A primer on Payments in Lieu of Taxes and why they exist — Part 1

By Seth Richardson

Payments in lieu of taxes (PILT), sometimes known as PILOT, is a concept for revenue sharing that originated between governmental entities and emerged decades ago as states began to understand that federal lands within their states were exempt from property taxation under the Supremacy Clause of the Constitution. In the beginning, states and local political subdivisions were often burdened with providing services such as law enforcement, roads, bridges and firefighting to federally-owned lands while at the same time being unable to collect tax revenues to pay for those services. This placed an undue burden on local taxpayers, often a crippling one, particularly in the western states where in some places, more than 85 percent of the land in some states, and many counties, is owned by the federal government. Indeed, nearly one-third of all of the land in the U.S. is owned by the federal government, with the vast majority in the western states.

This inequity was formally recognized by Congress in 1997 with the enactment of Public Law 97-258, when formal payments to state and local jurisdictions adversely affected by federal ownership of lands exempt from local taxation were authorized.

More recently, the concept of PILT has been expanded by state and local jurisdictions in an attempt to generate revenues from other tax-exempt entities and organizations, including public colleges and charitable institutions. The theory is that private non-taxable organizations such as charitable foundations that are tax-exempt under federal law, and property within one political subdivision (state, county, city) that is owned by another political subdivision and is therefore immune from taxation by the containing entity, still enjoy the benefits of services offered by the containing entity, but because no taxes are paid, it is felt by some that this is an unfair tax burden upon the taxpayers of the containing entity. An example is Washington, D.C., where half or more of the land is tax-exempt, but where city services such as law enforcement and firefighting, among others, must nonetheless be provided to all residents, even when they are on federal property.

There is nothing inherently wrong with payments in lieu of taxes, particularly between one government entity and another, since they are statutorily prohibited from taxing one another, because equity demands that local taxpayers should not have to shoulder the entire burden of providing basic services like sewers and water to tax-exempt governmental agencies from which local taxpayers receive no concomitant benefits.

But the PILT concept, like many good ideas, has metastasized into a cancer of ever-growing proportions as financially-strapped municipalities and politicians search for revenue sources to prop up dwindling sales tax revenues.

The best thing about a PILT is that it’s entirely voluntary, at least so far. This means that while some landowner otherwise exempt from taxation may agree to pay money to the local government to help defray the costs of providing public services, PILTs are not, so far, a tax-equivalent mandatory exaction.

This is not to say that cities, counties and states do not have considerable powers they can bring to bear on non-profits and other tax-exempt private organizations in order to “persuade” (read: coerce) them to agree to a PILT. Author Mark Murphy writing for the American Federation of State, County and Municipal Employees (AFSCME), the nation’s largest public employee union, wrote:

“Local officials sometimes force the issue with nonprofits that have not contributed by halting or slowing building permits or zoning approvals, by proposing to levy some alternate tax on nonprofits or even by challenging the organization’s tax-exempt status. The result is usually a negotiated settlement that allows the jurisdiction to collect some revenue while at the same time letting the tax-exempt organization project a positive image in the community and avoid an alternative that could be worse. That was the case in Baltimore, Md., last year, where 16 of the city’s largest nonprofit organizations agreed to contribute $20 million to the city over 4 years, after the mayor dropped a proposed energy use tax on nonprofit organizations within the city. Several Pennsylvania cities and counties mounted legal challenges to local nonprofit organizations’ tax-exempt status in the early 1990s. Many of these attempts were successful in collecting PILOT payments even after they lost initial challenges in court.”

Murphy goes on to recommend ways that public employees can work to enhance government revenues (and thereby preserve public-sector jobs) through public employee activism to encourage (read: coerce) PILTs from local non-profit organizations.

The problem with PILTs in this context is that the reason that such organizations are tax exempt in the first place is that they generally offer services to the community that the government would otherwise have to pay for itself, so the taxes are foregone precisely because of the greater fiscal benefits that the community realizes by having non-profits serving the community.

The National Society of Fund Raising Executives (NSFRE) published a position paper on PILTs in 1997 saying:

“These actions are motivated by a thirst for property tax revenues with no regard to the fact that, for over 400 years, western societies have exempted not-for-profit organizations from taxation because of “community benefit.” Not only do those living in the communities served by not-for profit organizations benefit from their presence, the not-for-profits work to preserve America’s voluntary philanthropic tradition. Studies continually reaffirm the finding that not-for-profit organizations deliver programs more cost-effectively and with better quality than government efforts.

In 1994, 10 million people were employed in the not-for-profit sector with an annual payroll of $144 billion. This is 10.6 percent of the total workforce. In addition, volunteers provided the full-time employee equivalent of 5.46 million people. If the services provided by these volunteers alone were not available, the government would have to pay over $49 billion to provide the same level of service.”

On the other hand, some organizations voluntarily make PILTs as a goodwill gesture to the communities they serve. An example is Harvard University, which paid the city of Cambridge $1.6 million and paid Boston $40 million in 2001 for their tax-exempt campuses.

But the key here is voluntariness. So long as local tax-exempt organizations can afford to contribute towards the municipal services they receive, fine. But as the NSFRE points out, the very reason they are tax exempt in the first place is that they provide far more by way of benefits than they consume in public resources. Even the Congress and the Supreme Court recognize this beneficial relationship, as the NSFRE paper points out. The failure to recognize the benefits such non-profits offer by bureaucrats, politicians and public employee unions is a case of not seeing the forest for the trees.

There is little argument that PILTs between different political subdivisions to offset the impacts of services provided to non-taxable government entities are inherently unfair or unreasonable. However, the essential component of the entire PILT concept, at least as originally conceived, is that the tax-exempt status of one jurisdiction’s property causes an unfair economic drain on the taxpayers of the other jurisdiction without any realized benefits, which therefore ought result in some compensation for those costs.

When the taxpayers of Colorado Springs have to pay for public services rendered to El Paso County government, from which the city taxpayers receive little or no benefit, then a PILT from the County to the City is likely to be appropriate and reasonable.

But when it comes to PILT payments from one municipal department or enterprise to another, such as from the Colorado Springs Utilities Enterprise to the city’s General Fund, that’s something else entirely… it’s a TABOR-evading fraud on the taxpayers… as I will discuss in Part 2 of this examination of Colorado Springs payments in lieu of taxes, coming soon to this column.

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