By Tad McGalliard and Ashley Badesch
PM Magazine, January/February 2019
When talking about the local economic ecosystems of the future, Ed Cohen-Rosenthal, an advocate for environmental issues, used to say: “After 40 years I finally understand chemistry, it’s all about bonds broken and bonds made.”
He was guided by a model suggesting that the role of government in economic development, particularly in distressed communities, is to create the appropriate chemistry of policy and programmatic bonds that can lead to good jobs, sustainable economic activity, and more livable communities.
Taking his cue from urbanist Jane Jacobs, Cohen-Rosenthal described communities, cities, and regions as the “nexus” of opportunity, with the prerequisites of market access, transportation nodes, infrastructure, raw materials, financing, and labor. When those elements come together as a refined package, competitive advantages can be realized. (1)
Unfortunately, many communities do not possess the necessary bonds and preconditions for economic and workforce development success. The reasons are too numerous to detail, and each community, city, or region can point to a variety of factors that has led to its stagnation.
In most places, whether prosperous or in need of revitalization, economic development is often a top priority. In fact, in survey after survey, ICMA members indicate that economic development is at the pinnacle of priorities of the governmental enterprise that they oversee.
In 2017, new federal legislation created another tool, fueled by tax incentives, for local economic development—the Opportunity Zones program.
Tax Policy and Economic Development
Tax policies are a sizable bucket of tools that local governments often use to retain existing enterprises and to attract new investments. Tax abatements, tax exemptions, and tax-increment financing are common strategies alongside such other approaches as tax credits, deferrals, stabilization strategies, and even accelerated depreciation of fixed assets, including equipment.
And while economic development is primarily a state and local issue, the federal government has played a key role in supporting local economic development activities for nearly four decades.
Starting in the 1980s, federal agencies began to examine a variety of market-based programs that leveraged tax strategies to advance growth and prosperity in economically challenged or distressed communities. The enterprise zone concept began in Great Britain as a strategy to reverse decades of high poverty rates and unemployment.
The Local Government, Planning and Land Act 1980 and the Finance Act 1980 ushered in the first wave of enterprise zones that featured property tax exemptions, deductions of corporate and income taxes, reductions in administrative requirements, and other fiscal and policy benefits for investors in areas that had undergone significant decline in economic activity.
Inspired by the model in the United Kingdom, President Ronald Reagan pushed for market-based, national-level, enterprise zone legislation in the United States. Those efforts proved unsuccessful at the federal level as Congress defeated a sequence of bills during his presidency.
Within a few years, however, many state governments began to pass their own legislation to designate locations, incentives, and guidelines for enterprise zones within their boundaries. By the 1990s, at least 40 states had passed some version of enterprise zone legislation.
In the aftermath of the Los Angeles riots in 1992, and recognizing the ongoing decline of major urban areas, President Bill Clinton signed into law the Omnibus Budget Reconciliation Act of 1993, which created the Empowerment Zone/Enterprise Community program. It provided tax incentives and credits for businesses that would expand their operations in certain designated communities.
New Market Tax Credits (NMTCs) are another federal tax strategy providing incentives to investors who make investments in certified community development entities that fund economic development in low-income communities. NMTCs have been used in a variety of ways for new development in low-income places, including redeveloping formerly used properties commonly referred to as brownfields sites.
The most recent federal initiative using market-based, tax policy approaches to spur investment in low-income communities is the Opportunity Zones program. In 2017, the Tax Cuts and Jobs Act was signed into law providing the enabling legislation for this emerging federal economic and community development program.
Simply put, this new program provides a vehicle for investors to invest in “opportunity funds.” These funds will, in turn, invest their resources into opportunity zones that have been designated across the country.
How the Program Works
According to a report from the Economic Innovation Group (EIG), a leading voice on opportunity zones, more than 50 million Americans live in economically distressed communities. (2) Even within the same city, many neighborhoods have been left behind by the economic recovery following the Great Recession. Concentrated distress within communities generates a downward spiral of stagnation, shrinking tax base, and lack of access to capital for revitalization.
Through changes to the federal tax code, the Opportunity Zones program seeks to unleash an estimated $2.3 trillion of unrealized capital gains on stock and mutual funds that are locked up due to reluctance to pay capital gains taxes. (3)
The program’s tax incentive enables individuals and corporate taxpayers to defer capital gains on the sale of stock, assets, and other property by investing the proceeds into a certified opportunity fund that provides equity to businesses or projects within designated, distressed communities.
To realize the deferment, the gains from the sale of an asset must be invested in one of the funds within 180 days of the transaction. The program spurs long-term investments of “patient” capital by providing the greatest benefits to investors who hold their investments for 10 years.
Chief executives of states, territories, and the District of Columbia nominated up to 25 percent of qualifying census tracts within their jurisdictions, focusing on tracts that have at least a 20 percent poverty rate or a median income that is less than 80 percent of the state, region, or metropolitan area median income to be designated opportunity zones.
