Payment-in-Lieu-of-Taxes (PILOT)

A cousin of TIF and a variation of local “off-balance sheet” financing is the securitization of anticipated revenues. Payment-in-lieu-of-taxes (PILOT) bonds are a version of this type of security. PILOT deals, which are typically economic development projects, involve payments from private entities that are used to pay debt service on tax-exempt bonds. A city may issue PILOT bonds backed by, for example, lease payments from a major league sports team over a 15-year period, and then use those bonds to pay for the construction of or upgrades to the stadium.

Another example of this type of financing approach can be seen in the securitization of tobacco settlement revenues. In the years following the Tobacco Master Settlement Agreement, in which the four largest U.S. tobacco companies settled with the attorneys general of 46 states in 1998, a number of state and local governments opted to issue so-called “tobacco bonds.” The issuance of this debt security enabled capital-constrained governments to access additional financial resources and transfer some of the risk of declines in future settlement agreement payments to bondholders. For example, Alaska invested a portion of its proceeds into infrastructure projects, and Alabama used them to finance economic development. Although some governments have benefited from being able to access additional resources in this way, a drawback of this tool (depending on the perceived riskiness of the revenue stream) is a potentially high interest rate, which makes the bonds more expensive.