Buried on page 130 in the new Tax Cuts and Jobs Act is a measure aimed at revitalizing America’s struggling neighborhoods by putting trillions of dollars in cash—unrealized capital gains—to work. Last week, governors from around the country nominated a portion of their low-income census tracts to be eligible for tax-friendly private investment. Known as Opportunity Zones, they serve as investment bait for communities left behind by the economic recovery. Success rests on an experiment in federalism, aligning investors and public officials behind a strategy for reengaging in distressed America.
Roughly 30 percent of Americans live in distressed zip codes marked by low incomes, education, and workforce participation, along with high rates of poverty. Meantime, five dynamic metro areas produced as many net new businesses as the rest of the country combined. Lawmakers are eyeing profits that investors have made in things like stocks or real estate, but that they let lie fallow to avoid being hit with capital-gains taxes. But now these investors can put that money—as much as $6.1 trillion—to use in so-called Opportunity Funds. In exchange, their capital gains taxes are deferred, reduced, or eliminated altogether.
Investing in struggling places is taking on new urgency. Harvard economist and Manhattan Institute fellow Edward Glaeser, together with his coauthors, recently found a widening and persistent gap in American regional economic fortunes. A man between the ages of 25 and 54 in Flint, Michigan, for instance, is more than ten times likelier to be out of work than a similarly aged man in Alexandria, Virginia. “It may be time to target pro-employment policies towards our most distressed areas,” Glaeser and his coauthors write.
Opportunity Funds pool dollars into qualified low-income areas. The longer they invest in local businesses or real estate, the better the tax treatment. As Brookings’s Adam Looney found, “Individuals in a high-tax state and with short-term capital gains can avoid $7.50 in taxes for each $100 they invest, even before considering any return on their Zone investments.” Funds can put money into a broad set of activities, from small-business startups to real estate ventures, as well as traditionally blue-collar sectors like manufacturing or energy.
Up to a quarter of a state’s low-income census tracts can qualify as Opportunity Zones, as selected by the governor and approved by the Treasury Department; another 5 percent of contiguous tracts may also qualify, as long as they are not radically better off than their neighbors. The near-term cost to the federal government is expected to be $7.7 billion over the next four years and $1.6 billion during the full 10-year window as deferred taxes are paid back.
Opportunity Zones are the brainchild of the Washington, D.C.-based Economic Innovation Group (EIG). The measure establishing them made it to President Trump’s desk thanks primarily to Senators Tim Scott (R-SC) and Cory Booker (D-NJ). Governors of every state and territory have been racing against the clock since last December to pick the right mix of poor areas for development before the initiative’s entry deadline closes this month. It has not been easy. California, for instance, could nominate up to 879 census tracts out of a total of more than 7,000. New York could pick up to 513. Several states, such as Tennessee and Idaho, launched portals allowing their cities and counties to pitch themselves for selection.
Unlike most economic-development efforts, this one appears to protect taxpayers; investors are on the hook for the risk and citizens benefit from the upside. Tax credits, by contrast, offer the wealthy a guaranteed subsidy while routinely capping outlays, lest too much success bust government budgets.
Opportunity Zones have their critics. For one thing, tax-favored zones have a lackluster record reviving distressed regions. Nineties-era Empowerment Zones, which channeled tax credits and block grants to high-poverty areas in six cities, spurred only limited job creation, at enormous cost. California’s enterprise zones couldn’t even boost employment. The most trenchant critique of Opportunity Zones is that, thanks to quirks in the census data, they may simply redirect dollars to already-flourishing communities. California’s Berkeley is no one’s vision of a down-and-out town; nevertheless, parts of it sit in qualified low-income census tracts. Areas with a large concentration of poor college students, say, or that grew significantly since the last census, are not only qualified as zones but also probably tempting to investors and governors looking for a quick payoff.
States and municipalities need to start planning now for the implementation of Opportunity Zones. Designating census tracts for the initiative is a governor’s statutory responsibility, but crafting a strategy and convening affected locals must be their responsibility, too. These strategies should be undergirded by data gathering and data sharing, with governor’s offices acting as information hubs, and outside institutions providing rigorous evaluation. “Places that do well with Opportunity Zones are going to be ones that have really thought through what happens to make each dollar work,” said John Lettieri, president of EIG. “Licensing, zoning, and permitting—there’s so much you can do.”
Whether Opportunity Zones end up a boon will depend in part on the communities themselves. “Some places are going to figure this out and say we have a strategy,” concluded Lettieri. “Other places are going to say: ‘I designated my zones and I’ll check back in a couple years.’ One of these approaches is going to be successful.”
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