The Impact Of Opportunity Zones: An Initial Assessment
The Impact of Opportunity Zones:An Initial AssessmentThe Council of Economic AdvisersAugust 2020September 29, 2017
Executive SummaryThe Tax Cuts and Jobs Act of 2017 not only cut taxes for businesses and individuals broadly butalso made targeted cuts to spur investment in economically distressed communitiesdesignated as Opportunity Zones (OZs). This report from the Council of Economic Advisers(CEA) compares the advantages of OZs with those of other Federal antipoverty programs anddocuments the characteristics of the nearly 8,800 low-income communities designated as OZs.It also quantifies the effect of OZs investment and finds that a large increase is alreadybenefiting OZ residents while potentially having only a small effect on the Federal budget.OZs chart a new course in Federal policy aimed at uplifting distressed communities.Antipoverty transfer programs subsidize the consumption of goods such as housing andhealthcare but can lead to reduced economic activity by raising taxes and discouragingeligible, working-age participants from seeking jobs. Also, under other existing place-baseddevelopment programs, the Federal government selects who receives grants or tax credits andnarrowly prescribes their use. By comparison, OZs cut taxes to increase economic activity byspurring private sector investment, job creation, and self-sufficiency. They also give greaterscope for market forces to guide entrepreneurs and investors because they have no cap onparticipation and require no government approval.The CEA finds that OZs, which are census tracts nominated by State governors and certified bythe U.S. Department of the Treasury to be eligible for the investment tax cuts, are among thepoorest communities in the United States. These communities have an average poverty ratemore than double that of all other communities and are home to a higher share of AfricanAmericans, Hispanics, and high school dropouts. Even among all the communities eligible tobe an OZ under Federal law, every State selected communities that, on average, had a medianhousehold income less than that of communities that were not selected.The CEA also finds that the OZ tax cuts have spurred a large investment response. This reportestimates that Qualified Opportunity Funds raised 75 billion in private capital by the end of2019, most of which would not have entered OZs without the incentive. This new capitalrepresents 21 percent of total annual investment in OZs and helps explain why the CEA alsofinds that private equity investment in OZ businesses grew 29 percent relative to thecomparison group of businesses in eligible communities that were not selected as OZs.The growth in investment has already made OZs more attractive to their residents, as reflectedin what buyers are willing to pay for homes located in the OZs. The CEA estimates thatOpportunity Zone designation alone has caused a 1.1 percent increase in housing values.Greater amenities and economic opportunity behind the housing value increase will be broadlyCEA The Impact of Opportunity Zones: An Initial Assessment1
enjoyed, and for the nearly half of OZ residents who own their homes, the increase provides anestimated 11 billion in new wealth.Regarding effects on the Federal budget, the CEA finds that each 1 raised by QualifiedOpportunity Funds through 2019 has a direct forgone Federal revenue effect of 15 cents. Bycomparison, each 1 in investment spurred by the New Markets Tax Credit, an existing Federalprogram with similar goals, results in 18 cents of forgone revenue. Including indirect effects,the CEA estimates that the OZ incentive could be revenue neutral, with economic growth inlow-income communities reducing transfer payments and offsetting forgone revenues fromtaxes on capital gains. Thus, the CEA projects that the capital already raised by QualifiedOpportunity Funds could lift 1 million people out of poverty and into self-sufficiency,decreasing poverty in OZs by 11 percent.The COVID-19 pandemic slowed investment everywhere in the second quarter of 2020,including in Opportunity Zones, but the initial evidence suggests that the OZ model has powerto mobilize investors; engage State, local, and tribal stakeholders; and improve the outlook forlow-income communities—all with limited prescription from the Federal Government. Thisreport’s findings highlight the potential for the Opportunity Zone model to help spur the postCOVID-19 recovery in thousands of distressed communities across the United States.CEA The Impact of Opportunity Zones: An Initial Assessment2
