New Research Adds to Evidence That Opportunity Zone Tax Breaks Are Costly and Ineffective

Important new resea­­­rch by economists Patrick Kennedy and Harrison Wheeler adds to a growing volume of evidence that opportunity zone tax breaks, created as part of the 2017 Tax Cuts and Jobs Act (TCJA), are costly and poorly targeted and do little to create jobs or improve conditions in poor communities. Instead, opportunity zones provide massive tax benefits to wealthy investors while subsidizing investment in few communities with relatively higher incomes, home values, and educational attainment as well as stronger income and population growth.

A growing body of evidence bolsters the case for commonsense reforms that would improve the transparency and accountability of zone incentives, such as instituting reporting requirements and requiring assets used to qualify for tax breaks to be used exclusively within a zone. Absent future evidence to the contrary, opportunity zone incentives should not be extended beyond their scheduled 2026 expiration.

Opportunity zones are the nation’s largest placed-based policy intervention since the early 1990s. When originally enacted, the opportunity zone provisions were expected to cost $1.6 billion per year; however subsequent estimates suggest the cost could nearly double. Under the program, more than half of the approximately 74,000 census tracts in the United States are eligible for opportunity zone designation based on income and poverty criteria, and governors are allowed to nominate up to 25 percent of the census tracts within their state for designation by the Treasury Department. While the tax breaks were ostensibly intended to direct capital to neighborhoods most in need, the large number of zones—8,764 census tracts designated in 2018, home to about 10 percent of the U.S. population—along with the ability to classify higher-income areas adjacent to poor neighborhoods ultimately undermined the program’s focus.

Opportunity zones structurally favor high returns, not community benefits

Opportunity zones have fewer limits on the range of qualifying investments and fewer safeguards to prevent abuse and revenue loss than other tax-based programs designed to promote community and economic development, such as the New Markets Tax Credit and the Low-Income Housing Tax Credit programs. What’s more, regulations issued by the Trump administration broadened the intent of the original law and created opportunities for abuse. As a result of lenient regulations, for example, investors can claim a full tax break even if only 63 percent of the capital in an opportunity fund is actually invested in an opportunity zone. Moreover, the original law includes no requirements that opportunity zone residents actually benefit from investments.

Opportunity zones’ singular focus on reducing taxes owed on capital gains structurally favors projects that generate high returns, rather than the greatest social impact. For example, a luxury apartment building could be a more lucrative investment generating larger tax benefits than low-income housing that fulfills a community’s greater need. Similarly, zone investors—who receive the tax breaks—are typically passive investors who use the opportunity fund structure to shelter gains earned both within and outside zones. The structure of the tax breaks make them of little use to community residents who lack a stock of capital gains but who have a long-term commitment to the types of investments that create a thriving community. Other flaws in the structure of the incentives allow investors to claim tax breaks for opportunity funds that invest in other funds rather than directly in a zone. A 2022 report by the Treasury’s Inspector General for Tax Administration found that slightly more than 1 out of 20, or 6.4 percent, of the opportunity funds it examined had made such circular investments, totaling $1.3 billion.

The new research fills an important data gap in understanding opportunity zones’ impacts

Despite their cost and scope, opportunity zones lack even the most minimal reporting requirements. To shed light on their impact, the new research from Kennedy and Wheeler, based on preliminary tax return data for 2019 and 2020, uses multiple data sources to provide important insights into program’s initial impact. The report’s four key findings show that:

1. Opportunity zone investment is extraordinarily concentrated in a relatively few zones, with nearly two-thirds—63 percent—of opportunity zone census tracts covered by the initial data receiving zero capital. Just 1 percent of tracts received 42 percent of the invested capital, and the top 5 percent received 78 percent of total investment. The New York City area received the largest volume of opportunity zone investment, at $3.8 billion—more than twice the amount received by the Los Angeles area, which ranked second at $1.7 billion.
2. Opportunity zone residents have higher poverty rates, lower incomes, and lower educational attainment than the U.S. population as a whole. However, the zones that received investment had relatively higher educational attainment, incomes, home values, population density, and concentrations of professional and amenity services and lower percentages of elderly and nonwhite residents compared with the zone areas that did not. As the authors of the report concluded, “[T]he tracts that received investment were the least disadvantaged of those granted OZ status.” They further noted that “the preliminary descriptive evidence suggests that OZ capital may disproportionately benefit a narrow subset of tracts in which economic conditions were already improving prior to implementation of the tax subsidy.” In other words, opportunity zone tax breaks tended to subsidize investments in areas that were already on a path toward gentrification.
3. Opportunity zone investment is overwhelmingly concentrated in real estate, construction, and finance. Real estate alone received more than half of opportunity zone dollars. By contrast, only 1 percent of the firms that received opportunity zone funds were in manufacturing. Rather than directly investing in property or business assets, the vast major of opportunity zone investments were structured as partnerships to allow investors to claim the special deduction for pass-through entities that was also created by the 2017 TCJA.
4. The average household income of opportunity fund investors—the direct beneficiaries of zone tax breaks—placed them well into the top 1 percent of the income distribution, at $4.8 million in 2019, compared with $117,000 for the population as a whole. This is not surprising given the fact that capital gains income is highly skewed toward the wealthiest households, as detailed in prior research by the Center for American Progress. These are the households that stand to benefit from the ability to shelter gains provided by opportunity zone tax breaks.

Additional evidence also points to lack of impact

The new study builds off prior research that finds minimal to no impact resulting from opportunity zone designation. Taken as a whole, research to date suggests that opportunity zone tax breaks have largely benefited areas already experiencing development, projects that would have occurred in the absence of an incentive, and/or projects—such as self-storage facilities and bitcoin mining facilities—that do little to create employment and economic activity in surrounding communities. Notably, the evidence includes:

• A comparison of changes in housing prices in opportunity zones and closely matched areas that were not selected as zones found negligible evidence of an increase after zone designation. The authors of the study state that their findings indicate that “buyers do not believe that Opportunity Zone status will generate a significant change in the economic fortunes of the neighborhood.”
• A comparison of job postings—which the researchers suggest can be a “leading indicator” of job growth—in opportunity zones and ZIP codes eligible, but not selected, for zone designation found no increase in postings in designated zones. Specifically, the authors of the study stated finding “no evidence of zip codes with OZs having more job postings than comparable non-OZ zip codes over the whole sample. Similarly, we found find no evidence of an effect for OZs with confirmed investment. Neither do we find an effect in construction and real estate industries, the industries in which we should expect a large number of projects taking advantage of the program.”

Policymakers should take steps to reform the opportunity zone program

The evidence to date bolsters the case for immediate and significant reform, as well the need for better data to inform additional research prior to the upcoming expiration of zone incentives. Policymakers should:

• Require the Treasury Department to collect data and report on opportunity zone performance. Data should also be made available for independent researchers to conduct in-depth analyses of the impact of the incentives on local economies and community members.
• Revisit opportunity zone designation to favor a smaller number of more targeted areas that are unlikely to attract private capital absent an incentive.
• Limit the range of projects that qualify for an incentive to exclude investments that have little potential for creating quality jobs in or attracting additional investment to surrounding communities.
• Require property qualifying for tax breaks to be used within a zone at least 90 percent of the time. Due to the interactions between the requirements for opportunity zone funds and business and qualified property, investors can currently claim tax breaks for property that is used within a zone as little as 63 percent of the time.
• Establish tests that limit tax benefits to projects that would not have happened in the absence of an incentive.
• Scale the size of the incentive to the amount of community benefit provided using measures such as creation of quality jobs or other criteria; establish local hire requirements for projects as a condition of receiving a tax break.

Conclusion

Recent estimates released by the Congressional Budget Office project that that extension of zone tax breaks would cost $103 billion through the end of the 10-year budget window. In the absence of evidence showing that opportunity zones benefit communities in a more cost-effective way than other approaches to economic and community development—and with the evidence thus far suggesting the opposite—opportunity zones should not be extended beyond its scheduled 2026 expiration.