The U.S. Department of Treasury approved more than 8,700 such designations across the United States as of March 2018. (4) According to an EIG analysis, the average poverty rate among the designated opportunity zones is 31 percent and the median income is only 59 percent of its area median, both of which are substantially above the thresholds required by law. (5)
Qualified funds are defined as “any corporation or partnership organized for the purpose of investing in qualified opportunity zone property and that holds at least 90 percent of its assets in such property." (6) In general, an “opportunity zone property” is one that conducts the majority of its business within the designated opportunity zone and is a business with most of its tangible property owned or leased within the zone.
One interesting feature of this new program is the lack of reporting requirements for opportunity fund investments, somewhat echoing the original, underlying “non-plan” theory of enterprise zones conceptualized in Great Britain that suggested administrative and planning restrictions in designated zones be minimized or eliminated. (7)
There remains some uncertainty if future rounds of regulations from the federal government will include more detailed reporting requirements.
The To-Do List for Managers
The opportunity zone effort has followed a familiar intergovernmental path for local jurisdictions. The program has been legislated at the federal level with zones designated by states likely with a relatively modest level of local input.
Now, as the program is coming closer to actualization, how do local governments and local government managers prepare to take advantage of this new opportunity?
First, they need to get up to speed. The purpose of this article is to give a basic primer about the program and some of its historical antecedents. There is, however, much more to learn about the nuances of the program as it continues its rollout.
Further, since local governments will be the primary beneficiaries, it is important that they are as fluent as they can be about the possibilities the program offers. The EIG website (https://eig.org) is the best source of up-to-date information on the program.
Localities should also explore whether any opportunity funds are forming in their state, region, or jurisdiction or if any have their investment sights set on the zones in their community. Qualified opportunity funds can be managed by a variety of types of organizations, so it will be important for local governments to get to know these new financial and investment stakeholders.
The Opportunity Zones program allows local governments to align planning, strategy, and project priorities that may be under way, or nearing start-up implementation. Any investments such as infrastructure improvements, investments in educational institutions, and workforce development training programs might be further refined given opportunity fund investors indicating interest in designated zones.
Local brownfields sites programs, land banking efforts, and other activities focused on formerly used commercial and industrial properties might also benefit from the Opportunity Zones program, so it will be important to make sure that these efforts are integrated into any strategic planning efforts.
Local governments should also think about how to effectively align the public and private partners that typically work with the jurisdiction on economic development activities, including chambers of commerce, community foundations, investor-owned and municipal utilities, colleges and universities, economic development corporations, nonprofit organizations, resident groups and commissions, as well as neighboring or surrounding jurisdictions like a county government.
Ensuring that all traditional economic development partners are fully up to speed on the Opportunity Zones program should be a priority so that everyone is speaking from the same set of talking points and strategies. Local governments should consider convening these stakeholders with investors, developers, financial institutions, wealth advisers, and tax experts to share information and position potential projects for investment.
The Opportunity Zones program might also be reason enough to conduct a retention and expansion survey of the local business community, including those already located and operational in a designated zone.
Through the survey, a local government can gauge the level of interest and understanding by the local business community about the zone program, especially those that could be considering expansion and looking for capital to do so.
ICMA data indicates that more than half of communities use promotional and advertising activities to highlight their area’s amenities for attracting new development. Updating websites, brochures, and other media is a good idea to account for the designated opportunity zones in your community.
Given that local jurisdictions can often offer financial and nonfinancial incentives to trigger retention or attraction of businesses, they may consider developing companion incentives to encourage investment in their designated opportunity zones.
Similarly, local governments should consider close coordination with state agencies to see what additional state-level incentives might be layered on as well to attract attention. Many states are considering incentive layers to enhance attraction to their multiple, local opportunity zones.
Opportunity zones are another in the long line of federal programs to spur investment in low-income communities by using tax and other incentive strategies. Various analyses indicate mixed success with previous efforts, including empowerment and enterprise community designations.
Despite the historical ebb and flow, however, local governments and their managers should be fully aware of the possible benefits of the program. Now is the time for local governments to build the bonds necessary for this new economic and investment opportunity.
1 Cohen-Rosenthal, Ed and Judy Musnikow, 2003. “What is Eco-Industrial Development” in Eco-Industrial Strategies, Greenleaf Publishing Limited (pages 14–30).
4 The national map of census tracts designated as opportunity zones can be found at a U.S Department of Treasury website (https://www.cdfifund.gov/Pages/opportunity-zones.aspx).
6 “Investing in Opportunity Act” (H.R. 828/S.293).
7 Wetherell, Sam, 2016. Freedom Planned: “Enterprise Zones and Urban Non-Planning in Post War Great Britain” in Twentieth Century British History, Volume 27, Number 2, (pages 266–289).