IntroductionOne of the main provisions of the Tax Cuts and Jobs Act, which was signed in December 2017,reduced U.S. corporate income tax rates to bring them in line with international levels.Lowering the corporate tax rate decreases the cost of capital, thereby stimulating investmentand growth in gross domestic product and wages (CEA 2017). The Opportunity Zones (OZs)provision of the act mirrored this effort to lower capital taxes but with a focus on distressedcommunities. By reducing taxes on the capital gains invested in such communities, theprovision lowers the cost of capital for businesses, which is expected to lead to newinvestment, jobs, and economic opportunity that has been lacking for decades. This CEA reportcompares the advantages of OZs relative to other Federal antipoverty programs, and itdocuments the characteristics of the nearly 8,800 low-income communities designated as OZs.The CEA also quantifies the effect of OZs on investment, finding a large increase that is alreadybenefiting residents while potentially having only a small effect on the Federal budget.To stimulate investment in OZs, the provision provides three potential tax benefits to investorsthat invest capital gains in Qualified Opportunity Funds, which are vehicles for investing inqualified OZ properties. The first benefit of investing in these funds is that the investor candefer paying taxes on capital gains rolled into OZs until potentially as late as 2026. Second,when these taxes are paid, the investor may omit 10 percent (15 percent) of the original gain ifthe investment is held there for at least five (seven) years.1 Finally, and most important, anycapital gains that accrue to investments in a Qualified Opportunity Fund are tax free if theinvestment is held for at least 10 years.Funds can make equity investments in partnerships or corporations that operate in OZs asdetermined by various tests, such as where they generate income or where their assets lie. AQualified Opportunity Fund can also directly purchase tangible property for use in the fund’strade or business, but the property must have its original use begin with the fund or the fundmust substantially improve the property. For example, a Qualified Opportunity Fund couldpurchase and install new solar panels in an OZ, or it could buy an apartment building andsubstantially improve it.Although the Federal tax incentive described here is at the core of OZs, all levels of governmenthave worked to complement this incentive. At the Federal level, on December 12, 2018,President Trump signed Executive Order 13853, which established the White HouseOpportunity and Revitalization Council.2 The order gave the council the mission of leadingBecause an investor must pay capital gains taxes on the original gain by 2026, the original option to pay taxes ononly 85 percent of the original has expired and would not apply to investments made in 2020. This is because theinvestments could not be held for the original seven years before having to pay the tax.2The council’s various efforts are highlighted on the interagency website OpportunityZones.gov.1CEA The Impact of Opportunity Zones: An Initial Assessment3
efforts across executive departments and agencies “to engage with State, local, and tribalgovernments to find ways to better use public funds to revitalize urban and economicallydistressed communities.” In its one-year report to the President, the council made 223recommendations to this end and, as of this CEA report’s publication, has taken more than 270related actions.Complementary efforts have also occurred at the State and local levels. For example, theAlabama Incentives Modernization Act provides additional State tax breaks for QualifiedOpportunity Funds, and the State of New Jersey has created an OZ website and data tool withresources for local governments, investors, and businesses. The city of Erie, Pennsylvania,along with local businesses and nonprofit leaders has created the Flagship Opportunity ZoneDevelopment Company to encourage investment in the city’s OZs. And the city of Clevelandhas taken a similar approach by creating the Opportunity CLE initiative to promote local OZinvestments.The CEA finds that OZs, which are census tracts selected by governors to be eligible for theinvestment tax cuts, are among the poorest communities in the United States. Thesecommunities have an average poverty rate that is more than double that of other communitiesand are home to a higher share of African Americans, Hispanics, and high school dropouts.Even among all the communities that were eligible to be an OZ under Federal law, every Stateselected communities that, on average, had a lower median household income than dideligible communities that were not selected.The CEA also finds that the OZ tax cuts have spurred a large investment response. The reportestimates that Qualified Opportunity Funds raised 75 billion in private capital by the end of2019, most of which would not have entered OZs without this incentive. This new capitalrepresents 21 percent of total annual investment in OZs and helps explain why the CEA alsofinds that private equity investment in OZ businesses grew 29 percent relative to eligiblecommunities that were not selected as OZs and thus act as a control group.This growth in investment has already made OZs more attractive to their residents as reflectedin the prices buyers are willing to pay for homes located in OZs. The CEA estimates that OZdesignation alone has caused a 1.1 percent increase in housing values. The greater amenitiesand economic opportunity behind this housing value increase will be broadly enjoyed, and forthe nearly half of OZ residents who own their homes, the increase provides an estimated 11billion in new wealth.Regarding effects on the Federal budget, the CEA finds that each 1 raised by QualifiedOpportunity Funds through 2019 has had a direct forgone Federal revenue effect of 15 cents.By comparison, each dollar in investment spurred by the New Markets Tax Credit, an existingCEA The Impact of Opportunity Zones: An Initial Assessment4
