Deep within the new tax reform law lies an attempt at hope for distressed communities across the country called “Opportunity Zones.”
The U.S. is riddled with distressed communities in desperate need for economic development. According to the Economic Innovation Group’s latest Distressed Communities Index, 52.3 million Americans live in economically distressed communities. That is, these communities have seen an average of a 6 percent decline in employment, have more than 20 percent of adults without high school diplomas, and an average poverty rate of close to 27 percent.
Living in a distressed community has severe implications for its population. Life expectancy decreases and mortality from mental and substance abuse disorders is 64 percent higher in than in prosperous communities. Public medical assistance and welfare benefits flow at rates much higher than affluent communities, despite these communities having 32 million fewer people overall.
To address this issue, one section of the tax law calls on state governors to identify and select Opportunity Zones (low income, high-poverty county subdivisions) to receive funds directed at economic development. These “Opportunity Funds” offer favorable tax incentives for investors, mainly if the investments are long-term.
Historically, targeted tax incentives like opportunity zones have experienced muddy outcomes. State-based case studies of Missouri, Arkansas, and Florida suggest these incentives fail to provide the widespread benefits purported by policymakers. However, localities using tax incentives most intensively not only have the weakest economies, but also suffer from low levels of economic freedom. Areas that suffer without economic freedom have poor tax climates, low labor market freedom, and burdensome regulatory landscapes.
Coupled with other tax reforms, namely the lowered corporate tax rate, Opportunity Zones might see positive outcomes. The reduced corporate rate will lead to investments boosting productivity and wage growth at home. Moreover, the reduced repatriation tax invites back foreign investment earnings sitting overseas. This, along with reducing capital gains taxes by transferring investments into opportunity funds, could be the tag-team necessary to spur communities out of their economic doldrums.
Though these efforts offer a bit of hope to communities with petering economies, state governments lack the local knowledge to identify the areas where these funds will actually work. Also, these incentives may hinder the development of other communities. Even if the new plant creates jobs, voters may not see the jobs lost elsewhere because of the higher tax burdens. Importantly, tax incentives are ripe for cronyist and rent-seeking behavior from businesses lobbying for these tax breaks.
If states can accurately identify Opportunity Zones while simultaneously approving the appropriate funds, some communities may very well see the economic boon promised by this administration. However, how these funds are used is key. Evidence from Kentucky makes known that initiatives that focus on education and workforce training are likely better uses for the opportunity funds than financing business startups. The West Virginia Universities Alliance focuses on these types of approaches along with offering workshops and events on topics such as broadband delivery and the opioid crisis. This “boots-on-the-ground” strategy might help the state get closer to identifying the most effective ways to revitalize the communities.
Another way Opportunity Funds may contribute positively to a community is where there are toxic wastelands. Once-thriving but now-barren coal towns in West Virginia could use the funds to encourage the re-mining of old mines using modern practices, as in Virginia. Deeming these areas as Opportunity Zones would direct funds to address the environmental effects of old coal mines contributing to the economic distress while simultaneously creating jobs in the community.
Alone, Opportunity Zones will likely be a wash. However, there is a chance that the lowered corporate tax rates and other reforms in the tax reform law, coupled with these targeted incentives, might be the incentive needed to spur economic development in some of these distressed cities.
Kevin D. Gomez (@gomek916) is a graduate student in economics at George Mason University.
