CENSUS TRACT three in Cumberland County, Maine covers part of the city of Portland, named America’s top food destination by Bon Appétit magazine. Its dock is the landing spot for an expected 200,000 tourists this year. Yet Census Tract Three has also been designated as an opportunity zone, America’s favourite new policy for increasing investment in poor places.
These zones are part of last year’s tax cut. The policy tempts investors to put their money into poor areas with generous tax incentives. It allows investors to defer tax on any unrealised capital gains they reinvest in the zones. If the resulting investment is held for seven years, 15% of that original capital-gains liability is written off. And if the investment is held for more than ten years, any associated capital gains tax due on gains during that decade is waived. The scope of the policy, as well as its cost in foregone tax revenue, is vast: nearly 35m Americans live in places designated as opportunity zones.
Investors are salivating. On November 10th Anthony Scaramucci, President Donald Trump’s one-time adviser, announced he would be starting a real-estate fund to invest in the zones. Boosters point to the trillions of dollars of unrealised capital gains ready to be unlocked, and Steven Mnuchin, the treasury secretary, has speculated that as much as $100bn could flow in to the 8,761 zones. The Joint Committee on Taxation has estimated that it will cost $1.6bn over their ten-year forecasting window. But as the scheme is uncapped, the final amount could be much larger than that.
Plenty of policy wonks like place-based policies in theory, because they worry that poor parts of America now find it harder and harder to catch up with rich ones. In theory, geographically targeted tax cuts or subsidies could encourage new clusters of economic activity to form, thereby lifting depressed places.
But getting good results, or good evidence, is not so straightforward. Earlier place-based policies have been difficult to evaluate, in part because some were tried in areas that would probably have recovered without them. They also have tended to be multi-pronged, making it difficult to know what precisely has generated any success. In 1994 Congress created a number of Empowerment Zones, offering both grants and tax breaks for employers, in places with high poverty or which had suffered a lot of emigration. This appears to have raised employment and wages in these places. More recently, the New Markets Tax Credit has handed tax credits to investors in certain areas. One study published in 2012 found the scheme raised employment and lowered poverty a bit in the affected places. Vetting was stringent: only 16% of applications for the credit between 2003 and 2017 were successful.
The other evidence is mixed. Enterprise Zones in Britain and France, for example, offered tax breaks to businesses operating in certain areas and appear to have raised employment, but at the expense of areas nearby. The European Union doles out “structural funds” for investment in poorer regions, which seem to raise local output and employment, but there are questions over how lasting their effects are. In America state and local governments compete with each other to attract business by offering packages of tax cuts, and it seems that successful bids do deliver benefits to the local community. But there is little evidence to suggest that this is much more than a zero-sum game between places.
Opportunity zones differ from these earlier attempts, in that they come with very few conditions. Investors will be free of any kind of approval process. There are some restrictions on what counts as a qualifying investment. Golf courses and massage parlours are out. Real-estate developers must make “substantial improvement” to a property within 30 months of buying it, equivalent to doubling the value of any pre-existing buildings. The law is not supposed to be for investment in mega-corporations either. To qualify, companies that receive investment must have at least 50% of their activity and 70% of their physical capital in a zone. But relative to comparable schemes there are very few strings attached.
One concern is that investors will pocket tax rewards for investments that they would have made anyway. The benefit to locals may not be worth the cost of the forgone federal tax revenue, which could otherwise be used for different things. Then there is the matter of creating a new, open-ended tax break for investors, who are usually the wealthiest Americans.
The Maine chance
Portland’s Census Tract Three, and other places like it, offer a warning. Ideally tax credits would do the most good in areas that were not showing signs of revival on their own. A study by Hilary Gelfond and Adam Looney of the Brookings Institution, a think-tank, found that 89% of selected opportunity zones do have poverty rates higher than the national average. But when selecting census tracts to be opportunity zones, most states picked places that were more likely to show signs of gentrification than eligible ones that were passed over. In such cases, it seems right to ask how much investment taking advantage of the tax break might have happened anyway.
Doug Ray, who helped Maine’s governor, Paul LePage, to draw up that state’s list of places, explains that to be picked as one of the opportunity zones, it helped to have sites ready for investment, as well as an adequate supply of workers and housing. “A lot of areas that are eligible are where investors would not probably want to put money,” he says.
Perhaps the most worrying element of the policy is that it will be fiendishly difficult ever to know whether it has succeeded or has just been a gigantic waste of money. So far it is unclear whether the government will track how opportunity-zone funds are used. If state and local governments simply use them to turbocharge existing development policies, or are forced to harness the incoming investment by offering even more tax incentives, then isolating their impact will be even harder.
The scheme is still in its infancy. The first batch of Treasury regulations was released on October 19th, and another is due later this year. John Lettieri of the Economic Innovation Group, a think-tank and advocate of the zones, says that “there’s a failure of imagination about what this could be if it’s done well.” For the moment, though, scepticism is in order.