Empowerment Zones

In the zone: Targeted areas seek alternatives to grant funding

by Martha Bridegam

The nation’s newest tool for economic development, the New Markets Tax Credit (NMTC), could be the “icing on the cake” for managers of longstanding programs in Enterprise Zones and other federally designated target areas.

At a May conference on economic development sponsored by the Department of Housing and Urban Development (HUD), the question facing zone program managers was how to continue their work using tax incentives alone, without direct cash subsidies. Equity attracted by the NMTC could help, they said.

Two different zone managers chose the same phrase for the NMTC, calling it “the icing on the cake,” and they suggested that while it might be helpful in starting a business, it wouldn’t necessarily do a lot for real estate construction financing.

Ethan Orr of the new Tucson, Ariz., Empowerment Zone (EZ) – featured at the conference for its online marketing efforts – was optimistic about the NMTC. “If the program takes off as much as we expect it to, I think it could be good,” he said.

Now, under the Bush administration, HUD is returning to former Secretary Jack Kemp’s vision of the zone program as providing what a recent rule-making document called “incentives of forbearance”: tax exemptions on bonds, employment tax credits, depreciation allowances--but no cash.

Round III of zone designation announcements set the new tone this winter: It designated eight new EZs and 40 members of a new category, Renewal Communities (RCs), but none of them were awarded cash grants. This was followed in the spring by the White House budget proposal that made a zero grant recommendation for the 1999 Round II designees, which depend on annual appropriations for their cash assistance.

First authorized in 1993, the EZ/EC/RC program designates troubled areas that can receive tax breaks, tax-exempt bond authority and extra eligibility points for federal programs. Projects in these areas also may qualify for the more widely applicable NMTC and low-income housing tax credits (LIHTC).

Generally, HUD administers the urban zones, and the USDA the rural ones.

In 1994, designated zones received large direct grants, but the next two designation rounds, in 1999 and 2002, have been successively less free with federal cash. From firm guarantees of as much as $125 million over 10 years in Round 1, the program dropped in Round III to indirect incentives only, with no cash grants.

EZ and Enterprise Community (EC) grant money, when available, has often gone for housing. Teri Campbell, program manager for affordable and accessible housing initiatives at the Chicago Empowerment Zone, said her zone started with $100 million in Round I Social Services Block Grant (SSBG) money, plus $33 million in state funds.

Of that, she said, the Chicago EZ has allocated some $24 million to housing and hopes to have “impacted” close to 1,500 units of housing by the end of the zone’s 10-year grant period in 2004.

HUD commissioned a major study of the Round I urban zones that was released this spring. It found that from 1995 through 2000, housing activities in a group of 18 “intensive study sites” received $72 million from the federal SSBGs. This group consisted of the six original urban EZs plus 12 selected Round I ECs. In these 18 sites alone, the report said, the housing expenditures “have helped to produce 1,549 new units of housing and 2,462 rehabbed units,” and zone homeownership programs, existing at 11 of the 18 sites, have served 4,447 residents.

Not all the zones have used the proffered advantages. Studies by HUD and the General Accounting Office (GAO) in the late 1990s suggested that businesses in designated zones have not taken extensive advantage of the tax breaks available to them. Wage credits were the most frequently used special zone-based tax credit, according to a 1999 GAO survey of businesses in EZs and ECs. Similarly, not all zones have used their bonding authority.

Housing developers speaking to Affordable Housing Finance three years ago were already placing the greatest value on the program preferences that come with location in a designated zone. (See Affordable Housing Finance April 1999, page 72.)

Ethan Orr, commercial revitalization specialist with Tucson’s Office of Economic Development, said this spring that one advantage of its new Round III EZ status that the city especially valued was the EZ eligibility preferences for federal grant programs.

Some programs allow as many as five bonus points to grant proposals involving EZ/EC/RCs. The just-issued HUD SuperNOFA offers two bonus points to any proposed project in an EZ/EC/RC area or in any of the runner-up Strategic Planning Communities. Orr said Tucson was working with the Arizona state government to seek extra consideration in state-level LIHTC allocations as well.

