Question

The following is taken from the Internal Revenue Service website explaining potential tax incentives for investment in certain lower-income neighborhoods (Opportunity Zones). Explain how these tax incentives might affect labor demand, full employment, real wages, potential GDP, and both the short and long-run AS curves

Opportunity zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.

Answer 1

This concept of encouraging investments is like having a special economic zones. This offers investors to. invest in those areas and may get tax incentives depending on tenure of Qualified Opportunity Fund (QOF) established for this purpose. Higher the investments tenure more would be the benefits.

It is clear that when investments come, new manufacturing and services units will be set up. Demand for labor will go up. Real wages. will go up as well as different skill sets will be rewarded accordingly. Economy can get into a virtuous cycles in which higher income will lead to high savings and then again high investments and high productivity. Once productivity goes up economy will have growth and long run aggregate supply(LRAS) will also shift to right. Short run aggregate supply will also shift right as more investments would come. At full employment only naturally unemployed people will be there.

Refer following graph which shows aggregate demand shift from AD1 to AD2 , if supplemented with shift in aggregate supply, LRAS shifts right taking economy potential to new levels.Price levels change from a to b and then to c.