There’s no evidence that simply giving rich people more after-tax income helps those with fewer means. If this new idea works, it’s because it incentivizes those with capital gains to reinvest their returns in places starved for capital investment.
Let me explain, and then talk about what could go right and wrong with this new tax policy.
When an investor sells an asset, she pays a tax, typically at a rate of about 24 percent, on the asset’s appreciation, i.e., its capital gain. But if she taps this new incentive, she can diminish her liability by putting the gain in a fund dedicated to investing in disadvantaged areas certified as Opportunity Zones (OZs). The longer she leaves the investment in place, the bigger the tax break on both the original capital gain and on the returns from the investment itself (see here for details).
OZs don’t assume that just because they get a tax cut, wealthy people will make investments that will somehow lead to higher incomes for others. The tax break is conditioned on investing in economically left-behind places where patient, equity capital is a scarce commodity. To push back on sheltering risk, investors can’t just park their deferred gains in OZs. They must be used to build new homes or businesses, finance new or expanding companies in the zones, or substantially rehabilitate preexisting structures and/or businesses.
As an early contributor to this idea, I was motivated by two realities. One, the United States is fraught with capital scarcity in most places amid race/gender unbalanced capital accumulation in just a few places. The vast majority (over 75 percent) of venture capital goes to white male founders in Massachusetts, New York and California. Two, it is increasingly well understood that the facile economic solution to being stuck in a depressed area — move to a better place! — isn’t working. Diminished geo-mobility has left too many families in places with too little opportunity. If policy is going to help them, it needs to bring jobs and investments their way.
It is inconceivable that a few white guys in three states are the only people and places where untapped potential exists. Instead, I’m sure the status quo underinvests in the future of ailing regions and less-advantaged demographics. Hence the bipartisan backing the Opportunity Zones idea garnered in both chambers of Congress before it was wrapped into the tax overhaul package.
It’s too soon in the life of OZs to evaluate actual investments, but we can examine some critical, early developments, including the zone certification process, market reactions and some early, proposed investment targets. Such monitoring is essential if we want OZs to realize their potential to help left-behind places and people, vs. them turning into another wasteful, ineffective, place-based tax break.
A good place to start is the outcome of the certification process, wherein governors designated over 8,700 OZs across all 50 states, the District, and U.S. territories (almost all of Puerto Rico received designation to aid disaster recovery) to receive tax-favored investments. Eligibility criteria include places with above-average poverty rates and below-average incomes.
According to the Economic Innovation Group, a D.C. policy organization closely associated with OZs (I co-chair EIG’s research advisory board), the average zone has a 29 percent poverty rate — nearly twice the national rate — and a median family income of $42,400, nearly 40 percent lower than the national median of $67,900. EIG finds that more OZ adults lack a high school diploma than have earned a bachelor’s degree. Likewise, on jobs, housing and life-expectancy measures (almost four years shorter among zone residents), OZs paint a picture of economic distress and disinvestment.
In Louisville, for example, the 19 certified OZs have a poverty rate of 43 percent compared with 14 percent for its metro area. Median income is $22,000 in the zone compared with $52,000 in the metro area; over half of zone residents are African American compared with 14 percent metro-wide residents.
However, some high-profile zones were poorly chosen, raising the risk of subsidizing places that are already on a stable footing. Exhibit A is the zone chosen for one of Amazon’s second headquarters in Queens. Not only will this area already receive over $1 billion in tax credits and subsidies from the deal local governments struck with Amazon, it also is considerably more prosperous than the typical zone. Its choice was a function of a glitch in the law that allows governors to nominate up to 5 percent of better-off places next to low-income ones. EIG found that governors used this discretion sparingly; it was tapped by less than 3 percent of OZs. Other, independent research found less than 4 percent of chosen tracts showing signs of gentrification before nomination. Still, even while these are small percentages, such leakage undermines the intent of the program and wastes valuable tax revenue. It is also possible that such places could absorb disproportionate shares of OZ investments.
That said, given that most zones appear to be well chosen, what kind of investments might follow?
To answer this question, I looked at a few of OZ investment prospectuses starting to come out, and I urge fellow skeptics to do the same. There’s evidence that governors worked with mayors to designate zones, and many mayors are now leading the charge to steward investment into their communities. One such case is Oklahoma City, which chose the 23rd Street Corridor, long a commercial and cultural hub at the core of the city’s African American community. In 2014, the city government designated the area as “blighted,” but development plans have foundered for lack of patient capital. Residential housing, retail (including a much-needed grocer), and health facilities are all featured options in their OZ prospectus. Similar ideas are in motion for Park DuValle neighborhood in Louisville, and the Civil Rights District in Birmingham, Ala. In Boulder, Colo., stakeholders are coming together to figure out how their local OZ can be used to address the city’s lack of affordable housing, a problem that has long kept low-income families from living close to work.
Yes, such investments invoke gentrification risk. It is not for nothing that James Baldwin relabeled the 1960s urban renewal as “Negro removal.” But unlike the federal projects of that era, OZs and their investment funds have zero power to override local rules. As columnist Jan Burton said about the Boulder initiation, “We control our zoning and land use decisions, and we retain the long-standing 1 percent per year growth limit on housing units. We control our own future.”
I’m keeping my powder dry on this one. If OZs turn out to largely subsidize gentrification, if their funds just go to places where investments would have flowed even without the tax break, or if their benefits fail to reach struggling families and workers in the zones, they will be a failure (my Center on Budget and Policy Priorities colleagues raise these and other concerns about OZs). Moreover, when it comes to anti-poverty policy, readers of this column know my preference for direct hits vs. bank shots. The most direct ways to help those left behind is to guarantee them jobs, incomes, housing and health care. The direct way to improve infrastructure in poor neighborhoods is for public projects to build it.
But the fact is that most OZ communities have faced disinvestment and depopulation for so long, they have both the need and capacity to absorb new investment, development and people without displacing local residents. And our politics is such that we’re living in a second-best world. At the same time, the inequality of our era means there are trillions of dollars in idle capital sitting on the sidelines over here, and communities suffering from decades of disinvestment over there. As Bruce Katz, a longtime regional development expert told me, “For a lot of these places, Opportunity Zones represent the last and best chance to drive a new economic vision.”
Thus, I suggest we give OZs a chance, while scrutinizing their progress. That will require the Treasury to dictate strong reporting requirements that will accommodate thorough evaluation. As I’ve stressed, my support for the idea is conditional on such data and what they show (my biggest concern is that the Treasury fails to collect the tracking data needed to evaluate relevant outcomes). I’m enthusiastic, not naive, and the last thing we need in this country is a new way for investors to shelter capital gains. But we have a pressing need to channel lasting, opportunity-creating investments to people in left-behind places, and OZs might just meet that need.