The Round III EZ bond authority – at least $130 million worth – is also “very, very valuable to us,” he said. “We love those things” because they are not subject to state bond-authority caps (a new feature of Round III bonds) and can be used for retail projects, a use ordinarily forbidden under the Arizona state constitution.

Of all the zones, the December 1994 Round I designees, authorized by P.L. 103-66, remain the most ambitious. President Clinton named six urban EZs, three rural EZs, 65 urban ECs and 30 rural ECs, for a total of 104 zones. HUD later designated four of the urban ECs--Boston, Houston, Kansas City and Oakland--as Enhanced Enterprise Communities (EECs). Los Angeles and Cleveland were named Supplemental Empowerment Zones.

In addition to tax advantages and bond authority, the original Round I urban EZs each qualified for $100 million in SSBGs to be used over 10 years. Cleveland and Los Angeles received $82 million and $125 million respectively through the HUD Economic Development Initiative (EDI). Rural EZs each got $40 million in SSBGs. The EECs got $22 million EDI grants and Sec. 108 loan guarantees, and all of the ECs got $3 million SSBGs.

The 1999 Round II and IIS designations created 15 urban EZs, five rural EZs and 20 rural ECs – 40 districts in all. The new zones received tax advantages and bond authority and were promised grants subject to annual appropriations.

The Round III zones, created by the Community Renewal Tax Relief Act of 2000 (enacted as part of PL 106-554), were publicly named in January and February 2002. The same act extended all EZ designations through 2009.

There are a lot of repeat customers on the Round III designation list. A HUD spokesman wrote that 20 of the RCs were existing zones that switched status, and all of them would be allowed to keep “previously awarded grant funding.” In addition, a number of urban zones--including Philadelphia, Chicago and Detroit--obtained RC status for areas that co-exist alongside older designated zones.

EZs and RCs--but not ECs--allow businesses to claim wage credits for employees who live and work in the designated zones. The EZ wage-credit maximum is $3,000 and the RC maximum $1,500.

EZs and RCs--but again, not ECs--qualify for zone-based increases in the Sec. 179 deduction for certain depreciable business property. However, RCs alone carry a Commercial Revitalization Deduction for new or substantially rehabilitated buildings.

EZs and RCs--but not ECs--also qualify for capital gains tax advantages.

Empowerment zone incentives fall short of expectations

Eight years into the federal Empowerment Zones (EZs) program, Congress and the Department of Housing and Urban Development (HUD) have abandoned their original vision of combining tax incentives with locally controlled community development grants to help depressed areas. Although the incentive/grant combination has produced some grand individual success stories, overall statistics suggest the program as a whole has not done as much good as it was expected to do.

A HUD-commissioned study by ABT Associates and the Urban Institute made favorable findings on some elements, especially job creation and minority business ownership--what a HUD spokesman termed "modest but statistically significant success."

However, auditors have criticized the urban part of the grant-making program for poor spending decisions and weak accountability, and the tax incentives have been significantly under-used. IRS data show that employers' use of the most popular zone-related tax credit had reached only about 17.4% of its predicted volume in 1998, when the main Round I zones had been operating for four years and there had been plenty of time to publicize the credit. Studies and audits from several sources also suggest that many zone residents and employers have been only distantly aware of the zone program, let alone able to credit it for specific gains.

The EZs, the lower-level Enterprise Communities (ECs) and a new category of zones, Renewal Communities (RCs), are effectively entering a transition. Legislation passed in 2000 offers expanded tax incentives, but no grant funding. Today, HUD is working hard to give its part of the program a new name and identity. It now oversees the 110 urban EZs and ECs, plus all 40 of the RCs, both urban and rural. HUD now calls its EZ/EC/RC program the "Community Renewal Initiative," with an emphasis on tax-credit marketing and the use of the overlapping New Markets Tax Credit.

