Since the Investing in Opportunity Act became law in December 2017, anticipation has been building around this new private equity tax incentive. Opportunity zones are showcased as a vehicle through which capital gains would be reintroduced into the economy before they are realized by directing them towards underdeveloped neighborhoods across the U.S.
We think that the best way to understand opportunity zones is by seeing them as the latest iteration of a decades-long effort to perfect a market-led solution for distressed communities. This article reviews four similar tax-deferment programs from the past―enterprise communities (EC), empowerment zones (EZ), renewal communities (RC) and New Market Tax Credit (NMTC)―and the lessons the new program can learn from their experience.
Know Your Tax-Abatement History: Before OZs, There Were ECs, EZs, RCs and NMTC
Enterprise communities and empowerment zones were inspired by the success of Hong Kong in the 1960s and 1970s. The ideas were spearheaded by British planner Peter Hall and Conservative politician Geoffrey Howe as a means to pump new blood into run-down areas, by freeing them from regulation and offering tax incentives to private capital. An early effort by Ronald Reagan to pass EZ legislation was blocked by Congress, and it was only a decade later, in December 1994, that Bill Clinton finally announced the designation of 104 EZs and ECs as part of the Omnibus Budget Reconciliation Act. The initial list included Atlanta, Chicago, New York, Cleveland, Baltimore, Detroit, Philadelphia-Camden, and Los Angeles. Three years later, fifteen more urban areas were added. In 2000, the Community Renewal Tax Relief Act highlighted 40 new RCs that would be subject to a similar initiative, while also kickstarting the first NMTC allocation round.
How Did These Precursors Of Opportunity Zones Incentivize Investors?
According to an overview made by the EIG, empowerment zones offered businesses a 20% credit on their first $15,000 paid in wages to employees hired from within the community, or who conduct most of their work within the area. In the case of RCs, investors gained a 15% credit applied on the first $10,000 paid in wages.
EZs could also benefit from facility bonds, with state and local governments able to issue loans to finance certain property types. For EZs in cities with under 100,000 residents, bond proceeds of up to $130 million could be put forward, while larger urban areas could get as much as $230 million. Capital gains on sold assets could be postponed if a replacement asset was purchased within a 60-day period. Furthermore, both EZs and RCs allowed qualified businesses to deduct an extra $35,000 on top of their annual deductible limit in the year an asset was placed in service.
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Investments in businesses located within renewal communities between 2001-2010 and held for more than 5 years were exempt from capital gains tax. New construction or renovation loans for properties within RCs that were issued through approved agencies could either be deducted―half of the expenses for the year in which was completed―or fully-amortized over a 10-year period.
With New Market Tax Credits investors received a 39% credit against federal tax liabilities, in exchange for financing, investments or even counselling to distressed areas. Investments had to be held for seven years, and the total tax credit was awarded incrementally: five percent annually for the first three years and six percent for each of the following four years. The Local Initiative Support Corporation (LISC) reported that $31 billion has been invested in the program since 2000, helping small businesses and manufacturers, charter schools, health and childcare centers.
Can Opportunity Zones Revitalize Distressed Communities Across the US?
When talking about the transformative potential of opportunity zones for distressed communities, it’s also important to be realistic about the range and scope of private sector investments. A look at a list of 72 existing Opportunity Zone Funds reveals that real estate development projects―most of them residential or multifamily―are the most common investment focus area, with only nine funds so far aiming to create businesses in struggling areas and only one OZF partnering with public agencies and officials on key transit-oriented development projects.
A good way to gauge the possible effectiveness of the OZ program is to look at some of the shortcomings revealed by previous tax-abatement programs and whether the new law addresses these. In 2013, an Urban Institute evaluation of NMTC projects drew attention to the fact that while investors said that 64% of projects would not have taken place without this tax-incentive, only half of them considered NMTCs to be the deciding factor in their investment.
Cited as examples of successful empowerment zones, Philadelphia and Baltimore still had a poverty rate of 44% and 36%, respectively in 2000. Unemployment levels also remained high: 19% in Philadelphia and 17% in Baltimore.
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One point that sets opportunity zones apart from these previous efforts―according to its proponents―is that it strives to harness the financial power of banks, venture capitalists, mutual funds and hedge funds, rather than relying on incentivizing small businesses or private investors that are unlikely to bring the large-scale investment necessary to change a community’s fortunes. The new program would also be used in combination with other tax deductions, something the NMTC for instance, could not do. And, of course, because it is not dependent on federal contributions to supplement the investment effort, less time will be spent navigating through the bureaucratic process.
Ultimately, the benefit of opportunity zones depends on their ability to work together with local authorities and community leaders to drive investment towards projects the area really needs, supplementing private capital’s contribution with strategic infrastructure expansion and upgrades.
