Infrastructure sector in India has not been able to perform to its full capacity, majorly due to the Government red tapes, lack of funds and very long gestation period in completion of the projects. With introduction of Public-Private-Partnerships (PPP), this scenario is expected to change.
Infrastructure Financing – one of the most crucial factors – needs to evolve to an advanced level from the till recent conventional ways of taking loans, grants, special allocations, etc.
This research article aims to discuss a not much explored way of funding the infrastructure needs in the country i.e. ‘Tax Increment Financing (TIF)’.
Introduction – Infrastructure Financial Needs:
As per the Master List recently issued by the Cabinet Committee on Infrastructure of Govt. of India, there are five main sectors and 29 sub-sectors in Infrastructure. Transport (Roads, bridges, Airways, inland Waterways, Ports, Railways, public transport), Energy (Generation, transmission, distribution, oil, gas, LNG), Water Sanitation (Solid waste management, water supply, sewage, irrigation, storm water drainage system), Communication (telecommunication), Social & Commercial Infrastructures (Education, hospitals, SEZ, Fertilizers, cold chain, soil testing, hotels) are the main five sectors.
It will be important to note that ‘Infrastructure’ per se cannot be imported or exported or shifted. It has to be built and constructed at the geographical place where it is required to be used.
Infrastructure is a ‘huge’ subject matter requiring primarily, huge amount of finance, labour and time. Infrastructure is definitely the backbone of the economy and if India has to grow at double-digits, then investment in this sector has to be given paramount importance. This is one of the sector through which the Government increases spending and creates various opportunities, thereby impacting the growth of the economy since lack of supportive infrastructure acts as a drag on the GDP growth rate.
In the first business session of the Annual Meeting of the Asian Development Bank (ADB) in Manila on Friday, 4th May 2012, Indian Finance Minister Pranab Mukherjee has said that, “India needs about $1 trillion investment in next five years for infrastructure development, half of which has to come from the private sector. India has made provisions for creating infrastructure debt fund to attract investment in this sector. Infrastructure offers huge scope for foreign investments also.” Also, IDFC Projects Ltd.’s Managing Director, Pradeep Singh in his presentation in the same meeting said that “In order to sustain growth targets (9% GDP), investment in infrastructure would need to increase further to over 10 per cent of GDP by 2017.”
In the Eleventh Five-Year Plan, investments that were allotted for this sector were to the tune of 20 lakh crore, which was raised to 50 lakh crore in the Twelfth Five-Year Plan. Further importantly, the government has envisaged that out of the total investments, around 50% would come from the private sector in the Twelfth Plan as against 30% estimated in the Eleventh Plan. This is a major step that the government has taken for this sector is involving private sector participation through encouraging Public Private Partnerships (PPP).
The Expert Group on the Commercialization of Infrastructure (GOI, 1996), also known as Rakesh Mohan Committee, inter alia, recommended for private sector participation in urban infrastructure development.
According to the Ernst & Young Study – Infrastructure Today, investments planned for infrastructure (sector-wise) in 12th Five Year Plan can been seen from the below pie chart:
Also the below chart shows the planned gradual increase in investments in infrastructure sector (sector-wise):
Infrastructure and other public utility services have traditionally remained under the domain of Government and other statutory bodies in India. But with an upsurge in the demand for transport, water supply, sewerage, drainage and solid waste management systems, Indian government has found itself lacking in the financial, technical and executive capacities that are needed to bridge the demand–supply gap in infrastructure.
Ways of Infrastructure Financing/Funding existing today:
Reasons for lack of funds for Infrastructure:
Tax Increment Financing (TIF) – Unexplored Way of Infrastructure Financing
Looking at the above ways of infrastructure funding / financing and considering their drawbacks or failures, unexplored ways of Infrastructure financing needs to be looked at by public as well as private agencies and more innovative ways needs to be introduced to make the infrastructure sector work to its full capacity and show the desired results.
Tax Increment Financing (TIF) is one such unexplored way of financing the infrastructure projects in India, particularly at the municipal or state level.
