2017: Arizona moves to reform system of tax breaks for developers

Arizona Watchdog
Thursday, March 23, 2017
Christian Britschgi


In September 2015, the Denver-based developer Amstar/McKinley submitted a proposal to build the Derby Roosevelt Row — a 19-story “micro-apartment” complex — on two vacant lots in Phoenix’s Central Business District.

In submitting its proposal, Amstar/McKinley made the case that the project would not be viable without major tax relief, a point the city agreed with. In March 2016, Phoenix City Council voted 7-2 to give the project an $8 million tax subsidy through its Government Property Lease Excise Tax, or GPLET program.

Under the terms signed with the city, Amstar/McKinley would hand over the deed to its property for a period of 25 years. In exchange, the City Council agreed to grant the developer an eight-year tax abatement. For the remaining 17 years, Amstar/McKinley would be allowed to pay a GPLET in lieu of a traditional property taxes.

The GPLET lease agreement worked out between Phoenix and Amstar/McKinley is hardly a unique one. Since their creation in 1996, GPLET agreements have been used across downtown Phoenix to lower the tax burden on a number of high-profile developments, from the Bank of America Tower to the luxury Renaissance Hotel.

Proponents of GPLET have long contended the program is an essential tool for revitalizing Arizona’s downtown areas and attracting jobs and investment to the state.

Less impressed with the program, however, is Mat Englehorn, owner of the Angel’s Trumpet Alehouse located across the street from the proposed Derby Roosevelt Row development. He said he views GPLET as an unfair arrangement that subsidizes his competitors while shifting more of the tax burden onto his own business.

Agreeing with Englehorn is Jim Manley, an attorney with the Goldwater Institute who is suing Phoenix on behalf of Englehorn over the Derby Roosevelt Row deal. Filed earlier this month, the lawsuit is the latest episode in a long-running battle to reform a program dubbed “wild west cronyism” by its detractors.

Wild West cronyism

The GPLET program has its roots in the early 1980s, when Arizona had virtually no restrictions on local governments taking property from private developers and leasing it back to them for a token rent payment, thereby using the municipality’s tax-exempt status to shield the private developer from taxation. The practice became so rampant that lawmakers were forced to take action, creating the possessory interest tax in 1985 — a property tax of sorts levied on government-owned properties leased for the exclusive use of a private party.

In 1995, however, an Arizona court found that a provision in the 1985 law that allowed for city governments to abate the tax for properties in central business districts ran afoul of the state constitution’s uniformity clause, which requires that property taxes be apportioned equitably and uniformly across the state.

Eager to preserve some tax abatement capacity for Arizona’s cities and towns, legislators went back to the drawing board and in 1996 came up with a replacement scheme — the GPLET.

The 1996 GPLET legislation converted the possessory interest tax from a property-like tax based on value to an excise tax based on square footage, retaining for cities the ability to grant an eight-year tax abatement of that excise tax. As the Uniformity Clause has specific implications for property taxes, lawmakers hoped this change would skirt the constitutional issue of the previous system.

Crucial for future fights over GPLET were other provisions in the 1996 law that determined what the GPLET rates would be, which properties would be eligible for it, and who ultimately would assess and administer the tax.

We don’t need no education

One of the biggest problems with GPLETs, says Sean McCarthy of the Arizona Tax Research Association, was the rates at which the excise tax was assessed. Though initial GPLET rates range depending on the type of property — from 50 cents a square foot for residential properties to $1.75 a foot for high rise office buildings — all of them, McCarthy said, come in “far below actual property tax rates.”

A 2010 update to GPLET raised rates, but it had almost no effect on revenue, as it grandfathered in past and pending lease deals.

Making matters worse is the tapering off of GPLET rates until they disappear entirely after 50 years. This means that Delaware-based RED Development LLC, which signed a 75-year GPLET lease for its CityScape Complex in the heart of downtown Phoenix, will get about 20 years of property-tax-free returns on some of the choicest land in the state.

The loss of revenue from lower GPLET rates has major implications for school district budgets, according to Sal DiCicio, a Phoenix city councilman from District 6, and one of only two no votes on the Derby Roosevelt Row GPLET deal. He estimates that GPLET deals in Phoenix cost some $30 million annually in lost tax revenue, about 80 percent of which would go to the school district.

“You’re basically taking money away from needed schools and giving it to large developers,” DiCicio told Watchdog. “Its plain and simple crony capitalism.”

