As a volunteer income tax preparer in the Bronx, I’ve worked with residents whose adjusted gross income often drops below the federal poverty line. Many of them are black, and their tax returns usually involve one or two sources of wage income or Social Security benefits. Rarely have they accumulated interest or capital gains, so their wealth is all but non-existent.
Unfortunately, this is the story for many black households who hold up to nearly 13 times less wealth than their white counterparts. For them, though, tax season is not necessarily a time for government to take their hard-earned money. It may represent the exact opposite: For low-income residents, a tax return may constitute the largest single check they receive all year.
In fact, tax season, and the tax code more generally, may be one of the biggest ways policymakers can bridge the $130,000 black-white wealth gap.
Wealth represents the difference between what a household owns and what it owes. It serves as safety net when family members lose their jobs or become sick, and it indicates a family’s potential for long term success. While one family’s wealth may allow it to purchase a new home or send its members to college, another family’s limited wealth can trap it in impoverished neighborhoods and below-average school systems, impacting the future generation’s ability to succeed. A family’s limited wealth forces it to live on the edge, as every setback can prove devastating.
The tax code already represents a way through which Americans can build wealth, delivering 90 percent of the government’s asset-building investments in 2009. Through various tax deductions and exemptions intended to encourage and facilitate wealth creation, the U.S. treasury loses almost $400 billion of tax revenue each year. Most of the benefits, however, accrue at the top of the income distribution and have little effect on those most in need: low- and moderate-income households that are unlikely to have accumulated much wealth.
Minorities are less likely to benefit from these expenditures, and the wealth gap between white and black families, especially, has remained incredibly wide as a result. In 2013 this wealth gap rested at its farthest divide in almost 25 years. While the median white household held over $141,000 in wealth, the median black household held only $11,000.
Black Americans, especially, have been shut out from wealth creation through decades of discriminatory housing and mortgage lending policies, low homeownership rates, and limited access to the country’s job markets. Demos and the Institute on Assets and Social Policy estimate that inequality in homeownership alone represents 31 percent of the racial wealth gap, and the number of years of homeownership explains most of the divide. An additional 43 percent of the gap reflects unequal return on income in the form of investments, benefits, and savings.
The tax code has failed to help black Americans overcome these historical disadvantages because tax policy has targeted the wrong demographics. Instead of helping those with little wealth, tax policy has provided the most benefits to those with the highest incomes who are already in the best position to generate wealth. Of the approximately $400 billion in tax expenditures intended to incentivize and support wealth creation, 53 percent of benefits in 2009 went to the top five percent of income earners, those making more than $160,000 each year, and only four percent of benefits went to those making $50,000 or less. Tax policy thus failed to reach over 60 percent of black Americans who live in this latter category.
Bridging the racial wealth divide demands that we rethink how the tax code incentivizes wealth creation. As Demos and the Institute on Assets and Social Policy note, we must focus our analysis on homeownership and helping families get the most out of their income.
The tax code rewards homeowners through the mortgage interest and property tax deductions, which allow homeowners to reduce their taxable income by the amount of interest paid on mortgage and home equity loans as well as the value of many property taxes on their homes. Although the deductions cost $100 billion each year, fewer than half of homeowners claimed the deduction in 2011. For those who do claim it, approximately 70 percent of the benefits go to the top 20 percent of income earners, while the bottom 20 percent of income earners receive less than two percent of all benefits.
Research suggests that neither the mortgage interest nor property tax deductions have a significant impact on homeownership rates because neither addresses residents’ income restraints and the high down payments and closing costs that serve as the largest barriers to homeownership. Since gains are only realized after purchase, when families file their taxes, the incentives do not adequately target those who need help buying homes and building wealth through their homes. Low-income filers, including many black Americans, thus fail to benefit from the costly mortgage interest and property tax deductions.
