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In the spring of 1996, city planning director Bob Litke had a problem: Under what circumstances should the city give public money to private developers?

The problem arose after homebuilder Steve Peacock asked for $2 million to build the streets, water and sewer lines, and storm-water drainage to support a new subdivision on 41 acres of raw land in far west Houston.

Litke was, at first, inclined to reject Peacock's proposal. At the time, Litke believed the city should subsidize only private development inside the Loop, where historically developers have been wary of higher land costs and an uncertain market.

There was also the issue of fairness. As Litke pointed out in a May 1996 memo to Public Works and Finance and Administration officials, other developers had built successful projects in the same area without the benefit of tax dollars.

"Granting a subsidy to the Peacock development may set a precedent that is not in the City's best interests to follow," the planning director wrote. "Using general fund monies to finance new infrastructure in middle income residential development -- where the market is likely to deliver a saleable product in the future -- may not be an equitable expenditure of public monies."

Despite his misgivings, Litke was under a mandate from then-mayor Bob Lanier to offer greater incentives to encourage more development throughout the city. To that end, the planning director focused on Peacock's request that the city create a tax-increment reinvestment zone, or TIRZ, which allows cities, counties and school districts to reimburse the developer's cost of laying in public infrastructure using future property tax revenues generated by the development.

Until Peacock came along, the city had used tax-increment reinvestment sparingly, for good reason: Each zone requires the local taxing entities to commit millions of dollars of revenue to a specific project for a long period of time, usually 30 years. Moreover, because taxpayers outside the zone get little in return, the state law that authorizes the creation of TIRZs restricts their use.

City Council created the city's first TIRZ in December 1990 and at the same time adopted its own policy regarding the use of tax-increment reinvestment. The city's basic criteria for creating a TIRZ were nearly identical to those in the state law -- or at least they were until Litke adjusted the guidelines to accommodate Steve Peacock.

In short, Litke's new policy not only changed significantly the city's use of TIRZs, it circumvented the state law at nearly every turn. In the three years since it was amended, the city's TIRZ policy has rendered the Tax Increment Financing Act of 1981 unrecognizable.

Just how much the statute has been manipulated became clear this summer, when the administration of Mayor Lee Brown fast-tracked seven new TIRZs past City Council, which agreed to forgo nearly $2 billion in property tax revenue over the next 30 years to fund specific projects. Some 7 percent of the city's taxable land is now within a TIRZ and controlled by appointed boards that are authorized to administer the zones' project and financing plans, with minimal oversight by elected officials.

To be sure, under Brown the city has created new zones in areas that are in fact starved for public improvements. The Fourth and Fifth wards, for example, have been neglected for so long that they clearly meet the TIRZ statute's requirements that there be "a substantial number" of substandard and deteriorated buildings; that there be "unsanitary or unsafe conditions"; and that an area be "a menace to the public health, safety, morals or welfare in its present condition."

Equally certain is that none of that is true of the Galleria, Upper Kirby and Memorial City areas, which were also designated tax-increment zones by Council in July. Even state legislators such as representatives Garnet Coleman and Scott Hochberg, both of whom have been active in shaping the Tax Increment Financing Act through the years, say the city has butchered the original intent of the law.

"I have some concerns," says Coleman. "The intent of the law is to develop communities that would not develop on their own, to create growth and life where it wasn't before. I don't know why there's a TIRZ in Upper Kirby. The market is driving that area fine."

Indeed, Upper Kirby is perhaps the most egregious example of the city's rapacious TIRZ policy -- and how it has already turned out to be a bad deal for taxpayers. Earlier this summer a group of property owners and developers asked the city to create a tax-increment zone, moaning that the bustling commercial corridor that straddles the Southwest Freeway between Buffalo Speedway and Shepherd is unable to "compete in the marketplace."

What wasn't mentioned in the developers' plan is that the Upper Kirby area is more competitive than ever. Long before the proposal was presented to City Council, some $110 million of new development, including at least three large apartment complexes, two shopping centers, a hotel and a supermarket, was under way or already completed -- a fact that discredits the plan's contention that "development in the zone will not occur solely through private investment in the reasonably foreseeable future."

