February 18, 2020, by Jon Peacock
As the 2020 legislative session winds down, the Wisconsin Legislature is rushing to pass a bill this week (SB 440)/AB 532) that would double a current state tax break for very wealthy investors who reinvest money in “Opportunity Zones.” A new issue brief by the Wisconsin Budget Project explains why the existing tax breaks for the rich are not having the intended effects and why it’s premature to increase those tax breaks.
The existing Opportunity Zone tax breaks began as part of the huge Trump tax cut bill enacted in December 2017. Comparable state tax incentives for wealthy investors were adopted by the Wisconsin Legislature at the tail end of the 2017-18 legislative session. Federal regulations finalizing the rules for the new tax breaks were not approved until two months ago, so implementation of the law is just revving up. Nevertheless, before we can clearly determine how it’s working, many legislators are ready to increase the state capital gains tax break for Opportunity Zone investments.
A list of resources at the end of the Budget Project issue brief demonstrates that organizations across the political spectrum have been highly critical of the Opportunity Zone program – in terms of either its original design or its implementation. Yet despite the numerous negative critiques of these relatively new tax breaks, there seems to be broad legislative support in Wisconsin for making our state the first to double the size of the capital gains tax reduction approved in 2018.
The Opportunity Zone program has the goal of using new tax breaks to encourage people or corporations with large investment gains to reinvest those capital gains in “distressed areas.” However, the program doesn’t seem to be working as intended. Rather than spurring investments that will help low-income neighborhoods, it seems mostly to be providing large subsidies for development that would happen anyway, often in areas that had already been growing rapidly.
A common critique from both the left and the right is summed up by Paul Krugman – the Nobel Prize winning economist and columnist for the New York Times – who recently wrote that Opportunity Zones “were supposed to help poor communities but have actually enriched billionaire real estate developers.” A a column published by the Badger Institute made a similar point in this quote of Stan Veuger, an economist with the American Enterprise Institute:
“You can look at the criteria and tell that a lot of people will benefit from the program that don’t need federal support. If you’re going to try to present it as a poverty-prevention program, rich people shouldn’t be the beneficiaries.”
I became interested in this issue a few months ago when I realized that a booming part of the Madison isthmus that I commute through on my way to work – the East Washington Avenue corridor – is one of the Opportunity Zones. That designation came after the area’s explosive growth of high-rise apartments and commercial establishments was well under way.
Another one of the 120 Opportunity Zones in Wisconsin is a thriving area on the west side of Madison that includes the UW Research Park. That zone also includes Exact Sciences, a booming biotech company with a market capitalization of more than $14 billion! Census tracts like that, which were enjoying explosive growth before being chosen as Opportunity Zones, are not the sorts of areas where we should give millionaires new tax breaks for making investments.
Those examples vividly illustrate that implementation of the recently enacted tax incentives, which some state legislators want to double, has gone awry. Our new analysis – The Top Ten Problems with Increasing Opportunity Zone Tax Breaks – explains how the program went off course and why state policymakers should not hurriedly pass a bill increasing the tax breaks that were rushed through the state legislature at the end of the 2018 legislative session.
One of the fundamental problems with the state and federal law is that the criteria for qualifying as an Opportunity Zone were poorly defined. In some cases, census tracts with relatively high income qualify because they have an average income that is at least 20% less than the surrounding metropolitan area. Some economically robust areas in university towns with median family income well above the state average managed to qualify because college students are included in the count of people living in poverty, which can make a flourishing area meet the loose poverty threshold for being “distressed.” In addition, a thriving commercial area whose residents are disproportionately retirees may also have low enough median family income to qualify. That appears to have been a significant factor in how the census tract that includes Exact Sciences met the eligibility criteria.
Another serious problem is that the criteria for qualifying for those tax reductions do not include any requirements that the projects funded in Opportunity Zones actually benefit the people living there. As a result, Opportunity Zone tax breaks are primarily subsidizing the type of investments that would happen anyway, such as high-end condominiums, apartments and retail establishments, rather than affordable housing and well-paying employment opportunities. In addition, some of the projects are likely to lead to gentrification, which hurts low-income Wisconsinites and people of color.
The biggest beneficiaries of the law are the corporations and very wealthy individuals who are able to reap substantial tax breaks by reinvesting large capital gains in “Opportunity Funds.” These funds generally have a minimum income requirement of at least $200,000 per year for individuals and $300,000 for couples, which excludes about 97% of Wisconsin tax filers. And when we look more closely at the distribution of capital gains income in Wisconsin among the 3% who appear to meet the income threshold, it appears that the top 1% will reap at least three-fourths of the Opportunity Zone tax breaks in our state.
Despite these and many other problems with implementation of the law, the legislation to increase the state tax breaks for Opportunity Zones enjoys bipartisan support in the state legislature. That can probably be attributed to the fact that many local government officials think the existing law and an increase in those subsidies could be a source of needed capital for investments in their communities. From their perspective, the subsidies are free money, even though these tax breaks will divert state and federal revenue from better targeted and more productive uses.
One can certainly understand that local and state officials representing distressed areas might be inclined to support these tax breaks. However, they appear not to realize that most of the incentives will go to investments in developments with higher returns, which in many cases will be located in census tracts that should not have qualified for the program.
One thing that may ease passage of the proposed legislation is that it has a relatively small fiscal estimate ($4.5 million during the period FY 2025 – FY 2027). However, that seems unrealistically low and does not account for the fact that the latest estimate of the national cost of the federal tax break was recently increased by about 75% to $3.5 billion per year. Also, subsequent to that re-estimate, new federal regulations were finalized that make the program even more generous to wealthy investors than the previously proposed rules.
Ironically, the legislature is also in a rush to pass a bill this week that makes many parts of the state tax code consistent with federal law, to make tax filing easier. Proponents of that bill have made broad pronouncements about the value of having as much consistency as possible between state and federal tax laws. However, the proposed Opportunity Zone tax break would do just the opposite by making Wisconsin the only state to offer a larger capital gains reduction than the federal law created.
Defenders of the Opportunity Zone tax breaks can make an argument that implementation of the law has barely begun in Wisconsin, so it’s too soon to say with complete confidence that it won’t succeed. That’s a defensible argument. But by the same token, it’s also much too soon to decide that the tax breaks should be increased and that state policymakers should complicate the tax code by making the Wisconsin incentives different than those provided by federal law.
Jon Peacock