The Inherent Flaw in “Opportunity Zones”

Map credit: Econ Focus

by James A. Bacon

The City of Norfolk is gearing up to take full advantage of tax breaks contained in the 2017 Tax Cuts and Jobs Act. City Council has designated the St. Paul area, home to three 50s-era housing projects, as an “opportunity zone.” Plans call for demolishing the three projects and replacing them with mixed-income development. The city will receive $30 million in Housing and Urban Development funds to jump-start redevelopment, but the bulk of investment is expected to come from the private sector.

More than 8,700 such opportunity zones have been designated across the country; about 10% are located within the 5th Federal Reserve Bank district, which includes Virginia. Through a mix of incentives, investors in opportunity zones can defer, reduce or in some cases eliminate capital gains taxes in the zones.

While the tax breaks may prove effective at channeling investment capital into the designated zones, it is an open question if it will actually help the poor people living there, writes Jessie Romero in the current issue of Fed Focus, a publication of the Federal Reserve Bank of Richmond.

The size of the potential tax break is what could lure new investment, but it depends on how profitable the investment is — which depends in part on rising property values and rents. So some observers fear that in many places, the opportunity zone designation will create or hasten a process of gentrification to the detriment of lower-income residents who don’t own their homes and instead are forced out by rising rents.

This strikes me as a legitimate concern. Indeed, the criticism goes to the heart of almost every government-subsidized redevelopment project. The more successful a project is commercially, the more likely it is to displace the very people it is meant to help.

The track record of tax-free investment zones — empowerment zones, enterprise zones, renewal communities, the New Market Tax Credit — is mixed at best. On the plus side, the tax incentives have steered capital into low-income neighborhoods, often creating job opportunities and higher wages. But rising rents and housing prices often displace the original residents. Moreover, some research suggests that empowerment zones simply shift economic activity from one place to another without any net gain.

This time will be different, advocates say. Opportunity Zones have several features to make them more effective than their predecessor programs. First, they are designated by state governors with input from local leaders who presumably know more about the needs and growth potential of their communities than federal bureaucrats. Second, the program pools resources of multiple individual and institutional investors, increasing the potential funds available and limiting the risk to any single investor. Third, the tax benefits are potentially larger.

Moreover, having learned from experience, governments can put “guardrails” into place — changes to zoning and permitting processes — to mitigate the effects of gentrification. That’s the theory. In practice, it’s not clear from the article what form such guardrails would take.

Bacon’s bottom line: I’m been skeptical of “urban renewal” projects for some time, but I’ve not been able to articulate precisely why. This article helps clarify my thinking.

Here’s the problem. Private-sector developers are driven by profit. They make profit by either renting or selling housing units for the highest price they can. Developers want to see property values rise. If property values don’t rise, and if developers don’t make profits, then they will stop investing. Duh! If property values do rise, then the lowest-income residents will be displaced… unless special measures (such as “workforce housing”) are put into place to guarantee them housing… which adds to redevelopment costs and cuts into profits. Cities can add “guardrails” but these add more layers of red tape and administrative delays… which cuts into profits.

Let me state the obvious: Lower-income people live in the most dismal neighborhoods because that’s all they can afford. People who can afford to move out of the worst neighborhoods do so as soon as they are able. If through a combination of HUD subsidies and tax breaks a locality improves the quality of a neighborhood, property values will rise. When property values rise, lower-income residents will be displaced.

The contradiction is inherent in urban redevelopment.

In the long run, society can’t improve the condition of poor people by upgrading the quality of their neighborhoods. Society can improve their condition by increasing the supply of housing stock generally, and encouraging smaller and/or affordable units such as trailers, manufactured housing, cargo-container housing, tiny homes, boarding houses, and single-room-occupancy housing. Society also can improve the lives of poor people by helping them, through education and workforce training, to become more economically productive and, thus, to increase their earning power.

No matter how well intentioned, urban renewal projects are a dead end. Indeed, by consuming resources that could be better applied elsewhere, they arguably represent a net economic loss to society.

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10 responses to “The Inherent Flaw in “Opportunity Zones””

  1. TooManyTaxes Avatar

    The appropriate thing to do is to adopt reasonable requirements for builders of residential units under a re-zoning case to proffer affordable and/or workforce housing. This especially works well with multifamily construction and, to a lesser degree, townhouses.

