Will Opportunity Zones help distressed residents or be a tax cut for gentrification?

States are fast approaching a deadline set by the new tax law to designate low-income neighborhoods as “Opportunity Zones”—a designation that will unlock favorable capital gains treatment for investments in those areas. Supporters say this will help revitalize distressed communities, but there is a risk that instead of helping residents of poor neighborhoods, the tax break will end up displacing them or simply provide benefits to developers investing in already-gentrifying areas.

Unfortunately, the evidence on the benefits of existing place-based policies is inconclusive. To understand whether Opportunity Zones are effective—and worth extending when key benefits come up for renewal as soon as next year—states have only a short window to act to incorporate evaluation mechanisms into their selection process. States and the District of Columbia must select qualified neighborhoods for Treasury’s approval by March 21. Only one in four low-income areas in any state can be designated as an Opportunity Zone, so states must reject more neighborhoods than they select. This is a perfect opportunity to build in a rigorous comparison of places that made the cut to those that did not, to see whether the program helps residents of low-income communities, which elements are effective, and whether it should be renewed.

For background, Opportunity Zones offer favorable capital gains treatment for taxpayers who invest in designated high poverty neighborhoods. Invest in real estate or businesses located in a qualified zone, hold it for ten years, and not only can you sell your investments free of capital gains tax, but you also you get a tax break on untaxed capital gains rolled into an Opportunity Zone investment. Individuals in a high-tax state and with short-term capital gains can avoid $7.50 in taxes for each $100 they invest, even before considering any return on their Zone investments. It’s very favorable treatment.

In high-poverty communities across the country, the persistent concentration of economic distress is a problem that dearly needs a solution. High poverty areas see a decline in the number of jobs and more businesses shuttering than opening. Children who grow up in them face long odds of climbing the economic ladder.

But our playbook of effective place-based policies is limited. In contrast to the new Opportunity Zones, the policy with the best proven record—Empowerment Zones—focused on people and local services not just capital investments. They encouraged hiring, subsidized upfront investment in capital and equipment, offered loan guarantees, regulatory waivers, a partial exclusion of capital gains, and large grants to local government authorities for local services and infrastructure. Researchers Matias Busso, Jesse Gregory, and Patrick Kline (2013) find that Empowerment Zones boosted local employment and wages. But the program was expensive and intensive, costing approximately $850 per resident. As a result, only 11 neighborhood zones were ever designated under the original design.

Beyond EZs, most other place-based policies haven’t been rigorously evaluated at all. For instance, while the New Markets Tax Credit program is widely lauded by investors and community organizations that help direct those investments, and has financed substantial numbers of projects, its design and implementation has thus far precluded a rigorous comparison of its net effect on investment or its benefit to local residents.

In high-poverty communities across the country, the persistent concentration of economic distress is a problem that dearly needs a solution.

There is no evidence that the design of Opportunity Zones will be as effective as EZs or other redevelopment efforts, particularly when it comes to benefits to local residents. Moreover, the theoretical effect of the Zone tax subsidies on local residents is ambiguous. It’s a subsidy based on capital appreciation, not on employment or local services, and includes no provisions intended to retain local residents or promote inclusive housing.

In an optimistic scenario, the tax benefits might encourage purchasing and rehabilitating residential property or expanding local businesses. But the value of the tax subsidy is ultimately dependent on rising property values, rising rents, and higher business profitability. That means a state’s Opportunity Zones could also serve as a subsidy for displacing local residents in favor of higher-income professionals and the businesses that cater to them—a subsidy for gentrification. Indeed, the highest returns to investors, and thus the largest tax subsidies will flow to those investing in the fastest gentrifying areas. Most major metropolitan areas are already grappling with the right balance between promoting development and helping existing residents. Opportunity Zones favor one side of that balance. With few guardrails that might promote so-called “smart gentrification”—policies to retain local residents and preserve or expand low- and middle-income housing—it is uncertain whether poor residents will benefit or be kicked out.

More immediately, the design of Opportunity Zones might encourage pressure on states to maximize tax benefits to their citizens—including their developers—to select gentrifying neighborhoods rather than the most distressed neighborhoods. Already-gentrifying areas are guaranteed to have large capital gains. Selecting those areas would maximize the tax savings to investors who would otherwise face large tax bills down the road. In contrast, the benefit for investing in moribund or deeply impoverished areas where rents and property values are stagnant is speculative.

One can see this clearly in recent Treasury guidance that provides a list of qualified low-income areas, relying on maps of Census data dating back to 2011. That means states can designate once-poor neighborhoods that have already gentrified over the last several years. In Washington D.C., for instance, qualifying areas include the planned developments around DC United’s new stadium at Buzzard Point, where investors plan to invest hundreds of millions in and around the stadium, and the NoMa neighborhood where office buildings and pricey apartments are sprouting. By designating those areas as Opportunity Zones, the D.C. government can wipe out the tax bill that would otherwise apply on the sale of those developments. The same is true for gentrifying hotspots like the Shaw, LeDroit Park, Truxton Circle, Mount Pleasant, and Brookland neighborhoods. According to one estimate, half of DC’s low-income neighborhoods have already gentrified—and not just in D.C. but also in cities like Seattle, Portland, Minneapolis, and Atlanta.  

In Atlanta, Vine City, just adjacent to the new Falcon’s Stadium, is eligible to be designated as an Opportunity Zone. Much of the available real estate there has already been snapped up by developers waiting for Atlanta’s wave of gentrification to sweep through. In San Francisco, SoMa qualifies even though it already has a Whole Foods, Trader Joe’s, and REI, as well as the new headquarters of AirBnB, Uber, and Pinterest. Let’s hope, for taxpayers’ sake, that their IPOs will not qualify as Opportunity Zone Property.

That’s why it’s imperative that states establish a transparent framework for selecting and evaluating the efficacy of their zones before they submit their selections to the Treasury. The fact that states can only select 25 percent of their low-income communities as Opportunity Zones provides a prime opportunity for evaluation. California must pick 878 tracts out of 3,500. If more than 878 are nominated, California could select winners by lottery or, by ranking them by a transparent priority—for instance, by municipality and by child poverty rate—and selecting the top 25 percent within each city. That would help us learn whether the lottery winners or last picked performed better than those not selected. Absent a transparent and rigorous selection methodology, it will be impossible to tell whether the program actually worked to use the evidence to drive policymaking when this provision comes up for renewal.

In the absence of evidence, unevaluated programs often become permanent and costly additions to the size of government whether they work or not. Opportunity Zones have already hailed a “policy triumph” by one optimistic observer, despite not yet having gone into effect, little evidence that they will be effective, and a price tag that might soar by billions if permanently extended. Let’s make sure we know whether “Opportunity Zones” work when it comes time to renew them.