Senior Tax Legal Analyst
Update, November 1: we’ve updated this post.
The New York Times and ProPublica have highlighted major flaws in the 2017 tax law’s “opportunity zone” tax break — which was ostensibly designed to encourage investment in low-income areas but is really a regressive tax cut for wealthy investors, with dubious benefits for low- and moderate-income households.
Moreover, the law’s ambiguous wording in creating this tax break has enabled lobbyists from various industries to stretch the tax break further in their favor. These flaws aren’t unique to opportunity zones; they exemplify those of the 2017 law more broadly, which is heavily tilted to the wealthy and has created a “bonanza” for tax lobbyists.
The opportunity zone tax break lets investors defer taxes on capital gains (profits from the sale of appreciated assets, such as stock) by “rolling” those gains into funds that invest in designated low-income areas, or opportunity zones. If investors keep that money in these funds for a certain number of years, they can get more tax breaks — including lower taxes on their deferred capital gains and a permanent tax exemption on all capital gains on their opportunity zone investments. That’s on top of the generous tax advantages that capital gains already enjoy, including a preferential rate and the ability to defer taxes until appreciated assets are sold.
Though proponents claim the opportunity zone tax break will revitalize low-income areas, it only directly benefits people with capital gains, which are heavily concentrated among the wealthy. Jasper Cummings, a tax practitioner and a former IRS associate chief counsel, described it as “geographical trickle-down” because it helps wealthy people in hopes that low-income residents might someday benefit. As we’ve explained, there are good reasons to be skeptical that residents will see sizeable benefits. In fact, the tax break could even hurt some of them: since the tax break is worth the most for investments whose value rises the fastest, analysts warn that it could accelerate gentrification, dislocating current residents.
With few protections to ensure that opportunity zone tax breaks will benefit low-income residents, Congress should carefully evaluate how the program is working, who really benefits, and how to prevent widespread tax avoidance — and then adjust the law as appropriate based on the findings.
The problems with the opportunity zone tax break reflect those in 2017 tax law as a whole. The law cut taxes for the wealthiest households and most profitable corporations while largely leaving out millions of low- and moderate-income working families. Its core provision, a deep cut in the corporate tax rate, mostly benefits shareholders and highly paid employees such as CEOs. It also showers large tax benefits on the heirs of multi-million-dollar estates, cuts the top personal income tax rate, and provides a special deduction for owners of “pass-through” businesses (as explained below), who are disproportionately high income.
Proponents promised that the tax cuts would spur investment, leading to higher wages. But evidence to date suggests that the law hasn’t meaningfully affected economic growth, investment, or wage growth. Further, decades of evidence show that tax cuts for the wealthy are an ineffective way to boost economic growth.
The hasty drafting and enactment of the 2017 law, which passed without public hearings or broad expert input, gave wealthy investors and lobbyists even more ways to benefit by leaving key decisions to the Treasury Department and the IRS as they write the regulations implementing it. The opportunity zone provision, for example, has many vague requirements, including that businesses use certain undefined amounts of their property in an opportunity zone. Though we and others urged Treasury to limit investors’ ability to qualify for the tax break without making significant investments in opportunity zones, the proposed regulations actually make it easier to do so.
Likewise, the law gave Treasury substantial leeway to implement the 20 percent deduction for certain pass-through income (income that the owners of firms such as partnerships, S corporations, and sole proprietorships report on their individual tax returns). This created an opening for a wide variety of wealthy individuals and businesses — from real estate professionals to banks and even veterinarians — to lobby Treasury to expand the scope of the deduction so they could qualify. The final regulations include favorable exceptions for certain industries, raising the deduction’s cost to taxpayers.
Though Treasury continues to finalize regulations implementing the 2017 law, such efforts can’t overcome all of its fundamental flaws. Only a basic restructuring of the law can.