Smart Growth Fiscal Impact Analysis (short paper)

Smart Growth America commissioned Arthur C. Nelson, James C. Nicholas, and Julian Conrad Juergensmeyer to build the rationale for fiscal impact analysis and to create a guide that can show municipalities the vital connections between land use and the cost of government services and tax revenues from new development. You can read a simpler version here, or read the full paper here


Leaders of every community, big city, or small municipality, whether they’re in a major metropolitan area or a rural area, strive to foster economic growth and prosperity. They want good jobs, successful local businesses, and ideally, for municipal resources to grow faster than the costs of existing programs. Regardless of party or ideology, every elected official prefers the choice of lowering taxes or increasing services (or some combination) to the reverse. Every city administrator or finance director wants to present budgets that offer their elected officials those favorable options. A growing economy and tax base make that easier to achieve, and so most local policies are intended to encourage new development.

From an economic and fiscal perspective, new development projects are generally seen as desirable (notwithstanding that they may be locally controversial in other respects), bringing new jobs, residents, and incomes into the community, and enhancing the tax base. This perspective often leads to the view that any development is good, anywhere. It may incline local officials to approve, and indeed incentivize, any development proposal that comes along.  Real estate developers may ask for—and receive—public utility infrastructure at taxpayer expense. Companies will expect—and be awarded— tax abatements and additional subsidies for locating facilities in that city or county.  And local officials are prone to pursue annexation of peripheral territory, on the assumption that they are thereby improving the long-term fiscal health of their city.  

Examining fiscal impacts of development through a geospatial lens, however, shows that these policies can in fact have negative consequences for the locality’s bottom line. It turns out that where and how development occurs matters in terms of “net fiscal impact” – the difference between the tax revenues generated by new development and the government’s costs of providing the infrastructure and services that it will demand.  There is a vital connection between land use and the cost of government services, as well as the tax revenues that are generated. Whether a community reaps the benefits from a positive net fiscal impact from new development can depend significantly on the development pattern created from the land use decisions made by local governments. These decisions are both explicit and implicit: They include the effects of zoning ordinances, tax policies, capital budget practices, as well as one-off actions spurred by a particular proposal. And yet, how these local policies impact the development pattern, and how the development pattern will ultimately impact government finances, is something that is not usually brought out during approval processes for new development proposals or comprehensive plans.  

Why this matters

There are obviously many factors that affect local revenues and the cost of government services. Often these are out of the hands of local officials:  There’s a national recession; a natural disaster strikes the region; the federal government decides to close a military base; conditions in international markets cause a major employer to close a plant; the state legislature imposes new unfunded mandates.  

Land use decisions, however, are key policy levers for local governments—it’s something they control, and it’s one of the few areas where they dominate the policy process. Even so, the impact of those decisions on the fiscal health of the municipality is not routinely considered as part of those processes.  By recognizing the relationship between the nature and location of development and government revenues and costs, and adopting an appropriate fiscal analysis policy, local officials can improve their community’s long-term fiscal sustainability.  

What is a fiscal impact analysis policy?

Broadly, a fiscal impact analysis policy is a policy adopted by a unit of government that requires that new development be analyzed to calculate its near- and long-term impacts on local government costs and revenues. Where multiple jurisdictions exist (such as with overlapping local governments, school districts, etc.) the policy could require analyses to be conducted on each so that all affected governments understand the costs and revenues that will result from the new development. The scope of the policy can be limited to private development or may include public facilities and infrastructure. Policies can also include threshold triggers that may specify, for instance, that only developments greater than a certain size are required to perform a fiscal impact analysis.  

Fiscal impact analysis is often performed for consideration of local development proposals, and occasionally in conjunction with major land use plan approvals. Typically, that analysis doesn’t consider the geospatial effects – the development pattern – as a factor.  Government costs and revenues are assumed to rise by some factor for a given amount of growth (new homes, new jobs) regardless of where the growth occurs or the form of the built environment into which it is introduced.  In technical terms, these studies employ an average cost method.  (See further explanation below.)  

To properly understand the full impact that new development will have on the budget of a municipality or county over time requires an approach to fiscal analysis that considers the pattern of development.  

What is the ‘pattern of development’?  

When we speak about development patterns we are referring to a set of features that characterize the built environment. This can include:  Geospatial dispersion (is development compact or sprawling?); the form of the street network (grid or dendritic?); the relationship of buildings to streets and to each other (do they form a “street wall”?); etc.  

For the purposes of fiscal analysis, practical considerations call for a simplified index to capture the essential variations in the pattern of development. It has proven useful to employ density as a proxy measure for development pattern as it generally captures the key factor of dispersion-versus-concentration.  

(Other factors are obviously of importance, especially for uses that require more nuance, but gauging economic performance against density can get us close to the effects of agglomeration. Agglomeration is a concept in economics that refers to the forces that drive clustering of activities; it is the basis for the creation of villages, towns, cities, and metropolitan areas for several thousand years of human society.  And just as there are economies of agglomeration that drive private activities to cluster, so for the public sector there are significant efficiencies that result from more proximate location of activities.)

How the pattern of development affects fiscal outcomes  

The impact of the development pattern on local fiscal systems depends on the degree to which the function of the development varies with geography. In effect, it varies with the number of taxpayers among whom costs can be spread – a block with a row of townhouses, say 40 units, does not require 10 times the infrastructure as the same block with 4 houses on large lots.  On the other hand, revenue generated per acre is significantly higher on a denser block.  These impacts can be divided into the effects on revenue generation and on costs:

  1. Revenue generation is very uneven in spatial terms.  Areas that are dense, mixed-use, and walkable produce substantially higher tax dollars per acre than those that are dispersed, single-use, and car-dependent. 
  2. The cost of providing infrastructure and municipal services to areas that are dense, mixed-use, and walkable are significantly lower than those that are single-use, and car-dependent.

