California must compete for ‘Opportunity Zones’

Tens of billions of dollars are reportedly being raised nationwide by hedge funds, investment banks, and money managers looking to capitalize on new “Opportunity Zone” tax incentives created by the 2017 federal tax law.

So, what exactly are Opportunity Zones?

They are not a program, but a tool that creates an incentive for investors to transfer capital gains into low-income neighborhoods. Projects that previously did not “pencil out” can now become feasible because Opportunity Zone tax benefits typically increase returns by 3 to 4 percent. The U.S. Treasury has certified 8,700 census tracts as qualified Opportunity Zones (QOZ’s), of which 879 are in California.

While 34 states have already acted to conform their capital gains treatment with federal law, California has yet to do so.

But California is at risk of missing this opportunity to invest in its poorest neighborhoods.

At an Opportunity Zones conference at Stanford on March 18, Gov. Gavin Newsom made it clear he does not want to miss the opportunity. He said, “I’m not just interested in Opportunity Zones, I’m committed to make them work for Californians in our low-income neighborhoods.”

The Legislature and local governments need to catch up.

While 34 states have already acted to conform their capital gains treatment with federal law, California has yet to do so. This is putting the state at a decided disadvantage, as investors consider where to direct their funds. (Currently, California treats capital gains as ordinary income, making any large gains subject to the state’s highest income tax rate: 13.3 percent.)

Thoughtful regulatory relief should also be considered by the Legislature. Investors can take their capital gains to projects in Opportunity Zones all over the country. They will go where there is predictability and certainty.

Residents in Opportunity Zones have heard all the historical reasons for lack of investment in their neighborhoods. The tax base is too low for municipalities to invest in infrastructure. The household incomes are insufficient to justify investment in market-rate housing. Discretionary spending is insufficient to justify investment in retail projects. The list goes on.

The federal incentives warrant a reevaluation of these projects. But while other states have deployed teams to help local governments work with prospective investors to identify and publicize feasible projects, California has yet to act.

California’s state government is responsible for a huge range of programs active in or near Opportunity Zone neighborhoods, from workforce development and poverty reduction programs to infrastructure projects. More than 150 different state financing programs and multiple grant programs exist to promote equitable and sustainable development. Gov. Newsom could direct state agency heads to strategically align these programs to help local governments maximize the attraction of capital—leveraging public resources with private Opportunity Fund investments.

At Stanford, the governor said he has initially prioritized affordable housing and clean technology projects for Opportunity Zones, but he asked for input on whether the state should take a broader approach. We favor widening this lens to include a broader range of state priorities, from business investment that creates well-paying jobs to new growth industries such as biomass that could help the state achieve its climate goals and increase resiliency, or even areas as specific as modular building startups that could help produce lower-cost housing.

One important reason for widening the lens is the importance of creating a strong jobs-housing balance in Opportunity Zones.  If all we do is improve housing, but don’t concurrently create living wage jobs, the result will likely be displacement and gentrification, an outcome that would be totally contrary to the intent of Opportunity Zones.

In short, if California is to compete for these investments, we need to rapidly conform our capital gains treatment to federal laws, provide thoughtful regulatory relief that gives OZ investors predictability and certainty, align state program spending to enhance the social benefits that will be key to Opportunity Zone success, support local government efforts to identify and publicize qualified projects, encourage investments in projects that create a strong jobs-housing balance, and be highly intentional about avoiding displacement and gentrification.

Action is needed quickly.

As the law currently reads, investors have a narrow window of time to maximize the tax benefits from qualified projects. They will be anxious to act within this window, and California does not want to be left empty-handed at the starting gate.
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Editor’s Note: John Chiang, former state treasurer, and Pete Weber are co-chairs of California Forward, a nonpartisan, nonprofit government reform group based in Sacramento.