Although some zones still receive grants under old authorizations, HUD is aggressively changing the program to emphasize its tax-incentive aspects. Under the Bush Administration, the agency has not only changed the program's name and letterhead logo, but is also working hard to transform its image and its practical emphasis from the grant-making/community development program of the Clinton era to its original focus as a firmly supply-side business-incentives program.

"The program is now where it was first intended to be," said Don Mains, HUD's deputy assistant secretary for economic development. Mains said he saw a potential for using about $150 million in tax incentives in each community.

Mains' mid-1990s predecessor at HUD sees things differently. Roy Priest spoke of the federal zone program's 1993 design with frank nostalgia for its lost possibilities. He said the EZ idea combined the conservative incentives philosophy with liberal social-service approaches championed by the House Black Caucus – a hybrid structure that "represented to me the culmination" of many years' of careful community development thinking. Priest said the 1994 community-planning competition among candidates for zone designation, which he supervised, engendered a unique level of interdisciplinary cooperation, sometimes in ways that did substantial good in and of itself.

But after the first EZs and ECs were named in late 1994, Priest said, the initial enthusiasm began to wane. As for the zone program's new approach, he said, "Tax incentives alone are not going to induce the kind of private sector investment that's needed to turn these neighborhoods around."

Looking back at the results of the programs, individual success stories are easy to find. There are neighborhood-governed revolving home loan funds in Philadelphia, home-loan assistance grants in Atlanta, bond-funded business projects in Cumberland County, N.J., and an Amazon.com customer service center in Huntington, W.Va. HUD has a Web page listing dozens of "Business Success Stories" from its urban EZ and EC programs.

The U.S. Department of Agriculture (USDA) officials who supervise the rural zones speak with pride about job creation, capital leveraging, citizen involvement and ground-level innovations like the "Poor Man's Bank" microloan program in southeastern Oklahoma, as well as an $11 million venture capital fund in the Kentucky Highlands district that they say has created 8,000 jobs.

If, as Priest said, some areas that got money lost enthusiasm, others kept up the enthusiasm without the money. Priest said Louisville stuck to its EZ program even though it was not selected to be an EZ. Similarly, over at the USDA, Dr. J. Norman Reid, acting deputy administrator for the Office of Community Development, said he decided to label the unsuccessful rural competitors as "Champion Communities," giving them special technical assistance and other help. Since the areas had spent months planning local development, he reasoned that they might as well put their plans into practice, even if they didn't qualify for new direct grants or tax breaks.

Reid said, "A lot of people looked at it with cynicism and said, 'fluff, fluff,'" but in fact the unofficial zones made "stone soup," drawing in help from other sources to pursue their strategic plans after all. He said they have leveraged $650 million in funding and created or saved 3,327 jobs under the strategic plans they formed for the zone competition. Some original "champion communities" have later been designated as EZs, notably Cumberland County, N.J. (now an urban EZ), and Aroostook County, Maine, (now a Round III rural EZ).

Reid, in a joint interview with G. Richard Wetherill, director of the Empowerment Programs Division within Reid's office, said the rural zones have an average population of 15,000. The 57 rural zones plus the USDA's five Rural Economic Area Partnership (REAP) communities could together claim 1,459 newly constructed homes, 3,928 rehabbed homes, and 34,423 new jobs. They said the rural zones have raised more than $3.7 billion in grants and loans, 40% of them federal, with $660.5 million in USDA rural development funds.

Many more figures are available on the urban zones. The findings that HUD treats as most favorable come from the Abt report, completed last November. That study--a major effort, involving many local academic contributors--looked at all 71 of the Round I urban zones over the five-year period of 1995 to 2000, focusing most closely on the six large urban Round I EZs--Atlanta, Baltimore, Chicago, Detroit, New York City and Philadelphia/Camden--and 12 other "intensive study sites" chosen from among the more substantial ECs, including all of those receiving Economic Development Initiative loan aid.

