A tax abatement is a reduction of taxes granted by a government to encourage economic development. The most common type of tax abatement is a property tax abatement granted to a business as an incentive to come to a city or expand existing operations within the city. Tax abatements last for a defined period for owners invest additional capital in the business.
Why Cities Adopt Policies Regarding Tax Abatements
Cities adopt economic development policies regarding tax abatements and other tax incentives. These policies force cities to think about what they are willing to do to encourage private sector growth. The city’s economic development director is responsible for drafting these economic development policies.
When a business is satisfied with the tax abatements allowed by policy, the economic development director and city manager make agreements that the city council will almost certainly approve. Economic development policies enable a city to set boundaries that the city council will think long and hard about before exceeding.
Cities expect to break even when they grant tax abatements. The amount they forgo in tax revenue from the business and spend in added operational costs should be exceeded by the tax revenue increase caused by the business’s economic impact.
Unless cities make an exception to policy, specific tax abatement amounts are granted according to a formula established in policy. A business must bring a certain number of jobs or a certain amount of property value increase to the city. The higher the job growth or property value increase, the higher the percentage of taxes that will be abated. Usually, the percentage of taxes abated decreases over time until the business begins paying the full tax bill.
Examples of Tax Abatement
- A real estate developer buys a 100-acre tract of land to build a residential subdivision. The developer expects all the houses to be built and sold within three years. The developer and economic development director agree that once the land is improved, the value of the property will increase by $1.5 million. City policy allows development with this economic impact to have 45% of its property tax to be abated in each of the first two years and 40% to be abated in the third year. The developer is not concerned about years beyond the third because he expects to have all the properties sold by then. Once each home is sold, the new owner pays the full property tax amount.
- An individual decides to open an automotive and small engine repair shop. The business will employ 12 full-time staff each making a living wage. Because the business will add jobs to the local economy, city policy allows the business to receive a tax abatement. In the first year, 40% of the business’s property tax will be abated. That percentage will drop by 10% each of the next three years. The business will pay full property taxes in the fifth year.
- A factory owner needs additional capacity in the factory. The owner decides to build a $2 million expansion of the facility. Under the city’s economic development policy, 50% of the property taxes on the expansion will be abated in the first year. Each subsequent year, that percentage decreases by 5% until the business pays full property taxes in the 11th year.