By including development that occurred before the zone was even created, the Upper Kirby TIRZ essentially fabricates the impact of the zone. It will also cost taxpayers about $35 million in revenue -- the taxes that would normally be collected from the new development over the 15-year life of the TIRZ.

The city's claim that the Galleria area will see nearly $200 million in new development within two years of creating a TIRZ there is equally specious. At least $180 million in projects were already on the table when Uptown Houston District, a group that looks after the interests of Galleria-area property owners, proposed creation of the zone. Not only will taxpayers lose the revenues from that development, but the TIRZ will end up subsidizing all future development in the Galleria area to the tune of millions in lost revenues.

Assistant director of planning Bill Calderon acknowledges that almost all of the development that the Upper Kirby TIRZ was ostensibly created to encourage is on the ground or under way. But, he says, the property tax revenues that will be generated by that development, as well as income derived from completed or nearly completed projects in the Galleria area, won't be available for more than a year, and therefore should go to the TIRZs.

While that reasoning does nothing to support the contention that the Upper Kirby and Galleria areas need TIRZs to entice private development, Calderon says it "doesn't necessarily mean" there isn't a need for the zones.

"The state law doesn't state that you can't include ongoing development projects within the boundary lines of a zone," says Calderon. "In fact there is some advantage to doing that."

The property taxes collected on current development taking place in the new TIRZ will "jump-start the revenue stream" needed to carry out public improvements that will support future projects in the zone, Calderon says. "Nowhere does it say we're going to give money back to the guys who are doing construction there today," he insists.

Maybe not, says Councilmember Annise Parker, but that doesn't mean it's the proper use of tax-increment reinvestment. Parker says the Upper Kirby zone reflects "a real disconnect" between the Brown administration and the state TIRZ law. "The subject of all the development occurring there came up," Parker says. "But no one dwelled on it or discussed it much. I don't think we need to be tying up our money that way."

Indeed, the Upper Kirby and Galleria zones appear to turn the state TIRZ law on its head. One criterion for a new zone is the "but for" standard -- that is, "but for" the TIRZ, the area would not attract new development. By designating as TIRZs areas that are developing on their own, the city has created a new "but for" standard: "but for" the TIRZ, new revenues from market-driven development would go to the general fund coffers of the city, Harris County and the Houston Independent School District.

Tax-increment reinvestment has been controversial since the moment it was first proposed, back in 1977. That's when the Legislature passed a bill that would allow cities to redevelop certain "blighted" urban areas using future property tax revenues. The 1977 law was, however, contingent on passage of a constitutional amendment, a ballot measure that failed in November 1978.

During the 1979 legislative session, lawmakers again passed a TIRZ bill, this time without requiring a constitutional amendment. That bill became law for about a minute. In May 1981, then-attorney general Mark White ruled that the TIRZ law violated the state constitutional requirement that taxation be "equal and uniform." In White's view, using property taxes to fund improvements in a specific area meant that the property was not contributing its fair share to the general fund.

The issue was thrown back to the voters, who approved a constitutional amendment in November 1981 that authorized cities to "issue bonds or notes to finance the development or redevelopment of an unproductive, underdeveloped or blighted areaŠ." The law allowed the "bonds or notes" to be repaid from increases in ad valorem tax revenues produced by the new development.

The Tax Increment Financing Act of 1981 was again challenged on constitutional grounds in 1987, in a case that made it to the Texas Supreme Court. While the court upheld the law, it also underscored the legislative restrictions on its application: "Tax increment financing," stated the court's ruling, "is designed to aid cities and towns in financing public improvements in blighted or undeveloped areas."

Until May 1996, when Steve Peacock proposed a TIRZ to subsidize his Village Enclaves subdivision in far west Houston, the city seemed content to adhere to the Supreme Court's interpretation of the law. To that point, the city had created zones in only three places -- Lamar Terrace, south of the Galleria; Midtown, between downtown and the Texas Medical Center; and Market Square, in the heart of the central business district. All three areas had suffered significant declines in their property tax bases as residents and businesses fled to the suburbs, discouraging private investment in the inner city.

