An opportunity to enrich the opportunistic

Published March 30, 2020, in Tax Notes Federal, weekly magazine of Tax Analysts Inc., where I was a reporter and editor in the early 1990s.

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Rendering of the Ritz Carlton hotel/condo/retail skyscraper under construction in Portland (GBD Architects)

This is a story about billionaires, how Congress makes laws, how city development officials work with rich people to ignore poor people, and how legislative dysfunction has spread from the nation’s Capitol to Oregon’s Capitol.

One of the billionaires is Sean Parker.

When Parker was in high school, the FBI raided his parents’ house, carting away his computer, from which he’d been hacking into systems around the world. At 19, he cofounded Napster, the music “sharing” service that unraveled on copyright violations. He negotiated Mark Zuckerberg’s permanent control of Facebook’s board with its initial investors. His friends tell reporters he’s nothing like Justin Timberlake’s dark and greedy portrayal in the 2010 movie The Social Network. He is an autodidact, a serial entrepreneur, and a philanthropist among the world’s elite.

With fellow investors, he founded a section 501(c)(4) advocacy organization, the Economic Innovation Group. From 2015 to 2017, EIG spent $2.88 million on lobbyists advocating a tax incentive labeled “Opportunity Zones.” When President Trump pushed Congress to pass a tax bill in December 2017 with no hearings and no deliberation, the provision’s proponents realized their opportunity.

Among Parker’s talents is the ability to recognize the commercial/political potential of someone else’s idea. Opportunity Zones are an old concept: tax incentives for geographically targeted private investment, intended to create economic activity in “distressed communities,” defined by certain poverty criteria. As Forbes put it in marketing an investor conference last May, Opportunity Zones aim “to unlock transformative economic potential and create lasting change in America’s overlooked communities.”

Jack Kemp, HUD secretary to George H.W. Bush and quarterback for the Buffalo Bills in the 1960s, made “enterprise zones” the first of these place-based tax incentives. In politics, Kemp was known for two things: championing low taxes for the wealthy (as a congressman he co-authored “Kemp-Roth,” which became Ronald Reagan’s 1981 tax cut), particularly capital gains; and being a rare GOP advocate for decaying urban cores and their predominantly black constituencies, a sensitivity that perhaps grew out of playing pro football. Enterprise zones tied his passions together.

The birth of ‘Enterprise Zones’

I was congressional correspondent for Tax Analysts when Kemp was HUD secretary, and I was present at the 1992 GOP Convention when the quarterback brought along as props his (black) linemen for a press conference in the Astrodome to push his idea, which at the time was being written into a bill responding to the Los Angeles riots that spring. (Bush vetoed the bill for unrelated reasons, and Bill Clinton signed one that included enterprise zones in 1993.)

In Kemp’s time, white people were still in the suburbs, where they had built well-funded schools and services, and their kids hadn’t begun streaming back into the cities.

Economic literature developed since shows that enterprise zones and the like have done nothing to help distressed communities and the people who live in them. As the Heritage Foundation concluded in July:

Academic and government studies consistently show place-based development programs fail to increase employment, raise wages, or advance general economic opportunity for targeted residents because they have not addressed the main causes of poverty.

What do they do? Accelerate gentrification.

The why is economics: Where government showers a benefit, the market prices it. If a particular square mile is bestowed tax or other monetary advantages, the value will pass through to the owners of that square mile. That is, the price of land within that mile will rise to absorb the difference in economic value between it and the surrounding area. So the businesses or homes within that favored mile will face higher property values and therefore higher rents. If you’re a business leasing space in a zone making widgets, your profit margin gets squeezed compared to the widget maker on the other side of the line. If you’re a renter, your apartment is now sitting on higher-value land, and your rent goes up — or the building gets renovated or replaced, for renters or buyers who can pay more.

The economics must be irrelevant to Congress. Twenty-five years later, the myth still holds about alleviating poverty or stimulating job creation — which perhaps is why some, like Sen. Cory Booker, D-N.J., believe tax incentives can revitalize cities like Newark. Or maybe he’s so desperate for a tonier skyline that he’s up for anything.

