By Jackie Bein
Congress recently announced a bill introducing reforms to the Opportunity Zones tax incentive program. The proposed changes include key provisions for expanding reporting requirements for participating projects, ensuring selected tracts are actually high-need areas, and providing better access for utilizing the incentive to finance small-scale projects in communities. If passed, these reforms will provide highly necessary improvements to the initial legislation.
Opportunity Zones were first implemented as part of the Tax Cuts and Jobs Act of 2017. The concept behind the bipartisan legislation, introduced by Senators Tim Scott and Cory Booker, had been formulated by the Economic Innovation Group, a public policy organization, as a way to address geographic disparities in investment as communities recovered from the Great Recession. The program seeks to catalyze development in underserved neighborhoods by granting investors significant tax breaks, including the ability to exclude capital gains from taxable income as long as they hold their Opportunity Zone investments for at least ten years. The policy was put in place with the idea that the federal government should have a smaller role in decision-making on the neighborhood level. One of the primary ways this program stands out from other federal housing and community development policies is that it encourages private investment rather than supporting development projects with direct subsidy or offering project-specific tax credits. It is also much less regulated than other Treasury programs like the New Market Tax Credit and Low Income Housing Tax Credit, in addition to delegating a significant amount of implementation authority up to state governments.
The concept of offering place-based tax incentives is not new. Previous programs such as Empowerment Zones and Enterprise Communities in 1993, Renewal Communities (since expired) and the New Market Tax Credit program in 2000 have utilized this approach with mixed results. For instance, Enterprise Zones were not found to have significantly contributed to increased employment opportunities. The programs were also thought to be overcomplicated and underutilized by developers as a result. However, limited data has been collected on these programs, so it has been difficult to measure their effectiveness. Researchers who have conducted preliminary evaluations of Opportunity Zones have also noted that the program could benefit from more rigorous and timely data collection to accurately report on program impact.
One of the distinctions between Opportunity Zones and its predecessors is that the policy aims to capture larger investment intermediary organizations and financial institutions. In contrast, the New Market Tax Credit has focused more on small businesses and funding smaller projects through locally-based organizations, such as CDFIs, which allowed a broader range of participants. A much smaller field of potential investors are eligible to participate in Opportunity Zones, as fewer institutions have the pre-existing capital gains to qualify to take advantage of Opportunity Zone tax breaks. Critics of the policy argue that this exacerbates the fact that Opportunity Zone investors tend to be distanced from and unfamiliar with the communities on the receiving end of their investments. Leveraging the significant investing power of banks, hedge funds, and private equity firms can be transformative for neighborhoods that have historically been left behind, but only if these investments are complemented by meaningful local engagement.
The Opportunity Zones program faced implementation challenges from its inception, beginning with difficulties in selecting which areas would be eligible for designation as Opportunity Zones. The legislation gave governors the power to decide which census tracts would attain this designation. However, states only had 90 days to select the tracts, which led to many rushed decisions rather than taking a more thoughtful, data-driven approach toward ensuring that selected areas would benefit from this kind of investment. Even the decision to utilize census tracts as the basis for delineating eligible regions was largely made out of convenience, despite the fact that the way census tracts measure information about poverty rates does not always accurately reflect neighborhood demographics. In addition to these issues, communities with large student populations had highly skewed data factoring into their designation as Opportunity Zones, which has also limited the ability to evaluate the effectiveness of the program. Moreover, as states were only able to select 25% of eligible tracts as Opportunity Zones, governors needed to consider a variety of factors beyond median income levels and previous development patterns when determining which areas would benefit most from Opportunity Zone investments. This challenge is emblematic of one of the primary tradeoffs created by the way the policy is structured. On one hand, states could designate the most distressed areas that need investment most. At the same time, areas that have already been experiencing gentrification and rising property values tend to be more profitable and desirable for investors, potentially generating greater overall development activity. There are also many qualifying areas in which developers may be interested in investing even in the absence of tax incentives. This tension continues to exist as stakeholders begin evaluating the success of Opportunity Zones.