    Let’s keep in mind that, while a builder gains wealth from investing in and constructing residences and, therefore, deserves to make profits, the builder gains financial windfalls through changes to the Comp Plan that permit more density and through re-zoning or special exception approvals. Those latter gains in wealth should be paid for through proffers and other contributions to public infrastructure and community needs. Taxpayers should not be forced to subsidize developers and builders. That’s not real capitalism. It’s corporate welfare.

  2. Dick Hall-Sizemore Avatar
    Dick Hall-Sizemore

    Not only is it not helping poor folks, the opportunity zone tax break is proving to be a bonanza for the ultra-rich (the rich get richer).

    1. It’s a quandary. Jim is right, poor folks get pushed out by the very gentrification intended to help them. And from the point of view of growing-the-tax-base, isn’t that a good thing for local government? But also agree with this comment under the Market Watch article you link to: “I’ll never understand this “keep poor people poor” pushback to economic development. It seems to flow from a paternalistic view of low income people as semi-human pets that have to be kept segregated from the rest of society, only to be viewed from afar.”

  3. LarrytheG Avatar

    Depends on the development. If it rewards business and not residential construction
    …….. The goal should be the kinds of businesses that provide permanent jobs. Would work the same way for rural and urban…….

  4. Reed Fawell 3rd Avatar
    Reed Fawell 3rd

    The overriding purpose of an opportunity zone is to put together mixed uses that working in synergistic ways create monetary and social wealth in places where there was none or far too little before so a to lift all boats willing, able and wanting to be lifted. Such wealth creation is never a zero sum game, and relocation of uses is inevitable, as the whole idea is to rebuild communities, or revive them in long term healthy ways. The process here is somewhat akin to issues discussed in earlier post and commentary found at:

  5. LarrytheG Avatar

    The thing is people who need jobs have to have education sufficient to do those jobs – opportunity zones can’t deliver education…

  6. OPPORTUNITY ZONES… Government picking winners and losers.
    As always the first question that should be asked is, “Is this Constitutional.” Of course it isn’t, so that should be end of discussion.
    Not to mention federal government subsidies of housing are UnConstitutional. …

    1. Reed Fawell 3rd Avatar
      Reed Fawell 3rd

      As for urban renewal, the hands on deeply involved government never fails to build sterile dead places. So here in these newly conceived opportunity zones, the government’s footprint, and its touch, must be light and invisible, yet effective. For in the end, true success always must be measured by schools, homes, marriages, families, and churches in close kit healthy communities giving meaning to all lives living and working there. Vibrant enterprise is the spark and then the fire fueling such vibrant human communities. The government can create none of this, so it needs to get out of the way.

    2. Reed Fawell 3rd Avatar
      Reed Fawell 3rd

      Published November 25, 2019 in Quillete: Why Do Progressives Hate Gentrification? by Coleman Hughes

      The word “gentrification” was coined in 1964 to describe the influx of wealthy newcomers into low-income inner-city neighborhoods, resulting in rising property values, changes in neighborhood culture, and displacement of original residents. Though gentrification predates the modern era, it has only become the target of criticism in recent decades, as cities like Washington, D.C., Atlanta, and Boston have witnessed rapid transformations. Opponents of gentrification have ranged from residents directly affected by it to wealthy college students directly responsible for it, as well as prominent Democrats such as Bernie Sanders, Cory Booker, and Alexandria Ocasio-Cortez.

      Critics of gentrification give two main reasons for their opposition: (1) wealthy newcomers drive up monthly rents, thereby displacing original residents; and (2) rapid change to neighborhood culture represents an injustice to original residents. Both critiques are magnified by the presumed skin color of the gentrifiers and the gentrified, who tend to be white and black or Hispanic, respectively.

      Though such critiques may seem reasonable at first glance, neither of them survive scrutiny. Not only is gentrification harmless, it’s actually beneficial. Indeed, for reasons I will lay out, it’s exactly the kind of thing that progressives should support …”

      For more of this timely, highly informed and important article please see:

      1. Reed Fawell 3rd Avatar
        Reed Fawell 3rd

        Meanwhile, I’m back to the painful process of listening to three elite liberal Law Professors pontificate without wisdom or deep understanding, and one excellent and highly informed lawyer who also happens to be a Law Professor expound wisely and deeply, on the proper process of impeaching an American President.

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