But Opportunity Zones are really about tax breaks for Parker, who told a Treasury-sponsored conference in August, “When you are a founder of Facebook and you own a lot of stock, you spend a lot of time thinking about capital gains.” Or as Forbes the magazine (distinct from the conference sponsor) headlined a story in July 2018: “An unlikely group of billionaires and politicians has created the most unbelievable tax break ever.”

So let’s return to the Opportunity Zones Congress authorized in 2017.

The rush to identify Opportunity Zones

Section 1400Z-1 gave the nation’s governors 90 days to designate as Opportunity Zones a portion of the census tracts whose poverty criteria were defined in another tax code version of enterprise zones called the new markets tax credit, in section 45D, created in 2000. Governors did so, guided by instruction (H. Conf. Rep. 115-466 at 538) that the tracts had demonstrated success under other federal or state incentives. In May 2018 Treasury certified the governors’ 8,700 zones throughout the country. (Corruption has been alleged around at least one of Treasury’s certifications, in Storey County, Nevada — which may be intrinsic to the story.)

Opportunity Zones have two types of tax incentives under section 1400Z-2. The first allows investors to sell assets, such as stock or other property, deposit the proceeds into a qualified opportunity fund (QOF) and defer the capital gain tax they would otherwise owe until 2026. In 2026 investors get a discount on that tax.

The second incentive applies to the investment in the QOF: If held in a fund for 10 years, the capital gain at sale is tax-free.

Example: I own $1,000,001 in Facebook stock that I bought for $1. Yesterday I sold the stock and put my million-dollar gain in a QOF. The capital gains tax rate is 23.8 percent, so in 2026, I will pay tax of $238,000, less a 10 percent basis increase. Had I sold the stock before 2020, my basis increase is 15 percent. But I didn’t because I’m not in-the-know like Parker, so I’ll pay $214,200 in 2026, whereas Parker will pay $202,300.

Now my million dollars are in a QOF, the financing vehicle for projects in Opportunity Zones. Wherever I invest it — and there are QOF projects all over the country — I can’t touch it for 10 years, so it better project a great return, otherwise I’d do better in something without that restriction (or not realizing the gain in the first place). The stock market produces returns of 7 to 10 percent and investment-grade real estate of 10 to 12 percent, to account for its relative illiquidity.

Thus, I’m eyeing Opportunity Zones that are likely to double in value — places where the population is booming and land is tight, but that have empty lots or land whose price is cheap but likely to get expensive. If I don’t have a big capital gain, I lose. The investment works only if my tax-free gain exceeds the returns from other options.

‘Tax Breaklandia’

As it happens, I live near downtown Portland, which is one of the hottest real estate markets in the country. (Bloomberg BusinessWeek in February won a George Polk Award for its 2019 story, “Welcome to Tax Breaklandia.”) And it’s all in Opportunity Zones, because the governor picked these census tracts that met the requisite poverty criteria (as of the 2011-2015 Census Community Survey).

Portland is hot because people are flocking here. Projects have been in the works for a while. And thanks to the looseness with which Congress and Treasury wrote the rules, a bunch of them essentially sold themselves into new entities to exploit the Opportunity Zone tax breaks. These skyscrapers, their financiers proclaim, include Oregon’s first five-star hotel/condo — with units expected to sell for $1.9 million to $6.5 million — and the most luxurious apartments in town.


Below the Portland skyline and I-405

What’s that do for the poor people who live downtown? Push them out to cheaper land, like the sidewalks, bike trails, and highway cloverleafs where Portland’s growing homeless population somehow survives.

Some citizens I work with recognized this outrage — tax breaks for people rich enough to have significant reportable capital gains (perhaps 5 percent of taxpayers) sold as help for the downtrodden — and the threat it poses to Oregon’s general fund. We couldn’t influence Congress — where our senator, Finance Committee ranking Democrat Ron Wyden, has a bill, S. 2787, to tinker around the edges of Opportunity Zones. But maybe we could reason with the state legislature.

When Congress passed the law, the Joint Committee on Taxation estimated Opportunity Zones would cost about $1.6 billion a year through 2025. In 2026, when the deferral period ends, the government would recover about two-thirds of its losses, but then in 2027, the losses would accelerate. Because the JCT only estimates the cost of tax provisions for 10 years, it had no estimate for year 11, when tax-free capital gains on QOF investments kick in. (If you think this design was accidental, you haven’t watched Congress write tax law for 30 years.)

