There’s a saying about downtown Rochester in the 1970s and early 1980s: if someone set off a loaded cannon on the corner of Fourth Street and First Avenue, the ball would sail through the air a long time before it struck anything.
The lack of activity was a symptom of spiking interest in the “cornfield” communities, which offered bountiful parking spaces and plots exponentially cheaper than what developers could acquire in the city’s center. Retail powerhouses migrated to surrounding malls, leaving the downtown gutted.
“If you were walking down Broadway, it was almost like a ghost town,” said Terry Spaeth, assistant city administrator.
Over the last 50 years, officials have jump-started the downtown by allocating hundreds of millions of dollars to incentives. The tool has remained an integral part of the city’s modern developments, supporting key initiatives associated with the Minnesota BioBusiness Center and Destination Medical Center, and boosting affordable housing projects far outside of the Broadway strip.
While current and past officials laud these tools as essential parts of growing the local economy, some business owners say it’s done nothing but drive up their property taxes. As the executive director of DMC points out, the ultimate barometer of these programs’ success may be that the city reaches a point where incentives are no longer needed.
The origins of an economic linchpin
As malls blossomed miles outside of the downtown, Rochester’s core lost one retailer after another. A 2019 historic designation study said that by the 1960s, these forces culminated “to diminish downtown Rochester’s importance as a center of commerce.”
When the Apache Mall opened in 1969, it was a nail in the coffin, bringing downtown anchors like JC Penney and Dayton’s with it. Downtown developers didn’t have much on their side. Apache Mall plots boasted costs of around $5,500 per acre while downtown per-acre costs for the Dayton’s property were over $900,000, according to Olmsted County property records. Notably, the downtown area’s costs were driven up by existing structures, whereas the Apache plots were likely just land at the time. Still, with abundant parking, improved roads and no need to replace rickety old buildings, the “cornfields" freed developers of the headaches that existed downtown.
This “cornfield” versus city imbalance, as several former city officials called it, wasn’t just a Rochester phenomenon. As local leaders observed how cities across the state and country struggled to maintain their downtowns, they saw one tool used time and again: tax increment financing.
TIF is a tool that uses tax revenues to finance improvements in a set district. After TIF areas are designated, the original property taxes are frozen, and the increment — or property tax increases after that starting point — are funneled back into the development. The increment is collected over a set term and the developer must use it to supply a public benefit, such as parking or other infrastructure.
TIF was first adopted statewide by California in the 1950s, and has since been used in nearly every state, with Minnesota starting to widely use it in the 1970s. The Chicago Law Review dubbed it “the most widely used local government program for financing economic development in the United States.” When Rochester jumped on the TIF bandwagon, officials drew a district around the retail center of the city which did not include Mayo Clinic, according to Gary Neumann, former assistant city administrator.
“That basically was an attempt to try and level the playing field,” Neumann said, referencing the imbalance between the city and surrounding areas. “(TIF) was then the main vehicle that the city used to incent developers to build new hotels, new retail, new office buildings.”
The stakes were high for local officials who were struggling to maintain a vibrant area to support Mayo Clinic, the city’s top employer.
It took a few years to get the gears turning, but by the1980s and 90s, the city started closing deals downtown. The Norwest Bank development was an early success. Another was the D5 project, which connected skyways to the cityscape and developed the area where University Square now sits. Slowly, developers built up those once vacant blocks with a vision of urban revitalization.
From economic blow to incentive boom
While the city rode the momentum provided by a flurry of downtown TIF projects and a growing Mayo Clinic, it sustained a blow in 1993 when IBM cut nearly 2,000 jobs from Rochester.
“That was a game changer,” said Gary Smith, former executive director of Rochester Area Economic Development Inc. Smith was part of a group of business and city leaders, including Neumann and former city administrator Stevan Kvenvold, who quickly joined forces to ease the sting of that job loss.
Enter: Pemstar. The manufacturing firm planned to take on hundreds of IBM employees and put their expertise to good use. “Let’s keep the band together, so to speak, and make it play a different tune,” founder Al Berning said, reflecting on the company’s origins.
As Berning and his team considered offers in areas other than Rochester, Smith knew the city had to put forward a compelling package.
“I remember saying this to Gary (Neumann) and Steve (Kvenvold) ... I said ‘Guys, you’ve got to do something now. You’ve got to do TIF on this project.’”
In the end, Pemstar stayed in town, clinched by a financial package that included TIF. Berning said the incentive was key in keeping the company from setting down roots in another city.
The deal paid off. As of its 2006 sale to circuit board manufacturer Benchmark, the company employed 3,500 people and was valued at $300 million. The way Smith sees it, Pemstar’s success made TIF a key financial strategy as the city considered future developments.
The emphasis on maintaining area talent drove the development of the Minnesota BioBusiness Center, which opened over a decade after Berning’s team set up shop in Rochester. The center was funded using a combination of TIF funding, along with rent income and state bonds to fund parking, according to Neumann.
Smith, one of the engineers of that deal, said it was an ideal formula for the city. They simply had to provide a platform where the already thriving science community could turn their ideas into a business in Rochester, instead of taking their talents to other biotech hubs in the Twin Cities or Boston.
“It's just the quality of the idea and the quality of the people,” Smith said. “It starts with good ideas. And Rochester is an idea factory.”
The risks and rewards of using TIF
TIF funds can be paid as the tax value increases — a “paygo” system — or issued as a bond at the front of the project. Rochester now primarily opts for the paygo method. Although not widely used when Minnesota adopted TIF in the early 1970s, paygo has become the most popular payment method in the state today, said Jason Nord, assistant state auditor and TIF director.
“The risk is transferred to the developer,” Nord said, explaining that if the tax increment doesn’t reach projected values, it’s not the city’s loss, but the developer’s. “It's definitely become the more popular and prudent method for cities.”
