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Executive Memorandum #334 on Smart Growth

June 9, 1992

How to Create a Successful Enterprise Zone Program

By


(Archived document, may contain errors)

0/92 334 HOW TO CREATE A SUCCESSFUL ENTERPRISE ZONE PRO GRAM After twelve years of deliberation, and pushed into long-m@ action by the recent riot in Los Angola, Congress at last seems poised to enact enterprise zone legisiatioti. What lawmakers now must do is remember the purpose of enterprise zones, take acc o unt of the long history of zones at the state level, and fashion a federal program that will worL An enterprise zone is a depressed area in which taxes are reduced and regulations streamlined in order to en- courage businesses to open and expand-thereby c r eating jobs and spurring an economic turnaround. Ova the past decade, some 37 states and Washington, D.C., have enacted enterprise zone programs. These programs offer a mix of tax, financing, and deregulatory incentives to firms investing in awn designate d as enterprise zones. According to the U.S. Department of Housing and Urban Development: (HUD), state enterprise zones since 1982 have created some $28 billion worth of now business investment and over 258,000 jobs. Prior to the riot, two major bills had l anguished in Congress. The &st, backed by the Bush was introduced in the House (H.R.23) by Charles Rangel, the Now York Democrat, and in the Senate (S.1032) by Democrats Joseph Ileberman of Connecticut and J. Bennett Johnston of Louisiana, and by Republic a ns John Danforth of Missouri and Robert Kasten of Wisconsin. Ibis bill would create fifty enterprise zones (one-third in rural areas) over a four-year period. Each zone would be eligible for 25 years to receive three generous tax in- centives to encourage business growdu of An exemption from taxation of capital gains on the sale of leMble" enterprise zone property (that Is, such things as buildings and machinery) hold for at bo two yam; A personal Income tax deduction for Investors of up to $50M In any tax a ble year, with a $250AN lifetime maximum, on the purchase of qualified enterprise zone common stock; and Of A refundable 5 percent tax credit to qualified enterprise zone employees on the first $109500 In annual wages, up to $525 per worker. The U.S. Trea s ury Department has estimated that these incentives would cost almost $ 1.8 billion in lost fed- eral tax revenues during the initial five years of operation. Supporters of the bill claim this is an overestimate, since the Treasury ignores new taxes that w o uld be generated by zone businesses. HUD would designate areas as zones on a competitive basis from among areas meeting certain criteria of distress (such as high rates of pov- erty and unemployment). A rival bill, REL 11, introduced by House Ways and Mew s Committee Chairman Dan Rostenkowski, the Illinois Democrat, also would provide tax incentives, but not as generous as those of the Rangel bill. More prob- lematic, the Rostenkowski bill in many ways would add bureaucracy. Specifically, it would require l o cal zone admini mum, known informally as "zone czars," to allocate federal tax incentives to the firms they wanted in the zones. The zone czars would pick and choose among businesses-forcing en to lobby for tax breaks. The Administration recently has deve loped several now enterprise zone incwtives.They have yet to be in- serted intDHIL 23, but likely soon will be.

Among these refinements: v-' investors would pay ro capital gains tax on the appreciation of "Intangbie" (such as stocks and bonds) as well as tangible property In an enterprise zone; of Enterprise zone businesses could raise capital through tax-exempt state and local bonds; of Unemployed, childless persons who obtained jobs In zones would recelve an earned Income tax credit (EITC) of up to $1, 8 00 annually. Currently, the EITC applies only to families with children. of Homeowners in enterprise zones would be exempt from capital gains taxation on up to $200,000 In profits from the sale of a home owned at least five years; and of The federal gover n ment would grant automatic enterprise zone status to any locally designated zone that meets distress criteria. Treasury officials calculate the five-year revenue loss of this expanded proposal at $2.3 billion. Some of these changes, such as the capital ga i ns and expanded earned income tax credit provisions, are sound. These measures would encourage more investors to risk their money in depressed areas, and they would raise the take-home pay of lower-skilled workers hired by enterprise zone businesses. But o thers, such as grant- ing enterprise zone status as an entitlement to any area meeting economic distress criteria, actually would weaken the program. Thus, in crafting a final bill, lawmakers should be careful to abide by four basic principles, underscore d by the experience of state enterprise zone programs: Principle #1: Enterprise zone designation should be competitive. The Administration's recent proposal to make federal enterprise zones into an urban entitlement program is a mistake. Enterprise zones a r e effective only if state and local governments remove obstacles to business growth, such as rigid zoning and onerous property taxes. A competition for designation would force states and cities to take necessary actions to secure a slot. But if the progra m is an entitlement, there would be no such incentive. Principle #2: Government at all levels must resist the temptation to overregulate and "micromanage" economic activity within zones. Federal enterprise zone legislation should spur business creativity b y reducing taxes and regulatory barriers for all entrepreneurs willing to take a risk-not just those who fit a bureaucrat's master plan. Micromanaging instead forces firms to lobby officials for benefits. And in such a tussle for influence, the small- est, newest firms would be least able to obtain relief. Principle #3: Zone benefits should be kept simple. Some state zone programs grant numerous and complicated tax, financing, and deregulatory incentives. Qualifying for them entails a large amount of paperw o rk, which can be especially time-consuming for the small businesses which zones are intended to attract. Complicatedrequire- ments thus encourage "tax shopping" by large, existing firms, and discourage the creation of new firms. Principle #4: The focus sh o uld be on small businesses. Small firms are the biggest generators of new jobs, es- pecially for lower-skilled workers. Thus the zone program should be founded on incentives that are of most help to these firms. Capital gains tax relief is especially impo r tant, because it would increase the flow of start-up cap- ital to businesses. State and local governments must clear away the red tape that is merely irritating to large firms, but often suffocating to small ones. The time is at hand to create federal ent e rprise zone legislation that fulfills the promise of the original idea. It is true that reducing tax and regulatory burdens in designated geographic areas should not divert attention from reducing them everywhere. It is true also that an enterprise zone i s but one element in the package needed to re- duce the isolation of the urban poor. Education reform also is needed, as is action to tackle crime, to reform the welfare system, and to foster homeownership in poorer neighborhoods. But a transformation will not occur fully until businesses open and hire people in the inner cities. That is why a properly crafted enterprise zone pro- gram is essential. Carl F. Horowitz, Ph.D. Stuart M. Butler, Ph.D. Policy Analyst Vice President Director of Domestic and Econom ic Policy Studies

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