Paul L. Caron

Friday, October 18, 2019

Weekly SSRN Tax Article Review And Roundup: Layser Reviews Does Government Play Favorites? Evidence From Opportunity Zones

This week, Michelle Layser (Illinois) reviews Ofer Eldar (Duke) and Chelsea Garber (Duke), Does Government Play Favorites? Evidence from Opportunity Zones (Oct. 3, 2019).

Layser (2018)

With the 2020 Census on the horizon, investors nationwide have been lobbying states to expand the areas designated for tax preferred investment under the federal Opportunity Zones law. In 2017, state governors selected 8,764 census tracts for Opportunity Zone designation. These tracts were selected from a pool of 30,981 low-income census tracts and 10,237 contiguous tracts that were eligible under the federal statute. Whether the IRS will permit states to expand or revisit their Opportunity Zone designations after the Census is yet to be seen. In the meantime, Professors Ofer Eldar and Chelsea Garber have provided a fascinating quantitative analysis of factors that may have driven the initial designation process.

The Opportunity Zones designation process is somewhat unique among federal place-based tax incentives. Where the Empowerment Zone law required HUD to assign tracts’ empowerment zone status, and the New Markets Tax Credit law specified tract eligibility in the statute, the Opportunity Zones law required state governors to designate which census tracts would receive zone status. Since governors are arguably in a better position than federal agencies to understand economic and social conditions in their states, it makes some intuitive sense to rely on their knowledge to define the contours of place-based tax incentives.

However, it is not at all obvious, from an empirical standpoint, that governors’ judgment about tract selection is superior to the federal governments.’ As the authors note, the “major concern with government discretion is that it may be tilted to favor investors or groups that are not the intended beneficiaries of the program.” This risk may be especially true at the state level, and multiple news reports have provided anecdotal evidence that at least some Opportunity Zones have been selected to satisfy investors (see here, here, and here). Now, Professors Eldar and Garber have provided a data-driven analysis that further supports the critique that investor pressure and political motives may have influenced Opportunity Zone selection.

Drawing on data from the American Community Survey (ACS) and voting records, the authors analyzed Opportunity Zone tract selection in order to shed light on various factors that may have influenced governors’ decisions. While their paper is full of interesting tidbits—metro tracts had a lower probability of selection (20.7%) than non-metro tracts (33.5%), and prior receipt of place-based subsidies increased the likelihood of selection by 12.2 percentage points—it had three major findings. First, more distressed tracts were more likely, on average, to be designated as Opportunity Zones than less distressed tracts. Specifically, designation was more likely in tracts with high unemployment rates and poverty levels and lower incomes. This, at first blush, looks like a good sign.

However, the authors noted that the number of tracts selected from the least distressed tracts was not trivial. Rather, 17% of tracts were selected from the least distressed eligible tracts. In addition, the authors’ second major finding was that that all tracts were more likely to be chosen if they had been on an upward trajectory in terms of poverty and income. (Tracts with “high and increasing” unemployment rates were also more likely to be selected than tracts with “high and constant” unemployment rates, though those results were not significant.) According to the authors, these findings “may suggest that although governors tend to choose more distressed tracts, they also prefer to focus on those that are upward trending and potentially gentrifying, versus those that are distressed and stagnant.”

The authors’ third major finding was that governors appear to have chosen tracts that “favor their most supportive constituents.” In fact, of all the factors analyzed, political support appears to have been one of the strongest factors. Simply “going from a tract in a county with 50% support for the governor to a county with 65% support for the governor increased probability of OZ designation from 21.7 percent to 24.2 percent.” Overall, the authors concluded that political support “has a large positive effect on designation probability.”

As someone who studies place-based tax incentives, I was excited to see this new, empirical analysis of Opportunity Zones designation. Understanding the designation process is undoubtedly an important part of the larger project of evaluating the tax law and its impact on communities. It is encouraging to learn that distressed tracts appear to have been more likely to receive designation than less-distressed tracts, though the evidence that governors were more likely to select tracts on an upward trajectory or to satisfy political constituents is potentially troubling. (The authors, for their part, tried to distance themselves from normative judgements about these findings. They note that their research cannot determine whether tracts were selected based on favoritism or their potential to advance program goals.)

One implication of this study is that the tracts selected for designation included a mix of distressed tracts, less distressed tracts, and tracts that are potentially gentrifying. The authors emphasized that, once selected, all investments in those tracts have the potential to qualify for the tax benefits. However, it seems unlikely that all designated tracts will attract investments to the same degree. By way of example, consider the Opportunity Zones that have been designated here in Champaign, IL, where I live and work. Three areas in Champaign-Urbana have been designated as Opportunity Zones, one of which is located on the campus of University of Illinois in a neighborhood we call “Campustown.”

Campustown is not a low-income neighborhood in the traditional sense—but it looks like a high-poverty area based on Census and ACS statistics, because the Census Bureau does not distinguish between students and non-student residents. The high percentage of “poor” students allowed the area to qualify. (Importantly, such variations would not have been captured by the authors’ study, either; however, it is probably unlikely that there would be enough tracts like these to skew the results.) The Campustown Opportunity Zone has recently made local headlines for its selection by an Opportunity Fund that plans to develop three new student housing buildings in the zone. Suffice to say, these new tax-subsidized properties have caused a few raised eyebrows around town. So far, I have not heard about investors targeting the other local opportunity zones.

A significant question, then, will be whether investors are equally willing to invest in various Opportunity Zones. What will the investment patterns look like in areas like Champaign, in which some tracts are clearly less low-income than others? Or in areas where some tracts are obviously gentrifying, and others are not? Questions about investor behavior were clearly outside the scope of this article, but they will ultimately be relevant to evaluate the impact of its results. Even if the number of non-distressed tracts selected for OZ designation was small, such tracts could significantly affect program outcomes if they serve as magnets for investments, ultimately reducing the amount of investments that flow to more distressed tracts.

This paper is timely and offers important new insights about the Opportunity Zones program. As such, I recommend this essay to any tax scholar who is interested in place-based tax incentives, geography and taxation, or tax law administration.

Here’s the rest of this week’s SSRN Tax Roundup:

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