Federal program with similar goals, results in 18 cents in forgone revenue. Including indirecteffects, the CEA estimates that the Opportunity Zone incentive could be revenue neutral, witheconomic growth in low-income communities reducing transfer payments and offsettingforgone revenues from taxes on capital gains. Also, the CEA projects that the capital alreadyraised by Qualified Opportunity Funds could lift 1 million people out of poverty into selfsufficiency, decreasing poverty in OZs by 11 percent.Comparing Opportunity Zones with Other Antipoverty orPlace-Based ProgramsUnlike antipoverty transfer programs—which raise taxes and reduce the incentive for programrecipients to participate in productive economic activity—OZs lower taxes to stimulateeconomic activity in distressed areas. Relative to other place-based policies, the OZ incentivesare more open-ended and less top-down in their design, which makes OZs more effective atattracting investment to communities most in need.Antipoverty Transfer PoliciesAntipoverty transfer programs provide cash grants or subsidies for the consumption of goods.Notable examples are housing vouchers, food stamps, cash assistance for needy families, andMedicaid. Although these programs support many Americans in need, they can also weakenthe incentive for working-age adults to find employment. Because of eligibility requirementslinked to income, taking a job or working more hours can cause a participant to becomeineligible if his or her income exceeds a program’s threshold. Considerable evidence confirmsthat such programs typically discourage employment (e.g., Hoynes and Schanzenbach 2012;Jacob and Ludwig 2012; Bloom and Michalopoulos 2001).Antipoverty transfer programs also raise taxes to fund these transfers. Even if the transfers andassociated eligibility requirements did not discourage work, they would still come at a cost.Each 1 raised through taxes costs society more than 1 because of the positive marginal costof public funds. This cost captures the effect of a tax in driving a wedge between the marketvalue of what an extra hour of labor produces and the worker’s value of that hour (i.e., heropportunity cost). Given this tax wedge, each 1 in funds raised by taxes costs society anestimated 50 cents in forgone value (Dahlby 2008; CEA 2019).CEA The Impact of Opportunity Zones: An Initial Assessment5
The rules governing OZs do not create a disincentive to work because eligibility is based oncommunity-wide measures of poverty and income rather than those of any particularindividual. Nor does the OZ incentive have the same marginal cost of public funds associatedwith transfers funded by tax revenues. The incentive cuts taxes on capital supplied to lowincome communities, which reduces the tax wedge associated with the supply and demand forcapital. The forgone Federal revenue might be made up through higher taxes elsewhere, or itcould be offset by declines in government transfers because of rising incomes in poorneighborhoods, which is considered in a later section.OZs, nonetheless, are not a substitute for cash grants or subsidies. Not everyone can work, andmost people living in poverty do not live in OZs. To the extent that transfer programs haveappropriate work requirements for those who are able to work, OZs complement suchprograms by fostering job creation.OZs also complement the Earned Income Tax Credit (EITC), which is an antipoverty taxincentive. The EITC targets low-income workers, especially those with children, and is phasedout as a family’s income rises. Because the EITC is only provided to low-income families withearnings, it encourages people to enter the workforce. Empirical research confirms that theEITC increases workforce participation for single mothers, who benefit the most from the credit(Nichols and Rothstein 2015). In this sense, the EITC increases the supply of labor, while OZsstimulate demand for it.Federal Place-Based Policies: The New Markets Tax Credit ProgramThe Federal program most comparable to Opportunity Zones is the New Markets Tax Credit(NMTC), though OZs offer improvements over the NMTC program. Both use tax incentives toencourage private investment in low-income communities, but the total tax benefit availablethrough the NMTC program is capped, limiting how much investment it can spur.3 In most yearssince 2007, Congress has authorized the NMTC program to award tax credits to support about 3.5 billion in place-based investments. On average, these credits account for about half oftotal project costs, so the program supports roughly 7 billion in investment annually. As of2016, nearly 3,400 census tracts have received NMTC program credits since the program’sinception in the early 2000s (Tax Policy Center 2020).NMTCs are a limited allotment of tax credits that reduce investors’ Federal tax obligations. Tax credits differ fromtax deductions, which decrease the amount of income subject to being taxed.3CEA The Impact of Opportunity Zones: An Initial Assessment6