Further reducing revenues from property taxes is how many properties can be considered eligible for GPLET tax abatements.

Under the current GPLET law, any property that is located within a central business district and has been designated a slum or “blighted” area can receive eight years of tax-free development. This provision was intended to ease the tax burden on hazardous or economically depressed areas of the state.

The problem, according to Manley, is that the definition of blight is overly-broad to the point of meaninglessness. As evidence, he points to the proposed Derby Roosevelt Row site. The city of Phoenix is relying on a 1979 determination of blight in order to justify its granting of a GPLET tax abatement to Amstar/McKinley in 2016. And that, Manley says, is not even the most arbitrary designation of blight he has come across.

“Governments have pointed to mail boxes needing to be repainted as evidence of evidence of blight,” Manley said, adding that there is not a property in the state that could not be considered blighted.

Not only does this broad eligibility requirement reduce property tax revenue even more, it also shifts the burden of the tax onto those properties that are not the recipients of a GPLET deal. This, says DiCicio, “creates an unfair advantage to the property owner that gets a GPLET. This allows you to keep your prices lower and attract other customers.”

Compounding all these features of GPLET has been its reliance on the lessees — and not the government — to calculate and collect the tax. A 2015 auditor general’s report on GPLET released just months after Derby Roosevelt Row plans were submitted to Phoenix found that the GPLET tax liabilities were often miscalculated, unreported or even uncollected. Of 12 randomly sampled GPLET leases in the report, 11 of them had incorrectly calculated their GPLET liability. In one of the 12 cases, the lessee had not paid any GPLET for three of the four years it had been responsible for it.

A useful development tool

All of these features have created a groundswell of support for introducing some measure of reform to the current GPLET system.

At the beginning of the 2017 legislative session, state Rep. Vince Leach, R-Tucson, working closely with the Arizona Tax Research Association, introduced H.B. 2213. The bill, while not abolishing GPLET, would change some of the more controversial aspects of the program by forcing lessees back onto the property tax rolls after eight years, a change from endless lease deals. It would also require local governments collect the tax, as opposed to relying on the current honor system.

The bill originally reined in blight designations as well, but that was later stripped out after encountering opposition from local governments.

So far, H.B. 2213 has proven moderate enough to attract the support of stakeholders who have otherwise benefited from the program. Among them is Tim Lawless, Arizona chapter president of the National Association of Industrial and Office Properties. While voicing support for H.B. 2213, and agreeing that GPLET is in need of reform, Lawless maintains that developers still need the program in some form.

“We have an inordinately high property tax burden,” Lawless told Watchdog. “It’s an impediment to economic development, attracting firms and jobs to the state.”

As such, he says GPLET should remain in place until there is a general lowering of rates. But he remains supportive of H.B. 2213, which he says is a win-win for property developers, schools and government reformers.

Patrice Klaus, legislative director of Arizona League of Cities and Towns, struck a similar cord on GPLET, describing it as useful tool for economic development while remaining supportive of reform.

“When you’re building a high-rise project you often need that incentive to make the project pencil out,” Klaus said, adding that GPLET projects “bring a lot of people and a lot of energy to downtowns, and that kind of synergy builds on itself.”

Still, her organization is also supporting H.B. 2213, which Klaus called “a good compromise.”

This broad-based support has seen the bill move rather smoothly through the Arizona Legislature, passing out of the House in February on a 50-9 vote. It now awaits a vote on the Senate floor, where it is expected to pass with similar ease.

The future of reform

Whether reform to GPLET will stop with the passage of H.B. 2213 is an open question. Many critics of GPLET as currently constituted will no doubt be mollified.

More hardcore reformers want to go further. DiCicio has called for the total abolition of the practice. The problems with GPLET run too deep, he said, and he would prefer to see Phoenix get out the business entirely.

Depending on how the pending litigation brought by Goldwater against the Derby Roosevelt Row project plays out, DiCicio might just have his way. The lawsuit makes a number of constitutional challenges, including claims that the deal violates the aforementioned Uniformity Clause as well as the Gift Clause of the Arizona Constitution, which prohibits public money going to benefit purely private ventures.

Were a court to find that these arguments apply not just to the Derby Roosevelt Row case, but to GPLETs in general, the longer controversial tax program, reform or no, might not be long for this world.

Christian Britschgi is an Arizona reporter for Watchdog.org. Contact him at cbritschgi@watchdog.org