"TIRZs work," says Garnet Coleman, whose predominantly urban district includes four TIRZs. "Look at the assessed valuation in Midtown compared to before. That would have never happened, if not for the TIRZ."

Indeed, upon first reviewing Peacock's TIRZ proposal in early 1996, city planning director Bob Litke was not convinced the developer had met the all-important "but for" standard. In a memo to other city officials regarding the Village Enclaves project, Litke noted that Peacock's contention that his land would not be developed unless the city paid for the infrastructure was based on "nothing but a judgment."

That said, Litke then set about rewriting the city's policy in such a way that "nothing but a judgment" was plenty good enough to justify the Village Enclaves TIRZ. Litke's new policy set out three criteria the city should consider before approving a TIRZ.

First, he said, there must be a real need for the subsidy. In other words, it must be "reasonably clear" that the project would not be financially viable without a subsidy. Second, the amount of the subsidy must not exceed the benefit gained, meaning the developer should be reimbursed for only those costs that result in a public good, such as a new street or water main. And finally Litke decided that such "incentives" should comply with the "letter and spirit" of the state TIRZ law.

By the end of July 1996 Litke had satisfied himself that Peacock's project could qualify for a TIRZ. He sent Lanier a memo recommending the city proceed with the Village Enclaves TIRZ, "[s]ubject to a final review of this project under state TIRZ law."

However, on September 10, 1996, one day before the City Council hearing on the Village Enclaves TIRZ, a Finance and Administration official produced an internal analysis of the proposal that challenged Litke's interpretation of both the state law and the city's policy.

"The justification for the project's eligibility based on the city's guidelines is weak," wrote the F&A official, who happened to be the same Bill Calderon who is now a deputy assistant in the city planning department and a staunch defender of the city's TIRZ policy. "This area is not blighted."

Calderon concluded that the Village Enclaves TIRZ could be approved only if Council granted an exception to its own policies. Calderon did, however, agree with Litke on one point: Peacock's proposal would set an undesirable precedent. "If the city does consider using [tax-increment financing] in a manner that is beneficial to developers," Calderon wrote, "we can expect to see many more such requests for this kind of assistance."

It's unclear if Calderon's views, which he provided to a higher-ranking F&A official, were ever shared with City Council, which approved the Village Enclaves TIRZ a week later. One thing's for sure, though: The policy Litke initiated with Village Enclaves became the standard by which councilmembers judged all subsequent TIRZ proposals.

Indeed, the city ordinances that designate the Upper Kirby, Galleria and Memorial City areas as tax-increment zones include a clause that states, "the city hereby excepts the proposed zone from compliance with any city reinvestment zone guidelines Š that the zone does not meet."

Eight months after it created the Village Enclaves zone, Council voted to expand it from 41 acres to more than 1,000 acres. In a deal struck with the Houston Independent School District, which had balked at committing future taxes to the zone, the city approved a plan that would dedicate TIRZ revenues for the construction of a new school near the proposed subdivision.

Actually, it was the second time the city and HISD had agreed to commit future tax revenues to fund school construction. A few months before, in January 1997, the city had created the Old Galveston/Howard Road TIRZ, on the east side, solely to pay for a new high school.

To some councilmembers, including those who had been supporters of the city's TIRZ policy, the use of tax-increment reinvestment to build schools not only clashed with state law, but was a slap in the face to voters, who had rejected a $390 million bond issue proposed by HISD the previous year.

"I said it at the time, and I still believe it," says Councilman Orlando Sanchez, who has opposed the city's recent use of tax-increment financing. "Those zones circumvented the will of the majority of voters who opposed the bond issue."

Sanchez was also among a minority of councilmembers who voted against a brazen policy initiative introduced by Brown early last month that was designed to squeeze every possible TIRZ dollar out of HISD. Brown proposed that HISD increase its participation in ten zones created before this year by nearly $500 million over 30 years. In a carefully worded memo to councilmembers, Brown explained that the additional funds wouldn't actually be used in the zone, but would be returned to HISD "for educational purposes."

The question Brown skillfully evaded was this: If the money was only going to be returned to the school district, why not just let HISD keep it?

