Proposed elimination of tax-exempt bonds for stadiums likely won't affect Detroit project

click to enlarge Rendering of new Detroit Red Wings arena - COURTESY OF OLYMPIA DEVELOPMENT OF MICHIGAN
Courtesy of Olympia Development of Michigan
Rendering of new Detroit Red Wings arena

In his proposed budget for the upcoming year, President Barack Obama wants to eliminate a federal tax-exemption on government-issued bonds for sports stadiums, but the change likely won't impact the financing for a new $450 million Detroit Red Wings arena near downtown.

Under the budget Obama released this week, the federal tax-exemption from bonds that finance sports facilities would be repealed for virtually all future sports stadium deals. It's a subsidy that has cost taxpayers millions of dollars and proliferated the number of publicly-financed stadiums across the nation since the 1980s.

Olympia Development of Michigan, the real estate arm of Red Wings owner Ilitch Holdings Inc., referred a request for comment to the Detroit Downtown Development Authority (DDA), which will own the new arena. 

“It is really too early in the legislative process to project a possible impact of Obama’s proposed budget on the downtown event center project, but staff for the Downtown Development Authority are monitoring the situation," said Robert Rossbach, spokesperson for the Detroit Economic Growth Corporation, a nonprofit development agency that supplies staff for the DDA and has negotiated economic deals for Detroit since the 1970s

But the proposal would only be effective for bonds issued after Dec. 31, 2015, so the change, if approved by the U.S. Congress, likely wouldn't impact the project in Detroit. The DDA closed on the bonds for the stadium before Christmas, according to one source familiar with the deal. As currently proposed, the Obama change wouldn't be applied retroactively. 

"Congress rarely applies tax law changes retroactively," said Dennis Zimmerman, a retired economist who worked for the Congressional Budget Office and currently serves as the American Tax Policy Institute's director of projects. 

Roger Noll, an economics professor at Stanford University who has written about tax breaks for sports stadiums, said in an email, "there is no ex post elimination of the tax exemption for a bond that is issued before the [change], if it passes, goes into effect." 

If the change passes, Zimmerman said, "that would be the death knell for the federal government providing the interest payments for these stadiums." But that wouldn't preclude municipalities from borrowing money for such projects, Zimmerman stressed. 

"They'd just be taxable bonds," he said. "They could issue all the taxable debt they'd want, if the rating agencies would approve it." 

Currently, how the federal tax-exemption for stadiums works is like this: local governments can use the proceeds generated from the issuance of "private-activity" tax-exempt bonds for stadium projects, "unless more than 10 percent of the debt service comes from a private business, and more than 10 percent of the use of the facility is attributed to a private interest," according to a report in Politico. The only way the tax emption would be denied is if both of those stipulations are true, which, at this point, is seemingly never.

Under Obama's proposal, that test would change: The exemption would be eliminated for any stadium where more than 10 percent of the use of the facility is used by a private business interest. That would apply to virtually all professional sports stadiums.

The exemption was created as a result of the Tax Reform Act of 1986, a law intended to "limit public subsidies by making cities more reticent to raise general taxes (or dip into general funds) to offer money to sports teams," according to a report in ThinkProgress.

But as more cities bought into the idea that stadiums boosted economic development in the city — though a glut of research suggests otherwise — the law had an opposite impact. 

"[L]ow-interest bonds became attractive as owners sought new stadiums and cities bought the idea that the facilities were good economic investment vehicles, and a surge of new stadiums followed as cities, states, and teams figured out how to manipulate the 10 percent revenue requirements to keep the bonds eligible for the exemption," ThinkProgress reported.

Though the Obama administration's effort to wade into the waters of sports stadium financing likely won't survive in the U.S. Congress, it does indeed send a message: federal taxpayers shouldn't subsidize a sports team's new stadium.

This sentiment was described in a document from the U.S. treasury explaining the thought-process behind the proposed change: Tax-exempt bond financing of stadiums "transfers the benefits of tax-exempt financing to private professional sports teams because these private parties benefit from significant use of the facilities," the document explained. Government bodies subsidize the sports stadiums with "taxes or other governmental payments to enable the facilities to qualify for tax-exempt governmental bond financing," the document said.

The tax break, more or less, stems from a municipality's effort to attract or retain professional sports teams, the Treasury said. (Think about how often you hear an owner imply they're interested in taking their team to another city.) 

"Moreover, the current structuring of the governmental bonds to finance sports facilities has shifted more of the costs and risks from the private owners to local residents and taxpayers in general," the Treasury document said. 

In layman's terms: The average Joe often pays a portion of the costs for a new sports stadium. 

Obama's proposal would save an estimated $542 million between 2016 and 2025, according to the proposed budget

An analysis by Bloomberg News in 2012 highlighted how much the exemption costs the public. Tax-exempt bonds issued for new sports stadiums cost the U.S. Treasury about $146 million per year, according to the analysis. About $17 billion of tax-exempt debt was issued between 1986 and 2012 for stadiums, Bloomberg reported.

By the time the last of that debt is paid off, in 2047, the tax-exempt subsidy will cost the public a hefty price tag: $4 billion. 

If you're interested in the financing of the Detroit deal, read on, but it's a complicated arrangement. In a nutshell: the $450 million in bonds will be paid off by an annual $11.5 million annual fee paid by Olympia, and $15 million-$17 million annually in public money from the DDA. The DDA levies a 1-mill tax on all property owners within a specified district in downtown, and collects a sizable portion of all property taxes within that district.

