Two years ago, the U.S. Treasury Department debuted the framework for the Opportunity Zone — a tax-overhaul program created to incentivize investment in the nation’s poorest urban, suburban and rural communities. But the very people and communities it set out to help have not benefited from the program because of deficiencies in the way it is structured.
The program was designed to incentivize wealthy Americans to invest capital gains in nearly 9,000 “economically distressed” communities across the country. Those funds were to be deployed to foster job creation and small business development, as well as expand affordable-housing stock. In return for their investment in an OZ project for at least 10 years, investors obtain a tax break.
While this sounds pragmatic in theory, this economic theory is not foolproof. The program clearly outlines the tax incentives for investors, but the guidelines for dispersing these funds are inconsistent and often miss the mark. Currently, the bulk of the $10 billion that has been invested in the program has not benefitted local business owners or community development. Instead, the funds are being funneled to large real estate infrastructures.
Temporary jobs and gentrification
The tax incentive requires a 10-year investment term, and taxpayers must have unrealized capital gains. As a result, the investors typically tend to be multimillionaires and billionaires. These investors are understandably seeking a quality return on investment ratio. Using this basic theory of market-rate return expectations, large-scale property development is most desired. Affordable housing and small business ventures typically will provide returns between 3% and 8%, but investors have expectations exceeding 12% for their returns on investment. In some communities, the program is only creating temporary jobs and accelerating gentrification.
This investment incentive is set to expire in four months. As a result, there will be bipartisan pressure to extend the program. Federal lawmakers have an opportunity to reshape the program and assist communities’ economic recovery in the way it originally sought to. The imperative to restructure the program is even more pressing now than when it was introduced. Hundreds of thousands of U.S. businesses are on the brink of closing because of hardships related to the coronavirus and shutdowns it induced. Lower-income communities and businesses are disproportionately being affected both by the virus and its economic toll.
Scaling tax incentives to local impact
Let’s not squander this opportunity to retool the regulations for qualified projects and require terms that make a meaningful impact on struggling communities. It is vital for these projects to be based on social impact first. To accomplish this, restrictions on terms and investment portfolios must be created and defined. The tax incentive should be correlated with an investment’s local impact. The greatest tax incentives for the fewest years of investment should be received by the following projects: investments in affordable or workforce housing; investments in existing neighborhood small businesses; investments that lead to permanent job creation; investments that lead to new business ventures that create socially progressive opportunities, such as trades schools, address food deserts, create discounted retail and so on. The increased tax incentives will offset some of the market-rate returns that investors are seeking.
Additionally, terms and conditions need to be accurately defined and outlined to eliminate the current ambiguity. Issues in the current verbiage allow for investors to exploit the rules and create tax havens rather than community investment tools. For example, lawmakers should propose changing the terms around investing in an “active business.” The current description allows investors to set up investments in ways that meet the criteria, yet do not benefit the community. This loosely worded term needs to be addressed to define local hiring, business partnerships and community sponsorships. An active business cannot be one that is merely registered to a certain geographical location for tax purposes but does not have any meaningful effect on the local community.
The extension of the opportunity-zone program is an opportunity for policymakers to make positive changes. Implementing new regulations and tiered tax incentives will help investors and struggling communities realize benefits. These changes might reduce some investor interest, but they will eliminate those who are only seeking tax havens. Just as a rising tide lifts all boats, delivering real change to struggling communities will exponentially help those communities because of the trickle-down effect.