Over the course of 2018 we’ve seen increasing clarity about the so-called “Opportunity Zones” included in the Republican smash-and-grab tax heist of 2017. Over at Alpha Architect they have an excellent breakdown of the tax advantages of these investment vehicles, so I’ll stick to the roughest possible outline:
- taxable capital gains (e.g. from the sale of an appreciated security in a taxable account) can be rolled into an “Opportunity Fund;”
- those rolled capital gains are untaxed for between 5 and 7 years, then are taxed at a preferential rate depending on the holding period;
- any gains within the Opportunity Fund itself are completely tax free after a 10-year holding period.
The one thing I would add to Alpha Architect’s otherwise-comprehensive post is that they actually understate the advantages of Opportunity Funds: there are three separate discounts that should be applied to the initial taxable capital gains rolled into the Opportunity Fund. Alpha Architect discusses only the explicit, 10-15% step up in basis for rolled capital gains. But that amount is also fixed in nominal terms, while the taxes are actually paid in less valuable future dollars. That means in real terms your taxes are reduced three times:
- Once by deferring them 5-7 years (you’d rather pay taxes later rather than sooner);
- Once by reducing them by 10-15% (you’d rather pay less than more);
- Once by paying them in 2027 instead of in 2018 (you’d rather pay in worthless 2027 dollars than in precious 2018 dollars).
For way more details on the tax implications of these investments, do check out the Alpha Architect post linked above.
Should economic policy be pro-business or pro-capital?
Consider, if you will, Census Tract 2.01, in Missoula County, Montana. This census tract describes, more or less, the part of Missoula locals call “the Northside,” and it’s eligible for Opportunity Zone tax incentives.
The first thing to realize is that there are already businesses on the Northside. The KettleHouse Brewing Company has a big brewery and event space there. All the big box stores on the East side of Reserve Street are in the Opportunity Zone; all the big box stores on the West side of Reserve Street are out of the Opportunity Zone. The hottest new restaurant in town is in the Opportunity Zone. The beloved, run-down local bowling alley falls just outside it. Just for fun I checked, and poor Karl Tyler Chevrolet is just over the census tract line, while DeMarois Buick GMC Mercedes-Benz is safely within it.
The most obvious problem this raises is the question of fairness, and it’s a perfectly fair objection, if you’re so inclined. If Mr. DeMarois sells his dealership to an Opportunity Fund, then not only is he going to get a better price than if Mr. Tyler sold, but the outside investors who purchase his dealership are going to be able to sell Buicks, GMC’s, and Mercedes-Benzes at lower prices due to their lower after-tax cost of capital, compounding the injustice.
But I’m not particularly concerned with the cost of capital. My concern is with business, which has nothing to do with the cost of capital, no matter how much financial capitalists try to convince you otherwise. Whether a brewery is profitable depends on whether it is making more money from selling beer than it costs to make beer. Whether a car dealership is profitable depends on whether it makes more money selling cars than it pays the manufacturer for cars. Whether a bowling alley is profitable depends on whether it makes more money selling games of bowling than it pays people to rummage around in the bowels of the building freeing stuck pins and whatnot.
And the problem with Opportunity Zones is that it’s an extravagant, expensive tax advantage handed out only to financial capital, not to businesses, including within the Opportunity Zone itself. If the Burns St. Bistro expands their hours, or adds more space, or hires more staff, they owe taxes on their expanded profits. If an Opportunity Fund buys the lot next door, hires their staff away, and sells the place in 10 years, their investors walk away without paying a cent in taxes.
Opportunity Zones point the way towards bold, ambitious policies
Like most people, I detest the 2017 tax reform bill because of its enormous transfer of the nation’s wealth to the owners of existing capital. But while the structure of Opportunity Zones is just another example of that looting of the public, the enthusiasm among the financial elite does illustrate the potential of bold, ambitious policies.
The key insight of the creators of Opportunity Zones was the magic of 0%. If you tell people they’ll get a 10%, or 50%, or 90% discount you might be able to budge their behavior a bit one way or the other. This is, indeed, how municipal bonds work today. But when you tell people they’ll pay nothing, ever, in taxes on an investment, they don’t just get excited, they lose their minds.
What would a bold, ambitious, pro-business policy look like?
The fact that Republicans were willing to sign off on a policy with literally unlimited cost to the American taxpayer (remember, unlimited capital gains within the Opportunity Fund are completely tax-free after 10 years) should be an invitation to people who believe in the value of business, as opposed to capital, to be more ambitious in our demands.
- If we want to target specific areas for business development and growth, why not simply exempt payroll within Opportunity Zones from FICA taxes? That way existing businesses and new businesses would enjoy the same benefits as financial capital.
- If we want to encourage hiring, why not make hiring easy? Create a single federal portal to process payroll and withholding for employees, so there’s no quantum leap between zero employees and one employee.
- If we want to level the playing field between small and independent businesses and those owned by financial capital, why not eliminate the employer’s role in providing health insurance and retirement benefits?
- If we want to encourage worker-centered economic development, why not reduce business taxes to 0% on worker-owned cooperatives?
The key difference between these proposals and Opportunity Zones is that they are focused on businesses, not capital. The money spent, which would be considerable, goes to the businesses that are engaged in economic activity specifically to encourage that economic activity. For worker-owned businesses, that money goes to the workers. For privately owned businesses, it goes to the owner. And for corporate entities it goes to the corporation.
Some people want to single out corporations for punishment; I don’t feel any need to go that far. The corporation is a perfectly reasonably form of economic organization, where appropriate.
But the one thing I know is that we shouldn’t be singling out financial capital and specialized investment vehicles for special treatment while leaving actual operating businesses to suffer what they must at their hands.