The extent to which the Opportunity Zones program has brought about positive change for communities depends on what goals the program was purporting to achieve. For instance, Michel & Griffith (2019) argue that Opportunity Zones have not done much to address the underlying causes of poverty in distressed neighborhoods, but this is not necessarily what this policy had set out to do. Large amounts of new investment in areas that have otherwise been stagnant has the potential to bring about transformative change. Novogradac reported that as of February 2021, $15 billion has been invested into communities through Opportunity Zones, and these investments have continued steadily even throughout the pandemic. But while such developments might alter a neighborhood skyline, the Opportunity Zones program does not ensure that these investments will actually serve existing community residents. Preliminary evaluations of the program have underscored that the lack of oversight and reporting requirements has led to a dearth of detailed data describing the specific kinds of development that have been funded with Opportunity Zone investments. Few regulations mean that while capital may be pouring into a given area, it may be in the form of housing that is unaffordable to existing residents or commercial developments that do not create jobs that can be accessed by the community.
Furthermore, the structure of the program encourages investors (who are already primarily profit-driven) to generate the highest returns possible on development projects, which creates less of an incentive to develop affordable housing. There are few provisions in place to encourage the development of the types of projects that will actually serve people in the communities within the designated zones. Many of the smaller, mission-based groups that would typically pursue projects that generate below market-rate returns do not have sufficient capital to participate in Opportunity Zones. This does not mean the program model is ineffective; but it does raise concerns about residential and commercial displacement and the inability of original residents to be able to benefit from jobs being created locally. One way of mitigating this concern and better ensuring that Opportunity Zone investments are making a deeper community impact is to more formally involve CDFIs and other more local organizations that could help funnel the capital to where it is most needed.
One intention of the program’s design was that increased development activity within the designated Opportunity Zone tracts would make investors more willing to take on risk in neighboring areas that they would not have considered previously. This idea was bolstered by the 2018 provision that allows 30% of investments to be made outside of designated zones. Critics of the program argue that this is another way in which Opportunity Zones have primarily benefited investors more than they have actually contributed to broader place-based improvements and economic revitalization in communities that need it. Given the difficulties in designating Opportunity Zone tracts and the various loopholes that state governments and investors alike have used to take advantage of the tax breaks in more profitable areas, early research has shown that only a small share of subsidies have actually impacted the most distressed areas. Studies have shown that areas where home prices are appreciating at a higher than average rate (a sign of gentrification) were more likely to be selected than comparable census tracts that were also relatively low-income. Given this, there is an inherent danger of “crowding out” private investment that would have been likely to happen regardless of the opportunity to access tax breaks or other subsidies.
Another way the program can be evaluated is in the impact of investment on property values in designated neighborhoods. A 2019 study notes that if Opportunity Zones worked as intended, all properties in the area would see increases in price, not just the specific property being redeveloped. Their study revealed that only properties funded by Opportunity Zones have increased in price, which raises continued skepticism about the effectiveness of Opportunity Zones and place-based programs more generally. Also, the program has not been as successful from a business development standpoint, as most investments have involved developing vacant land rather than supporting existing local businesses. The program is better suited to real estate development than job creation. This is not necessarily a reflection of the program’s success or failure, but underscores the need for ensuring that Opportunity Zone investments accurately respond to the needs of individual neighborhoods.
One key aspect of the program, the 10-year minimum period that it takes for investors to be eligible for tax breaks, seems short, especially when compared to other subsidy programs, such as those that include 30- to 40- year affordability restrictions into their regulatory agreements. Although the structure of Opportunity Zones is different from other federal programs that subsidize investments directly, this reinforces the question of the extent to which Opportunity Zone investments will provide long-term benefits to neighborhoods. This is especially hard to track due to the lack of real time information about what kinds of investments are being made, which typically only becomes publicly available once properties are sold. The program has scant reporting requirements, which aligns with its creators’ intention to limit bureaucracy and federal involvement; however, this may lead to poor community outcomes. Moving forward, it will be critical to follow what happens to these investments once they reach their 10-year mark.
The tradeoffs inherent to the Opportunity Zones model have made it difficult to assess the extent to which the program has had a transformative impact on neighborhoods. Balancing the initial goal of limited government involvement and less bureaucracy often benefits investors more than the neighborhoods where development is occurring. Still, the tax breaks have encouraged financial institutions to activate a substantial amount of capital that would have otherwise remained passive. More collaboration with neighborhood-based organizations and some form of localized guidelines for developments will better allow Opportunity Zones to have a transformative impact on communities.
Jackie Bein is a second year Master of Urban Planning student at NYU Wagner. Her interests include affordable housing development, municipal finance, and civic tech.
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