In addition to being smaller in scale than the OZ initiative, the NMTC program has a top-downapproach to distributing tax benefits. The U.S. Department of the Treasury administers theNMTC program through its Community Development Financial Institutions Fund (CDFI), whichultimately selects what applicants can receive tax credits. Community development entitiesmust first apply to the CDFI to be qualified for the program. Those that are qualified thenidentify investment opportunities and submit applications to compete for a limited pool ofcredits. In 2018, development entities requested 14.8 billion in NMTC funds, but only 3.5billion were available, and only about a third of all applicants received funding (Lowry andMarples 2019).Even for approved applicants, the NMTC program places greater restrictions on investors.Funds must remain invested and compliant with program requirements for seven years or elseforgo all their tax benefits (with interest and penalties). With OZs, funds can liquidate oneinvestment and roll the proceeds into a new one without penalty, though standard taxes applyto any capital gains. OZs are also flexible in other ways; investors can contribute funds up toany size, and they can pool their funds with any number of other investors (Vardell 2019;Bernstein and Hassett 2015).Many of the participants in the NMTC program are large financial intermediaries equipped tonavigate the CDFI’s application process and manage compliance risk (Vardell 2019; Hula andJordan 2018). To manage the risk, most NMTC transactions use a complex leverage model thatcombines debt and equity. According to Hula and Jordan (2018,23), the model requires “a teamof accountants and attorneys” with relevant expertise to structure the investment. By contrast,any investor with eligible capital gains can invest in a Qualified Opportunity Fund. These funds,in turn, need only self-certify their investments on their tax returns and follow the broadguidelines provided by the Department of the Treasury’s regulations.4Although the NMTC program is more prescriptive than OZs, it is more flexible than theeconomic development grants given by the CDFI Fund. Harger, Ross, and Stephens (2019) findthat the tax credits—but not the grants—increased the number of new businesses in lowincome communities. They attribute the difference in part to the greater flexibility of the taxcredit relative to the grants. At the same time, the authors found that even the NMTC programmay not have had much effect on local employment.4The final regulations are available at www.irs.gov/pub/irs-drop/td-9889.pdf.CEA The Impact of Opportunity Zones: An Initial Assessment7
Other Federal Place-Based Development ProgramsAlong with Opportunity Zones, in recent decades three other Federal programs have also reliedon tax policy to spur economic development in specific places: empowerment zones (EZs),enterprise communities (ECs), and renewal communities (RCs). EZs and ECs date to 1993, whileRCs were authorized in 2000. These programs extended a mix of tax benefits and grants tobusinesses in designated census tracts. These programs had a smaller geographic reach, withmany States having little or no participation in them. A key tax benefit among these programswas an employment tax credit of up to 3,000 on the wages paid to people who lived andworked in the designated tract. Other tax benefits included increased limits for expenseddeductions, tax-exempt bond financing, and exemptions from certain capital gains taxes (CRS2011). The EC and RC programs have both ended, and only the tax benefits associated with theEZ program continue. Early research on the effects of the programs showed little evidence ofsuccess, but more recent studies have documented beneficial effects on unemployment,wages, and poverty (CRS 2011; Ham et al. 2011; Busso, Gregory, and Kline 2013).The Federal Government also supports place-based economic development through grantprograms, with the largest being the Community Development Block Grant program. The U.S.Department of Housing and Urban Development (HUD) administers the program and providesabout 3 billion a year in block grants. The program’s structure makes rigorous evaluationdifficult, and few systematic evaluations have been do
CEA The Impact of Opportunity Zones: An Initial Assessment 5 Federal program with similar goals, results in 18 cents in forgone revenue. Including indirect effects, the CEA estimates that the Opportunity Zone incentive could be revenue neutral, with economic growth in low-inc
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