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In December 2017, President Donald Trump signed the Tax Cuts and Jobs Act, which slashed the top tax rates for corporations and investors. Critics said it was a giveaway to big businesses and the super wealthy. But proponents touted part of the bill that they said would stimulate economic development in financially distressed areas across the nation.

Under the provision, states could designate 25% of their low-income census tracts as Opportunity Zones. Investors who funded projects in those areas could defer taxes on their earlier capital gains. And any profits from Opportunity Zone investments would be tax-free so long as the investors kept their money in for at least 10 years. Trump praised the idea as the “hottest thing going” and boasted that it provided “massive new incentives for investment and job creation.”

As the Opportunity Zone program quickly attracted wealthy investors, it also caught the attention of Rebecca Lester, an associate professor of accounting at ���˴�Ƭ Graduate School of Business, a faculty fellow at the ���˴�Ƭ Institute for Economic Policy Research (SIEPR), and a former tax accountant. “I’m naturally interested in how tax policy influences investment decisions,” she says.

Lester was intrigued by one unusual aspect of the Opportunity Zones program. Congress typically designates the recipients of the tax breaks it approves. “What’s so different here,” she explains, “is that the federal government delegated the selection to state governors.” She wondered about how politics influenced the decisions about which areas received the special designation.

Along with colleagues of the University of Virginia and of the University of North Carolina, Lester probed that issue in a recent in the Journal of Public Economics. They found that politics often does appear to play a role in the selection of Opportunity Zones. Overall, governors were nearly 8% more likely to pick census tracts of areas that had the same party affiliation.

However, that figure doesn’t break down evenly by party. Republican governors were around 13% more likely to put Opportunity Zones in Republican-leaning districts. Democratic governors, in contrast, were around 1% less likely to pick Democratic-voting areas and were also less likely to pick a tract if it had competitive elections. But Republican governors were more likely to select any area where their party had won, even by a narrow margin.

A Finger on the Scale

It’s hard to tell what safeguards against favoritism are in place because not all states have been transparent about their selection process. But political bias doesn’t have to intrude upon the selection process, Lester says.

At least 15 governors have used a proportional requirement in their selection processes that appears to help reduce the political bias. “When you allocate across an entire state, you’re giving every constituency a chance to weigh in on Opportunity Zone selection,” she says.

Alabama Gov. Kay Ivey, a Republican, used such a process. “I serve all 67 counties as governor of this state, and it is very important to me to ensure that every county had an Opportunity Zone,” Ivy explained in 2018.

Another way of countering political bias is to delegate the nomination of Opportunity Zones to local leaders. Former Montana Gov. Steve Bullock, a Democrat, asked cities, towns, counties, tribes, and economic development organizations to identify places where investment was most likely to benefit communities.

That approach works regardless of party. “Obtaining initial selections from local authorities, thereby diversifying the pool of individuals responsible for identifying Opportunity Zones, completely offsets the role of political affiliation in Republican-governed states,” Lester and her colleagues concluded.

Are Opportunity Zones Working?

The problem of political bias is even more significant because another of Lester’s findings calls into question Opportunity Zones’ value as an economic stimulus. In many instances, governors appear to be awarding the tax break to places where investors are already active. Lester and her colleagues found that governors were nearly 35% more likely to select census tracts that already showed signs of gentrification.

“The result validates concerns about the misallocation of federal tax expenditures to communities that were already improving economically, and thus not in need of fiscal stimulus,” the researchers concluded.

Lester also notes that the 2017 tax bill didn’t say anything about what types of Opportunity Zone projects investors should fund. “There’s nothing in the law that forces the investment to be something that actually creates jobs,” she says. Critics worry that a lot of the money is flowing into big real estate projects, the sort of opportunity that’s attractive to investors but may not help people who already live in the area. Lester says these projects can take years to come together, and it’s difficult to determine if they will create jobs or raise living standards.

A recently unveiled to reform the Opportunity Zone program would implement new reporting requirements. That change, Lester says, “would go a long way in helping us understand if the local residents benefit or if it just resulted in gentrification.” The new bill would also strip Opportunity Zone status from census tracts that exceed a maximum family income threshold.

At this point, it’s impossible to tell how much revenue the Treasury will lose as a result of the tax breaks given to Opportunity Zone investors. As Lester’s paper notes, the amount of money flowing into the zones — $30 billion from 2018 through 2020 — has been much higher than expected. “We’re not going to know the true costs of Opportunity Zones for at least another 10 years, if not more,” she says.

However, Lester is hopeful that Congress will revisit the original legislation to make the selection process less political and more transparent. “This is a way to really drive investment dollars to clearly distressed communities,” she says. Eliminating political bias, she says, could help ensure that the benefits get to those who need them the most.

This story was by ���˴�Ƭ GSB Insights.