AGENCY COORDINATION AND OPPORTUNITY ZONES.

• Author: Saito, Blaine G.
• Position: A Taxing War on Poverty: Opportunity Zones and the Promise of Investment and Economic Development

Introduction 1204 I. Some Opportunity Zone Basics 1206 A. Basics of the Program 1206 B. Concerns with OZs 1208 C. The Complexities of OZs 1210 II. Agency Coordination for Opportunity Zones 1211 A. Agency Coordination and its Benefits 1211 B. Coordination Pitfalls 1215 C. Coordination Versus Reorganization 1216 III. Structuring OZ Agency Coordination 1217 A. Agencies Involved 1217 B. Coordination from OMB and OIRA 1219 C. Managerial Coordination Tools 1220 i. Memorandum of Understanding 1220 ii. Information Sharing 1221 iii. Line-Level Teams and Line-Level Outreach. 1223 D. Improving Community Input 1224 Conclusion 1226 INTRODUCTION

The Opportunity Zone (OZ) program, one of the centerpieces of the 2017 Tax Cuts and Jobs Act (TCJA), is another in a long line of place-based tax incentives to improve certain distressed areas in the United States. (1) And, unlike the TCJA at large, OZs have bipartisan provenance and support. Senator Cory Booker (D-NJ) continues to serve as one of the Democrats loudly supporting a major program that came into existence under a Republican-supported tax law that passed with few Democratic votes. (2)

Furthermore, many state governors also appreciate the OZ program. That is because, as structured, they have a great deal of latitude in determining what areas qualify for OZs.

But OZs have also had many problems. Recent reports have shown that many OZs and investments in them are of questionable value in reviving neighborhoods. Some already existing development projects have fallen into the OZ provisions' deferral of gain. Others have noted that many of the communities within OZs have little say in the types of development there. And there is an overall sense that the OZ program is, in the end, not really here to help economically disadvantaged people, but rather to help the financially well-off grow their wealth through limited tax requirements.

The rest of this issue catalogs these problems and some credible solutions regarding OZs. This short Essay instead focuses on something smaller, the question of whether the Internal Revenue Service (IRS), the primary federal agency involved in administering OZs, along with the Office of Tax Policy at the Department of Treasury (OTP), are up to this task of managing economic development for underserved communities.

The management, administration, and oversight of OZs is beyond the IRS's capacity. The IRS, as it stands, does not have the requisite expertise to implement many desirable changes in the OZ program, were they to come to pass. The IRS does not really have the ability to work with states to ensure they are selecting OZs properly or providing them with technical support to be cost-effective. The IRS also cannot help in ensuring that community voices are heard. And the IRS may not be able to coordinate across the federal government to improve OZs and other community development-related programs effectively.

But the IRS still has an important role to play. The OZ program requires some complex investment entity structures to provide equity in development projects and businesses in the OZs. There are significant tax calculations and concepts embedded in the program. The IRS also has some visibility regarding other related tax programs that seek to revitalize neighborhoods.

This Essay draws on existing work on tax coordination. It proposes that rather than eliminating the IRS's role, the federal government select the OZ program as a prime candidate for tax coordination among the IRS, OTP, and other federal agencies in the community development space, such as the Treasury's Community Development and Financial Institutions (CDFI) Fund, the Department of Housing and Urban Development (HUD), and the Department of Agriculture (USDA) to better manage and monitor the program. Thus, it can draw on these agencies' expertise and help coordinate OZs with other programs and other tax expenditures to ensure that OZs work in concert and do not run at cross-purposes. This tax coordination could also help improve the lack of community input, as some of these other agencies have far better outreach mechanisms.

The Essay consists of three parts. Part I provides a brief overview of the OZ program and some of its problems. Particular attention is paid to the complex interweaving of tax and non-tax matters within the program itself.

Part II then outlines some of the benefits and pitfalls of agency coordination, with a particular focus on OZs. This Part considers why agency coordination makes more sense than moving the program out of the IRS's management.

