Menu
Tax Notes logo

Repeal Opportunity Zones

Posted on Oct. 26, 2020
[Editor's Note:

This article originally appeared in the October 26, 2020, issue of Tax Notes Federal.

]
Calvin H. Johnson
Calvin H. Johnson

Calvin H. Johnson holds the John T. Kipp Chair Emeritus in Corporate and Business Law at the University of Texas Law School. He thanks Theodos Brett and especially Alan Mallach for helpful contributions. Any remaining errors are his own.

In this article, Johnson argues that Opportunity Zone incentives do the poor more harm than good because they destroy affordable housing and increase tenant rents.

This article is part of the Shelf Project, a collaboration of tax professionals to propose and refine ideas to protect the tax base and raise revenue in ways that improve the fairness and efficiency of the tax system.

Copyright 2020 Calvin H. Johnson.
All rights reserved.

Opportunity Zone (known as “Ozone” by some of us) tax subsidies hurt poor people by driving up rents and reducing affordable housing. Affordable housing is torn down to make way for more expensive — often luxury — housing and for commercial structures built in response to incentives. Investors, even with Opportunity Zone tax subsidies, ordinarily want higher profits and commercial buildings and high-income housing provide higher profits than maintaining or building affordable housing.

Opportunity Zone investments drive out poor people by increasing rents. Opportunity Zone investments increase the value of real estate. The poor are usually renters, not landowners, and renters have no tenure and do not share in property value increases. Higher-value real estate is associated with the tract being more attractive to higher-paying tenants. In a process called gentrification, landlords increase rents and displace lower-income people. Low-income renters tend to be Black or brown minorities and the new tenants in gentrification tend to be white. Apparently plowing under a traditional minority neighborhood is sometimes the purpose of an Opportunity Zone, but overall the disparate impact is probably not large enough to prove deliberate targeting.1 In any event, higher property values are a detriment, not a benefit to low-income renters. There is no obligation to provide relocation housing to the low-income tenants displaced by the Opportunity Zone program.2

On the opening night of the Republican Convention, Sen. Tim Scott, R-S.C., claimed that Opportunity Zones were the “first new, major effort to tackle poverty in a generation.”3 That is an especially cynical claim. Tackling poverty is a good idea, but Opportunity Zones hurt rather than help the impoverished.

It is possible to have a program that does in fact “tackle poverty.” Qualified Opportunity Zone investments to which the tax subsidy attaches could be limited to investments in low-income housing. A qualified plan might be required to increase the supply of affordable housing — maybe double or triple it — and not decrease it. At the very least, the Opportunity Zone program should stop giving tax subsidies for the building of luxury apartments and pretty office buildings that displace low-income individuals.

The most efficient way to relieve poverty is to give the poor money. The indigent have many urgent needs, not only for housing, but also for food, clothing, medical expenses, work expenses, and children’s shoes and food. Poor people are better than any governmental agency or legislated rule at juggling what money they have to try and cover their most desperate needs every month.

Giving money to the indigent will increase the value of the dollar. The Little Match Girl, for instance, gets a near infinite value for an extra dollar because it will keep her from freezing tonight. Those with enough cash to cover the necessities get less value. At the top, Uncle Scrooge McDuck gets almost nothing from an extra dollar. For Uncle Scrooge McDuck an extra dollar just goes on top of his vaults’ swimming-pool-sized piles of dollars. Give the indigent money directly, not via some Rube Goldberg machine that gives money to other people, who do not pass it on to the poor and indeed hurt the poor (again). The indigent only get displacement from increases in Opportunity Zone property values, so for them, the rising fair market value of real estate is a detriment and not a figure to celebrate.

Pending a reform that gives the tax subsidy directly to the relief of poverty, repeal the Opportunity Zone provisions. Opportunity Zones violate the first rule of medicine — “first, do no harm” — because they do more harm than good to low-income renters. Stop the harm by stopping the Opportunity Zones program.

