Too Soon for States to Consider “Opportunity Zone” Tax Breaks

Update, July 12: we’ve updated this post.

I’ve noted that the new federal Opportunity Zone (OZ) tax incentive program will automatically cut state as well as federal taxes for individuals and corporations investing in distressed areas unless states “decouple” the relevant parts of their tax code from the federal code. That’s bad enough, since states will sacrifice revenue to subsidize investments that often occur in out-of-state OZs. Worse, many states are considering additional tax breaks for OZ investments. That would be very premature, for four reasons.

First, the OZ program is barely underway. Before considering more tax incentives to shape the amount, type, or location of OZ investments, states should see what the existing incentives produce.

Second, state and local tax incentives in general have done poorly in stimulating investments, creating jobs, or boosting the incomes of low-income people in cost-effective ways. “At least 75 percent of the time . . .,” tax expert Tim Bartik concluded, “local job creation would have occurred without the incentive.” Place-based tax incentives like OZs, which aim to steer investments or job creation into particular geographic areas, appear especially ineffective. Summarizing a large body of research on state and federal “enterprise zone” (EZ) programs — precursors to OZs — economist David Neumark wrote: “it is very hard to make the case that the research establishes the effectiveness of enterprise zones in terms of job creation, poverty reduction, or [economic] welfare gains.”

Such findings argue against additional state incentives until we have evidence about OZ incentives. Whether, as I’ve noted, the program will create jobs and boost the incomes of low-income people — many of them people of color — in or near the zones or mostly enrich wealthy OZ fund investors is an open question.

Third, courts could ultimately rule that some incentives that states are considering unconstitutionally discriminate against interstate commerce because they apply only to in-state businesses and projects. Under previous court decisions, property tax abatements for OZ projects would probably pass legal muster because the abated tax only applies to in-state property. But a new West Virginia law that exempts profits from in-state OZ projects from income tax and a new Rhode Island law that provides more generous capital gains tax breaks for in-state OZ businesses might not, because income taxes apply to income that residents earn both in-state and out-of-state.

Fourth, before they consider new incentives for OZ projects, states should reexamine their existing place-based tax incentives, especially EZs and tax increment financing (TIF) districts. Almost by definition, state tax breaks for investments in OZs undermine tax breaks for EZs and TIF districts that aren’t in an OZ by shifting investment to OZs. The reverse is also true: those pre-existing programs undermine the potential potency of OZ incentives. Rather than layer costly new tax incentives onto the excessive array in nearly every state, policymakers should ensure that existing incentives don’t operate at cross-purposes with OZ incentives.