Oregon conforms to federal income tax benefits by default. If Congress does it, Oregon does it, unless the legislature “disconnects.” (California and two other states are nonconforming, and nine states, including neighboring Washington and Nevada, lack personal income taxes and so don’t offer Opportunity Zone benefits. North Carolina disconnected in 2018, and in Maryland a bill has passed the House.)

The legislature’s economists extrapolated from the JCT’s estimates a revenue loss of about $8 million a year in the current biennium, about 0.5 percent of the JCT estimate. In December the JCT doubled its estimate, to $3.5 billion a year. Oregon, by that scale, is now out $35 million per biennium, with no guess for the out-years. QOFs are an unmeasurable liability.

A citizens campaign

My watchdog group, Tax Fairness Oregon, tried and failed to get the legislature to disconnect in its 2019 session. In October we began assembling a coalition of unions and civic and policy organizations, and over the next four months met with about three-fourths of Senate and House members. The chair of the House Revenue Committee, Nancy Nathanson, became a champion. When the legislature convened February 3, Nathanson introduced a bill to deny Oregon investors the state’s income tax break on all QOF benefits — the deferral, discount and 10-year, tax-free gain. (Most Oregonians, as the legislature’s economists recognized, will invest wherever they can maximize returns, and not in Oregon.)

Portland’s state representatives supported disconnection, seeing that the benefit went to millionaires financing construction that would occur anyway, especially when we documented that several projects, including the hotel/condo and the apartments, had reorganized themselves to get the tax advantages.

Many Republicans, representing rural areas, saw that little investment would come to their districts because what makes Opportunity Zones work is scarce land in growing markets, but they were reflexively anti-tax. The House Republican leader, Christine Drazan, was intimately familiar with the issue and critical of the bill when we met. Her husband, Daniel J. Drazan, is a real estate lawyer in an Oregon firm, Dunn Carney. One of his partners submitted a six-page letter opposing the bill on behalf of 44 interests, naming 10 Dunn Carney lawyers — but not Daniel Drazan.

Officials in Washington County, much of which is a booming Portland suburb and home of Nike and an Intel campus, cried that development would be in jeopardy without the state subsidy. Some Washington County representatives — all Democrats — heeded their pleas.

Short of votes despite Democrats’ 38-22 party advantage, Nathanson wrote a substitute that would allow Oregon investors to keep the deferral and the 2026 basis increase, but cut the 10-year exclusion in half. Thus, taxpayers under the original bill would have paid Oregon’s top tax rate of 9.9 percent in 2026 and 9.9 percent on any gain upon sale of QOF investments after 10 years; under the substitute they would effectively pay only 4.95 percent on sale of QOF interests.

More importantly, the substitute would require QOFs in Oregon to report to the state the particulars of their investments — the only granular reporting requirement anywhere in the nation of which we are aware. Treasury’s final rules, issued in December, don’t require QOFs to disclose information that would allow study of the provision’s effectiveness.

Nathanson’s substitute was voted out of committee and scheduled for a final vote on the House floor February 25.

On February 24, Senate Republicans walked out of the Capitol to deny the chamber a quorum. The senators were protesting a bill creating a cap-and-trade system for carbon emissions — the same issue that spurred their walk-out in 2019. The next day, as the Opportunity Zone bill was scheduled in the House, the GOP walked out of that body.

Under the state constitution, the legislature requires a two-thirds quorum for business, and the GOP holds just over one-third of the seats in both chambers. The walk-out can work because the constitution also requires the legislature to adjourn its even-year short session after 35 days. That expiration came March 8. All pending legislation died.

I left my career as a federal tax policy analyst in 2014, bored with congressional dysfunction. I moved to Oregon in 2018. It appears that the Potomac virus has reached the mouth of the Columbia, site of Cape Disappointment.


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1 Response to An opportunity to enrich the opportunistic

  1. Catherine Schultz says:

    Excellent article as always from Benton!

    Liked by 1 person

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