The answer is that until September 1, school districts were allowed to take the taxable value of land in TIRZs "off the books," thereby artificially lowering their tax bases. The lower HISD's tax base, the more funds it receives through the Texas Education Agency's school-financing mechanism. Every dollar the district sends to a TIRZ, even if it's immediately returned, is replaced by the state.

If this isn't exactly like money laundering, it's certainly close. While completely legal, it is at the least unseemly, especially considering the timing: The city had just forwarded seven newly created zones to the HISD board of trustees for consideration. The district's participation was crucial to those projects, and the windfall created when Council approved Brown's proposal no doubt put trustees in an accommodating mood.

While there is apparently nothing in the state TIRZ law that prohibits it, Brown's scheme to milk the maximum amount of TIRZ revenues out of HISD is yet another manipulation of the state law. Indeed, the flurry of TIRZ activity this summer was an attempt to cash in before September 1, when an amendment to the statute eliminated the right of school districts to exclude TIRZ land as part of their taxable value. That means any school district that now chooses to participate in a TIRZ will actually lose state funding.

Representative Scott Hochberg was one of the sponsors of that 1997 amendment. Hochberg generally supports TIRZs -- his district includes the South Post Oak zone, which, he says, is needed to spur development in a decaying area of town. But, he says, the city and HISD may have gone too far by what he calls "double-dipping" into the school-financing pool. According to Hochberg, legislators never anticipated that a city would amend TIRZ agreements to suck more money from the school districts before the September 1 deadline.

"Somebody read the law, and they read it very carefully, put a good mind to it and came up with a loophole," Hochberg says. "That was not something that we considered and decided was okay. What we were trying to do was shut this stuff down in the long haul, and I don't believe anybody discussed the possibility of this happening, in committee or otherwise."

Hochberg believes Brown's ploy opens the door for a school-finance watchdog group, such as the Equity Center of Austin, which has brought suit to guarantee equal funding for schools, to challenge the maneuver in court.

"I would think," he says, "that if there was a significant finding that the transaction amounts to a sham -- that is, is it a transaction that is specifically created just for the purpose of avoiding the school-finance law -- then it would not be unreasonable for someone to go to court and say, 'That action was illegal.' "

For weeks the board of trustees for the Spring Branch Independent School District was consumed by the Memorial City tax-increment zone. Rarely had the trustees been confronted by an issue so divisive. The TIRZ literally divided the community. Residents north of I-10, which splits the zone, saw the TIRZ as a way to funnel more resources to their declining neighborhoods, as well as to correct the perception that SBISD provided superior educational facilities south of the freeway.

Meanwhile, the more-white-collar residents south of I-10 were outraged to learn that the major beneficiary of the Memorial City TIRZ, Metro National Corporation -- which owns nearly half of the developable land in the zone -- had plans for $1 billion worth of new real estate projects on that side of the highway.

In Metro National's view -- or more precisely, in the opinion of former city planning director Patricia Knudson, a consultant who prepared Metro National's TIRZ proposal -- without the zone, those projects were in trouble: "[A] growing shift in the tax base and sales tax revenue to surrounding suburban communities Š threatens the continued viability of this area," stated the proposal. "[U]nless the mobility and utility infrastructure issues are addressed, the forecast for the Memorial City area economy is, at best, stagnation."

Despite vehement opposition from a group of residents representing neighborhoods adjacent to the proposed zone, City Council approved creation of the Memorial City TIRZ on July 28. However, the city's contribution to the 30-year zone would pay for only a portion of the proposed $98 million in public improvements. The most significant contribution would come from SBISD, which took up the Memorial City TIRZ at two meetings early last month.

On August 9 opponents of the TIRZ put on a 30-minute presentation for SBISD trustees that argued, among other points, that the zone did not meet the requirements of the state Tax Increment Financing Act. The residents reminded trustees that the state law had been challenged on constitutional grounds before and, in fact, Harris County Attorney Michael Fleming had recently asked the state attorney general's office to rule on the legality of TIRZs in areas that were clearly not "unproductive, underdeveloped or blighted."

The opponents also pointed out that if Metro National believed the market would support $1 billion in new development projects, why did the company need a public subsidy?