The tax benefits of Opportunity Zones initially flow to taxpayers that have capital gains from some source. The program’s provisions allow a deferral of tax on realized capital gain if the amount is invested in a certified Opportunity Zone. If the Opportunity Zone property is held for 10 years, the provisions make the gains derived from real estate development tax exempt.

Capital gain realization is top-heavy. A 2016 study showed half of all capital gain is realized by taxpayers with reported income above $1 million, and 77 percent of capital gain is realized by taxpayers with reported income exceeding $200,000.4 Almost all the investment goes into the purchase and development of real estate.5 The tax incentives increase the price of Opportunity Zone land so the tax benefits initially given to investors are shifted and shared in part with the existing owners of land within the Opportunity Zone who sell their property.

But the poor people in Opportunity Zones are rarely the property owners. They are renters who have no tenure and get no benefit from the increased value of the real estate. There are elderly homeowners who should be classified as poor even once the annualized value of owning a home and avoiding rent is taken into account. Still, those who have a big asset like a house are not the poorest of the poor. Indeed, those who get the most value from the increase in value in an Opportunity Zone are those who own the most real estate in the first place — and they are not poor in any sense of the word. Overall, the poor are renters and they are displaced, not helped by the increase in real estate values.

Qualified Opportunity Zone investments in practice are almost entirely investments in the purchase and development of real estate,6 but they could in theory be investments in the equities of businesses within an Opportunity Zone. In practice, only an estimated 4 percent of Opportunity Zone investment funds are committed to businesses.7 One should be skeptical about the benefit to poor people even within that insubstantial 4 percent. An Opportunity Zone outside of Reno, Nevada, for instance, is sparsely populated desert land, which already has a Tesla factory and Google data center on it.8 The tract is sparsely populated enough and the poor population a small enough fraction of the population that there are not many potential employees in the Opportunity Zone. Giving a subsidy to another plant or center would be unlikely to show up in poor people’s paychecks. The indigent will relocate for available jobs outside of Opportunity Zones. Given labor mobility, unless jobs created by an Opportunity Zone business investment are earmarked for poor people only (which they are not under current law), it is difficult to see what benefit they would get from a business within the Opportunity Zone. Even if Opportunity Zones created more jobs, the nearly trivial (4 percent) investment in business equities means that most Opportunity Zone investments are in real estate. As noted, the increase in property values hurts rather than helps poor tenants. The actual detriments to renters swamp the speculative benefits to poor people from investments in business equities.

There is some limited development of low- and moderate-income housing projects underway.9 Low-income housing is not typical, however. Investors with a profit motive put Opportunity Zone investments into higher-income housing and high-rise office buildings because the profit is greater than in the development of affordable housing. A sample of eight major projects in Washington, Opportunity Zones show lovely steel and glass office buildings, handsome co-ops, and high-rent apartments near a Metro station for an easy commute downtown.10

The building of luxury apartments with Opportunity Zone-subsidized investments is typical within the program — and some examples are appropriately called outrageous. For example, Census Tract 12099001700, in Miami-Fort Lauderdale-Palm Beach, lies on the shore next to the Rybovich superyacht marina. The tract was reportedly included in the Opportunity Zone program by former Florida Gov. Rick Scott at the “request” of Rybovich owner Wayne Huizenga Jr. Huizenga has said he plans to develop upmarket apartments on the shores of the marina.11 The shoreline area next to the marina now qualifies as an Opportunity Zone with median income under 80 percent of that in the Miami-Fort Lauderdale area. A picture of the superyacht marina, included in the press report, doesn’t look as though the upscale apartments to be built by the marina owner next to the yachts will be available to or give benefit to the poor, any more than the superyachts themselves are charity for the poor.

It is difficult to see how the displacement of poor renters by luxury projects helps the poor in other projects. Portland, Oregon, Census Tract 41051010600, in downtown Portland, for instance, is an Opportunity Zone with a high poverty rate. Half of the residents (48.4 percent) are poor. Yet, a Ritz-Carlton hotel and the most expensive condos that Portland has yet seen are under construction there.12 By the general rule of real estate value, “location, location, location, this tract has very valuable property — that is, as soon as the poor people get cleared out.

