The Week in Public Finance: The Tax Reform Program Many Hope Will Revive Distressed Communities
Previous federal programs to incentivize investment in low-income areas haven't worked. Some are betting this will.
For decades, the feds have experimented with ways to incentivize investment in the nation’s most distressed communities. Be it empowerment zones in the 1990s or the New Markets Tax Credit in 2000, each effort has tried, but generally failed to combat uneven patterns of economic development across the country.
Now, some say a new program created as part of the federal tax overhaul in December could succeed where the others have faltered.
So-called opportunity zones allow investors to defer their tax liability by investing equity into different assets within a distressed community. It has the potential, says Urban Institute expert Brett Theodos, to be the largest community economic development program in the nation. (Currently, that status belongs to the $3.3 billion Community Development Block Grant program.)
To qualify as an opportunity zone, a census tract must meet certain requirements set forth by the Treasury Department to ensure investments flow to areas with high unemployment and low median incomes. Last week, governors submitted the areas in their state eligible for investment.
Once designated, these areas will be eligible for investment via "opportunity funds." It works like this: Private investors who earn money selling stock would normally have to pay a capital gains tax on those earnings. But if they instead take those earnings and invest them in opportunity funds, they can defer taxes on those gains until 2026. What’s more, the longer they keep their investment in the fund, the bigger discount they get when they pay those taxes: up to 15 percent if they keep the investment through the end of 2026.
There's another perk. If investors keep their money in an opportunity fund for at least 10 years, any additional money they make from their fund investment won't be taxed. The idea is to encourage investors to invest for the long haul.
The program is the brainchild of the Economic Innovation Group, which first pushed the free-market idea three years ago in Washington, D.C. To EIG President John Lettieri, opportunity zones address some of the criticisms about prior tax credit programs in that they encourage long-term investment and put the financial risk on the investor. “Unlike other programs, there is no guarantee here,” he says. “If you have losses, there is no benefit. So, you’re not putting full the risk on the taxpayer, but you’re keeping it on investors.”
But, counters Theodos, the concept isn’t totally without risk to the taxpayer and -- like prior versions --doesn’t guarantee the investment will ultimately help communities. “The government is still going to spend a bunch of money," he says, and will have no guarantee that the investment will benefit distressed communities. "I think it remains to be seen how good a deal this is.”
Indeed, it's too soon to know whether the program will be effective or not. But observers are encouraged by early developments, specifically the census tracts selected by governors.
About 57 percent of the country’s neighborhoods meet the criteria to be designated an opportunity zone. Many worried that governors would select only those areas considered safe bets for investors. For example, notes The Boston Globe, neighborhoods in the Boston suburbs of Cambridge, Chelsea and Quincy have been designated as opportunity zones, even as investments in real estate have already been surging in recent years.
But an analysis by the Brookings Institution shows that most states designated deeply impoverished areas for the new subsidy. Of particular note, California and Georgia allocated most of their picks to their most distressed neighborhoods.
In other public finance news this week:
The States That Could Be Most Hurt Most by China Tariffs
Iowa could be the biggest loser if trade wars with China come to fruition, Fitch Ratings is warning. The Hawkeye State is one of the U.S.’s largest exporters of soybeans, corn and pork to China -- a $6.8 billion business in 2016 alone. Washington state is also exposed to potential higher tariffs from China because it ships more than half of its aircraft parts globally. In 2016, the $46.4 billion in these exports equaled nearly 10 percent of Washington's economic output.
This month, China published a list of 450 U.S. products (worth $50 billion in annual exports) that would be tariffed. The announcement was in response to President Trump’s threat to slap high taxes on China imports. Fitch notes the likelihood of the tariffs actually being enacted is uncertain, but adds that they could “lower business activity and sales and income taxes,” which could ultimately hurt state and regional tax revenue.
Kansas -- At It Again
One year after Kansas lawmakers repealed Gov. Sam Brownback’s 2012 tax cuts, some are now pushing for their own brand of tax relief. Legislation being considered by the House would -- among other things -- raise the standard deduction taxpayers take from their declared income on state tax returns. The measure, which is expected to cost the state $141 million next year, was passed earlier this month by the Senate.
The proposal comes as the state’s once-tumultuous budget has stabilized and officials are projecting a surplus of up to $610 million. Some are worried that a tax cut now would set the state back from that progress.
Even if the House approves the legislation, the Kansas Supreme Court will have the final say: It has to sign off on any plan that might affect its mandate on the legislature to increase education funding. That mandate will ramp up funding so that within five years, schools receive $500 million more each year than they do currently.