The study found that job creation increased in five of the six zones (it decreased in Chicago). Because the 1995-2000 period saw general economic expansion, this might not say much in itself, but the study further found that job growth in four of these EZs outstripped growth in comparable districts (it did not meet this test in Chicago or Philadelphia), and in three of the zones, job growth was "correlated with specific EZ programmatic activities." (Atlanta had job growth for other reasons.)

The study found overall increases in zone businesses' employment of local residents, a "marked" increase in minority business ownership and a "substantial" increase in employment of zone residents. The study found that the 18 "intensive study sites" had helped "as many as 16,000" zone residents to find jobs.

At the same time, the ABT study found flaws in the zone programs: The grant-funded management structures often saw local political conflict, some of it highlighting the program's built-in tension between business-incentive and social-service approaches to helping poor neighborhoods. High turnover and controversy surrounded the Atlanta and Chicago zone-management offices, and the study said that the Camden part of the joint Philadelphia/Camden zone was stumbling while Philadelphia moved ahead.

In these as well as other places, local political disagreements about priorities and the meaning of inclusiveness erupted. In some cases this conflict kept the zones from "drawing down" appropriated grant funds as planned.

On the use of business incentives, the ABT report confirmed earlier findings by the General Accounting Office (GAO) and the Brookings Institution that businesses were not making extensive use of the EZ employment credit and other zone advantages. The ABT report included surveys of businesses in the six original EZs, conducted in 1997 and 1998 and again in the summer of 2000.

The more cautious of two early Treasury Department estimates had predicted that zone businesses would use $250 million per year in tax incentives, 95% of it in the form of the Empowerment Zone Employment Credit. In fact, an IRS study released in 2000 said that for 1996, tax claims invoking the employment credit represented only about $15 million, or less than 7% of the predicted amount. (The report said this figure was an undercount, but probably not by much.)

More recent statistics provided by the IRS public affairs office show larger employment credit claims in 1998: Individual returns claimed about $22 million and business returns claimed about $19 million, for a total of around $41million, or about 17.4% of the Treasury's prediction.

The IRS reported that in 1999, the tax credit claim figures went up again. Figures from business returns were not available yet, but individual returns alone claimed about $31 million, compared with around $22 million on individual returns in 1998. However, the 1999 figures are not really comparable to the earlier ones because at the start of 1999, the populations of 20 new Round II Empowerment Zones joined this tax category.

"The business incentives never seemed to do much of anything for anybody in anything we ever looked at," said Noah Temaner Jenkins, who directed a research project on the urban EZs from 1994 through 1999 at DePaul University's Egan Urban Center.

As designed in 1993, the program placed a strong Great Society-style emphasis on local control. This aspect has been praised for promoting local democracy but also criticized for leaving the program without standardized measures for success.

"The program objectives were never clear," said Jenkins. She said at the federal level there were goals like "empower communities, alleviate poverty," but no objective benchmarks. Each zone was to prepare its own strategic plan and set its own goals and then meet them. This might not in itself have been a problem, but Jenkins said, "it quickly became clear that the zones couldn't be held to their own standards."

At first, Jenkins said, "Chicago took the community empowerment part very seriously ... they really thought they were going to be held to it." The zone staff created a large board that included community activists as well as local officials. But she said the resulting process turned out to be not especially "empowering," and some participants were disappointed. She said part of the trouble was that HUD did not reinforce the original vision of local democratic control, seeming to be satisfied with "community participation" by City Hall insiders.

In any event, she said, "Most people living in the Empowerment Zones didn't know anything about it. That doesn't mean it didn't affect them, but they weren't participating."

Priest regretted that most zones were administered by existing departments of municipal government. He said the original idea had been to set up a truly interdisciplinary governing structure that would continually cause people with different concerns and specialties to share expertise. Of the original zones, he said, Baltimore came closest to that vision by setting up an independent corporation to run the zones, and by fostering local control in six separate "village systems."

