City seeks more deliberate use of incentives

The arrival of the Roebling Row Apartments on the east side of Greenup Street in the early 2000s brought a wave of new residents to the outskirts of downtown Covington.  

COVINGTON, Ky. - Tuesday night’s caucus meeting of the Covington City Commission featured a 16-page PowerPoint filled with numbers and definitions that sparked a long and technical discussion of a specialized tax incentive called “industrial revenue bonds.” 

The discussion of IRBs at times got so far down in the proverbial weeds that weeds themselves would seem as tall as trees.
Few people witnessed it.
But for anyone who lives in Covington or pays taxes here - or for anyone who is thinking of moving to Covington or investing in the City to be a part of the vibrant energy downtown that is attracting national attention - the presentation provided a fascinating crash course in challenges and decisions that will be critical in the years ahead in determining how Covington looks and its residents live.
“This is a real important policy discussion,” said Mayor Joe Meyer in what one onlooker quipped was the understatement of the night.
The CliffsNotes version is this: Covington plans to continue using IRBs and other tax incentives to attract jobs, retail establishments, and housing developments, but City leaders want to be more strategic and deliberate - i.e. “smart” - in the how, when, what, where, and why of incentives to ensure that business growth benefits residents instead of undercutting them.
That’s the basic premise behind policy changes being proposed by City economic development and finance experts at the request of Covington’s elected officials, who listed a new IRB policy as one of their 23 priorities. Those proposals will be discussed over the next few weeks.
If you have a short attention span, you can stop reading right here ... but if you want to understand the new guidelines being recommended and the analysis and reasoning behind them, then you need to know a little bit about Kentucky tax policy, how the City funds services, and how IRBs work.
“Unfortunately, this is a complex issue and may take a while to get through,” Economic Development Director Tom West told the Commission in what was deemed another understatement. “These types of things you’ve probably never seen before.”
We’ll keep it short and simple:
Tax policy: Kentucky law forbids local communities from collecting sales tax, ergo none of the tax on meals, drink, goods and services stays here in the City.
Covington’s budget: 50 percent of the tax revenue that Covington uses to provide services like police protection, fire and EMS, and safe roads comes from payroll tax. Taxes on insurance premiums and property contribute about 14 percent each of the total revenue. So when it comes to providing services to residents, the creation of new jobs - especially good-paying jobs - has more direct benefit to the budget than new housing, and the sale of beer and sandwiches at restaurants and bars has no direct financial benefit to the City budget at all.
Industrial revenue bonds: Local governments use IRBs to help developers make projects happen. It’s a complicated arrangement involving leases and bonds and what’s called “PILOTs” (Payments In Lieu Of Taxes), but stripped to its simplest explanation, a developer agrees to make a small payment to taxing entities instead of paying property tax over the term of the deal. IRBs were created by state legislation primarily to help communities attract industries and businesses with lots of jobs, because jobs - i.e. payroll taxes - is how local governments most directly benefit.
That’s the context.
The “weeds” of the discussion came during a presentation on the IRB analysis conducted by Covington Economic Development Project Manager Ross Patten.
Covington has issued IRBs for six active projects dating back to Roebling Row Apartments in 2001. But five of the six projects were primarily residential in nature, with a small amount of retail. Other benefits of new development aside, that means the financial return to the City in the way of taxes collected has been strictly limited.
Furthermore, the more recent IRB deals were structured in ways that severely limited the financial payback. For example, the taxable values of the properties weren’t set by a third-party professional. Also, the tax rates were locked in for 30 years using the first year’s rate. And finally, the amounts of the PILOTs were frozen at a low level - 20 percent of the tax obligation - for all 30 years, instead of periodically increasing like in earlier deals.
In fact, Patten said, when you add in other incentives that the City contributed, Covington’s financial return on investment on some of the deals was actually negative - i.e. the City budget and taxpayers “lost” money.
To illustrate that point, Patten led the Commission through two different deals that put dollar figures to his analysis and showed how, over a 30-year period, the difference in financial return is vast.
The PowerPoint showed the collective budgetary impact of incentives with a chart that showed the rapidly widening gap between the City’s net and gross tax revenues. “We expect there to be a gap,” West said. “It’s the size of the gap that we need to be comfortable with.”
The City continues to believe that incentives such as IRBs are sometimes needed to make proposed projects viable in a market like Northern Kentucky, but “as players in the development, we deserve a positive return on investment,” West said. “We need to be able to provide quality services and pay for them.”
Hence the proposed changes.
In general, the proposed new guidelines on IRBs would balance the needs of developers with the needs of residents, provide flexibility to staff, and recognize that not every deal is the same, West said.
Among the proposed new guidelines are specific recommendations to: 
  • Use IRBs only when necessary to close a deal, instead of as a guaranteed initial piece of financing.
  • Treat projects differently based on the number of jobs they create.
  • Have property values set by the county property valuation administrator.
  • Stop locking in the property tax rate.
  • Require that the return on investment for taxpayers be positive.
  • Increase PILOTs (the payments) over the life of the deal.
 The City Commission would still approve every deal, West said.
“We’re still going to use incentives - if we can’t offer incentives, we can’t compete,” he said. “And we’re still going to pursue developments that provide housing. But there’s a balancing act. ... We need to do the right thing for the City and taxpayers.”
West acknowledged that “return on investment” includes more than just tax revenue, and he agreed with Commissioners who pointed out that the existing IRB deals have helped to create a rebirth in Covington’s urban core whose housing options, restaurants and entertainment are attracting national attention and pulling in visitors and new residents.
And he agreed that the elements of an energetic downtown are interwoven: Companies create jobs because they have confidence that they can find talented workers, and those workers move to cities that feature attractive places to live, and developers base decisions on building houses, condos and apartments on whether there are retail and recreation amenities nearby.
But the vectors of that formula travel many different ways, he said. Sometimes new jobs are the impetus for new housing and talent transfers. That’s why it’s important to take a holistic look at growth and the projects the City pursues, he said.
And Covington is in a much different position than it was 15, 10 or even 5 years ago, West said. With nearly a thousand market-rate and luxurious housing options recently built or in the process of being built, Covington can afford to be more strategic in guiding growth, emphasizing the creation of jobs, and making sure that development helps create revenue to pay for services.
That latter need - maintaining revenue to keep the City safe and its infrastructure up to date -- is especially important going forward because of budgetary pressures, City Manager David Johnston said: 
  • New development is increasing the demand for City services, and the expectations about the quality of those services is understandably and increasingly high.
  • The Internal Revenue Service’s decision to close its processing center in Covington next fall will reduce payroll tax revenue by at least $1.2 million a year, and the City is looking to make up that revenue.
  • State government is ordering Covington and other local governments to increase their public pension payments by 12 percent each year on a compounded basis, which for Covington will mean a $754,000 increase in the first year alone. 
“For these and other reasons, it’s imperative that we be good stewards of taxpayers’ money,” Johnston said.
In the end, Mayor Meyer urged the rest of the Commission to continue asking questions and making suggestions. The topic will be discussed for several more weeks, with the new framework for IRB policy likely being proposed for approval in the form of a legislative order rather than an ordinance.
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