Federal Income Taxes are Colorblind, but Are They Neutral?

With the rise of recent Black Lives Matter protests across the United States and the globe, tax economists and lawyers at the American Bar Association are studying how the federal income tax code, state and local taxes, and international taxation impacts highly marginalized people of color. The IRS has never asked taxpayers to identify their race nor ethnicity on their returns and neither do policies debated by Congress. This makes our tax system appear fair and neutral, but are they really affecting all people in America equally?

The Federal Income Tax System, similar to most government programs, is a series of specific policy choices. Deep racial inequities exist in the USA’s education, employment, housing, and criminal justice system, especially for Black and Hispanic households, and the Internal Revenue Code is no exception. This means that even though the 1040 form does not ask for race or ethnicity, the policies and tax laws that are passed can intersect with other racial inequalities in the federal government to make the equality gap better or worse. 

Racial Disparities in the Income Tax System- An Interactive Feature

Under our current Internal Revenue Code, taxpayers pay different tax amounts based on their types of income and tax-preferred actions. The government pays individuals a great amount of tax dollars back in refunds according to the following tax benefits in Figure 1.

Figure 1

Researchers Kim S. Rueben and Aravind Boddupalli set out to create a feature that would uncover structural racism in the U.S. Tax forms. This feature can be explored on the individual income tax form 1040 and other documents at http://apps.urban.org/features/race-and-taxes/.

Retirement Savings

The U.S. Federal government gives incentives to taxpayers who contribute to their assets to retirement plans. An individual needs sufficient income before they can contribute to an IRA or 401(k) plan, which disproportionately affects people of color. In 2016, 60% of White families reported having a retirement account, compared to 34% of Black families, and 30% of Hispanic families.

Earned Income Tax Credit

The Earned Income Tax Credit (EITC) was implemented to help low- and moderate- income working parents. It is a major expense of the U.S. Tax system and will cost the government $300 billion from 2019-2022. Black and Hispanic populations make up the majority of low-income households in America; over half of the households with income under $30,000 are non-White in 2018 (Figure 2). That means the EITC credit should help these families the most, right? Not necessarily.

Figure 2

While this credit does help families of color and is attributed to lowering poverty rates in some cities, White households are still the largest group receiving this benefit because they constitute the majority of the working population. Senators Sherrod Brown, Michael Bennet, Richard Durbin, and Ron Wyden have proposed the Working Families Tax Relief Fund Act to reform the EITC to reach more families of color. If the act is passed, it would make both the child tax credit and the EITC refundable, boost the EITC’s support to families with children, and apply the EITC credit to working parents who do not live with their children. This legislation is estimated to help 16 million women of color (about one third of the Black, Hispanic, and Native American women in the U.S.) and would better help the population it is intended to reach.

Audit Rates

EITC returns are audited more frequently (1.6%) than individual income tax returns overall (0.6%) because of how much money the government spends on the credit. Over time, audit rates have fallen for all groups, less sharply for EITC returns, due to budget cuts and “complications in auditing wealthy taxpayers” (IRS). This means wealthy families, which are more likely to be White, are audited less than families who claim the EITC credit (ProPublica analysis of IRS data).

Housing and Homeownership

Another benefit the IRS pays taxpayers for is a deduction for home mortgage interest and exclusion of certain realized gains from a home sale. It is one of the IRS’s top expenses, estimated around $280 billion from 2019-2022. While this tax provision was added to raise home sales in America, data shows that it has incentivized buyers to unnecessarily upgrade to bigger houses and take on riskier debts.  In addition, Black and Hispanic families are less likely to own homes and this credit has not helped increase their homeownership. Black households also have a history of redlining and segregation in the United States, which has heavily affected the rate of homelessness and wealth disparities.

With the passing of the Tax Cuts and Job Act of 2017, the tax benefits individuals could claim from itemizing their benefits became unattractive and hurtful to low-income households. Under current tax code, only high-income households will continue to itemize their housing benefits, as most other households realize the detriments itemizing their tax returns under this new code.

Where to Next?

After exploring the interactive feature, it is natural to feel discouraged and helpless against the effect of America’s structural racism. The start to the solution is recognizing the problem, which is why the feature was created and should be shared freely. After seeing what problems credits create and fix in the U.S. economy, it is important for state legislatures to reevaluate tax laws and adjust as needed. In addition, there are not many people of color who hold seats, and their representation has been lost in recent tax reforms.

As the coronavirus pandemic continues to spread, it is unclear exactly how the federal tax code will adapt. Tax law and policy reforms will soon come again, and it is important for the deciding vote to be representative of the population it is trying to help.

Amanda Gile

Note: This information cannot take the place of advice from a lawyer. Each case is different and needs individual legal advice. You should contact the LITC or a private attorney if you need representation on a tax matter or if you have questions.