Part III develops the way forward on coordination of OZs. Given the complexity of the program itself and the potentially large amounts of money involved, it suggests there should be a relatively intensive level of coordination. Part III also discusses some of the most useful tools from the agency coordination and tax coordination literature to facilitate coordination between the IRS and other agencies in this sphere. Finally, it also talks about how coordination can help to engage and empower citizens on the ground.

1. SOME OPPORTUNITY ZONE BASICS

   This Part outlines some of the basics of the OZ program and highlights some of the problems others have mentioned regarding OZs, with a focus on matters that likely rely on the IRS's expertise and matters that fall outside the IRS's expertise.

   1. Basics of the Program

      The OZ program enacted in the TCJA is different from previous place-based community revitalization tax expenditures. While tax incentives like the New Markets Tax Credit (NMTC) (3) or the Low-Income Housing Tax Credit (LIHTC) (4) are designed to allow leveraging of debt-financing for development projects, OZs seek to create opportunities for equity investments and potentially unleash new amounts of capital into place-based economic development efforts.

      The main tax benefits of an OZ stem from two areas, gain deferral and a potential increase in the basis to cover those deferred gains. (5) Generally, there are funds--called Qualified Opportunity Funds (QOF)--that pool equity investments from various investors into projects in an OZ. (6) The investors then get to defer the tax on the gain they earned on the QOF investment until the sale or exchange of that investment or December 31, 2026, whichever is earlier. (7)

      Furthermore, the investor in a QOF can increase the basis of their QOF investment. If they hold the QOF investment for at least five years, then 10% of the deferred gain is added to the basis. (8) If they hold it for at least seven years, then 15% of the deferred gain is added to the basis. (9) And if they hold it for at least ten years, the investor can essentially eliminate all gain by electing to change the basis amount to the fair market value of the QOF investment on the date of the sale or exchange. (10)

      QOFs can invest either in interests in Qualified Opportunity Zones (QOZ) Businesses, which earn 50% of their gross income from within the QOZ, or in QOZ property, which is tangible property that a QOF purchased and uses in a trade or business. (11) For QOZ property, the property must either have its original use commence with the QOF or the QOZ Business using it or be substantially improved by the QOF or the QOZ Business. The property must also have at least 70% of its use within the QOZ during 90% of the time the QOF or QOZ Business held the property. (12)

      QOZ are certain census tracts that meet particular requirements as low-income areas, similar to the requirements under the NMTC, or a census tract contiguous to a low-income area provided that the median income there does not exceed 125% of the median family income of the adjacent low-income census tract. (13) States then select no more than 25% of those eligible tracts within the state to be QOZ, (14) and the Treasury then determines whether they qualify and grants the designation. (15)

      The OZ program, as envisioned, includes multiple parties. There are investors. (16) There are the QOFs, special purpose entities for this program. (17) There is the federal government. (18) There are state governments. (19) And there are the businesses and communities themselves that fall within a QOZ. (20) The story sounds like one of doing well by doing good, but commentators have started to highlight some problems. (21)

   2. Concerns with OZs

      Others in this Symposium pointed out that OZs have had numerous pitfalls. (22) This section highlights some of the challenges OZs face relevant to this Essay.

      One considerable concern is that many areas that governors chose to designate as OZs were areas that already had significant economic growth. (23) Indeed, some significant projects that used OZ financing were already planned prior to the program's development. (24) Many OZ projects may thus be inframarginal investments, meaning that they would have occurred without the existence of the program. (25) If the program falls too heavily on such inframarginal effects, it may not be economically efficient.

      Additionally, some critics have raised concerns that areas designated as OZs are not the areas facing the most significant economic challenges. (26) The ability to use census tracts adjacent to some of the most low-income and distressed areas may mean that investment may not occur in the areas with the greatest need. Furthermore, even among those census tracts that qualify based on their status as low-income tracts, some of these tracts have greater needs for investment than others. The lack of technical understanding of those needs and how best to meet them, along with potential political pressures, may lead governors to designate OZs that do not truly help the most low-income communities. This misguided designation may then further blunt some of the desired gains in place-based economic development. Furthermore, this combination of flexibility and lack of technical support in trying to find the communities of greatest need and how best to help them with...