In 1998, HUD’s Office of Inspector General (OIG) released audits of the Round I EZs in Atlanta, Chicago, Denver and Philadelphia, which showed that they all had overstated their accomplishments by taking credit for programs that took place in the zones but did not receive zone funds. The audits also criticized uses of zone grant money to help people and businesses outside the designated areas. A 1999 report criticizing HUD's oversight of the EZ program was also unresolved as of March, with OIG waiting for HUD to develop more standardized monitoring procedures for the zones.

The Atlanta EZ recently lost its status because a new Renewal Community overlapped its territory. A HUD spokesman said, "As I understand it the mayor is about to announce the new Renewal Community administration there, and its inheritance of the whole Empowerment Zone legacy, which is mixed" – but with a valuable asset: Atlanta's RC will be able to spend the remainder of the EZ's $100 million block grant.

HUD is now working on holding its zones more closely to their own standards. "We collect some pretty detailed information," the spokesman said. A HUD official more specifically said that the current goal in HUD's Performance Monitoring System (PERMS) was to "refine our terminology, collect more standard-type data," and he acknowledged the need to review the use of funds in a more standardized way. The individual PERMS reports, available online at HUD's Web site, now note progress toward "milestones" set early in the program, and progress toward undated "projected outputs."

HUD did not reply to more detailed questions about EZ/EC oversight.

A number of other questions remain unanswered. Studies seem to have focused generally on the climate for business people in the zones, not for residents. Priest noted that little attention has been paid to tracking the often very large volumes of federal grants that zones received partly because EZ/EC status entitled them to bonus points on applications. He wondered, for example, whether such grant money, if it supported a job-training program, actually went to train zone residents.

With cash grants fading out and bond authority increased, bonds may become more popular. Until recently the Round I zones could issue bonds only under strict federal volume caps. However, the Round II zones were not under such caps, and since January 1, 2002, all EZs except the District of Columbia may issue facility bonds up to $60 million in rural areas, and $130 million or $230 million, depending on population size, in urban areas. As of 2002, all EZ facility bonds are exempt from state bond-volume caps.

There are, however, reasons that the bonds are not yet widely used in the program. In Minneapolis this spring, Empowerment Zone director Kim Havey unhappily listed half a dozen "bond deals that we crossed off." In his bailiwick--also a Round II EZ--businesses have had trouble meeting the federal tax code's strict definition of "qualified zone property" for bonds.

For example, Havey said, a roofing company already operating in the Minneapolis zone had hoped to finance a new building with EZ bonds. It easily met the requirement of employing at least 35 % local residents. The hitch was that the business also had to earn more than half its income inside the urban zone, and most of the actual roofing jobs were out in the suburbs. Havey said the new building did get financed, but with taxable bonds and much extra trouble.

The Round I grants are now running down, and the Round II zones are not assured of further appropriations. This year the Senate Appropriations Committee recommended $30 million for the 15 Round II EZs to share, but it stated "the Committee remains concerned over accountability in this program and notes that the HUD Inspector General has been critical about how communities have implemented this program and used EZ funds." In last year's conference report, Congress asked OIG to audit the use of all the EZ/EC program grant funds. The audit report is due in December.

How the nine EZs work

HUD and USDA supervise zones designated in three "rounds" effective 1994, 1999 and early 2002. Round I legislation created nine EZs – six urban, with $100 million apiece, and three rural, with $40 million apiece. It estimated 95 ECs – 65 urban, 30 rural, with smaller levels of funding – with all the of grant funds appropriated in advance for use over 10 years. All received some federal tax breaks and get other help such as "bonus points" on federal grant applications.

Only the EZs received bond authority and a wage-credit opportunity for zone businesses that employ local residents. Cleveland, Los Angeles and the District of Columbia later received further zone designations.

In Round II, Congress created 15 urban and 5 rural EZs and 30 ECs, on terms similar to those of Round I, except that this time, the grant funding depended on annual appropriations. In Round II, the EZ bond authority was much more usable because Congress exempted it from state volume caps. Round III, creating more EZs and 40 new RCs, provided much bigger tax and bond incentives, but no cash grants at all.