It was a compelling presentation that resonated with SBISD trustees. A week later, on August 16, the board members reconvened to vote on the Memorial City TIRZ. They had arranged to move the meeting from district headquarters on Campbell Road to the auditorium at Memorial Middle School. More than 800 people, most of whom opposed the TIRZ, crammed the room. Less than an hour later they were on their feet, cheering the trustees, who voted 5-2 to decline SBISD's participation.

As it happened, the intense lobbying of trustees by Metro National and its consultants may have had diminishing returns for the corporation. Several trustees complained that in the days leading up to the board vote both Metro National and the city were clearly desperate for SBISD's approval. The TIRZ plan seemed to change daily, they said, with ever-greater compromises, not to mention more promises of vast new wealth for SBISD, being offered. Moreover, trustees were apparently told by Metro National that the TIRZ would likely proceed without SBISD participation, so the district may as well join in.

Maybe it dawned on the trustees that if that was the case, they could vote down the TIRZ and still reap the increased property tax revenues. Whatever, in the end, they obviously didn't know what to believe about the Memorial City TIRZ and weren't about to take Metro National's word for it.

"This issue boiled down to one issue: trust," board president Brandon C. Coleman told the Press later. "The community does not have confidence in the organization that sponsored the proposal. If we would have voted for [the TIRZ], we would have lost the community's trust for years to come, and we could not afford to take that risk."

Apparently other school districts have decided that school district taxes should be spent on schools and not private real estate development. Two weeks ago the Fort Bend Independent School District rejected four TIRZs proposed by the cities of Sugar Land and Missouri City. One FBISD trustee simply said, "It's not right." Another noted that the school district couldn't afford to wait 30 years to receive the property tax benefits of the new development.

On the other hand, supporters of the Fort Bend zones were outraged. Sugar Land Mayor Dean Hrbacek self-righteously proclaimed his wish that voters "remember the financial stupidity" of the dissidents on the FBISD board, who, the mayor added, "dealt a blow to the children."

On that same day, August 26, trustees for the Houston Independent School District met to consider their own full plate of TIRZ issues. On the HISD agenda were seven new zones recently approved by City Council. The board would also decide whether or not to amend ten other TIRZ plans according to the scheme proposed by Brown in early August.

The HISD board has yet to reject any TIRZs created by the city, so it was hardly unexpected when trustees swiftly approved the new zones. More surprising, though, was the lack of discussion on the ethics of Brown's proposal. To be fair, trustees should always be on the lookout for ways to increase funding to the district. Still, the absence of thoughtful debate on why HISD would give up additional TIRZ revenues only to have them "kicked back" to the district suggested that trustees either didn't understand the matter or weren't sufficiently bothered by this massaging of the school-financing system.

Indeed, the board's absolute trust in the inherent goodness of tax-increment reinvestment was summed up by trustee Lawrence Marshall. "We have nothing to lose by investing in these projects," he said moments before the vote.

That may very well be true for elected officials, who, in the case of city councilmembers and HISD trustees, have come to believe that tax-increment reinvestment is a panacea. For taxpayers, though, who can say? They have become unwilling participants in a massive public spending spree that will tie up untold millions of dollars over the course of a generation.

Perhaps if the city's TIRZ program had been put to a vote, the basic premise -- that the zones are needed to encourage development that would not otherwise take place -- would have been more thoroughly evaluated. Maybe then, elected officials would have been forced to take into account the considerable amount of unsubsidized, market-driven development that has occurred in Houston the last few years.

One body that has stepped back to take another look at tax-increment reinvestment is Harris County. Commissioners are clearly in no hurry to commit millions of future tax dollars to the seven TIRZs recently created by Council. And they probably won't until the constitutional issues raised in June by county attorney Fleming are ruled on by the state's lawyers.

In the meantime, the city's TIRZ policy is likely to have at least one significant consequence: There is no longer any incentive to redevelop a neighborhood or area of town that really needs it.

"Why would anybody develop in a blighted area if they can get the same deal for going to a good area where it will almost certainly be more profitable," says state Representative Scott Hochberg. "What does the incentive become then?"

E-mail Brian Wallstin at .

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