What’s in the Box III: Feasibility of the Valiant Proposal (Part E)

A continuation of the series that began with analyzing the Roxbury report on the Valiant proposal.

In reading the Valiant proposal for the Library Lot, one is struck by the huge sums promised to the City and, they add, to the State.  The Appendix B for the proposal states that over 20 years, the project will bring an aggregate total of $113.7 million, with an NPV of $61.6 million.  The use of the NPV term indicates the notion of treating the project like a long-term business operation; it is a method of estimating cash flows and indicating a yield rate.  But, as Wikipedia states, “it does not provide an overall picture of the gain or loss of executing a certain project.”  I’m inclined to agree with Karl Marx in this context, who called it “fictitious capital“.  But that is a discussion well beyond the scope of this blog.  Let’s just look at the aggregate total and the gains attributed to the project.  After all, apart from the perceived need for a conference center, one reason that the City of Ann Arbor supposedly issued this RFP was to make money to support the dwindling city coffers.  One way to do that, apart from outright revenue from sale of property,  would be an increase in the tax base.  And it is indeed mostly taxes that the Valiant proposers use to justify their estimates of yield to the City.

6. Taxes

1. Payroll Tax

Appendix B lays out a number of the assumptions that Valiant’s figures are based on.  One is that they are assuming the creation of new jobs.  These include 260 construction jobs and 187 permanent jobs.  Much of the accrued value to the city and state are based on these.  Oddly, they acknowledge that these will not be highly paid jobs.  The average salary of conference center employees is estimated at $42,188 while the average hotel salary is $19,000.  There are also a few jobs associated with the residential condominiums, mostly maintenance, and those are also very low.  But the payroll taxes from these jobs are a major component of the dollar benefits cited for the project. They list both “direct” (presumably from employment of the project itself) and “indirect” (perhaps from other area business employment?).

Here is the 20-year summary of payroll tax benefits:

Source Direct Indirect
Construction (24 months) $    655,000 $   328,000
Regular Operations (20 years) $25,438,000 $17,283,000
Total $26,093,000 $17,611,000

So of the total aggregate benefits that Valiant claims over 20 years ($113.7 million), $43,704 million are in the form of payroll taxes.   (The remaining amount is $70, 038 million from all other taxes.)

Skipping over whether their assumptions are valid (numbers of jobs, etc.), there remains the uncomfortable fact that payroll taxes are collected by the Federal government to support Social Security and Medicare.  They are completely irrelevant to City or even to Michigan finances.

2. Sales tax

The majority of that $70 million remaining is evidently as sales tax.  The calculation is not quite broken out, but the elements that are revealed are puzzling. The percentage shown for state sales tax is “5.16%” and then there is a column for city tax at “14% of state sales tax” – so it is calculated at 0.84%.  However, the Michigan sales tax is 6%.  There is a program that was set up to return some portion of that revenue to local units of government.  However, that revenue sharing has been steadily reduced since the new system was introduced in 1998.  The system is supposed to include a constitutional share (required to be paid) and a statutory share to municipalities, as explained in this white paper from the Michigan Municipal League. But the “statutory” share is subject to the whim of the Legislature and has been a favorite source of fixes for our state’s decade-long budget problems.   The formula is complicated, based both on population and and prior amounts received.  It is possible that Valiant’s reference to the city tax % of state tax is alluding to the shared tax formula.  But there are two important points about that (ok, three):

1. The sales tax collected in Ann Arbor will go into a statewide pool, thus will not benefit Ann Arbor directly; and

2. The portion of the state sales tax collections coming to Ann Arbor are likely to decline in any event; but also

3. Don’t forget that the City does not collect any sales tax directly, and is prohibited from doing so by state law.

And yet, given all that, it is clear that not only are a major portion of the “tax benefits” supposedly accruing to the city are sales taxes, but that they are primarily collected from the restaurants and retail businesses that are part of the development.   Those have not been described or even necessarily planned.

3. Accommodations Tax

The Accommodations tax is levied on hotels primarily to support the Convention and Visitor’s Bureau.  As explained in an article by the Ann Arbor Chronicle,  Washtenaw County collects the tax and passes it on to the Bureau.  The rate was increased from 2% of room rents to 5% in 2009, and the County renegotiated its contract with the CVB so that it receives a higher percentage (10%) of the tax as an administrative fee.

The Valiant proposal calls this a “use and occupancy tax” and calculates that about $5.4 million would be subject to the tax in the first year, or about $271,000 in tax collection.  Presumably this is multiplied over the 20-year period (which would be about $5.4 million total) to add to the total benefit calculation.

But this is again irrelevant to the City of Ann Arbor.  All this tax revenue goes to the county and the CVB.

4. Property Tax

So what is left?  Those of us who follow tax and budget issues in the City of Ann Arbor are continually bellyaching about the diminution of our tax base due to encroachment by the University of Michigan, the loss of assessed value because of the recession and housing bust, etc.  We are, of course, talking about property tax.  And one motivation, we are told, in encouraging development is to increase the property tax base.

Ann Arbor actually collects two kinds of property tax.  One is the tax on real property – those of us who own a house are very familiar with that one.  The other is the misnamed “personal property tax“, which is levied only on businesses and is actually a tax on the value of equipment used in the business, including furniture.  So a hotel would obviously have two big tax bills – one on the assessed value of the real property itself and one on the furniture and other equipment used in operation of the hotel and restaurant. But the proposal is mostly silent on the subject of property taxes. Property taxes are not included in the “benefits” summary and it appears clear that the developers do not expect to pay them.  Here are some likely explanations.

a. They are counting on leasing the ground rights. As we explained earlier,  the arrangement would be for a very complicated formula by which a Ground Rent would be calculated on the basis of a Net Operating Income, or NOI.  If the city retained ownership of the ground rights, property tax might not be payable.  (They are also separately selling part of the air rights for condominiums, which would be taxable.)  (Note that “personal property taxes” for a business would still be payable in leased property.)

b. No PILOT either. The original proposal called for a “PILOT” of $250,000 a year.  Though this is not spelled out, it apparently refers to a Payment In Lieu Of Taxes.  This is a common way to pay municipalities some portion of taxes lost because a non-profit enterprise is occupying real estate.  A number of universities have paid them to cities.  Significantly,  a PILOT was involved in a prior project by one of the Valiant partners,  Michael Bailkin,  who was behind a (failed) project, the New York Sports and Convention Center.  In a move similar to that project, Valiant’s proposal called for applying the PILOT to payment of the bonds to finance the conference center (they also mentioned applying “real estate taxes on the hotel/retail – average of $250,000 plus” to the bond repayments, perhaps the same thing.)   However, the revised proposal drops the PILOT.

c. What about the DDA? Since this project is in the DDA district, any property taxes collected would presumably go to the DDA instead of the City of Ann Arbor (because it would be all new construction and therefore subject to the Tax Increment Financing provision).  This could, of course, be corrected through negotiation.  But as a column in the Ann Arbor Chronicle discussed, there is perhaps a thinning of the membrane between the DDA TIF fund and parking fund, and the City has been withdrawing huge sums from the parking fund.  So possibly, even if the property taxes were collected, and even if they did end up with the DDA, the city might benefit from them.  But direct payment to the City’s general fund of any real estate taxes from the project – or even the personal property taxes –  is not a certainty, and is apparently not planned.

So in conclusion, the Valiant partners claim that their development will bring the City over $100 million in taxes over the next 20 years – but none of it is actually payable to the city.

Next – what about those condos?  And other things.

Explore posts in the same categories: Business, civic finance

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