Opportunity Zones and the Libertarianoid Style in American Public Policy
REVIEW ESSAY
Only the Rich Can Play:
How Washington Works in the New Gilded Age
by David Wessel
PublicAffairs, 2021, 320 pages
In 1955, in perhaps his least heralded achievement, Milton Friedman invented a new style of policy reform. “A stable and democratic society,” he acknowledged, “is impossible without . . . a minimum degree of literacy and knowledge on the part of most citizens.” Hence, the government was justified in both mandating and financing a minimum level of education. Yet it does not follow, Friedman argued, that government should directly administer the school system. On the contrary, the government could instead issue parents tuition vouchers redeemable at approved private institutions. Parents would then have more choice in education, while competition among schools would spur efficiency and performance. The power of the market, in short, could be harnessed to achieve government ends.
Since then, Friedman’s device—directing government funds to private actors to carry out a public program—has not only triumphed but become perhaps the dominant style of public policy in the United States. Ironically, despite decades of promotion, the original application of Friedman’s idea—school vouchers—has made limited progress. Yet the template he established has proved irresistible. In the early 1970s, for example, after public housing fell into disrepute, the Nixon administration proposed Section 8 rental vouchers to replace it. In the late 1980s, when Republicans needed a universal health care plan of their own, the Heritage Foundation proposed that all households be required to buy health insurance coverage from private carriers. (Twenty years later, with the passage of the Affordable Care Act, the idea became law, yet because the Democrats had by then embraced it, not a single Republican voted in favor of “Obamacare.”) In 2002, when expanding Medicare to cover prescription drugs, Congress made the new benefit—known as Medicare Part D—available not directly through Medicare but through the purchase of subsidized insurance policies. In each case, the approach is the same: rather than have government provide a good directly, individuals and firms are induced to buy or sell it themselves.
Whatever its merits, consumer-driven, market-based—or, as I call it, “libertarianoid”—policy reform suits the structural and ideological needs of the American political system. It allows Democrats to expand the reach of government without having to increase state capacity. It allows Republicans to proclaim at once their compassion for a program’s beneficiaries and their commitment to the free market. And it allows both parties to shower interest groups—from landlords to health insurers—with subsidies.
Opportunity Zones Past and Present
Little wonder, then, that what passes for innovative policy in the United States today follows a familiar pattern. In Only the Rich Can Play, financial journalist David Wessel reveals how Opportunity Zones—perhaps the ne plus ultra of libertarianoid policy reform—went from dinner conversation to law in less than five years. The story has an all-too-likely hero: Napster founder, Facebook investor, and Silicon Valley wunderkind Sean Parker. While touring Tanzania, Parker allegedly had an epiphany. What the world’s poor needed most, he determined, was not government assistance but private investment.
Of course, Parker could have just used his own money to invest in Tanzania. But that would have been costly: his fortune was tied up in Facebook stock, which he could not sell without having to pay tax on his capital gains. The tax system, by discouraging the sale of appreciated assets, was effectively neutralizing vast amounts of idle capital. Rather than be taxed for selling stock, Parker reasoned, he and his fellow billionaires should instead be rewarded, provided that they invested the sale proceeds in the world’s most impoverished regions.
Fired with enthusiasm, Parker floated an early version of the idea at the Davos World Economic Forum. Somehow, his idea received less attention than the $1 million bacchanal, featuring stuffed animal heads shooting laser beams from their eyes, that he threw for his fellow global elites the next night. (That party, in turn, attracted less attention than his later $10 million Tolkien-themed wedding celebration at Big Sur.) Chagrined yet undaunted, Parker continued to chat up his idea. He soon enough encountered a former Obama White House staffer, who recommended that he focus not on impoverished foreign countries but economically distressed areas in the United States.
Parker was convinced. He put $3 million into a new tax-exempt think tank, selected a staid name—the Economic Innovation Group, or EIG—and commissioned a clever logotype. Consultants and law firms were hired, economists recruited to the masthead, white papers released, and conferences announced. Parker himself contributed lavishly to the campaigns of both Republican and Democrat candidates who seemed the most pliable. Not long thereafter, EIG had Corey Booker and Tim Scott—two African American senators, one a Democrat and the other a Republican—sharing a stage and trading jokes at EIG events.
Meanwhile, EIG created an interactive online map that allowed website visitors to view the economic health (measured by median income, unemployment, poverty, and four other indicators) of every zip code in the United States. Journalists, congressional staffers, and casual browsers could easily compare, say, Fairfield County to nearby Bridgeport, Connecticut, or Aspen, Colorado, to nearby Leadville. A public relations coup, the map scored a front page story in the New York Times business section. EIG had arrived.
While the slick promotion may have suggested some novelty, EIG’s reform idea—tax breaks in exchange for investing in distressed areas—had been kicking around Washington since Parker was born. (Wessel does not spoil the billionaire-comes-to-Washington narrative to say when, exactly, Parker and his team realized that their proposal was not exactly new.) As far back as 1980, Senator Scott’s political mentor, Jack Kemp, had introduced legislation tying tax incentives to investment in “Enterprise Zones.” In 1993, at President Clinton’s urging, Congress enacted a version of the idea, now designated “Empowerment Zones.” After Empowerment Zones fizzled, Congress tried again in 2000 with a program called the “New Markets Tax Credit.” By the time EIG’s own iteration became law, forty-three states, reports Wessel, were already offering place-based tax incentives.
