How taxes exacerbate racial disparities

The Tax Code applies to Americans of every race equally, but IRS audits, tax rates and certain breaks and subsidies are exacerbating the racial disparity in wealth, according to a new study.

White households benefit more from tax advantages for capital gains, retirement savings and homeownership than Black households since white households own more of those assets. Higher ownership of these assets leads to greater benefits from the tax advantages for white households.

That’s according to a report last month by the Brookings Institution and Urban Institute Tax Policy Center called “How the Federal Income Tax System Can Worsen Racial Disparities.” 

Meanwhile, the IRS has been significantly more likely to audit Black taxpayers, and the equalizing effects of credits for families fail to reach those of the lowest income.

The findings mirror many similar studies displaying the impact of systemic racism and inequalities that have resulted in Black households having just 16% of the median wealth of higher income white ones, according to the Fed. For financial advisors, the research offers a reminder of the larger importance of assisting people of every background in building wealth through serving an inclusive client base and participating in pro bono work in the community, said Rick Nott, a managing director with Santa Monica, California-based Angeles Wealth Management. 

“Money has a very well-documented and subtle way of changing your outlook on life,” Nott said in an interview. “That should be the spirit of our industry, is just helping people from all walks of life.”

READ MORE: The industry’s opportunity to work with new Black and Hispanic investors

Tax Policy Center researchers reached four conclusions:

• “Lower tax rates for capital gains and retirement savings overwhelmingly benefit wealthy white families.”
• “Tax subsidies for homeownership worsen historical racial inequities in housing.”
• “Tax credits for families help reduce some racial inequities but provide limited benefits for those with the lowest incomes.”
• “Black taxpayers are three to five times more likely to be audited by the IRS than other taxpayers.” 

White households get 84% of the benefits from the mortgage interest deduction and 92% of the tax value from the incentives for capital gains, estimates cited by the report showed.
“The federal income tax system is a powerful tool to advance equity, but it needs reforms to support all families,” the researchers wrote. “Identifying, confronting, and removing structural barriers to economic opportunity in the federal income tax system can help policymakers and advocates reshape federal resources and investments to better and more equitably support all children and families.”

The study illuminates another way that America’s racial history keeps playing out today around income and wealth. For example, the persistent racial wealth gap between Black and white households would take more than 300 years to eliminate at the current rate of change, another study last month by the McKinsey Institute for Black Economic Mobility found. 

The IRS is now trying to focus its audits on the wealthiest households. Other policy shifts aimed at narrowing race-based differences in taxes would require much more radical action like getting rid of the ability of married couples to file jointly, according to Dorothy Brown, a professor at the Georgetown University Law Center and the author of “The Whiteness of Wealth.”

“If we required everyone to file individual tax returns, no longer would marriage impact your tax bill — which is ideally what I would like,” Brown said in an interview with McKinsey in 2021. “When I think about the deductions, loopholes, and exemptions — they were all made with white Americans in mind. They were all made to advantage white taxpayers, which left Black taxpayers behind because Black Americans experience these things differently. 

“Whether it’s marriage or homeownership or college or jobs, we live in a society where race, unfortunately, still matters,” Brown said. “My solution is getting rid of the loopholes, exemptions, and deductions, taxing all income at the same rate — no more preferential treatment for capital gains — and allowing everyone a living allowance deduction.”

READ MORE: One year after Secure 2.0, retirement race gap remains stubborn

Conversations about race and government duties also bring to mind the term “Black tax,” which was a policy in apartheid South Africa but often refers to how prosperous African Americans provide financial support to family members, money coach Lynnette Khalfani-Cox wrote in Vox.

“Here’s the harsh reality about being Black in America: The deck is often so stacked against you that the weight of it all can feel overwhelming — no matter your income, your net worth, or how much you’ve achieved,” Khalfani-Cox wrote. “For African Americans like me, systemic inequities and generations of poverty can make it seem like whatever you’ve done is never enough, especially when you know you’ll have to help support relatives or make contingency plans for any number of scenarios out of your control.”

Advisors cannot transform systems and government policies with a magic wand, but they can take individual actions such as designing fee models that make it feasible to work with clients of any income level or adopting psychological methods addressing the trauma many people feel toward money.

Nott often recommends that clients read Morgan Housel’s book, “The Psychology of Money,” and he volunteers to teach local high school students about entrepreneurship through an organization where he’s on the advisory board, Project ECHO. 

The Tax Policy Center report prompted him to recall how legendary investors Warren Buffett and Charlie Munger criticized the smaller taxes on capital gains compared to ordinary income and what many lower-paid employees tell Nott after he gives presentations about their companies’ 401(k) plans.  

“It really seems like the most backward part of the entire Tax Code,” Nott said. “‘I can barely make ends meet, how do I find the money to put away in this 401k?’ And that really shouldn’t be the case.”