The White House Council of Economic Advisers boasts that the Opportunity Zone program has attracted $75 billion in investment in its first two years.13 That is a better measure of the harm that Opportunity Zones have done to poor people than it is of the benefits the poor receive — and the harm could get worse. Opportunity Zone investments are limited by the amount of capital gain realized in the year, but no other budget control is applied. Realized capital gain is at an estimated level of $123 billion per year14 or 3¼ times the current level of Opportunity Zone investments. Unless stopped, the Opportunity Zone program could grow to do 3¼ times more damage than it currently does.

Description of the Tax Benefit

The Opportunity Zone tax subsidy consists15 of a deferral of capital gain realized from some other source, and also permanent exclusions. The Opportunity Zone tax provisions first allow a deferral of realized capital gain tax if the amount equal to the capital gain is invested in an Opportunity Zone. The invested capital gain has a zero basis — it has not been taxed. Deferral ends at the earlier of the sale of the Opportunity Zone property or the end of 2026. If the taxpayer still owns the Opportunity Zone property on December 31, 2026, the taxpayer is treated as if they had sold the property for the lesser of the amount of the deferred capital gain or the FMV of the property on December 31, 2026.16

Opportunity Zones also allow permanent exclusion of the capital gain in part. If the investors hold the Opportunity Zone property for three years, their basis is increased by 10 percent of the deferred capital.17 The increase in basis means that that 10 percent is never taxable. If the investors hold the property for seven years, the basis is increased by another 5 percent, so that a total of 15 percent of the gain is never taxed.18

What is probably the most important benefit of the Opportunity Zone, but little noticed, is the complete exemption of development gain if the Opportunity Zone property is held for 10 years. The deferred capital gain realized before the Opportunity Zone investment will be fully taxed (or 20 percent excluded) at least by 2026. But gain from development of Opportunity Zone tracts is tax exempt if the Opportunity Zone investment is held for 10 years. Opportunity Zone investments gain by reason of the real estate developers developing the property within the Opportunity Zone with luxury housing or office buildings or by holding on to Opportunity Zone property as its market value rises because of other people’s improvements. The gain from developing property is ordinary income subject to tax at up to 37 percent. The permanent exclusion of that development gain both induces the taxpayer to hold on to the Opportunity Zone property for 10 years and is likely to be the most expensive part of the tax subsidy.

An area will qualify as a potential Opportunity Zone if the median income level is under 80 percent of the median income of the metropolitan region. For rural populations, the required average income level is 80 percent of the income of the entire state, not of the metropolitan area. This income limit typically allows an average income within an Opportunity Zone that is roughly twice the poverty level. Dallas, for example, has a median household income of $69,445 (2018) and 80 percent of the median is $55,336.19 The poverty line for a Texas family of four is $29,600 (2020),20 which is 53 percent of the level that makes a tract eligible as an Opportunity Zone. An Opportunity Zone does not have to have really poor people in it — but must have below-average income overall. An area will also qualify as a potential Opportunity Zone if 20 percent of its population falls below the poverty line.

The actual qualification of a tract of land as an Opportunity Zone occurs through its nomination by the state’s governor and certification by the Treasury secretary. A governor may nominate no more than 25 percent of the tracts in the state that qualify under the statutory rules (income below 80 percent of the average, or at least 20 percent of the tract population in poverty). Some contiguous areas can also qualify for Opportunity Zone designation, even though they do not meet the general requirements, but contiguous areas can make up no more than 5 percent of the nominations within the state.21

The Opportunity Zone program is a tax expenditure, that is, a subsidy administered through the tax system rather than by government spending. Budget controls on tax expenditures are weak — weaker than the pushback on the government spending cash. Indeed, many consider any tax reduction to be justified in and of itself, even though it has the same effect on the deficit and residual taxpayers as government spending. The lesser budgetary controls apparently explain why nobody asked about the damage that Opportunity Zones would do to low-income renters. Opportunity Zones provide a general lesson that government programs would be more responsible if run through the budget controls and political pushback of government spending. Do not spend money through the tax system. Spend government cash.