Indeed, by the time Parker arrived in Washington, the effects of enterprise-zone programs had been extensively studied. Senators Booker and Scott did not need EIG to tell them whether enterprise zones would work. The Congressional Research Service had already published lengthy papers going back decades. Every study had reached the same conclusion: those who received the tax break obviously benefited, but the trickle-down effects to distressed communities were slight. Often, the best-performing areas were those that already were recovering.
No matter. Parker’s contribution to the debate was to double down. First, EIG argued, the incentives offered by earlier programs were not big enough. A marginal incentive would not attract enough capital; the incentives instead had to be so massive as to create an entire new class of investment. Second, prior programs entailed too much complexity, oversight, and bureaucratic sludge. Rather than require businesses and investors to satisfy a host of criteria to ensure the integrity of a program, they should instead simply self-certify and thereafter proceed unencumbered. For Parker and his team, true enterprise zones, like true socialism, had never been tried.
For a moment, in late 2016, an enterprise zone revival seemed as unlikely as a tech boom in downtown Camden. Donald Trump’s campaign for president had upended decades of seemingly settled GOP policy consensus, and zombie ideas from the Reagan era seemed finally ready for a peaceful burial. But in the end, Republicans in the Trump era ended up governing just as they always had. In December of 2017, Senator Scott demanded enterprise zone legislation as a condition of his yea vote on the Tax Cuts and Jobs Act. He faced little resistance; the idea turned out to be a convenient way to provide relief to Puerto Rico, lately hammered by Hurricane Maria. And so yet another enterprise zones program—rebranded once more, this time as “Opportunity Zones”—became law. Kempism, under Donald Trump, had triumphed.
Grey Areas
Over four years later, one can hardly say that Opportunity Zones have failed. The Trump administration estimated that $75 billion had been invested in Opportunity Zones. A later General Accountability Office study reported that Opportunity Zones held a mere $29 billion in assets. Whatever the true figure, the transfer of so much capital, like decanting the Caspian Sea, is bound to yield at least some winners. Many of them may even be sympathetic.
Though Wessel goes to heroic lengths to uncover the impact of Opportunity Zones, he is hampered by lack of data. Scott’s legislation, as drafted, required Opportunity Zone funds to report the extent and location of their investments, but those provisions, to appease the Senate parliamentarian, were scrapped in the final Tax Cuts and Jobs Act. (The budget reconciliation process, which was used to pass the Tax Cuts and Jobs Act, deems provisions that do not affect revenues, such as Opportunity Zone reporting requirements, to be “extraneous”; as such, they can essentially be stricken by any senator’s objection.) To arrive at their $75 billion estimate, Trump’s own Council of Economic Advisers could only extrapolate from SEC filings and information voluntarily provided to a private accounting firm. Any analysis of the program thus amounts to guesswork.
In lieu of statistics, Wessel journeyed the country for anecdotes. The book profiles dozens of Opportunity Zone promoters, investors, and middlemen, from financier and circus act Anthony Scaramucci to Donté Hickman, an East Baltimore preacher who stood by Trump’s side at a press conference only to find that not a dollar was ultimately invested in his neighborhood. Wessel also recounts the success or failure of dozens of Opportunity Zone projects, from new self-storage units in south San Antonio to a Goldman Sachs–backed development in Baltimore that was already under way when it received an extra boost from an Opportunity Zone designation. In the end, though Wessel fails to paint a convincing picture, he does paste together an interesting collage. As if to make up for the lack of firm conclusions, he closes over a dozen vignettes with the italicized mantra, “Don’t blame the players, blame the game.”
Expensive Lessons
Nevertheless, despite the paucity of evidence of results, the design of the Opportunity Zone program teaches some valuable lessons about public policy today.
First, market-based reform has strayed far from Friedman’s original conception. In proposing school vouchers, Friedman assumed that the government ought both to mandate and to finance a minimum level of education. Vouchers were simply an alternative way of providing a benefit that taxpayers were paying for anyway. The proposal did not entail a transfer from one class of persons to another.
Later market-based reforms, by contrast, have intentionally enriched well-positioned private parties. Thus, Section 8 vouchers gave landlords a guaranteed rental income without the hassle of having to collect from tenants or screen them for creditworthiness. Both the prescription drug benefit and the individual mandate expanded and entrenched the health insurance industry. In similar fashion, the Opportunity Zone program awards tax breaks to individuals who happen to own appreciated assets. Regardless of whether Parker, Scott, and Booker are correct that the solution to poverty is more private investment in distressed regions, it does not follow that the government must hand out welfare payments to wealthy taxpayers with capital gains. Yet that is precisely how Opportunity Zones work.