A more useful model would better encourage homeownership by offering a refundable tax credit for first-time home owners that would offset the transactional costs that inhibits first-time home owners from purchasing a home. A refundable credit reduces a family’s tax bill, possibly bringing it below zero and giving the family a larger refund. According to the Tax Policy Center, if the credit were phased in during the initial years of homeownership, it would prove to be highly progressive, offering tax cuts for low- and moderate-income families and tax increases for high income families — those most able to pay.
A continued annual refundable tax credit for homeownership and a credit to offset partially local property taxes would then help households build equity on their homes. In conjunction with limiting the mortgage interest deduction and eliminating the property tax deduction, these reforms would not cost any more than what the federal government currently spends.
Instead, their structure as refundable tax credits would help tax policy intended to bolster wealth creation more efficiently and more effectively reach its target audience: low and moderate-income households, especially those belonging to black Americans.
Tax expenditures meant to augment retirement savings and help families get the most out of their income have also failed to produce wealth for black Americans. By capitalizing on income through retirement benefits and investments, taxpayers can realize a higher return on their income. These policies costs over $140 billion each year and include certain tax deferral and exclusions for retirement account contributions.
For instance, when taxpayers make contributions to traditional 401(k) plans or Individual Retirement Accounts (IRA), they can defer income taxes on their deposits until they withdraw the money in retirement. This arrangement serves both as a deduction in the current year’s income taxes and an eventual reduction in taxes paid on the money deposited into the accounts — assuming that reduced income in retirement leads them to pay a lower rate.
Tax expenditures for “roth” 401(k) and IRA plans work in reverse. Although contributions are taxed at the point of deposit, appreciated assets in the accounts and withdrawals during retirement go untaxed. As a result, the “inside buildup” of wealth within the accounts is not subject to income or capital gains taxes, costing the Treasury roughly $20 billion each year.
These expenditures overwhelmingly benefit high income earners, as the Center on Budget and Policy Priorities, notes: “[T]he top 20 percent of households receive nearly twice as much in retirement tax subsidies as the bottom 80 percent combined.” Black Americans are especially disadvantaged. While over 60 percent of white Americans hold assets in retirement accounts, only 38 percent of black Americans do. As a result, a strong majority of black households receive little to no benefit from government policy intended to support wealth creation before retirement.
Amending these policies involves expanding programs already run through the tax code. The Earned Income Tax Credit program (EITC), for example, offers working families with low incomes a refundable tax credit of up to $6,242. The program has not only lifted millions of families out of poverty but is also associated with an increase in academic achievement and college enrollment among recipients’ children, as well as increases in health for pregnant mothers and newborn children. Most importantly, EITC overwhelming benefits low- and moderate-income households, with over 97 percent of benefits going to households making less than $50,000 a year, an income category that includes over 60 percent of black Americans.
Expanding the EITC program by raising its income thresholds and credit amounts would help black Americans generate wealth in two ways. First, by incentivizing workforce participation and increasing earnings, the program would also raise household Social Security benefits, giving households an increased safety net in retirement. Second, the program would also function as a source of income support for families struggling to get by. The EITC can help them get through economic hardship and being to build wealth without having to draw from what little reserves they have.
Black Americans would receive an additional boost if the saver’s credit program were adjusted to make the credits refundable. Currently, the program offers a nonrefundable credit to low-income families for up to 50 percent of a their contributions to retirement accounts. Making the credit refundable would allow it to bring a family’s tax burden below zero, effectively giving them a refund and further helping low-income families build wealth.
Some may contend that reforms are too expensive or that it’s not government’s role to intervene, but their criticism would ignore both the role that tax code already plays in helping Americans build wealth and the revenue-neutral proposals available. Since both black and white Americans support policies intended to help minorities get ahead, policymakers can no longer ignore the wealth divide that has left many minority households behind.
Although the tax code has largely failed to build wealth for black Americans, it still remains the ideal venue through which to bridge the racial wealth divide. When we think differently about how we tax wealth and incentivize wealth creation, tax season can help build more secure households and vibrant communities. It can make all the difference for the many struggling Bronx residents I’ve met.