How developers of Lexington’s flashiest mall got a tax break meant for blighted areas

Editor’s note: This is the second in a series of stories about tax breaks and incentive programs that cost Kentucky billions of dollars each year, leaving lawmakers little money to fix Kentucky’s ailing pension systems.

In 2013, as an Alabama development company prepared to turn a farm at Nicholasville Road and Man o’ War Boulevard into an upscale shopping center called the Summit at Fritz Farm, the company decided that it would like some taxpayer help with complicated stormwater issues at the site.

So Bayer Properties turned to tax increment financing, a program in Kentucky first set up in 2002 to improve blighted urban areas by luring developers with generous tax breaks. The program gives back to the developer a portion — usually 80 percent — of the increased property, sales and withholding taxes that their development creates in order to help pay for infrastructure costs, such as parking garages and sewer improvements.

The Summit property wasn’t urban or blighted, and it didn’t meet other TIF qualifications either. So the developers’ lawyer, Bill Lear, himself a former legislator, went to Frankfort to change the TIF law.

“I drafted it,” Lear said recently about what in 2013 became House Bill 431, which amended state law so TIF projects could include mixed-use projects with “either or both significant public storm water and sanitary sewer facilities in communities under a court decree.” Lexington is under such a decree after the U.S. Environmental Protection Agency sued the city to fix its leaking and overflowing sewer systems.

“We convinced them it was a good idea,” Lear said, and the state approved a tax rebate of $24 million over 20 years from a combination of new property, sales and withholding taxes generated by the $155.6 million project.

Lear wasn’t the first person to successfully change the law for a specific project. In all, the TIF law has been modified eight times since 2002, mostly to accommodate proposed projects that included sports arenas and developments near military bases.

Last year, when the telephone cooperative WKT in Western Kentucky wanted to convert a bankrupt college campus into a technology park, they turned to lawyers and legislators, who quickly drafted a new definition for TIF properties “previously owned by a liberal arts education institution … bounded on one side by a four-lane United States highway.”

The Kentucky Economic Development Finance Authority then gave preliminary approval to the $115 million project, now known as the WKT Technology Park in the far Western Kentucky town of Mayfield (population about 10,000). It’s not yet clear how many millions in incentives will be approved.

Overall, Kentucky has given developers $111 million through TIF tax rebates in the past decade, and at least $2.9 billion has been pledged on current projects over their 20- and 30-year terms, according to state records.

And yet, no one in state government tracks what economic impact they have on Kentucky or how they affect state and local government revenue.

So as lawmakers look at tightening state budgets and possible tax reform, they might want to examine a law that seems to expand every time a new project comes along, said Pam Thomas, a former analyst with the Legislative Research Commission who now works for the liberal-leaning Kentucky Center for Economic Policy.

“It’s another example of providing benefits to corporations without the requisite backside evaluation to determine if those changes result in improvements,” said Thomas, who recently wrote a white paper on the subject. “There’s no way to know what the net value is to Kentucky.”

In addition, the law allows local governments to issue their own TIF projects, but there is no central reporting or state oversight, so no one knows exactly how many there are or what their financial ramifications might be.

For example, a TIF issued by Grant County and the city of Williamstown to the Ark Encounter, an amusement park based on what’s advertised as a life-sized Noah’s Ark, lets the amusement park keep 75 percent of the increase in its property taxes for the next 30 years without any requirements for job creation or any other reporting.

State law does prohibit school taxes from being included in TIF payouts, an important protection for schools, which rely heavily on property taxes for funding.

Rep. Jim Wayne, D-Louisville, a longtime proponent of tax reform, calls the program “corporate welfare.”

“I think it’s a bit of a scam,” he said. “If the government is going to support some businesses or create initiatives to create businesses, we should say we’re going to support it, make it a line item in the budget,” he said. “Instead, what we do is create these shell games. It’s corporate welfare.”

Checks and balances?

The law has its defenders. John Farris, who was secretary of finance in the administration of Gov. Ernie Fletcher, said developers were constantly asking for state aid on infrastructure pieces of a development, such as parking garages.

“We wanted to get the state out of parking garages,” he said.

Instead, under the TIF program, “the state won’t give you the money up front, but if you pass a series of tests, we will allow you to collect up to 80 percent of taxes and put them back into public infrastructure.”

Farris, who helped shape a major expansion of the TIF law in 2007, now works on a majority of TIF projects as a consultant with his business, Commonwealth Economics. Sometimes he advises local governments; sometimes he helps developers. He said the program has a series of checks and balances, thanks to independent reports commissioned by the state that make their best guesses on the future financial impact of each TIF proposal.

He estimates that only about half of proposed TIF projects ever get approved by the state, and those that do get approved sometimes aren’t able to collect their full tax break. Farris cited CentrePointe, the controversial development in downtown Lexington, as an example.

