The tax legislation that US President Donald Trump signed into law last December will dramatically increase inequality and the federal budget deficit. Yet, hidden within it – and within budget legislation enacted in February – are two promising programs for helping state and local governments address the needs of disadvantaged Americans.
The new tax law creates generous incentives to encourage private investment in distressed urban and rural areas; and a provision in the budget package will establish a competitive grant program to help states fund “pay-for-success” contracts. Both ideas have their roots in the Democratic administrations of Presidents Bill Clinton and Barack Obama; but they attracted congressional Republican support because they empower state and local governments, rely on public-private partnerships, and encourage rigorous impact assessments.
The provisions in the tax law to encourage private investment in impoverished areas center on the creation of “Opportunity Zones” (a term coined more than 30 years ago by New York Governor Mario Cuomo). The OZ program grants US governors the authority to designate up to 25% of low-income census tracts – those with an individual poverty rate of 20% or higher, and median family income below 80% of the state or territorial average – as OZs.
Private investors are then granted significant tax incentives to reinvest their unrealized capital gains into OZs through “Opportunity Funds.” OFs can choose the nature of the assets (the risk/return profiles) they offer their investors, but must be organized as corporations or partnerships, which invest at least 90% of their capital in OZs.
Individuals who invest in OFs are eligible for several tax benefits. These include a temporary tax deferral on unrealized capital gains; a step-up in basis on the capital gains earned and reinvested in such funds; and a permanent exclusion from taxes on capital gains earned on fund investments held for ten years or more. A recent Brookings Institution report estimates that, “Individuals in a high-tax state and with short-term capital gains can avoid $7.50 in taxes for each $100 they invest, even before considering any return on their Zone investments.”
Read more at Project Syndicate