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Lorenzo Gonzalez is a recent graduate of the University of Waterloo’s Master of Economic Development and Innovation program.

Recently, a lot of attention has been given to U.S. President Donald Trump’s Tax Cuts and Jobs Act, and whether the tax reform is beneficial or detrimental to the U.S. economy. What has been overshadowed by this debate is the new Opportunity Zones program – a policy tucked into the act that aims to help states with economically distressed areas by encouraging private capital investment.

It is well documented that private capital investment is concentrated in only a handful of areas. According to Steve Case, the entrepreneur and venture capitalist perhaps most famous for co-founding America Online, three states – California, Massachusetts and New York – received 75 per cent of venture-capital investment in the United States in 2016. The other 47 states were left fighting for the remaining 25 per cent of investment. Urbanists Richard Florida and Karen King quantify the problem to be even greater at regional levels, with just three so-called “megaregions” in the United States accounting for three-quarters of venture-capital investments. The San Francisco Bay Area alone accounted for more than 40 per cent of investments.

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More recently, a report by the National Venture Capital Association suggests that venture-capital investment patterns in the United States during the first quarter of 2018 remained focused on only a few select regions. This is despite growing opportunities to invest outside of traditional venture-capital hubs.

The story is similar in Canada. A 2015 report by the University of Toronto’s Martin Prosperity Institute found that venture-capital investment in Canada is concentrated in a few metropolitan areas. Five metros – Montreal, Vancouver, Toronto, Ottawa-Gatineau, and Calgary – accounted for 86 per cent of total investments, with Montreal leading with $633-million (32 per cent), followed by Vancouver with $380-million (19 per cent) and Toronto with $358-million (18 per cent). The report emphasized that venture-capital investment in Canada is overwhelmingly urban, a trend that mirrors global venture-capital activity.

Clearly, there is a dearth of private capital investment in other areas, especially those which are economically distressed.

The Opportunity Zones program attempts to address this problem by creating incentives for investors to pour money into low-income communities across the United States. Investors receive a temporary tax deferral on unrealized capital gains invested into “opportunity funds” that can only be used in designated low-income census tracts in each state.

The more patient an investor is, the more they are rewarded. In the case of an investment held for five years, an investor receives a 10-per-cent tax break on their original capital gains. This increases to 15 per cent if an investment is held for at least seven years. More importantly, if an investment is held for more than 10 years, an investor permanently avoids capital-gains taxes on proceeds from the opportunity fund investment.

However, like all public policies, the Opportunity Zones program may have unintended consequences.

Research by Harvard Business School professor Josh Lerner notes that problems may arise if governments interfere with the venture-capital process. The venture-capital process requires that the incentives for investors and entrepreneurs are aligned – neither party should receive substantial gains until the business is sold or goes public. When incentives are aligned, the potential for strategic behaviour that benefits one party but hurts the other is minimized. It is fair to speculate that a significant tax incentive for investors, as in the case of the Opportunity Zones program, may distort this balance.

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Another concern rests on government officials ability to deliver and execute the program in a way that remains true to its intent. This is particularly relevant when identifying which communities are considered “opportunity zones.” According to The New York Times, state economic development officials worry that opportunity zones may be wrongly designated and investments that are already in the pipeline will end up being subsidized. Alternatively, there may be a risk of subsidizing developments in low-income communities that are already being gentrified, which may lead to further displacement of local residents.

Furthermore, increasing investment alone does not guarantee that distressed communities will become magnets for economic activity. Economic development strategies must be in place to encourage collaboration among local actors to create an environment that is conducive to innovation, entrepreneurship, social development and economic growth.

If done right, the Opportunity Zones program is a much-needed policy action to promote private capital investment in distressed areas that are considered forgotten by many. For Canada, the program will be a perfect test-bed for future economic development policies and we should be mindful of its progress and outcomes.

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