TIF incentives, by nature, are supposed to make projects feasible that would not be in the absence of the funding, a rule called the “but for” clause. It’s one of the more thorny areas of using this tool, because there is no objective way to determine if the project would have gone forward without this funding. Some are wary that without stringent regulation, developers will build TIF into their bottom line and work backwards.
“(TIF) is neither a good thing or a bad thing inherently. What matters is how you use it,” said Nord. Think of TIF like a hammer, he added. “If you're using a hammer to pound nails, it's a great tool. If you're using it to pound other things, that's maybe not such a good thing.”
When compared to five other large Minnesota cities, Rochester ranked fifth in percentage of TIF capacity used.
Local officials are quick to remind that while TIF has gotten a bad rap for being used loosely in some areas, that’s not true of Rochester. John Wade, RAEDI’s interim president, says the educated workforce and quality of life in the area acts as an incentive of its own, and when necessary, programs like TIF can be deployed sensibly.
“We don't have a big sign up at the border, saying ‘move all your businesses here, you're going to pay the lowest taxes in the United States of America,’” said Wade.
Who do incentives serve?
One of the most frequent critiques of the TIF program is that it strays from its requirement to be applied toward a “blighted” area. One high-profile case from outside of the state: many of the top-bidding cities for Amazon’s second headquarters offered the then-$280 billion company TIF funding.
This debate over where TIF is most needed weighs heavily on Rochester City Council member Nick Campion’s mind.
“If you start incentivizing every project, developers start building it into their pro forma and they come expecting it,” said Campion. “It's critical that it is not expected, that it is applied where there's kind of this confluence of city need and developer need.”
One of Campion’s priorities on the council was to shift the city away from providing TIF for hotel projects and more to affordable housing. Housing redevelopments often generate a smaller TIF increment than other developments, he said. Still there are significant differences in TIF funding allocated to affordable housing since 1999. While about $70 million has been apportioned to redevelopment projects, $21 million has gone to housing.
Historically, incentives often haven’t been used to support the businesses or populations they should, said Dee Sabol, executive director of the Rochester Diversity Council.
“We have perpetuated inequitable application of incentives, without any forethought of malice,” Sabol said, citing the “good old boys type of environment,” where business owners and developers with connections are rewarded with incentives.
This has improved in recent years, Sabol said, and she’s encouraged by the rare spark she sees in Rochester.
“This is a community that doesn't just have the desire to be exceptional. It also has the capacity. And that's not always the case,” Sabol said.
While some incentive funding is being allocated to alleviating living expenses for residents, one local business owner says they’re costing him tens of thousands.
“My ability to operate my business is being taken away predominantly from these incentive packages, because my taxes are affected by the surrounding projects,” said John Kruesel, whose General Merchandise company has been downtown for over 40 years. Kruesel said his property taxes have steadily increased, jumping $16,000 in a recent year.
Even if the incentive packages do draw more people to the downtown area, he’s doubtful it’ll be enough to offset these costs.
“There are no incentives for small businesses,” Kruesel said. “The incentives go to the big boys.”
It’s a struggle Kvenvold sympathizes with.
“I get somewhat disappointed in that downtown is lacking some of that vitality that has existed before,” he said, adding that construction on sewers and streets, largely prompted by Destination Medical Center, have pushed some people away from frequenting downtown businesses. Compounding this, the pandemic has slammed those who were already struggling to pay their property taxes.
“People that have their businesses and own their buildings...all of a sudden had higher property taxes to pay, and not necessarily higher income,” Kvenvold said. “It's really hard to stay alive.”
From angel investors to historic preservation
While TIF funding has a storied history in the city, it’s just a slice of the pie. A variety of incentives, from historical tax credits to angel investor credits bolster different sectors of the business community.
Minnesota’s Historic Tax Credit, which is approaching the end of its 10-year duration, provides 20 percent tax rebates for rehabilitating approved buildings. Advocates say the credit has been a success in the state, more than paying off its costs.
For startup companies, angel tax credits and research tax credits are some of the most widely used, especially in Rochester’s thriving life sciences scene.
“The Angel Investor Tax Credit allows for those innovations...those life-changing drugs that have been able to allow people to not only live longer, but have better quality of life,” said state Sen. Carla Nelson (R-Rochester) who was recently appointed chair of Minnesota’s Senate Taxes Committee.
Six Rochester businesses qualified for angel investment in 2019, and three received it.
In a 2014 statewide evaluation of the credit, 18% of investors said they would have made the same investment without the credit, and 34% said they would have made an investment, but in a smaller amount without the credit.
The 40-year-old research tax credit benefits eligible businesses embarking on research endeavors. It received lackluster praise in its 2017 state evaluation, where reviewers found it generated “relatively small growth,” and is quite “complicated” for those wishing to use it.
DMC, the largest public-private partnership in Minnesota history, also benefits from incentive programs in the state. Millions of dollars in TIF funding will be directed to approved projects, according to DMC projections, for developments such as Two Discovery Square.
Yet, it’s not the main driver for the initiative, said Patrick Seeb, DMC’s executive director, who said at least half of the nearly one billion dollars in private investment in the DMC district hasn’t had any incentives associated with it.
Plus, Seeb said while TIF developments often get a lot of attention for who they do and do not directly benefit, the funding for infrastructure — such as roads, sidewalks or sewer systems — associated with these projects is often overlooked.
“There's never a ribbon cutting for a new sewer,” he quipped.
For Seeb, the real goal of using incentives may be propelling the community to a place where they’re no longer needed. By improving downtown spaces, drawing more people to the area, and bolstering public transit, the area picks up a momentum of its own.
“It becomes this virtuous cycle where later projects require less and less and ultimately, no public subsidy.”