In 2013, the state approved the hotel and office development as a TIF project, giving developers the possibility of recouping $48.8 million over 30 years for the cost of an underground parking garage. However, the program requires the countdown for those rebates to start ticking two years after approval. CentrePointe’s clock started in 2015, but the garage, which is almost complete, probably won’t be usable until the buildings proposed above it are completed. That means owners will have less time to take back taxes, probably reducing the rebate by millions of dollars.

In this case, the program’s safeguards worked, Farris said.

More generous than most

Forty-nine states and the District of Columbia have TIF programs, according to a 2015 report from the Council of Development Finance Agencies, but critics argue few have made them as generous as Kentucky’s.

Unlike Kentucky, 35 states limit their TIF programs to property taxes. Also, 32 states allow TIF tax breaks only in areas designated as “blighted.”

In Kentucky, developers can receive rebates on a combination of taxes — sales, withholding and property. The rebate is supposed to come from taxes generated by new businesses within a defined area near the TIF project, but Kentucky’s law also allows existing businesses to move into TIF districts. That means taxes that those businesses were previously paying to city and state governments instead go directly to the developer.

A TIF district can sometimes be much larger than the development being subsidized. That’s what went wrong in 2006 at the much-publicized KFC Yum Center in Louisville. The TIF district expanded six miles through downtown Louisville in order to capture as much tax revenue from surrounding businesses as possible to pay off the $435 million project. When the 2008 recession hit, though, sales and occupational taxes at those surrounding businesses didn’t grow, leaving the arena’s financing in severe trouble.

That deal was investigated by state Auditor Mike Harmon, and state legislators placed new restrictions on the size of TIF districts.

“I think TIFs in general can serve a purpose, but we need to make sure we have good data,” Harmon said. “The other question you have to ask is, how much taxpayer dollars do we want to dedicate to a project that by all anticipation should be able to support itself if not immediately, then in the future?”

That question is pertinent to another Louisville project, the University of Louisville’s ShelbyHurst campus on the east end of town, one of the city’s most valuable development areas. The property is being developed by the U of L Foundation and its partner, NTS Development Co. Plans for TIF-supported buildings include the expansion of a Homewood Suites hotel, a new conference center, a new research and development building, a new office and technology building, and a 1,115-space parking garage.

In all, the project is estimated to cost about $831 million and would be eligible for as much as $253 million in tax rebates over 30 years.

TIF rebates aren’t yet being collected because, as a “signature” project, its developers must first spend $200 million, said Keith Sherman, interim executive director of the U of L Foundation.

“Why would you need a TIF there?” asked Wayne, the Louisville Democrat. “It should be an attractive enough location. Why can’t you just put it on the open market?”

Sherman said he understands Wayne’s skepticism, but he thinks TIFs are essential to building unique projects such as ShelbyHurst, which combines commercial and academic space.

A necessary evil?

The University of Louisville has two other TIF projects that were started by former President James Ramsey, an enthusiastic designer of TIF projects who used the program to help pay for academic buildings at a time when state funding was drying up. All of the projects received financing from the U of L Foundation, where he also was president.

The 856-acre U of L Belknap TIF project includes U of L’s entire main campus, including the Speed Art Museum, and seven planned research and development buildings. It also includes Coit Cleaning and Enterprise Rent-A-Car. The project is estimated to cost $1.3 billion and could get a rebate of $709 million over 30 years.

The Belknap project has reached the $200 million spending requirement, but city and state officials are trying to determine what tax rebates they owe the Foundation.

The third TIF is known as the Health and Life Sciences project, a 210-acre district in what’s known as the Haymarket area of downtown. That TIF started with the construction of the Nucleus building, which was supposed to kick off a neighborhood of health technology businesses. Instead, an existing health care company called Atria Senior Living became the anchor tenant.

U of L Foundation officials said 57 new businesses have moved into the TIF district since 2007, but the district also includes Kentucky One Health (formerly Jewish Hospital) and University of Louisville Hospital. That means a portion of the withholding taxes on high-paying hospital salaries now go to the U of L Foundation instead of to city and state coffers. So far, the foundation has collected $24 million in TIF rebates on the project.

“I think TIFs can be a very good thing,” said Sherman, who became interim leader of the foundation after its board and U of L’s board were replaced last year amid allegations of financial mismanagement. “I think they have to be thoughtful and thoroughly analyzed and well planned, and there has to be partnership with local and state entities and a commitment to growing the (TIF) district.”

Leading lawmakers, meanwhile, view TIFs as a necessary evil.

Senate budget committee Chairman Chris McDaniel, R-Taylor Mill, said he doesn’t like TIFs, “but the fact is that TIFs are a modern reality of competing for jobs and development.”

Developers need help sometimes with road, water and other major infrastructure required for big developments, McDaniel said, but the program should come under more review.

“Everything touching the tax code has to be looked at as we approach tax reform,” he said.

This story was originally published October 26, 2017 at 8:45 AM with the headline "How developers of Lexington’s flashiest mall got a tax break meant for blighted areas."