What Can Opportunity Zones Do for Chattanooga?

Last year, Congress passed the highly contentious Tax Cuts and Jobs Act. It permanently reduced corporate tax rates, provided a sunset provision for middle-class tax cuts, and expanded the deficit by approximately $1.5 trillion over the next ten years. The major provisions of the tax bill itself were divisive and largely praised or condemned on strict partisan lines.

However, tucked away a hundred pages deep in an otherwise-polarizing piece of legislation is a quiet, innovative, and bipartisan program designed to bring relief to the nation’s distressed communities.

Senators Tim Scott (R-SC) and Cory Booker (D-NJ) spearheaded the initiative based on legislation drafted earlier in 2017. The idea was driven by the Economic Innovation Group, a bipartisan-run think tank founded by Sean Parker to address challenges in communities where incomes remain well below the national average and poverty rates are high.

What Is an Opportunity Zone?

As outlined in legislation based on the Investing in Opportunity Act, an Opportunity Zone is an innovative new community development policy that will provide a unique incentive for equity capital investments in low-income communities across America.

In the Tax Cuts and Jobs Act, Congress empowered governors of all fifty states to designate 25 percent of all eligible Low-Income Community census tracts as nominated Opportunity Zones. Within the zones, corporations, funds, and financiers who invest in the Opportunity Zones will enjoy favorable capital gains treatment. The following benefits are present for investors who put their capital in these distressed neighborhoods through an Opportunity Fund:

• Gains accrued from investments held for at least ten years in qualified neighborhoods through an Opportunity Fund are permanently exempt from capital gains taxes.
• Immediately, there is a temporary deferral of inclusion in taxable income for capital gains reinvested into an Opportunity Fund.
• Over time, there is a stepped-up basis for taxable income on invested capital gains. Once investments have been held at least five years, there is a 10 percent step-up in basis, and after seven years, the step-up in basis rises to 15 percent.

Essentially, this allows significantly lower capital gains tax burdens on the appreciations of investments in an Opportunity Fund and substantial increases on effective annual returns compared to equivalent non-Opportunity Fund investments, assuming the same rate of return. For investors, this is a very favorable treatment and, in theory, will incentivize private investors to make substantial investments into previously distressed communities.

Opportunity Zones offer distressed communities a way to potentially reallocate up to $6.1 trillion in existing unrealized capital gains, a figure based on data from the Federal Reserve.

Opportunity Funds, the investment vehicle through which capital gains may be reinvested, must hold at least 90 percent of their assets in a qualified property. After the designation of Opportunity Zones by the US Treasury Department in coordination with the governors of all fifty states, the Treasury Department will issue further guidance on how investors and fund managers may set up Opportunity Funds.

Why Does It Matter for Chattanooga?

As it stands, the Opportunity Zone program offers a potential 2‑3 percent after-tax increase in annual rates of return over non-Opportunity Fund investments. This has the potential to incentivize substantial sums of capital investment in neighborhoods in critical need of community development and additional infrastructure. An Opportunity Fund could reasonably leverage private investment and philanthropic dollars to invest in grocery stores, affordable housing, mixed-use retail development, and small businesses that would not have traditionally attracted investment from the private sector.

The special treatment under the provision is something of an experiment. While the idea of a geographically focused incentive area is not new (eg, Promise Zones, Enterprise Zones, Empowerment Zones, Choice Neighborhoods), the vast majority of these prior programs focused on providing a preferred status for grants, bonding authority, and tax credit eligibility status at the federal and state levels. Opportunity Zones, unlike their predecessors, are among the first place-based initiatives to utilize the tax code to provide a direct incentive for individual investors.

It’s unclear how significant this incentive might be in jump-starting distressed communities in our county. One could reasonably imagine that the preferred treatment would not be enough of an incentive if market-ready investment opportunities are not present. However, if an Opportunity Fund were to build a portfolio of investments that provide near-market rate returns, then the outcomes of the program may be quite substantial in infusing capital directly into communities that need it most.

Census tracts are considered eligible if the tract has either (1) a median family income at or below 80 percent of Area Median Income or (2) a poverty rate of 20 percent or greater as determined by data from the US Census Bureau. Furthermore, additional tracts are eligible if they meet certain high migration thresholds, contain an Empowerment Zone, or are contiguous to a qualifying low-income tract. Hamilton County has thirty-three census tracts that are eligible to be nominated as Opportunity Zones by Governor Bill Haslam.

See which census tracts qualify at the state of Tennessee’s Opportunity Zone proposal portal: https://www.tn.gov/ecd/opportunity-zones.html

Metro Ideas Project has identified several eligible census tracts within the city of Chattanooga as particularly good candidates for designation as an Opportunity Zone, based on the stated intent of the legislation:

• Westside (census tract 16)
• East Chattanooga (census tracts 122, 123)
• Alton Park (census tracts 19, 23)
• Glenwood (census tracts 11, 12, 4)
• Highland Park (census tracts 26, 13)

These selections are predominately based on the poverty and unemployment characteristics of the area, as well as ready access to support institutions and service providers, arterial transit corridors, gross rent as a percentage of household income (GRAPI) figures, and availability of developable parcels.

Depending on the intent and selection of these census tracts to be nominated as Opportunity Zones, it may be reasonable to include the following contiguous census tracts within an Opportunity Zone:

• Downtown Chattanooga (census tract 31)
• UTC/MLK Area (census tract 124)
• Highland Park/National Cemetery (census tract 14)
• East Lake (census tracts 24, 25)

What’s Next?

While the deadline for Governor Haslam to submit a list of nominated census tracts to the US Treasury Department was extended to April 20, 2018, the deadline set by Tennessee’s Department of Economic & Community Development for submissions for consideration from Tennessee’s county mayors has already passed.

At this point, the governor is fulfilling his statutory role to review the submissions and make a formal nomination of a series of census tracts to the US Treasury Department.

We are eager to see which tracts will be nominated as designated Opportunity Zones, as this program could potentially spark a substantial inflow of investment and capital opportunities for neighborhoods in dire need of an economic spark. Our community should begin planning now for the implementation of those zones—from rigorous evaluation of proposed investments to the convening of potential investors and partners.

We know that public programs that jump-start private investment can be leveraged to great effect in low-income communities. California’s Freshworks program utilized $30 million in seed funding to bring in over $273 million in financial investment to open grocery stores and healthy food options in underserved communities across south Los Angeles. The Corridor Investment Fund is the result of substantial public-private partnerships that have resulted in over $170 million in financing for over thirty-six projects and 1,000 new or rehabbed housing units that have collectively begun to revive the urban core of Detroit.

If Chattanooga is serious about utilizing an Opportunity Zone to provide stronger pathways into the middle class, seed community anchors that foster neighborhood equity, and foster sustainable employment opportunities that offer a living wage, then we encourage the convening of a wide range of community partners and residents.

It’s important that we’re cautious in the implementation of the Opportunity Zone, as well. As Brookings Institution researcher Adam Looney recently outlined, the risk of straying too far from the Opportunity Zone’s stated intent of assisting distressed communities is very real. Rather than bringing critical resources to struggling neighborhoods, there’s a possibility that the tax benefits could accelerate displacement trends in economically shifting neighborhoods by favoring developers and investors who already stand to have large capital gains. Efforts to avoid this outcome through thoughtful investments, a resident-focused portfolio, and data-driven rigor when determining qualifying projects are highly recommended.

Given Chattanooga’s long history of successful public-private partnerships, our neighborhoods are poised to stand out as a model for what a successful Opportunity Zone could look like. Let’s take full advantage of this new tool to lift up the residents who need it most.