Opportunity Zones: Will this time be different?

Harvard’s Ed Glaeser, writing in City Journal in 2007, ruffled an entire city’s feathers by asking if public investment in Buffalo’s revival was ill-conceived. Noting the loss of 55 percent of its population and a median income 60 percent below the national average, Glaeser concluded:

“Buffalo’s collapse … seems to cry out for a policy response. Couldn’t Senators Hillary Clinton and Charles Schumer use their influence on Capitol Hill to bring some needed relief? The truth is, the federal government has already spent vast sums of taxpayer money over the past half-century to revitalize Buffalo, only to watch the city continue to decay. Future federal spending that tries to revive the city will likely prove equally futile.” (emphasis added)

After more than a decade—and Gov. Andrew Cuomo’s Buffalo Billion—have passed, Buffalo’s economy looks much the same. Construction spurred by the Billion and Bills owners Terry and Kim Pegula has spruced up the center city—yet job growth since 2010 places Buffalo No. 93 out of the 100 largest U.S. metros. The rest of upstate has fared no better.

Glaeser’s article is part of a longstanding conversation about economic development dubbed the “people vs. place” controversy. Every metro area contains neighborhoods of persistent poverty—the South Bronx in New York City, Watts in Los Angeles, the Crescent in Rochester. Policymakers ask a logical question: How can we grow jobs in these chronically depressed areas?

Tax Cuts and Jobs Act: Opportunity Zones

The latest program to target troubled geographies is the federal Opportunity Zones program. A little-known component of the Tax Cuts and Jobs Act that passed Congress last year, it provides investment incentives for the nation’s distressed communities. Each state can designate up to 25 percent of its eligible census tracts to be Opportunity Zones. A tract qualifies if the poverty rate is at least 20 percent and the median household income does not exceed 80 percent of the greater of metropolitan or state median household income.

The benefits of investing in an opportunity zone are considerable. As summarized by the Council of Development Finance Agencies:

Opportunity Zones are eligible to receive investments from Qualified Opportunity Funds, which are investment vehicles that deploy capital into opportunity zones. Opportunity Funds are required to hold at least 90 percent of their assets in Opportunity Zones, and can invest equity into businesses or real estate projects located in Opportunity Zones. … The capital gains invested in a Qualified Opportunity Fund are eligible for partial tax forgiveness if the investment is held in a Qualified Opportunity Fund for at least five years. After five years, only 90 percent of the original gain is taxed. If the investment is held for seven years, only 85 percent of the original gain is taxed. If an investment in a Qualified Opportunity Fund is held for 10 years, any tax on the appreciation of that investment is forgiven.

New York has designated its Opportunity Zones. See maps by region here. Thirty-one census tracts in the Finger Lakes region are eligible (note that the “suggested” tracts have now been approved as “final”). The Monroe County map is pictured (with one zone in Webster off the map).

What did we learn from the Empire Zones?

Will the program work? The history of place-based economic development is not particularly encouraging. Arguably the worst recent example was New York’s Empire Zones program. Originally aimed at distressed communities when created in 1986, the program failed to attract much interest and was substantially revised in 2000.

The revised program loosened eligibility criteria, opening the door to widespread abuse. By 2006 it was clear that the program was little more than a windfall for firms savvy enough to take advantage of it generous benefits: “Another pork barrel scam,” declared the New York Times. Tenacious reporting by the Syracuse Post-Standard yielded a series of reports that shone a bright light into some very dark corners. In 2008 the Post-Standard called the program “a $550 million juggernaut with enough loopholes to allow companies to maneuver around its main mission: Creating jobs.” By 2017, the Post-Standard estimated that the total cost of the program would exceed $3 billion.

Some particularly egregious “investments” stand out. One-fifth of the city of Geneva residents are in poverty. Accordingly, the city was awarded an Empire Zone. Yet its largest tax credit—some $22 million—was granted to “Great Eastern Mall L.P.” Where’s that? Turns out that the listed address is that of Victor’s high-end Eastview Mall.

Perfectly legal, the revised eligibility rules allowed zones to designate noncontiguous geography for benefits. A number of law firms—more than 70, by the Post-Standard’s count—took advantage of the program for themselves, having become smart about the rules on behalf of clients. Between them, Bond Schoeneck & King and Harris Beach earned over $2 million in credits in 2005.

The program was designed to favor “new” firms—but didn’t prevent firms from reorganizing under a new name and claiming benefits. Destiny USA in Syracuse pulled down $113 million in credits after applying as a “new business entity” in 2002. The mall was built in 1990 as the Carousel Center Mall.

The Empire Zones program is an outlier, to be sure. Roundly criticized by nearly everyone (except the recipients!), I am not predicting comparable failure for Opportunity Zones.

The challenge of “place-based” economic development incentives

All “place-based” economic development programs confront the same problem: The decision of business owners to avoid distressed communities is not driven solely by prejudice, although racism and classism may contribute. Cost factors like security for property and staff, access to suppliers, and quality of work life for staff play a role. Economic development programs must offer a powerful inducement if the goal is to bring about substantial change in business location decisions.

The business community, always quick to point out tax differences and lobby for reductions, can lead policymakers to believe that tax policy can be a powerful force. Consider a simple example, however: The total tax bill of a business may be 2 percent or less of total receipts, although this varies widely by business type and jurisdiction.

If labor cost is 40 percent of the total, the complete elimination of the tax bill is equivalent to a 5 percent swing in labor cost. In this context, a public program that cuts the tax bill in half but makes it ever-so-slightly harder to recruit workers is a poor bargain. The differential is even greater in service businesses where the cost of labor can be 75 percent or more of total receipts.

Moreover, as New York lawmakers learned with the Empire Zone program, the beneficiaries of incentive programs are often the well-heeled and well-connected investors and developers, not the individuals actually living in the targeted geography. True, program benefits can be regulated to require that benefits flow to people in need, but that adds a layer of bureaucracy that will reduce program take up.

We can be confident that the states will designate the least distressed of its qualifying census tracts for Opportunity Zone status. Is it surprising, for example, that Amazon’s new “HQ2½” in Queens is located in an Opportunity Zone?

Finally, we forget that people are mobile. A very successful economic revival in a locality can spur the displacement of the target population. A reduction in the share of poverty in a census tract might simply mean that the people in poverty have moved elsewhere.

Are Opportunity Zones different?

The Opportunity Zone program relies on a different source of funding than a tax break for participating businesses. The incentive here is the forgiveness of capital gains earned on other investments. For some investors, this tax forgiveness will be very sizable. While the incentive could be larger than the more conventional tax forgiveness scheme (thus more powerful), this also suggests that our ability to balance the incentive offered to the benefit received will be limited.

In summary, tax incentives are often too small to be effective at all. When they are employed, they can be poorly targeted, reducing the tax liability of the prosperous while conferring little benefit on people in need. The lost tax revenue must be made up by other taxpayers or cut from worthy programs.

Gentrification is a common outcome of “successful” programs. If the goal of the program is to help people, not firms or groups of buildings (and their owners), then people-based programs are a more effective use of public funds.