A truly cynical explanation for the Opportunity Zone program is that its favor is purely a result of its name. Everyone likes opportunity; who could oppose an Opportunity Zone? If Opportunity Zones were more accurately labeled as “Increase Rent on Poor People Zones,” “Ethnic Minority Displacement Zones,” or “Real Estate Developers Shouldn’t Ever Have to Pay a Dime of Tax Zones,” or even “Predator Zones,” proponents could not tout them in public, and it is doubtful the program would have had any traction.

Tinkering?

Michelle D. Layser of Illinois Law School has critiqued the Opportunity Zone program and recommends not the repeal of the program, but a revision under which councils of citizens currently residing in the Opportunity Zone would decide where Opportunity Zone money would go.22 The developer of the shores of the Rybovich superyacht marina might well not convince representatives of the old community that the luxury housing was worthy of an Opportunity Zone designation. At a minimum, they would have to be paid off with some development that actually helped renters.

Still, the faults of Opportunity Zones are too deep to be remedied so easily. Opportunity Zones reduce affordable housing because Opportunity Zone investors buy up properties, replacing affordable housing with higher-rent properties, and they increase the values of the properties and hence the rents that make the remaining housing unaffordable to poor renters. That would remain true even with a citizens group deciding which properties increase in value. Poor people are generally renters, not substantial property owners, and they get nothing but displacement from property value increases. Layser’s reforms would not put money in the hands of poor people directly. Citizen groups might increase business investment in Opportunity Zones above the current 4 percent level. But unless jobs are earmarked exclusively for poor people, the poor will not get the benefit.

Better Substantive Investment Focus

Opportunity Zones would be a better program if investors were not allowed to put their money into luxurious high-rises but instead were required to put it into affordable, low-income housing. Focusing on housing for the poorest of the poor would maximize the good that an Opportunity Zone investment would have, but also reduce the profits to be achieved by development. A second-best program would divert some investment away from low-income housing and allow investment in moderate-income housing. The diversion would reduce the focus of the program on the poorest of the poor where it is most needed, but if there were more beneficiaries, there would be greater political support.

Money Instead

In Capitalism and Freedom, economist Milton Friedman advocated giving a negative income tax to poor people under the principle of “consumer sovereignty.”23 A negative income tax puts money in the hands of poor people who know best how to juggle their money to meet the demands of food, employment expenses, children’s shoes, healthcare, and housing expenses. No central planning and no legislative principle can do as good a job in determining where the money would be best used to satisfy the most desperate needs.

A second-best solution would be to give the indigent vouchers that they could use to pay part of their rent. Housing vouchers would not pay the doctor’s bills, or car repair, or food for the children, when that is the more pressing need, but they would get money into the hands of the people who need it, in stark contrast with Opportunity Zones.

Just Repeal

Even if Congress is unwilling to enact negative income tax or housing vouchers, which would do the most to help tackle poverty, it needs to stop Opportunity Zones now. The first rule of the medical profession is “first, do no harm.” That rule can be generalized and applied to everything. Simple repeal of the Opportunity Zones would at least stop the harm they do.

FOOTNOTES

1 For an apparent intent to “plow under” a Black neighborhood, see Caleb Melby, “A Virginia City’s Playbook for Urban Renewal: Move Out the Poor,” Bloomberg Businessweek, Sept. 22, 2020; Alan Mallach, a senior fellow at the Center for Community Progress, looked at the 22 Opportunity Zones in Travis County, Texas, and concluded that minority population was higher in the certified Opportunity Zones but not by much, finding Opportunity Zones had median Latinx share of 51 percent, tracts that qualified as Opportunity Zones but were not designated as Opportunity Zones had 44 percent Latinx. County population as a whole was 34 percent Latinx. Black population of Opportunity Zones was 8 percent, which is the same as the 8 percent for the country as a whole. Email of Mallach to author (Sept. 27, 2020).

