Big Questions Ahead for New Tax Incentive Targeting Poor Communities – Next City

Big Questions Ahead for New Tax Incentive Targeting Poor Communities

A map of census tracts eligible for investment under a new federal tax incentive program targeting low-income census tracts. The magenta tracts are considered low income and the blue are considered “low-income adjacent.” Adjacent tracts can make up up to 5 percent of the designated tracts. (Credit: Enterprise Community Partners)

Amid the scramble to protect community development programs whose funding has already been slashed by Trump Administration budgets and the impact of recent tax cuts, parts of the community development world are now also rushing to get to the table to help shape a new program that could offer a new source of capital for areas of high poverty.

Tucked into the recently passed tax bill, the Investing in Opportunity Act gives chief executives of every U.S. state and territory up to 120 days (starting from December 22, 2017) to designate low-income census tracts in their state as “Opportunity Zones”, eligible to receive badly needed investments. Low-income is defined as a poverty rate of at least 20 percent and median family income up to 80 percent of the area median income.

“So many people are wrestling with the tax bill’s implications for existing tax programs, this new program has gone relatively unnoticed,” says Rachel Reilly Carroll, associate director for impact investing at Enterprise Community Loan Fund.

As a sign of interest in the program no one expected to pass any time soon, around 800 attendees participated in a webinar Enterprise hosted about the program, its largest webinar attendance ever.

So far, at least one state, Missouri, has issued a request for proposals from county and municipal executives to nominate low-income census tracts to become an Opportunity Zone. Each state can choose up to 25 percent of its total low-income census tracts to designate.

If states don’t respond with a selection of census tracts to designate as opportunity zones, they are effectively opting out of the program. The designations will last for ten years.

Some elements of the Opportunity Zones may feel familiar. The Empowerment Zones program took effect under President Clinton, to much fanfare. Under that program, the Department of Housing and Urban Development designated high-poverty areas in six cities as empowerment zones, making them eligible for a range of benefits, like employment tax credits and complementary social service block grants meant for things like job training, business renovations, public safety initiatives, and other services. But the results were not good. About ten years after it was implemented, a Government Accountability Office review found that although improvements in poverty, unemployment, and economic growth had occurred in the empowerment zones, the office could not tie those changes to the empowerment zone designation.

The opportunity zones program is distinct from the empowerment program in a few ways. One key distinction is the designation process—it won’t be limited to a few cities. Instead, since state executives choose low-income census tracts in their states, the program has the potential to be much larger in geographic scope, and it can benefit rural areas as well as urban.

Another distinction is the type of benefit provided. Since it provided employment tax credits to businesses for locating in and hiring residents from within the target zone, the empowerment zone program drew criticism for subsidizing businesses that simply moved from one part of the city to another, instead of producing new jobs.

The Investing in Opportunity Act could still run into that same issue, but it’s less likely since the program doesn’t subsidize businesses directly for doing anything. Instead, it may draw criticism for a different reason — it’s primarily another tax cut for the already wealthy. The act allows investors to defer some of their taxes on capital gains in exchange for investing some of their accumulated wealth into the opportunity zones. Economic Innovation Group, the research and advocacy organization behind the act, estimates that, in the U.S., there are some $2.3 trillion in unrealized capital gains that investors would like to cash in on. The group’s idea was to create an incentive for those dollars to make a stop in low-income communities on the way back into investors’ bank accounts. It would be a big windfall to someone like Napster founder and early Facebook investor Sean Parker, who is a co-founder of the Economic Innovation Group.

Those wealthy investors, however, won’t necessarily be cherry-picking deals. Reminiscent of the federal new markets tax credit program, the Investing in Opportunity Act will set up a distributed decision-making system to determine the program’s pipeline of projects and businesses. While some consider its system to be too costly and cumbersome, the new markets tax credit program has shown better results than the empowerment zones program.

The Investing in Opportunity Act creates “Opportunity Funds,” special investment funds that will be certified by the U.S. Treasury, which will be required to invest at least 90 percent of their investment dollars into businesses or properties located in designated Opportunity Zones.

It is not yet clear whether any existing organizations will automatically qualify as Opportunity Funds. For example, the U.S. Treasury has already certified more than a thousand community development financial institutions, although that certification only requires 60 percent of an institution’s investments be made into low- or moderate- income census tracts. The U.S. Treasury also certifies community development entities which provide access to the new markets tax credit program.

Some advocates see it as a lost opportunity that the Investing in Opportunity Act did not automatically designate minority-depository institutions, which already have a track record of serving many low-income communities, as eligible to receive investment from the program.

It’s still unclear how many states will participate in the program, and how open the process will be to decide which low-income census tracts will get a designation. It’s also unclear whether designated census tracts will be able to absorb whatever new capital that might be made available to them. Another huge question is who will decide how the funds get invested. Finally, there’s no predicting how much money the program will actually raise. The Joint Committee on Taxation estimated the program would result in a cost of $1.6 billion in deferred tax revenues over ten years, indicating some expected uptake, but there’s no sure way to tell what amount of investment that would represent, since the program rewards investors on a sliding scale—the longer they leave their money invested in opportunity funds, the more in capital gains taxes they can avoid paying in the end. Opportunity funds could end up raising too much capital without enough deals in the designated census tracts, blunting the impact per tax dollar lost, or they could end up without enough capital raised to make a discernible difference.

At least one thing is certain. It will be very flexible capital, not just for housing but for broader uses like small business lending or economic development. “There’s room to create products with the potential to unlock new capital for the broader community development ecosystem,” Reilly Carroll says.

Oscar is editor of Next City. Before that, he was a Next City contributing writer and 2015-2016 Equitable Cities Fellow. Since 2011, Oscar has covered community development finance, community banking, impact investing, equitable and inclusive economies, affordable housing, fair housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha, and Fast Company.

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Tags: economic developmentpovertytaxescommunity development corporationsopportunity zones