In practice, the law strongly favored builders over business owners with little benefit for lower-income residents, and arguably needs a major overhaul. Nonetheless, OZs have a powerful lobby and clearly are darlings in the White House now that it’s again occupied by a former property developer with friends and family prominently in that business. Influential proponents are licking their chops.
Meanwhile, last month’s wildfire disasters in Los Angeles County have homeowners, local businesses and regional policymakers scrambling for feasible ways to rebuild. The devastation in residential areas only worsened an existing housing shortage. Many former residents and businesses will never return. The process of land regulation and assembly for new construction will require some re-thinking by urban planners and new, better tools for rebuilders. A similar problem remains from the aftermath of hurricane damage in the southeastern U.S. along with other communities destroyed by tornadoes, floods and earthquakes. Therein lies the case for longer-term public policies to promote recoveries.
This is where a new category of Opportunity Zone tax incentives could play a limited but important role in rebuilding devastated communities — but only if new legislation focuses on results and not tax-dodging gimmicks. So it’s important to focus on where these tax expenditures would be worthwhile and how to write rules that actually work.
Shaping OZ 2.0
With the Super Bowl of Taxes coming soon in the inevitable 2025 congressional tax legislation, it’s almost certain that Opportunity Zones will resurface as favored children with a strong chance of new authorizations. That makes this the perfect time for state and local leaders to advance their version of what might be called "OZ 2.0," with not only economic growth but also natural disaster recovery in mind.
For local communities, the specific tax incentives to be allowed by Congress are less important to this idea than the eligibility requirements. It’s almost a given that wealthy investors and property developers will be lured with federal tax incentives. That’s the How. State and local government associations will generally have little influence in designing the size and nature of the federal tax breaks, and need to focus their attention foremost on the Where and the What.
The Where, for OZ 2.0 purposes, should be a better definition of eligible zones. Foremost should be a specific authorization for any census tract that has been declared a federal disaster area to be eligible for OZ tax incentives for something like a seven-year period thereafter. Nationally, fewer zones overall would be better, as the socioeconomic criteria embedded in the original rules were too sloppy and scattershot, resulting in literally thousands of zones uselessly designated in remote and impractical areas.
The states should be given greater discretionary authority to each designate at least a handful of target zones that would attract global manufacturers and genuine economic development — the kind that create hundreds, not just dozens, of long-lasting jobs that generate sales and revenue from outside the zone. Then Congress can come up with a formula for maybe 1,000 other zones based on median household income.
The What involves the types of projects and businesses that should enjoy such favorable tax treatment. Where housing shortages prevail, multiunit residential developments should be included with a bias toward middle-class, senior-citizen and lower-income housing, not luxury condos and McMansion enclaves. Individual single-family homes should not be OZ-eligible.
Stronger requirements for post-construction business employment fostering in-zone residency for more workers should be another key criterion. Federal tax laws could also provide unlimited authority for local governments to provide coveted tax-exempt private activity bond funding for OZ 2.0 projects that meet such requirements with official support from local agencies responsible for economic development.
Finally, the new approach should directly support startup and returning businesses that employ local workers who reside in a disaster-area zone or an adjacent census tract. This could include new federal income tax credits for the qualifying businesses and their on-site employees who reside locally and earn less than the national median household income, now $80,000. That’s a new tax-break strategy that the state and local government lobbyists should pursue aggressively on Capitol Hill.
An Expanded Role for States
Municipal officials should also promote matching requirements for state aid and financial inducements to go with the federal carrots. If done right, this would actually reduce the federal tax expenditure, which would help with the budget math by requiring state leaders to put their money where their mouths are. Congress should help those who help themselves, and there are numerous ways to do that. A federal-state cooperation rule would at least empower some states to check runaway giveaways to billionaires.
For example, OZ 2.0 eligibility could require some form of equivalent state aid to local municipalities that have suffered catastrophic losses, as well as those with qualifying lower-income census tracts. Where states have income taxes, targeted tax credits for the workers and local businesses who build or rebuild would be one tool to include or even require. States with no income taxes could be required to provide comparable property tax relief, either directly to the local owners or indirectly through reimbursable local tax credits and waivers.
For their part, participating states should outlaw predatory and exploitative business practices, including below-market property acquisition and price- or rent-gouging by beneficiaries. Otherwise, well-intended tax incentives could fuel practices that taint the entire endeavor. State authorization for local redevelopment agencies with powers of eminent domain, tax abatements and tax increment financing would all be supportive of complementary partnerships in such situations. Congress could simply include a brief, broad-brush authorization for states to put such rules on their books as a condition of eligibility and leave the implementation entirely to them without micromanaging.
Somebody in the state and local government community needs to boil their most vital ideas for OZ 2.0 down to a single page of tax-law text. Too many details will torpedo any proposals on Capitol Hill. Attaching a few — but just a few — complementary state and local strings to these juicy federal tax breaks will help impose fiscal discipline and mitigate the crony capitalism that tarnished the original version of Opportunity Zones.
That may annoy a few White House or Mar-a-Lago chums, but it’s the right thing to do. Those in the political minority should take note, as should true fiscal conservatives and the public-sector associations’ leadership. They can all help prevent OZ 2.0 from becoming yet another fat-cat boondoggle that just rewards rich developers for doing what they already would do without new tax breaks.
These ideas will not fall out of the sky into the brains of the folks on Capitol Hill writing the 2025 tax bill. Today’s entrenched Opportunity Zone lobby has no incentive to consider the interests of states and municipalities — or local residents, for that matter. So this is an issue that requires quick concerted and coordinated action by the state and local government associations and their professional affiliates. Governors, mayors, city and county administrators, and finance officers all need to unite soon with a common and concise summary proposal if any of these concepts are to materialize in the forthcoming tax legislation.
Governing’s opinion columns reflect the views of their authors and not necessarily those of Governing’s editors or management.
