Fiscal Impact Analysis: How to Use It and What to Look out For

By Mucha, Michael J. | Government Finance Review, October 2007 | Go to article overview

Fiscal Impact Analysis: How to Use It and What to Look out For


Mucha, Michael J., Government Finance Review


Fiscal impact analysis can be a powerful tool for predicting the long-term financial consequences of policy decisions. One of the most common applications of this tool is to evaluate the impact of new private or public/private economic development projects. It also may be used to analyze the impacts resulting from businesses leaving.such as the closing of a manufacturing plant, or changes to any other major program, service, or even a community condition.

Predicting the impact of new development in a jurisdiction is critical because such projects not only have the potential to generate additional tax revenue and service fees, but also often require government expenditures to build new infrastructure and provide additional services to support the new development. This article specifically deals with fiscal impact analysis for development projects, but the concepts apply to analysis of any decision or policy that will impact a jurisdiction's long-term finances.

Fiscal impact analysis is not a new tool. It was used by planners during the 1930s and 1940s to examine the impacts of public housing and urban renewal programs. Over time, its use was expanded to other types of residential development, and by the 1970s, fiscal impact analysis was conducted on most large-scale residential and nonresidential developments. Today, local governments commonly use fiscal impact analysis to predict the effect of population change, examine possible economic development initiatives, identify the extent to which new developments might require subsidies from existing revenue streams, and compare the effect of alternative densities, patterns of development, and land use plans as growth management mechanisms. Given the importance of understanding how today's public investments affect a jurisdiction's long-term financial sustainability, fiscal impact analysis is an indispensable tool for long-range financial planning and a necessary part of any government's long-term planning processes.

THE PRACTICE OF FISCAL IMPACT ANALYSIS

In a fiscal impact analysis, the sum of all the additional costs for a government is compared to the sum of all the additional revenues over a given period of time. Although the concepts described in Exhibit 1 on how to conduct a fiscal impact analysis are straightforward, in practice fiscal impact analysis can be a difficult exercise. It is almost impossible to characterize and predict all of the impacts a development will have on the existing community and on the jurisdiction's financial situation. Each step of the fiscal impact analysis process, described in Exhibit 2, involves numerous decisions on important assumptions that will impact both costs and revenues. In addition, there is no single accepted standard for conducting fiscal impact analysis, guiding governments through the process, or determining the analysis' accuracy Experts have developed complex econometric models to estimate impacts; however, the choice of model can heavily affect the prediction.

To be sure the study has value and can be used as a reliable tool to assist decision making, the answers to several questions must be carefully considered and clearly stated as a part of the analysis. These questions and answers, discussed below, lead to most of the critical assumptions in the analysis and provide necessary insight into its limitations for anyone using the resulting information for decision making. Any fiscal impact analysis that does not clearly state critical assumptions should be viewed with skepticism.

I) What Is the Scope of the Analysis? Whose Costs and Revenues Matter?

The first important decision is to define which jurisdictions to include in the scope of the analysis. Development projects are likely to affect multiple governments, but most fiscal impact analysis only considers the impacts on select jurisdictions. For example, an analysis may only account for the impacts on a host city, even though the project may affect costs and revenues for overlapping governments such as the county, township, park district, school district, water/sewer district, and possibly the state government. …

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