CHICAGO -- Polk County, Iowa, officials have warned that the growth of tax increment finance districts outside city limits could threaten the county's financial health.

James Koolhof, country manager, said officials intend to seek legislative changes in the state tax increment law to ensure that county finances are not harmed by creating the districts in unincorporated areas. Koolhof said he expected the issue to be discussed in the next session of the Iowa legislature, which begins Jan. 11.

"We want to raise a red flag before it becomes a practice," Koolhof said.

The creation of tax increment finance districts in unincorporated areas costs the county a portion of property tax revenues, according to Koolhof. In addition, the county must assume the additional cost of providing road-related services to those areas, he added.

The recent formation of an increment district by Pleasant Hill, a Des Moines suburb, triggered the county's call for limits on such districts, Koolhof said.

In October, Pleasant Hill formed a district covering 22 acres of the city and over 3,700 acres in an unincorporated part of the county. The district is twice as large as the municipality, Koolhof said, and the unincorporated area represents "a major concern" and could be "precedent-setting."

"Obviously, if all municipalities did what Pleasant Hill did and we're required to provide the services, that becomes a significant threat," Koolhof said. "It's not yet damaging the strength [of the county], but it could if limits are not set."

Koolhof said cities should be required to notify the county of their intentions to create such districts and that limits should be placed on where the districts can be set up. In addition, Koolhof said current state law does not include a provision on how long the districts can remain off the county's tax rolls.

Gov. Terry Branstad of Iowa is "open to changes in the law," according to Lisa Green, his spokeswoman. She added that the governor does not want the law eliminated.

"The governor believes it is appropriate to work with county officials to work on reforms to avoid any kind of misuse of the law," Green said.

Under Iowa law, cities are allowed to place areas in need of development into increment districts. Increases in any property taxes because of growth in those areas are used to provide improvements there and can be used to back bonds issued for the improvements.

Pleasant Hill created an increment district outside its boundaries to capture tax revenues to back a proposed $2.9 million bond issue needed to build a fire station for the area covered by the district, Koolhof said. However, voters rejected the bond issue earlier this week.

Since the tax increment finance law was passed in 1978, 76 tax increment finance districts have been formed in the county, Koolhof said.

The districts have cost the county $11.5 million in property tax revenues since 1978. In fiscal 1992, for example, the county lost $1.5 million, or 2% to 3% of its levy, Koolhof said. He added that formation of the districts has grown 17% annually since 1978, compared to the 5% annual growth in the county's tax base.

Meanwhile, a lawsuit challenging the formation of Pleasant Hill's increment district has been filed in Polk County District Court.

The suit, filed by a group of residents who live in the increment district, contends that creating a district outside a city's boundaries is unconstitutional, according to Frank Smith, attorney for the residents.

The residents live in a suburban estate settlement known as Rising Sun, Smith said.

He said approval of the district by Pleasant Hill's city council represents taxation without representation because no Rising Sun residents hold seats on the city council that approved the district.

Smith, a Rising Sun resident, said a decision on that issue could potentially set a precedent because it has never been tested in court.

He added that the residents also challenge Pleasant Hill's designation of the increment district as a commercial-industrial area in need of revitalization. They say the area they live in is residential.

Southeast Polk School, which would lose a portion of its tax revenues because of the increment district, has taken legal action to preserve its right to file a lawsuit in the future, Smith said.

Lee Gaudineer, attorney for the school, did not return phone calls.

Shona Ringgenberg, Pleasant Hill's administrator, referred all questions regarding the district to Robert Josten, the city's attorney. Josten did not return phone calls.

In the meantime, Rising Sun is attempting to incorporate as a city and is challenging Pleasant Hill's efforts to annex the area covered by the tax increment finance district.

Jamie Burr, vice president and assistant director at Moody's Investors Service, said he is monitoring developments in the area of tax increment finance districts for any credit implications.

David Hitchcock, a direct at Standard & Poor's Corp., said the rating agency will review the impact of tax increment finance districts on Iowa counties on a case-by-case basis.

The county has about $20 million of outstanding general obligation debt that is rated A by Moody's and AA by Standard & Poor's.

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