2 The Uniform Relocation Assistance and Real Property Acquisition Policies Act (42 U.S.C. section 4622 (a)) gives some assistance to persons displaced by the acquisition of real property “for a program or project undertaken by a federal agency.” Presumably, the Relocation Assistance Act does not apply because Opportunity Zone acquirers are private taxpayers and not a federal agency, but there has been no court ruling that Opportunity Zones or their tax subsidy predecessors are included in or excluded from the act. See Uniform Relocation Assistance and Real Property Acquisition Policies Act of 1970 (42 U.S.C. sections 4601-4655), 33 A.L.R. Fed. 9 (1977 with current supplements).

3 Elaine Melanie Mason, “Tim Scott Offers His Personal Story at RNC as Counterpoint to Democrats’ Agenda,” The Los Angeles Times, Aug. 24, 2020.

4 Congressional Budget Office and Joint Committee on Taxation, “The Distribution of Asset Holdings and Capital Gains,” at 32 (Aug. 2016) (49 percent of capital gain realized by income group with more than $1 million income, 13 percent by income group of $500,001 to $1 million, and 15 percent by income group $200,001 to $500,000).

5 Brett Theodos et al., “An Early Assessment of Opportunity Zones for Equitable Development Projects,” at 61-62 (June 17, 2020) (Urban Institute Research Report). See also Alan Sage, Mike Langen, and Alex Van de Minne, “Where Is the Opportunity in Opportunity Zones? Early Indicators of the Opportunity Zone Program’s Impact on Commercial Property Prices,” at 2 (May 1, 2019) (finding benefits are going to owners of vacant land and tear-down depreciated property within the Opportunity Zones).

6 See Theodos et al., supra note 5; see Sage, Langen, and Van de Minne, supra note 5.

7 Id.

8 Census Tract 32029970200 is the home of a Tesla gigafactory, Switch Citadel data center campus, and a Google data facility, but not many people. It has a population of 4,000 and a poverty rate of 7.5 percent (below the required 20 percent) or 300 households in poverty. The designation reportedly came at the request of former junk bond king Michael Milken, who has development interests in the area. Dees Stribling, “A Yacht Club, Michael Milken and Tesla: Meet 10 of the Nation’s Swankiest Opportunity Zones,” Bisnow, Aug. 24, 2020.

9 As of November 2019 the National Housing and Rehabilitation Association has announced three Opportunity Zone projects for the development of low- and moderate-income housing. NH&RA, “NCSHA, EIG Publish Three Case Studies on Affordable Housing in Opportunity Zones” (Nov. 20, 2019).

10 Jon Banister, “8 Major Projects Planned in D.C.’s Opportunity Zones,” Bisnow, Apr. 19, 2019.

11 Stribling, supra note 8.

12 Id.

13 Council of Economic Advisers, “The Impact of Opportunity Zones: An Initial Assessment,” at 4 (Aug. 2020).

14 CBO and JCT, supra note 4, at 1.

15 A clear description of the Opportunity Zone tax rules with hypothetical numbers is found at JCT, “Qualified Opportunity Zones: An Overview,” at 11 (June 2019).

16 Section 1400z-2(b)(2)(A)(ii).

17 Section 1400Z-2(b)(2)(B)(iii).

18 Section 1400Z-2(b)(2)(B)(iv).

19 Department of Numbers, “Low Inflation Means Real Income Growth” (Jan. 19, 2016).

20 Department of Health and Human Services, “U.S. Federal Poverty Guidelines Used to Determine Financial Eligibility for Certain Federal Programs,” 2020 Poverty Guidelines (Jan. 21, 2020). Poverty line is 53 percent of the $55,555 median income that qualifies an Opportunity Zone.

21 Section 1400Z-1(e)(2).

23 Friedman, Capitalism and Freedom: Fortieth Anniversary Edition 192-194 (2002).

END FOOTNOTES

Copy RID