Opportunity Zones

The recently-passed Tax Cuts and Jobs Act calls for states to establish, and private funds to invest in, low-income “Opportunity Zones” throughout the country.  The plan offers tax incentives for such investment.

This sort of incentive distorts capital allocation by giving preference to investments in less-efficient projects in “opportunity zones”  over investments in more-efficient projects elsewhere, at the margin.  The belief must be that externalities produced by opportunity-zone investment are more positive than externalities created by investments elsewhere, and that the difference is big enough to overcome the effect of the distortions that prevent capital from flowing to its most profitable use.

Potential externalities

  • Real estate values: investment in low-income areas lifts real estate values by a greater amount than investment in higher-income areas.
    • This would help homeowners, but may actually make renters worse off as they are priced even further out of the housing market[1]
    • A short-term boost to a long-lived asset is not a clear boon to the area. In order to capture gains, either the gains would have to be permanent or else homeowners would have to sell, putting downward pressure on home prices and detracting from the long-term economic viability of the region as people move away.
    • For home price increases to be permanent, the investment would have to raise the long-term economic prospects of the region. What are the determinants of long-term economic success?  Can 5- to 10-year investments create these?  I’m thinking about natural resources (minerals, rainfall, dairy herds, etc.), infrastructure, educated population, and some other things I’m probably missing.  If 5- to 10-year investments fail to create these, then the boost to real-estate prices will not be permanent.
    • If new investments temporarily create more demand for housing but the supply curve also quickly shifts out (new construction), then:
      • House prices may not rise much
      • The long-term situation might be even worse than otherwise if the investments don’t create permanent economic growth. When the effect wears off, people will move away again and leave an over-supply of housing.
    • Infrastructure: new investment might spur new infrastructure (roads, airports, sewer systems, etc.) that makes the area more attractive to future business even after the tax incentives under the Opportunity Zone program disappear in 2026.
    • Human capital: new jobs teach workers new skills, which potentially make them better off in the long run whether or not the job is permanent.
      • An investment that creates a new entry-level computer programming job in Silicon Valley is not likely to teach new skills to someone living in Palo Alto – that person probably already has appropriate skills.
      • An investment that creates a new computer programming job in Buhl, Idaho, may confer new skills on someone who would otherwise work in retail or agriculture. If the skills learned are useful in other industries, they might be valuable and this might contribute to the success of the Opportunity Zone program.

Finally, the things everyone likes to talk about–job creation and wage increases–are not the right outcome variables. One region’s additional jobs and wages are another region’s (marginal) losses.  Program success has to be about externalities–real estate values, infrastructure, or skills.

Finally finally, how do we know it’s better to move the businesses to the people instead of moving the people to the businesses?  Maybe the program should invest in helping poor people move from Buhl, ID, to Seattle, WA, where job growth is already happening.

 

[1] The City Council of Redwood City, CA, is worried about exactly this.  See “City wants out of ‘opportunity zone’ designation”, The Daily Journal, April 16, 2018.