Rep. Erik Paulsen: How tax reform brings opportunity to poor neighborhoods

America’s new economy is finally taking off.

In January 2017, prior to tax reform and regulatory reforms, the Congressional Budget Office projected only 1.9 percent growth for 2018. CBO now projects 3.3 percent growth for 2018, the highest annual growth rate since 2005.

While all Americans will benefit from this growth, some still need even more help. In the average state, 15 percent of the population lives in a distressed community.

The new tax law contains a provision designed to help areas that are not growing so fast. Governors select specific areas (or “tracts”) for tax-favored private investment.

What contributes to the problems in these struggling communities? It’s difficult to say, and it can include anything from a paucity of capital investment and employment opportunities—possibly due to high and complex state and local taxes, and overregulation—to underperforming schools, and drug and alcohol abuse. Reformers have long looked for legislative solutions that can provide relief, and “Opportunity Zones” may be an answer that puts the power back into the hands of local communities.

As a component of the Tax Cuts and Jobs Act, Opportunity Zones are intended to incentivize long-term private investment into low-income areas, based on the Census. This approach allows state governors, and not Washington central planners, to select 25 percent of the state’s low-income census tracts as Opportunity Zones. If the state has fewer than 100 low-income census tracts, governors can designate 25 of them. Because of this local focus, Opportunity Zones can succeed where past location-targeted programs have shown, at best, mixed results.

For example, a Colorado Enterprise Zone study showed some evidence of job creation; whereas, a California Enterprise Zone study finds no evidence of increased employment. What did they have in common? They were all federally designated geographic areas of high poverty and economic distress. Alternatively, Opportunity Zones are designated at the state level and offer investors more discretion than many past programs.

Sen. Tim Scott, R-S.C., recently wrote in a USA Today op-ed that governors and local leaders will identify key qualifying locations to assure “the zip codes most in need are the ones that reap the benefits.”

Similarly, the Economic Innovation Group’s John Lettieri and Steve Glickman wrote in The Hillthat previous location-targeted programs offered an “overly prescriptive, top-down approach that left no room for local experimentation.” Additionally, they explain that Opportunity Zone flexibility will bring, “the best possible mix of investments in new and expanding businesses, infrastructure and energy projects, commercial real estate, affordable housing, and more.”

The motivation to invest and build value long-term is another important aspect of this new approach. The tax benefits are greatest when value is created. They are not granted merely for temporarily employing more people. The benefits are less for projects that are not successful.

Once governors determine which areas will receive the special treatment, investors can invest pretax capital gains earned on any investment anywhere, i.e., not necessarily in a designated Opportunity Zone and realize immediate tax benefits. Those benefits include capital-gains tax deferral for the first four years, followed by progressively larger tax reductions after holding the investment for five, seven, and 10 years.

My own state of Minnesota is hoping to attract additional long-term private investment into 128 census tracks recently selected as opportunity zones.

Opportunity Zones have the potential to bring long-term capital investments into struggling communities, which will hopefully lead to sustained economic growth. However, they will have a much better chance of succeeding if they are accompanied by market-friendly taxation and regulation, as well as better schooling and training policies. Federal tax reform and deregulation will help; but, to maximize Opportunity Zone benefits, state and local governments should facilitate further market-friendly reforms.

In the meantime, by allowing decisions to be made closer to home, we’re taking a step in the right direction.