By: Mark Glennon*
How might you reinforce the worst stereotypes of both parties – greedy Republicans handing a pointless tax break to the rich, and reality-challenged Democrats wasting money on a well-intentioned program for the poor likely to fail and perhaps backfire?
It’s the new Opportunity Zone program, and it’s being implemented in Illinois and the rest of the country now. Treasury Secretary Steven Mnuchin predicts $100 billion in investment will go into Opportunity Zones. That’s serious money.
Unfortunately, there’s little evidence they will be effective for the poor though they are manna from heaven for taxpayers facing bills on accumulated capital gains, who are mostly well off.
Before we get to the evidence and to how the program is being implemented in Illinois, we’ll first review the background and why it’s so controversial, despite its bipartisan heritage.
The zones are intended to encourage investments in poverty-stricken areas by taxpayers who have accumulated capital gains, from whatever source, and want to avoid taxes thereon. That’s a huge sum available to induce investment. Estimates of the total accumulated capital gains awaiting taxation run as high as $6 trillion.
The tax break is generous. Invest in real estate or a businesses located in a qualified zone and you get these benefits, as summarized by the Tax Foundation:
- Capital gains tax on the rolled over investment is deferred until 2026 or upon withdrawal from the fund.
- Capital gains tax on the rolled over investment can be reduced by up to 15 percent after seven years in an opportunity fund via a step-up in basis.
- If the investment is held for at least 10 years, any new gains derived from the opportunity fund are permanently excluded from capital gains taxation.
The concept initially appeared in Congress as a standalone bill with Republican and Democratic sponsors in both houses, as well as private sector support – an “unlikely group of billionaires and politicians,” as Forbes put it.
The Trump Administration liked the idea, too, so it ended up as part of the major tax overhaul passed in December 2017.
The federal law left broad discretion to the states to pick qualified zones. The only significant federal requirement is that they be low-income, high-poverty census tracts. From those census tracts, each state was free to designate one-fourth as Opportunity Zones. The resulting total is 8,700 zones nationally. A national, interactive map showing showing both the census tracts and the qualified opportunity zones is linked here.
The general idea isn’t new. Tax incentives targeting impoverished zones have been tried here and abroad with support from conservatives and liberals alike. Margaret Thatcher’s U.K. called them Enterprise Zones, which were replicated here during the Reagan Administration. The Clinton Administration championed Empowerment Zones.
Have they worked? The Brookings Institute charitably says the evidence is inconclusive, but proponents usually cite only particular examples of apparent success. Other researchers, however, looking at the aggregate performance of each particular program, are more negative. A professor of urban policy at the University of Albany summarized it this way:
Numerous efforts have been made to assess the effectiveness of such zones, both in the U.S. and the U.K. On the whole, scholars have reached the strikingly similar conclusion that the programs did not work, at least not as hoped.
Why? What’s the problem?
Opportunity zone criticism centers mostly on two matters.
First, zone selection inevitably includes areas already destined for development or gentrification, or are adjacent thereto. Investors thus end up with a windfall tax break for doing what they would have done anyway.
That’s how this subject first came to my attention. A researcher in a different state shared a confidential report he prepared for a developer. The purpose was to identify sites already suitable for the projects they intended to build that now could reap Opportunity Zone tax breaks. The researcher felt the program was a senseless giveaway to developers like the one that commissioned him for the work.
Search the national press and you’ll see plenty of examples confirming that problem is already unfolding, one whopper being Amazon’s new headquarters site in Long Island City. “That Long Island City is a designated opportunity zone Amazon might exploit is especially mind-boggling given that the fast-gentrifying area has had no trouble attracting new investment,” wrote one critic. The Amazon project apparently will disrupt affordable housing already planned for that city.
A researcher at the Urban Institute found nearly one-third of the nation’s 8,700 Opportunity Zones are showing signs of pre-existing heavy investment. It’s in those zones that you can expect to see development, and the tax breaks therefore wasted.
The second general problem with Opportunity Zones is more fundamental. The zones are a form of what’s called “place-based” assistance. But help for the poor works best if you target people, not places, zone critics say. The dubious premise behind Opportunity Zones is that if you live in a poor neighborhood with no jobs, rampant crime and crummy schools, stay there and we’ll fix it up.
But that defies a time-proven method for escaping poverty: Moving.
Sounds harsh, but it’s true. Move, just move. According to the Census Bureau, moving early in life to a neighborhood where children experience better overall outcomes can increase a child’s income by several thousands of dollars later in life. Chances of ending up in jail are greatly reduced as well.
The Economist criticizes Enterprise Zones for just that reason. “Places matter,” it says. “Even a short distance can make a big difference.”
Indeed, decreasing propensity of Americans to flee failing areas is a growing problem contributing to entrenched poverty. From the Brookings Institute:
The flow of people from struggling to vital counties is one important mechanism for binding the United States into a common market with roughly similar economic fortunes. This process enhances productivity and wage growth, and can play an important role in cushioning regional shocks. However, this mechanism has broken down in recent decades. Migration from low-income to high-income places has decreased in tandem with falling economic convergence among states. Workers have also become less likely to move to a new job or to a new state and mobility is less responsive to labor demand conditions than in the past.
That’s why the whole program may backfire. Moving, not place-based assistance intended to keep people in, is what many experts say works for the poor.
By no means does that mean flight is a simple answer to poverty, or a long term policy. Fixing the underlying problems that caused the flight should be the ultimate, real policy goal.
Implementation in Illinois
The federal government left it to state administrators to designate Opportunity Zones from the list of impoverished census tracts.
As you’d expect, Illinois officials were immediately set upon by developers anxious to have their favorite sites designated. The law, passed in December 2017, gave states only until March 21, 2018 to make the designations – far too little time for a thoughtful analysis, according to critics.
To avoid those seeking favoritism and to get the designations made on time, Illinois, like most states, therefore used a formulaic approach to pick its allowable 327 zones from its 1,305 impoverished census zones. The formula was based on poverty, unemployment, number of children in poverty, violent crime and population. Each county was assured one zone and each town or city was limited to five, except Chicago.
Chicago, however, submitted its own list of requested zones. Since the number of zones it requested was less than its share based on other factors, its designations were accepted. The criteria used by Chicago is described in a new report by the Urban Institute just released.
Will it work here or will the concerns of program skeptics outlined above turn out correct?
I suppose only time will tell and I’m no real estate expert, but I sure suspect that many of our zones are in places developers have already targeted, or are adjacent thereto. Undoubtedly, however, a few successes will occur. They will be held up as supposed proof of the program’s overall success.
And the issue of moving to escape poverty and crime is particularly interesting respecting Chicago’s zones. Chicago’s population loss is mostly attributable to just that – African-Americans fleeing horrible neighborhoods for something better. Is place-based assistance right for them and will it work?
Finally, many Chicagoans would object even to the program’s notion of what “works.” Gentrification is the goal, but that’s precisely what many of the city’s community activists fiercely oppose.
If it’s any consolation, the cost of the program will be carried by the federal government, not the state, but good luck getting a clear understanding of what that cost will be. Congress initially projected a $1.6 billion cost over a decade, according to one report, but that was before the Treasury Department made the tax breaks even more generous in their guidelines. It will all depend on how long the program is left open.
Nothing above should be taken as criticism of developers or taxpayers who use the program. They will be doing what their government incented them to do and they have every right to minimize their tax bills. I expect they’ll do well.
But for other taxpayers and the poor, expect different results.
*Mark Glennon is founder of Wirepoints.
UPDATED 1/10/19 to add reference to a new Urban Institute report on the zones in Cook County and Chicago.