A Note on David Wessel’s Only the Rich Can Play

I’ve been meaning to write something on David Wessel’s book Only the Rich Can Play for some time. I had in mind a review/commentary, but Jason Furman more than ably covered the main points I was going to make (and some I hadn’t thought of), so that took the wind out of my sails. Nevertheless, there are a couple of points I’ll, very belatedly, add (while recommending Jason’s review).

In the book, Wessel describes how Opportunity Zones came into law and tracks what, as best can be ascertained, they have, and have not, accomplished in delivering on the goal of boosting investment, economic development and job creation in “poverty-plagued, left-behind communities.” Of the thousands of pages in the Internal Revenue Code, Opportunity Zones, passed in 2017, are of particular interest for two reasons. First, they had bipartisan support in Congress. That is unusual in general and particularly for current-day anti-poverty initiatives. Second, there have been headline-grabbing instances of wealthy investors garnering lucrative Opportunity Zone capital gains tax breaks for investments in areas far more prosperous than those ostensibly targeted.

There is a certain aura to measures that are supported by lawmakers of both political parties — an impression that if both parties support something it must reflect all that is good, and none that is bad, about each party and the ideologies that motivate them. In the realm of social policy the thinking is that if it’s bi-partisan we’ll get Republican’s enchantment with the efficiency of free markets, combined with Democrat’s fixation on doing social good, and end up with a highly efficient, market-based, policy that does social good. That can happen, but it is at least as likely that we get Republican’s fixation with lowering taxes on the wealthy combined with Democrat’s tendency to throw money at problems and get the worst of both worlds. Setting aside critical judgement because a policy is bi-partisan is a bad practice.

This book makes clear that most of the Opportunity Zone investments we know of would have happened anyway and many are in communities that few would consider “poverty-plagued.” This isn’t surprising. The way eligibility of a community for the tax preferred investment is determined is laughable. Governors get to choose among census tracts that meet very broad criteria as low-income. Eligible communities can include college towns, prosperous commercial census tracts with very few people, rapidly gentrifying areas and other areas that meet loose criteria for being in need but actually are not. Because states are competing nationally for investment, governors had a strong incentive to pick census tracts that were most attractive to investors — whether they were particularly needy or not. By definition, those tracts were already the most attractive to investors among the possible selections. Of the Opportunity Zones the governors selected, investors, in turn, are most likely to invest in the ones that are likely to be most profitable — which are very likely to be ones they would have invested in anyway. That isn’t to say that no socially conscious investor has been moved by this tax benefit to put their money where it’s needed most. But this is no way to target capital where it can do the most good in fighting poverty.

Although the poor design of the law is a problem, in some ways it masks a universal problem with investment incentives. That universal problem is that most of the money, the fiscal cost to government, almost always goes to supporting activity that would have happened anyway. Most of the money spent on tax incentives is, in this sense, “wasted.” Most people would have bought their houses without the home mortgage interest deduction or save for retirement without 401(k) accounts. Companies would still invest without accelerated depreciation and expensing, and engage in research and experimentation without a tax credit subsidizing it. There are already extremely strong market incentives to do these things — the tax break is just the cherry on top. That doesn’t mean all tax incentives are bad, that there aren’t market failures they address, but it does mean they deserve close scrutiny and a look for more efficient alternatives.

Also, to be clear, there are always “design problems” with tax incentives. It’s one reason public-spirited lawyers tend to favor these things less than economists. Economists think “look, this will bring down the cost of capital for investments in low-income communities so we’ll get more investment in low-income communities.” Lawyers think “how will this be exploited to reduce tax liabilities, regardless of the intent of the incentive.” The lawyers know that, with anything like this, it will be a constant game of whack-a-mole trying to close the paths that lawyers and accountants find for gaining the tax benefit for activities that were not intended. They also know that it’s almost always a losing fight because once the tax benefit is in place there becomes an entrenched interest in preserving it and coming up with arguments why limiting it will do more harm than good. “Better targeting rules will make it too complicated!” “What’s wrong with investing in business districts next to college campuses!” “Look how many jobs our luxury hotel on the upper west side of Manhattan created!” Elected officials get little credit for closing tax loopholes but they can take a lot of grief from lobbyists, donors and self-interested constituents for doing so.

In one way Opportunity Zones were better than many other tax incentives in that they weren’t strictly on autopilot: benefits weren’t available simply by complying with broad, legislatively defined, criteria. With Opportunity Zones, governors could limit them if they wanted and be held accountable if their actions resulted in misallocation of resources. Unfortunately, the governors didn’t feel an obligation to honor the intent of the legislation.

One question is, why did Opportunity Zones pass despite flaws that many policy experts recognized. Well, from a Republican standpoint the worst that was going to happen was that some wealthy people get tax cuts, which they support anyway, without the poverty alleviation intended. From the standpoint of Democrats, the worst that could happen would be that the share of money flowing into low-income communities would be less than hoped — with too much going into relatively higher income areas — and some rich people would get undeserved tax breaks. That’s bad — but it still means that some more money would go into poorer communities than without the law, even if the bang for the buck is bad. It’s not like, at the time, Congress was choosing from a vast menu of ways to help poor communities. This was the only show in town.

I’m going to end with a critique of the book that isn’t really a critique of the book. The question is: “David, why pick on Opportunity Zones?” Sure, it’s an inefficient waste of money. Or, to use your words: “OZ money going to heavily celebrated, heart-warming projects appears to be a small percentage of total OZ investments.” But at least there are some scraps for communities and people who need it. There are plenty of provisions in the tax code that aren’t as well targeted as they should be and the excess all goes to people or companies that don’t need it. Why not write a book about one of them! The reason I say this is not really a criticism is that if I had been wanting to write a book about a tax provision I’d probably have chosen Opportunity Zones too, for the reasons I said at the beginning. It’s an interesting study of bi-partisanship gone awry. It is also distinctively distasteful to see a government program intended to help the poor end up mostly lining the pockets of wealthy investors and serving communities that don’t need the help.