These impacts have been understood by economists and planners for decades, but are not generally incorporated into government policy at any level.

In rough terms, the local government functions for which spatial factors drive costs can be divided into three broad categories:  Streets and roads; those that run under the streets and roads;  those that run on top of the streets and roads.  (Think, water, sewer, storm drains;  police, fire, school buses, trash collection.)

The problem with most fiscal analysis of new development  

When it is employed as part of the policy process, fiscal impact analysis is typically performed using an average cost method.  For example, a prospective development (factory, sports arena, residential subdivision, shopping center, corporate headquarters, etc.) is evaluated in terms of the revenues that are expected to be generated as a result of its introduction into the jurisdiction (property tax, sales tax, etc.) and the cost of additional services that the local government will have to provide (streets, utilities, police and fire protection, library services, office space for clerks at city hall, etc.).  Using the average cost approach, these costs are assumed to be equivalent to those currently incurred, on average, by taxpayers.  For example, suppose a new development is anticipated to bring in 100 new residents to a town.  To estimate the cost of services that the new residents will require, the cost of providing the services (essentially, the annual budget for local government) to current residents is divided by the number of current residents (giving the “average cost”) and then multiplied by the number of new residents (100 in this example).  The problem with this approach, as noted by Nelson et al., is the assumption that “a development’s impacts in one part of the local jurisdiction will be the same as any other.” [p. 67]

Certainly, the average cost approach can be reasonable for a wide variety of municipal services for which that assumption is valid.  The number of employees required at city hall (or the amount of office space required to house them) may be proportional to the population, irrespective of where or in what kind of development that population lives.  A sizable fraction of the infrastructure and services that the local government provides may be effectively invariant to geographic differences.  However, for a considerable segment costs can vary greatly based on the level of geographic dispersion.  

The policy consequences of failing to recognize the fiscal impact of development pattern  

The general lack of understanding of how locational efficiencies (and inefficiencies) affect their budgets means that neither local officials nor the public recognize when local governments are effectively subsidizing sprawl. They continue policies that weaken their long-term fiscal health – often thinking they are doing just the opposite.  In many cases, these decisions can generate inequities, without realizing it.  Here are a few examples:

Example:  Utility fees. In most communities, fees related to government-provided services for water (including drinking water and waste water) are applied on an average cost per gallon basis.  If you use 100 gallons, you pay a fee based on the per-gallon rate, times 100 — irrespective of where you live in the community, and without reference to the variation in cost of bringing water to your house, and removing it as waste water.  Everyone pays the average cost.  But the infrastructure cost of reaching households varies with distance and the density of development.  Those who live close to the center of town, in higher density communities, are less expensive to serve.  Those on the fringe, in more spread out neighborhoods with large lots are more expensive to serve.  If everyone pays at the same rate based on average cost, the result is that residents in denser, more compact neighborhoods are subsidizing those in low-density neighborhoods.

Example:  Annexation.  For many municipalities, annexing territory beyond their boundaries has seemed a good strategy for growing the tax base and providing fiscal sustainability.  In some cases, this leads to a competition among cities racing to claim adjacent land before their neighbors can do so.  Not infrequently, areas that are not adjacent or contiguous to municipal boundaries are acquired, under the assumption that the city’s finances will be improved.  Expanding a municipality through annexation may make sense in given circumstances, for a variety of reasons.  Nonetheless, acquiring a larger area to serve, often with low-density development patterns in place, may bring more to the cost side of the ledger than to revenues, and long-term liabilities.  (As some communities have started to realize.)  Seldom is a spatially-based fiscal impact analysis performed beforehand that might reveal whether in the long run the annexed areas may add more to costs than they do to revenues.  

Example:  Development incentives.  Many cities and counties offer incentives to promote development.  They spend resources for things like tax abatements to induce a company to locate in the jurisdiction, or subsidies for infrastructure like paying for water and sewer lines to facilitate a new residential subdivision.  Whether such subsidies are a good idea at all is a separate subject that can be debated; the issue here is how they are applied.  While many local governments have well-articulated planning and development goals (“reinvigorate Main Street”; “strengthen tourism and hospitality”; etc.), those goals and the various incentives offered are frequently not brought into alignment.  The plan may call for focused attention in certain “priority” areas, but the incentives are given out for development anywhere in the jurisdiction.  Proper fiscal impact analysis might well show that some of the subsidized development will never pay for itself, and perhaps add to the government’s bill in the long run.  Alternatively, such analysis could be used to identify areas that offer the highest potential return on investment for the public.  Combining a fiscal impact analysis policy with a policy governing the application of any development incentives can save taxpayers’ money, and help realize development goals.  

Fiscal impact policies for local government.  To improve their chances for long-term financial sustainability, local governments should consider adopting a policy to require geospatial net fiscal impact analysis.  There are different approaches to measuring net fiscal impact, and there can be different approaches to incorporating fiscal impact analysis into policies and procedures.  The key is to adopt a policy that:

  1. Employs an approach to analysis that takes account of the spatial or locational impacts of development on revenues and costs; and,
  2. Makes such estimation a routine part of planning decisions and development approvals.

The model ordinance developed by Professor Nelson, et al., provides one approach that may be useful for many communities, at least as a starting point for discussion and adaptation to specific local circumstances.  

Economic development