Opportunity Zones' Biggest Myths
America’s corporate tax rate is no longer the most controversial part of the Tax Cuts and Jobs Act of 2017. A then-little-known provision establishing tax incentives for investment in Opportunity Zones – legally designated, economically-distressed census tracts – has generated debate nationwide. Within many of the designated areas, the prospect of fresh capital has been greeted with enthusiasm. Opportunity Alabama CEO and Founder Alex Flachsbart, for example, attests that “this small part of a bipartisan tax act has done more in the last 15 months to mobilize investors and communities across the state than any other federal tax incentive in the last 15 years.”
Opponents of the legislation, however, argue that Opportunity Zones will benefit investors more than communities and pour fuel on to the flames of gentrification. To resolve some of this discrepancy between local excitement and national concern, let’s address some of the most common misconceptions about Opportunity Zones.
Misconception #1: Opportunity Zones benefit investors more than distressed communities.
Of course, investors will benefit from Opportunity Zones. The incentive is designed so that investors liquidate unrealized capital gains, moving their capital into investment funds created specifically for Opportunity Zone projects. The benefits are threefold: investors can potentially be granted immediate tax deferral for qualifying gains invested in Opportunity Zone funds; up to 15% of the original capital will remain tax-exempt indefinitely if left invested for at least seven years; and capital gains accruing from Opportunity Zones projects will be entirely tax-exempt if held for at least ten years. Clearly, this legislation offers investors a powerful incentive.
Yet there is great potential for communities to benefit as well. While government funding is contentious, over $6 trillion in unrealized capital gains lies untapped, and there is significant demand for investment capital throughout the country. The average poverty rate across the 8,762 Opportunity Zones is estimated to be nearly 31 percent, in contrast to a national average of 12 percent, and the unemployment rate of 14.4 percent is well above the 3.8 percent national average. Meanwhile, post-recession economic growth is concentrated in a small number of wealthy metro areas; five of these areas alone produced as many new businesses as the rest of the country combined from 2010 to 2014, according to the Economic Innovation Group. It is clear that without intervention, distressed communities are unlikely to realize the kind of economic development needed to reduce poverty – if they realize economic growth at all. That’s why Opportunity Zones were designed to be sizeable, commensurate with Main Street America’s need for capital. But more than this, they have been designed to empower the very communities that successive interventions have left behind.
Misconception #2: This incentive has been previously implemented.
The term “Opportunity Zone” may invoke the ghosts of development incentives past, such as Empowerment Zones, Renewal Communities, and Enterprise Communities. Opportunity Zones, however, differ significantly from prior incentives in terms of scope. In contrast to their sprawl, with 8,762 designations across 50 states, only 38 Empowerment Zones, 40 Renewal Communities, and 115 Enterprise Communities were ever authorized for investment. By expanding eligibility to an additional 8,000 communities, Opportunity Zone legislation wields a much greater potential for impact than previous efforts.
Additionally, previous incentives did not easily provide for passive investment. Introduced under the Omnibus Budget Reconciliation Act of 1993, theEmpowerment Zone, Enterprise Community, and Renewal Community initiatives primarily offered tax credits to businesses located in designated zones. Included among the incentives were a wage credit of up to $3,000 for each employee living and working in an Empowerment Zone, an increase of $20,000 in depreciation expensing limits, and the introduction of a tax-exempt bond for expansion projects. This had the effect of limiting capital investment to those willing to invest actively and be located in the area. Opportunity Zones, on the other hand, allow passive investment, expanding the pool of potential investors.
This era differs from decades past in the revolutionary way social impact is measured and analyzed. Data scientists are now able to identify and target more accurate measures of shared community prosperity and growth. The granularity and rigor with which social issues are now investigated make the challenge of achieving long-term, sustainable, systemic change all the more attainable.
Misconception #3: Opportunity Zones will accelerate gentrification.
Perhaps the most pervasive concern around Opportunity Zones is that they will accelerate gentrification. Although gentrification has brought new buildings, chic eateries, and tech-fueled economic growth to cities such as San Francisco, Portland, and Seattle, it has also ravaged existing communities. As a wealthier class colonizes revived spaces, crippling increases in rent push out hard-working residents who have lived in the area for decades.
Critics of Opportunity Zones are concerned that investors, incentivized by the high profits associated with gentrified economic development, will pour their capital into areas which have already experienced significant socioeconomic change. They fear that additional investment in these areas places low- and moderate-income residents at risk for displacement, hurting rather than helping Opportunity Zones’ intended beneficiaries and replicating the experiences of cities like San Francisco and Seattle. Furthermore, finite funding would be wasted on the communities most likely to see continued growth regardless. Based on these concerns, the Urban Institute conducted an analysis of investment flows and socioeconomic changes for all eligible Opportunity Zone tracts and compared them to eligible but non-designated areas. The results indicate that critics’ concerns have been disproportionate to the risk: fewer than 4 percent of designated Opportunity Zones show signs of substantial existing investment. This implies that low- and middle-income residents in the vast majority (96%) of Opportunity Zones are at little risk of displacement, and may actually be able to share in some of the economic benefits. Nonetheless, many stakeholders are still working proactively to manage gentrification risk.
The stakeholders involved in managing risk are both widespread and varied. The U.S. Impact Investing Alliance, Beeck Center for Social Impact + Innovation at Georgetown University, and Federal Reserve Bank of New York have partnered with other organizations to create an Opportunity Zone Framework that will help investors deploy capital in a manner that generates positive social outcomes. It also includes a reporting framework for measuring impact. Meanwhile, the Kinder Institute at Rice University notes that many cities are guiding Opportunity Zone investors towards projects that are less likely to facilitate gentrification, using strategic marketing and various incentives. Cities also wield power in the form of land and zoning permissions, but many stakeholders are working more proactively, mobilizing and collaborating community-wide to engage investors and direct capital to projects that will benefit areas holistically. Together, effective use of these tools will be able to minimize the gentrification risk.
Any opportunity for growth entails risk, and there will be mistakes along the way. Some investors will not act within the spirit of Opportunity Zone legislation. And for this, they will receive the ire of an informed media and the court of public opinion. Despite bad actors, this is not a race from the bottom. To cast Opportunity Zones in such a light does nothing to shift the status quo.
The stark reality is that without intervention, the current economic stagnation across much of America will continue to engender negative outcomes. Epidemic opioid addiction, decreasing life expectancy — for the first time since the first world war — and devastating poverty can all be expected to continue uninterrupted. At its heart, the Opportunity Zones provision is an attempt to address old problems in an innovative way, mobilizing a vast reservoir of unused capital for the social good. While some debate its merits, others in the most economically desolate tracts of the country are getting to work, collaborating across sectors in an unprecedented manner. Their eyes are fixed on the future, filled with hope.
This article is featured on Forbes here.