The blog of the Urban Institute
June 17, 2020

The Opportunity Zone Incentive Isn’t Living Up to Its Equitable Development Goals. Here Are Four Ways to Improve It

COVID-19’s disproportionate impact on Black communities and the recent killings of George Floyd, Breonna Taylor, and other Black Americans have shone a spotlight on the US’s ongoing legacy of state-sanctioned violence, segregation, discrimination, and racially driven disinvestment. Nationwide protests have lifted up the need for government to invest in Black neighborhoods and remedy the poor economic conditions it purposefully created for these communities in decades and centuries past.

The Opportunity Zone (OZ) incentive, created by the Tax Cuts and Jobs of Act of 2017, aimed to establish an economic development tool that would foster equitable development outcomes—such as quality job creation and business growth—in undercapitalized communities, many of which are majority Black. Two years after OZs were designated, is the incentive living up to its goals?

Without the federal government requiring detailed reporting on OZ investments, answering that question has been challenging. But through nearly 70 interviews with a range of stakeholders working on mission-oriented OZ projects across the US, we assessed how the program is working in practice.

What we heard was clear: although there are compelling examples of community benefit, the incentive as a whole is not living up to its economic and community development goals. The incentive’s structure makes it harder to develop projects with community benefit in places with greatest need. In contrast, OZs are providing the biggest benefits to projects with the highest returns, which are rarely aligned with equitable development.

As the nation grapples with the public health and economic threats from COVID-19, the place-based inequities that compelled the creation of the OZ incentive are at risk of widening. Federal policymakers could alter and expand the OZ incentive to help it play a more positive role in economic recovery after COVID-19 and to spur truly equitable development, especially in Black communities.

 Why OZ incentives aren’t reaching mission-oriented projects

Through these interviews, we learned OZs are helping spur the evolution of a new community development ecosystem, engaging project developers and investors who previously hadn’t engaged in community development work. But we also heard that many mission-oriented actors are facing challenges in accessing capital because of a variety of factors.

Mission-oriented actors are struggling to reach the class of investors for whom OZ incentives are tailored. Project sponsors report ongoing difficulties getting access to and interest from potential OZ investors, such as family offices (firms that manage a single family's wealth), high-net-worth individuals, and other people with capital gains.

Many mission-oriented project sponsors want to support a community asset beyond the 10-year time horizon effectively set by the OZ incentives, but 10 years can feel too long for investors. There is a mismatch between the type of investment many mission actors desire and the OZ market’s investment parameters, which favor assets providing the highest returns in shorter timelines.

Although OZs were designed to spur job creation, most OZ capital is flowing into real estate and not into operating businesses. This is caused by a variety of program design constraints and investor preferences and because some small businesses don’t want to sell equity in their firms.

Most developers and investors view OZ incentives as providing a relatively small boost to overall returns. A few developers said the incentives made a difference in allowing a project to go forward, but most admitted their project would have proceeded regardless of whether they raised OZ equity.

Four ways to improve the OZ program

Philanthropic and local and state actors can partially reorient OZs to improve community outcomes, but only the federal government can correct the structural barriers that discourage and prevent mission-oriented actors from using OZs to their full potential. The broad principles that should guide the improvement of OZ incentives include the following.

  1. Redesign the incentive to better support investments in small businesses

The program’s biggest failure is that very little OZ investment is going to small businesses, the group of investees the incentive was supposed to most benefit. Policymakers could change the tool to support subordinated or hybrid debt or equity products for small businesses, rather than pure equity. Policymakers could also grant greater flexibility around certain program rules to mission-driven funds that specialize in small-business investing.

  1. Size the incentive based on the impact

To meet the program’s goals, rather than providing the largest incentives to the most profitable projects, the incentive should depend on project impacts. By targeting incentives to investments with the greatest impacts, these investments could be more deeply subsidized while more efficiently using total federal tax expenditures. OZ tax incentives could be based, for example, on the number of quality jobs created by the OZ investment or other discrete and measurable outcomes.

  1. Broaden who can invest

Limiting incentives for community investing to only taxpayers who already have prior capital gains freezes out most stakeholders from investing in their own community’s revitalization. A refundable tax credit, rather than a capital gains exclusion, could open opportunities for these investors. Creating an incentive for other actors with substantial resources, such as foundation endowments and pension funds, could also draw more investors interested in community development.

  1. Support mission-driven funds that are accountable to the community

Community development financial institutions (CDFIs) have a long track record of making substantial investments in low-income communities. They are also accustomed to taking on higher risks than conventional investors and working with the kinds of investees struggling to access OZ capital. A redesigned OZ incentive could encourage equity investments in CDFIs that, in turn, invest in or lend to OZ projects. This would greatly expand the catalytic role CDFIs play in distressed communities and help realize the promise of OZs for the many project sponsors who have struggled to access OZ capital.

The intersection of Martin Luther King Jr Avenue Southeast and Good Hope Road, the gateway into historic Anacostia, in Washington, DC, on Tuesday, August 8, 2017. (Photo by Jahi Chikwendiu/The Washington Post via Getty Images.)

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