many municipalities also reported that the developers they dealt with were very sophisticated and probably well aware of SSAs for this purpose, but simply did not request their use from the government. Several other governments had specifi c policies against using SSAs for this purpose. Th ere are several reasons for this unpopularity of SSAs, which have relevance for the Leviathan explanation of government behavior. Although SSAs for this purpose are less risky for governments than securing debt under their own authority or contracting with the developer to build supporting infrastructure (even with letters of credit), the public’s poor perception of SSAs is greatly infl uencing many governments. Although the cost, resale, and mortgage price of properties aff ected by SSAs for this purpose should be lower than properties without SSAs, property owners do not perceive the tax payment in this manner (Do & Sirmans, 1994). Rather, they clearly see an additional tax burden on their properties that can be substantial relative to the regular tax burden. According to a 2008 SSA disclosure report from the Village of Huntley, homes in the same subdivision are charged equally for the bond payments (Huntley 2009). In the Southwind subdivision, for instance, one property worth about $225,000 in 2008 ($72,000 EAV) paid about $1400 in SSA property taxes, which is approximately $2 per $100 of EAV. Th e regular tax rate on this property in 2008 was about $6.7 per $100 EAV. It is apparent in many cases that the public does not perceive these SSAs as a debt that will be paid off eventually but rather perceives them as permanent taxes. Several government offi cials reported that they were aware of subdivisions in which the SSA tax levy was greater than the municipal government’s regular tax levy and felt that this was undesirable. Evidence also showed reports of homeowners having to pay off their SSA debt in order to facilitate the sale of their home. Th us, it is the perception of property owners who are now aware of the full costs of public facilities supporting their property that are driving the behavior of government rather than government’s Leviathan tendencies.

PRIMARY PURPOSE 4 SSAs are used to fi nance Business Improvement Districts (BID) that provide services and some infrastructure improvements to a designated commercial area. Although BIDS may be established in conjunction with purpose three, they can also be implemented independently in established commercial areas where no signifi cant improvements are occurring. An excerpt from the 2014 Adopted Budget and Financial Plan from Elgin explains specifi c purposes of BIDs and how they are administered (City of Elgin, 2014). An SSA (for a BID) is an economic development tool that provides commercial districts the fi nancial means to create and maintain clean, attractive and competitive districts beyond basic city services. A nominal tax assessment is put on each property within a specifi ed district which provides locally managed funding for services and programming. Th ese typically include area maintenance landscaping, minor capital improvement fi nancing, retail attraction and promotion programs, security planning and coordination, parking improvement strategies, façade improvement rebates and special events. Th e SSA is professionally managed by a service provider, such as a development group, chamber of commerce, or other economic development agency. Th e Elgin BID is administered by the Elgin Downtown Neighborhood Association. Th e Ravinia Business District in Highland Park (administered by the Ravinia Business District Advisory Committee) and the Joliet City Center (administered by the Joliet City Center Partnership) are other examples of municipalities in the region using SSAs to fi nance BIDs.