April 12, 2009 - CityNorth - Goldwater Institute, Phoenix AZ

CityNorth legal fight has fallout for business

Case could change the way cities, developers make deals

CityNorth legal fight has fallout for business

A legal battle over parking garages for upscale shopping center CityNorth could trigger major changes in how cities work with private developers and in the longtime practice of awarding sales-tax subsidies to them.

A high court decision against a $97.4 million subsidy offered to CityNorth by Phoenix potentially could scuttle other deals, create liability for cities and change the equation on developers' decisions on whether to build high- profile projects.

Billions of dollars in sales-tax rebates have been handed out by Valley cities to car dealers, mall developers and retailers.

Projects such as Tempe Marketplace, Mesa Riverview and the Nordstrom at Scottsdale Fashion Square were subsidized by such rebates. Several major new developments, including the Prasada master-planned community in Surprise, include sales-tax rebates as well.

Over time, both developers and cities came to expect some incentives to be in play. Cities offered the deals, saying they would spur development and boost sales-tax revenue and jobs. Developers came to rely on the subsidies to help them recoup costs sooner.

Now, the future of such deals is uncertain as a result of an Arizona Court of Appeals decision that found the subsidy offered by Phoenix to CityNorth to be unconstitutional. The CityNorth case, brought by the Goldwater Institute, a conservative public-policy organization, against the city and developers of the northeast Phoenix shopping center, has been appealed to the Arizona Supreme Court.

As the sides wait for the court to decide whether to hear the case or let the Appeals Court decision stand, cities and developers are scrutinizing their existing deals, and other development discussions have been put on hold.

Supporters contend that tax breaks and other incentives will bring in far more sales-tax revenue than is lost by the incentives given to get the project under way.

The Goldwater Institute and others say the deals give these projects unfair advantages, placing higher tax burdens on citizens and on other businesses as a result. With cities facing huge budget shortfalls, public sentiment is running more strongly against the practice.

"People are very leery of these arrangements," Mesa Mayor Scott Smith said. "They can't see the incremental benefit." Smith was elected last year after campaigning against sales-tax subsidies.

Test case

The Arizona Legislature moved to rein in sales-tax rebates in 2007, requiring that they be used only to reimburse developers that make infrastructure improvements that benefit communities.

That year, the Klutznick Co. of Chicago, developer of the $1.8 billion retail-residential CityNorth project near Loop 101 and Tatum Boulevard, said the subsidy was needed to get the project off the ground.

The parking garages were to accommodate customers for Arizona's first Bloomingdale's department store, among other retail outlets at CityCenter at CityNorth. A small number of spaces were to be reserved for park-and-ride bus patrons.

The CityNorth agreement calls for a 50-50 split of sales-tax revenue for 11 years and three months, or until the $97.4 million cost of the garages is recouped.

The Goldwater Institute sued Phoenix in 2007, contending the agreement violated the longstanding "gift clause" in the Arizona Constitution, which in most cases prohibits governments from granting money or credit to private entities.

Clint Bollick, director of the Goldwater Institute's Scharf-Norton Center for Constitutional Litigation, said the group chose to challenge the CityNorth agreement because it was "the most egregious case of abuse we could find."

The rebate to the Klutznick Co. of Chicago initially was upheld by Maricopa County Superior Court Judge Robert Miles, who rejected the Goldwater Institute's claim.

The institute appealed. Last year, the Arizona Court of Appeals agreed with its claim, ruling that the agreement violated the state's Constitution. The court acknowledged that the 200 parking spaces that would be reserved for park-and-ride bus patrons indeed would benefit the community. But it found the remainder would be used primarily by customers of the center's projected retailers, including Bloomingdale's, Neiman Marcus, Nordstrom and Macy's department stores.

"We think these payments are exactly what the gift clause was intended to prohibit," the Appeals Court ruling said.

The court also rejected increased sales-tax revenue and more jobs as justifying such agreements.

Phoenix attorney Grady Gammage, who represents CityNorth, said, "They (the Appeals Court judges) completely ignored the Legislature."

Gammage said the Phoenix-CityNorth deal was crafted to meet lawmakers' requirements that such payments be tied to infrastructure improvements. The garages, he said, should have been considered municipal infrastructure.

Paul Katsenes, Phoenix deputy director of community and economic development, said, "The agreements make development occur sooner, in new ways and in specific areas. If the ruling stands, they potentially go away as an economic development tool."