Under state law, the DDA can capture the increased property tax revenue generated as a result of new development, called tax-increment financing, or TIF. As part of the deal to facilitate the project, the DDA's TIF district was expanded to include the footprint of the new arena. In addition, the DDA will continue to capture TIF monies until 2046, extended under the deal from 2028. 

(No general fund revenue of the City of Detroit will be used for the project. Though, to be clear, if the DDA's tax capture was eliminated, most of those property taxes — including what's generated by the new Detroit arena and proposed ancillary development — would flow to Detroit's coffers and could be used for city services.)

Olympia anticipates it will fill 5,500 construction jobs for the project; when the arena is operational, it expects to hire 400 full- and part-time employees. That's expected to generate $15.8 million in total new income tax revenue for the City of Detroit over the next 30 years, according to city council documents.

Here's how the arena financing will work: The DDA will sell $450 million in bonds to the Michigan Strategic Fund, an economic arm of the state, that will be separated into two groups: $250 million in 30-year tax exempt bonds, and $200 million in 30-year taxable bonds. 

In turn, the MSF will issue $250 million in tax-exempt Series A bonds that will be purchased by Bank of America. These bonds will be repaid by at least $15 million in school taxes the DDA can divert, per state law, and a separate $2.15 million annual DDA tax capture. (This is the type of bond Obama is targeting under his proposal.)

The state has said it reimburses Detroit Public Schools for the lost school revenue through the state School Aid Fund, though it's unclear how that gap is filled. (Wherever it may be, at some point, it's coming out of the taxpayers pocket.) Initially, the deal called for a hard cap on the $15 million figure, but that has since been lifted at the request of Bank of America, which said it would not agree to purchase the bonds otherwise. If the DDA tax captures generate more than $15 million, that additional money would be set aside for a reserve fund

The MSF will also issue $200 million in floating rate Series B bonds, which are taxable because they're backed by private funds — and will be purchased by Comerica Bank. These bonds will be repaid by the $11.5 million annual fee paid by Olympia, as required under the Concessionaire and Management Agreement approved for the project. According to the loan agreement with MSF and the DDA, these limited-obligation bonds can only be repaid with Olympia's arena revenues. This means the DDA won't have to come up with the shortfall if Olympia's arena revenues fail to materialize, But, as MT previously reported, the DDA will enter into an interest rate swap on the Series B bonds.

The swap deal adds a potentially dangerous risk to the DDA — and, hence, taxpayers. The swap, essentially a financial gamble, will allow the DDA to synthetically fix the interest rate, and assumes a benchmark interest rate used by financial institutions across the world will rise, rather than fall. The swap will last until the bonds are retired in 2045. Under that agreement, the DDA will pay Comerica (also the counter-party in the swap deal) a fixed interest rate payment — in turn, the DDA will receive a variable interest rate payment from Comerica based on LIBOR, the London Interbank Offered Rate, an interest-rate benchmark. The DDA's swaps adviser on the deal is New York City-based firm Mohanty Garglulo.

Heber Farnsworth, associate professor of finance at Penn State University's Smeal College of Business, previously told MT the DDA will come to an agreement with Comerica as to what both sides believe the LIBOR rate will be when the swap kicks in — likely in 2018. If the DDA's gamble headed south, Farnsworth offered a possible worst-case scenario: If the LIBOR rate drops, the DDA could be stuck with paying a fixed rate, while receiving a smaller amount in return from the counter-party. If that happens, and the DDA is on the "losing" side of the bet, it could have to post collateral — similar to how Detroit posted its casino revenue when the city's infamous interest rate swaps went sour. (In 2013, Detroit filed a municipal bankruptcy petition, in part, because it lost this bet.) 

And to end the swaps, it proved costly: Detroit will spend $85 million to terminate its swaps agreement with Bank of America and UBS. In a separate deal, the Detroit Water & Sewerage Department had to spend a whopping $571 million on termination fees for a bad swap deal. As the banking industry was deregulated in the mid- to late-1990's, swaps became more popular for municipalities. In Detroit's case, it's unclear if the city has ever ended up on the winning side of a swap — or if it has ever even allowed a swap to last its entire lifetime without having to terminate it.

DDA officials have pointed out out that interest rates are expected to rise in the near term. But, as finance experts previously told MT, over the next three decades, LIBOR is expected to rise and fall — again and again. If rates are pushed as low as they have been since the 2008 recession, then the DDA may end up on the losing side of the swap, forcing it to guarantee payments. If the DDA were to then miss a swap payment, Comerica could simply "seize all the collateral," as Farnsworth previously explained. But whatever the DDA could possibly post as collateral is entirely unknown. The DDA board approved the swap agreement in December, the same time it green-lighted the $200 million floating rate bond sale. 

Olympia projects the 18,000-seat stadium, which will be the anchor of a proposed new district with $200 million in ancillary development, has a lifespan of about 48 years

Update (Feb. 9, 2015, 1:15 p.m.): This story previously didn't name the DDA's counter-party to the swap, Comerica Bank. 

About The Author

Ryan Felton

Ryan Felton was born in 1990 and spent the majority of his childhood growing up in Livonia. In 2009, after a short stint at Eastern Michigan University, he moved to Detroit where he has remained ever since. After graduating from Wayne State University’s journalism program, he went on to work as a staff writer...
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