Second, the political success of market-based reform depends on its fiscal opacity. If Congress had simply directed the U.S. Treasury to pay cash to wealthy taxpayers who invest in impoverished areas, public outrage would be immediate. Yet by providing the equivalent amounts in the form of a complex set of tax expenditures, the political salience of the giveaway is all but eliminated.
A similar lack of transparency is essential to other market-based reforms. For years, for example, GOP leaders such as Paul Ryan have dreamed of replacing Medicare with a system of health insurance vouchers, or what they call “premium support.” On close inspection, voucherization of Medicare shifts the bill for rising health care costs from the government to consumers. Paul Ryan and his disciples prefer not to admit that they wish to cut Medicare. Instead, they hide their designs in a Rube Goldberg contraption, which they advertise as “consumer-driven” and “market-based.”
Third, the libertarianoid style takes bad policy as given. Nixon’s Section 8 housing vouchers, for example, accepted the dubious premise that housing is undersupplied. By creating a specialized market for government-subsidized, means-tested tenants, the Section 8 program only succeeded, like its public housing cousin, in freezing poverty and dysfunction in place. The Heritage Foundation’s individual mandate proposal conceded that most Americans would continue to obtain health care through employer-provided health insurance. The proposal’s legislative spawn, the Affordable Care Act, ended up perpetuating the waste and spiraling costs of a third-party-payer system.
Similarly, Opportunity Zone programs take it for granted that the tax code will continue to subsidize the retention of assets. The code does so in two ways. First, gains go untaxed until they are “realized”—that is, when the appreciated property is sold or otherwise disposed of. As a result, the most effective way to defer tax is to hold onto appreciated property indefinitely, while perhaps borrowing against it as needed for liquidity. Second, gains are wiped out at death, when appreciated property is deemed to have a fresh cost basis equal to its then fair market value. As a consequence, individuals can hold onto their assets during their lifetime so that their heirs can sell them tax free.
The combination of those two rules—taxing gains when realized and forgiving them at death—effectively locks in place the ownership of appreciated property and prevents capital from being more efficiently deployed. Rather than address those distortions, the Opportunity Zone program attempts to overcome them with even greater distortions of its own. To induce taxpayers to sell assets and reinvest them, the program offers not only to forgive a taxpayer’s existing gains (currently, the forgiveness lasts only through 2025 but Congress is already considering legislation to extend that deadline) but all gains from future Opportunity Zone investments.
Those benefits have managed to spur many individuals to reinvest gains in Opportunity Zone funds. In 2018, EIG estimated that unrealized capital gains in the United States exceeded $6 trillion. If that number is correct, and $29 billion was ultimately invested in Opportunity Zones, that means that Opportunity Zones diverted 0.5 percent of the nation’s total unrealized gains. On the other hand, the fact that 99.5 percent remains locked in place shows just how powerful are the incentives to defer gain, despite the ability to avoid tax through reinvestment in Opportunity Zones.
Fourth, the very freedom that market-based reform confers undermines its effectiveness. By design, Opportunity Zone participants may invest their gains however they like and still qualify for tax benefits, so long as the investments are located in an area designated as an Opportunity Zone. Not surprisingly, investors who have realized substantial gains seek assurance that they will not lose their money. Thus, as Wessel reports and as anyone acquainted with the Opportunity Zones industry can attest, virtually every Opportunity Zone fund invests primarily in businesses with predictable cash flows such as real estate development. Parker conjectured that economically depressed areas needed private investment. What they received was something else: senior living facilities, student housing, and warehouses. Whether those projects can catalyze an economic revival remains to be seen.
Finally, market-based reform is no answer to the Hayekian critique of government planning. Ironically, the Opportunity Zone program seems if anything to have demonstrated the folly of private investment in distressed areas: by avoiding investments in anything other than real estate projects with predictable revenue streams, the Opportunity Zone investors have revealed, by the power of the free market, that investment in distressed areas will just lose money. The reasons that private investment in impoverished areas is unlikely to pay off were analyzed over fifty years ago by Edward Banfield in The Unheavenly City. In brief, Banfield found that a large portion of the population in distressed areas has a psychological orientation to the present, which in turn is associated with crime, failure to save, underemployment, and lack of trust. That syndrome generates poverty, which is transmitted from one present-oriented generation to the next.
Nobody knows how, exactly, to change even one individual’s time preference, much less the time preference of a whole community. Jack Kemp’s conviction forty years ago that private investment would somehow relieve poverty is as utopian as the New Deal Democrat’s conviction forty years earlier that slum clearance and free public housing would do the trick. Neither breed of rationalist utopian wishes to face the harsh limits on what public policy can accomplish.
In the end, there is no reason to believe a priori that any particular policy can be improved by creating an ersatz free market. Privately owned buildings with Section 8 tenants have proved just as dismal as public housing projects, while Medicare Part D prescription drug policies proved just as costly as traditional Medicare (only more bewildering). That a market-based policy will actually help its intended beneficiaries is doubtful; that it will enrich some private parties able to exploit the rules is certain. For politicians, that may be the whole point. The libertarianoid style elegantly marries corrupt practice with noble professed intentions. The presumption should be against it.