Far-reaching implications

City North says its second phase could be delayed without the rebate and that the ruling could endanger deals with department stores, including a possible Neiman Marcus, because they are based on the developer providing parking, CityNorth spokeswoman Najla Kayyem said.

Developers of numerous other projects that have been completed or are under construction or are still in the planning phase are reviewing their status.

A ruling against the rebate could affect some high-profile projects in downtown Phoenix, such as CityScape, a mixed-use project that has $96 million in city subsidies, including $26 million in tax breaks.

Mall developer Westcor has been given a $240 million sales-tax rebate by Surprise to develop Prasada, a proposed 13,000-home community and retail center near the planned Loop 303 freeway.

Garrett Newland, Westcor's vice president of development, said the company is confident that its deals would hold up because they are primarily reimbursements for infrastructure improvements.

Westcor also has sales-tax rebate deals for planned malls in Goodyear, Surprise and Casa Grande. Projects could be more difficult to finance without the agreements, he said.

Communities that used tax breaks to attract retail developments have temporarily halted the process pending the outcome of the case.

Oro Valley near Tucson already has stopped making subsidy payments directly to developers and is instead putting the money into an escrow account. The town has deals with Vestar Development Co. of Phoenix, Bourn Partners of Tucson and the Hilton El Conquistador Golf & Tennis Resort.

Queen Creek Town Manager John Kross is confident its approximately $27 million in deals with Vestar, Westcor and Sunbelt Holdings meet the test.

The sales-tax rebates covered the costs of installing and widening roads and a new railroad underpass.

Surprise Deputy City Manager Sintra Hoffman, also is confident that their deals with Vestar, Westcor and others are safe because they are tied to infrastructure improvements that benefit the community as a whole.

Other subsidies

Some economic development experts and developers also expressed concern that instead of striking down the ruling, the Supreme Court could broaden the decision to include development subsidies besides sales-tax rebates.

That could affect employee-training grants, bed-tax rebates and billions of dollars in government property lease excise tax, or GPLET, deals. In GPLET transactions, the property is transferred to a government entity, such as a city or town, which results in substantially reduced property taxes for the developer.

GPLET projects in Phoenix include the planned CityScape development, Arizona Center and the Collier Center and Renaissance office towers.

Jay Butler, director of real estate studies at Arizona State University, believes Phoenix took a risk by appealing the decision.

He said that a broad ruling by the Supreme Court disarming the state's economic developers of their weapons to attract new business could be a disaster.

"They're part of the arsenal we need to compete with other cities," he said, adding that the recession has made California cities much more aggressive in competing for new jobs and businesses.

History of incentives

Valley cities and towns fiercely compete with one another and out-of-state counterparts to attract businesses that generate sales. For cities and towns, sales taxes are the main source of revenue.

The deals often have been struck to spur retail development on the Valley's fringes.

In 2007 two major auto malls opened within two miles of each other in Gilbert and Chandler. Gilbert offered $60 million in rebates to attract dealers to its mall in an effort to combat $40 million offered by Chandler.

Mesa granted $80 million in incentives for the Riverview shopping center and Bass Pro Shop.

Peoria has used tax rebates to attract car dealers, help build the Park West retail center and attract projects around the Peoria Sports Complex.

In addition, Mesa voters recently approved a $51 million bed-tax rebate for an upscale 1,200-room hotel and convention center to be developed near Phoenix-Mesa Gateway Airport by Gaylord Entertainment Co. of Nashville.

Changing landscape

Proponents say such deals are seed money that eventually generates many times the amount in increased sales-tax revenue. Queen Creek's Kross estimated the agreements made between the town and developers have brought in an additional $5 million in sales taxes.

Opponents say such incentives favor developers more than the communities and amount to lost revenue and giveaways of taxpayer money.

The political landscape is changing on the issue. Three of the four Phoenix City Council candidates who won seats in the November election oppose the CityNorth deal. Mayors of cities that once supported the deals, such as Scottsdale, Mesa and Tempe, now ardently oppose sales-tax rebates as an economic development tool. New Scottsdale Mayor W.J. "Jim" Lane favors expedited city approvals over tax rebates.

Mesa's Smith is taking a hard look at such incentives, which he believes do not provide the promised economic gains.

"I'm very, very leery of using sales-tax rebates to generate incremental growth," Smith said. "I don't think they work."

Original Story - Arizona Republic