Under the Tax Incremental Financing (TIF) is a means of funding public sector investment infrastructure judged to be necessary to unlock regeneration in an area, and which may otherwise be unaffordable to local authorities. The goal of TIF is to support and guide the limited public finances available for regeneration and helping to lever in additional private sector capital. TIF uses future additional revenue gains from taxes to finance the borrowing required to fund public infrastructure improvements that will in turn create those gains.
When a public project such as a new road is constructed in a particular area, increase in the value of the land as well as new property and business investment can happen. This results into increased site value and then this investment generates increased tax revenues. These increased tax revenues are the ‘tax increment’.
Tax increment financing (TIF) works by allowing local authorities to borrow money for infrastructure projects against the anticipated increase in business rates income expected as a result of the said infrastructure project. They can use that borrowing to fund key infrastructure and other capital projects, which will support locally driven economic development and growth.
Under tax increment financing, project sponsors pay property taxes based on the value of the property prior to any improvements. However, due to the improvements or new infrastructure there is an increase in property values and thus an increase in property taxes within the designated TIF. The difference between the pre-improvement taxes and the new tax amount is directed into a fund, which in turn will go to finance the improvements or service the debt.
The TIF system relies on the appreciation in value of the land and buildings in the TIF district. If a development is profitable, then the debt and other costs will be paid for by the growth of property tax revenues. If the property fails to increase in value, the improvement costs fall back on the general taxpayer.
TIF is an economic development tool available at the municipality level.
The increment to the tax base is usually calculated as the difference between the current assessed value of property in the district and the assessed value of property at the time of inception of the district.
Case Law: Greater Hyderabad Municipal Corporation (GHMC)
Recently, the Greater Hyderabad Municipal Corporation (GHMC) has taken the TIF route to take capital improvements in localities lacking roads, underground drains and water supply, parks and street lights.
They funded the capital improvements by accessing bank loans to be repaid by the households, as an annual tax increment, which would get immediate benefits due to the implementation of the TIF programme in select neighbourhoods.
An approach was followed to develop complete hard infrastructure in all neighbourhoods by providing water supply, underground drainage, roads, storm water drains and street lights. In the core area of GHMC, the focus was on augmenting city infrastructure like over-bridges and white top roads.
Neighbourhood residents had to contribute 30% of the local water project cost if internal distribution lines had to be laid. Nearly 800 neighbourhoods were identified based on the existing infrastructure gaps in the peripheral neighbourhoods. In the first part, the hard infrastructure requirements were evaluated through a rational-technical survey by Engineers. Then the survey findings were confirmed by the area sabhas, ward committees and the local elected representatives. Lastly, operational plans were divided into stages, and during the first phase, those already having water supply and drainage network but no roads; those not having water supply or drains, and those requiring only recreational facilities, such as parks and playfields, were selected.
The financial distribution was: 200 crore for infrastructure in peripheral areas, another 200 crore for co-financed water-supply projects and 200 crore for core area infrastructure. Accessing 600 crore from financial institutions was done after the general body of GHMC and the government of Andhra Pradesh accorded permission to raise the loan.
Expressions of interest were invited and 13 banks and HUDCO participated in the bidding process. State Bank of Hyderabad was selected because it offered the lowest interest rate of 10.75%. The loan repayment period was 10 years and the loan was to be accessed in tranches according to requirement and progress of works.
Largely, the loan repayment is planned to be accomplished through property tax enhancement by 5% every year for 10 years on all the properties in the neighbourhoods and the surrounding areas that are to benefit from the development works. The property tax hike of 5% was approved by the Standing Committee, ensuring that entire loan was likely to be repaid from the annual property tax increments. Significantly, the property tax increment was proposed to be collected only after the infrastructure works was completed in the neighbourhoods.
The Hyderabad municipality has achieved a great success with this model.
It’s time for other city municipalities to adopt such ways to fund their requirements and create a better place for people to live.
Prof. Anand Wadadekar
B.Com, M.A. Economics, PGD Finance & Banking (SIBM), AMFI, DIT, GCIPR, MS-CIT
Working as ‘Faculty In-Charge & Editor’ – SAMVIT School of Infrastructure Business, Pune