The legislation creating Round III also gave new bond authority to all EZs, including those in Round I. All EZs except the District of Columbia are now able to issue tax-exempt "facility bonds" up to $60 million in rural areas, and $130 million or $230 million, depending on population size, in urban areas. (See Affordable Housing Finance July/August 2002, page 28 and April 1999, page 72.)

Appropriations unlikely for EZ grants

It always takes last-minute haggling to get federal grant money appropriated for Round II Empowerment Zones (EZs) and Enterprise Communities (ECs). However, this year the prospects look worse than usual.

For the first time, Round II funding is entirely missing from the White House budget proposal. Given Washington’s preoccupation with security spending, it may be tough to equal even last year’s appropriation of $3 million per urban EZ, let alone the larger sums available in the late 1990s.

In 1998, to local officials competing for Round II EZ or EC status, it appeared at first that the winners would get grants through HUD and the USDA comparable to what the Round I zones received in Social Service Block Grants through HUD: $100 million for urban EZs, $40 million for rural EZs and $250,000 for rural ECs.

However, because Round II funds are subject to annual congressional appropriations, the grant payments have been unpredictable, and in smaller amounts than anticipated. Round II’s 15 urban EZs--the biggest spenders--have been allocated a total of $21.9 million apiece over the last four fiscal years.

Urban EZs generally receive their grants through the VA/HUD appropriations bill, while the five rural EZs and the 20 Round II ECs are funded through the USDA. This year, administrators in both categories are worried.

Kim Havey, director of the Minneapolis Empowerment Zone, was gloomy about the chances of any further money in fiscal 2003, saying, “It doesn’t look good this year, but we’ll see.”Lobbyist Dennis McGrann of the Lockridge Grindal Nauen firm, which represents the Minneapolis city government, said, “Every year we’ve fought the battle on this stuff, and for the last three, four years it’s been a very formidable task.” He said the very “targeted” constituency seeking this funding – only the Round II designees – made the annual political battle particularly difficult.

Rep. Frank LoBiondo (R-N.J.) introduced a bill in the summer of 2001, H.R. 2637, that would authorize annual $10 million payments to urban Round II zones for the rest of their existence – through 2009. However, its chances right now are not very strong. LoBiondo also asked the VA/HUD appropriations subcommittee for at least $5 million per zone to help his own district’s Cumberland County EZ and similar urban EZs elsewhere.

Meanwhile a Democratic staffer said congressional advocates for the Round II funding had informally requested only $45 million, or $3 million per urban EZ.

Resources

Details on the tax advantages of the EZ/EC/RC districts can
be found in IRS Publication 954, available at http://www.irs.gov/pub/irs-pdf/p954.pdf.

A HUD tax-incentive guide is among the Community Renewal publication links at http://www.hud.gov/offices/cpd/economicdevelopment/library/index.cfm.

The main Community Renewal Initiative page is at http://www.hud.gov/offices/cpd/economicdevelopment/programs/rc/index.cfm, providing links to other zone program information as well.

HUD’s five-year progress report on the Round I EZ/ECs’ achievements is at http://www.huduser.org/publications/econdev/ezec_rpt.html. A contact list for all the districts except last-designated Tucson appears in HUD’s SuperNOFA at 67 FR 13849.

The SuperNOFA text is available at http://www.hud.gov/offices/adm/grants/fundsavail.cfm.

HUD provides a number of online contact indexes, including lists at http://www.hud.gov/offices/cpd/ezec/contact, and an interactive map at http://www5.hud.gov/urban/tour/statestour.asp that provides links to individual applications and annual reports.

The USDA provides rural zone contact information and annual reports at http://www.ezec.gov/communit/ruralezec.html.

The USDA also lists the Round I and II zones’ exact census tracts at http://www.ezec.gov/round3/designated_ezec_census_tracts.html.

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