Racial Inequity and the Tax Code

As lawmakers push to address racial inequities in government policy, we look at why tax policy presents a unique challenge and how Minnesota compares in one area that’s received national attention.

Last month the House Tax Committee heard a bill to enhance the state’s beginning farmers tax credit.  The credit had a very modest budget impact and featured significant bipartisan support, all of which normally means a couple minutes of uneventful discussion.  Yet the bill prompted one of the testiest and emotionally-charged moments we have ever witnessed in a legislative hearing.  It was triggered by a small carve out specifically designed to improve credit access to people of color, indigenous communities, and immigrants to start farms.  There was no controversy over the inclusion of this provision itself.  However, in advocating for the bill, a testifier linked this provision to the ongoing need to correct for centuries of systemic and structural racism.  This prompted a member to comment such remarks were an unnecessary issue to interject as part of the bill’s consideration.  That in turn prompted rebuttals for the need for people to come to grips with the history of structural racism in government policy which further devolved into a brief exchange on accusations of lecturing.

Given the events and circumstances of the past year, this moment perhaps shouldn’t have been too surprising - especially with the added stresses of a budget session.  Sensitivities and defenses are heightened and emotions are raw.  The Walz administration has emphasized addressing racial inequality and injustice in all his budget and policy initiatives this session.  As a result, every area of public policy has come under greater scrutiny as to how various provisions and their administration may reflect racial bias and foster inequity.  Tax policy was not going to escape introspection. 

The Data Problem

Gaining a greater understanding of if, how, and to what extent racial inequality exists in our tax code is challenging for a significant reason: IRS data is colorblind.  As a recent tax law review article[1] noted, “Not only does the 1040 not ask about race, but the IRS Statistics of Income Division, the Treasury Office of Tax Analysis, and the Joint Committee on Taxation do not include race or ethnicity in their tax data analysis, forgoing the imputation or matching techniques that could reveal race and ethnicity even if the underlying data was colorblind.”  This is in stark contrast to other areas of government policy where a plethora of race and ethnicity information is available to inform policy analysis.  It continues:

Citizens who want to know more about equal access to education can go to the Department of Education to look up higher education and enrollment by race, but if they go to Treasury to look up participation in tax preferred college savings accounts, they are out of luck…. A Senator concerned about equal access to affordable housing can look up Section 8 utilization by race, yet when consulting with Joint Committee on Taxation for reforming the mortgage interest deduction, race and ethnicity are absent from the analysis.

There is no law preventing this; it just hasn’t been part of tax data administration since the passage of the Revenue Act in 1913.  No less interesting is that, according to the article, the IRS refrains from asking about race or ethnicity even in rare situations when an assessment of tax liability is contingent on it.  As one tax expert has noted, being colorblind may have served a protective purpose in the early days of the income tax when being identified as a minority entailed considerable risk for overt racial discrimination by government.  Today, it is a major impediment to obtaining an understanding of any disparate effects.

Racial equity matters aside, this absence of information creates a basic taxpayer transparency and accountability issue, especially with respect to tax expenditures and their mammoth role they play in the federal budget.  The Biden administration has issued an executive order establishing an Equitable Data Working Group which includes the Treasury Assistant Secretary for Tax Policy suggesting some changes may be forthcoming in the next few years. 

Until any such information is available, scholars and researchers have two approaches to examine racial inequity in the tax code — both of which are sub-optimal.  The first is to generate their own descriptive statistics by imputing tax impacts from non-tax data.  This is done by cobbling together information and data available from other agencies and employing complicated research designs to control for income and other variables that can affect results besides race.  A few of the more notable federal tax policy topics on which such studies have been done (and found evidence of disparate racial impacts) include:

  • marriage penalties and bonuses in the individual income tax
  • federal earned income tax credit
  • tax preferences for pension contributions and earnings
  • reduced tax rate on capital gains
  • carryover basis on capital gains and gifts

Policy think tanks are attempting to provide additional assistance to these types of investigations.  For example, the Urban-Brookings Tax Policy Center is now embarking on an effort to update its microsimulation tax model to better inform these issues.  Yet the relative scarcity of such studies over the decades indicates how challenging these investigations can be.  Moreover, social science research designs and their conclusions are always justifiably open to critique and criticism and therefore are a poor substitute for publicly funded and available tax data directly from government institutions.

The second is to study the existence of income and wealth inequality fostered by the tax code and use it as a proxy for racial bias.  The analytical justification is that tax provisions which disadvantage lower income households have a disproportionate impact on racial minorities because they, in turn, are disproportionately represented among people at the lower end of the economic scale.  It’s an idea prevalent in many of the special reports and commentary pieces we have reviewed.  

However, it can be argued these studies are actually capturing bias and inequities against economic class due to decades of having the economic interests of higher and middle-income taxpayers prioritized in tax policy because of their greater representation in government, not racial discrimination.  To many, this appears to be a distinction without a difference.  In any event, it provides an explanation why the recommendations contained in recent reports and commentaries examining racial bias — adoption of more progressive income taxation, higher corporate taxes to fund state services, expansions of working family credits, etc. — are largely indistinguishable from previous work and advocacy by progressive interests over the years to reduce income inequality and improve tax fairness.

A Closer Look at Racial Equity in Property Taxation

Income taxation is only one piece of the tax system.   Perhaps the most direct and striking evidence of structural bias and disparity comes from two recent research studies examining local property taxation.

The first, a report from the Federal Reserve Bank of Minneapolis[2] merged data from 118 million homes in the United States with geolocation detail for 75,000 taxing entities. It documented a nationwide “assessment gap” — overassessment of less expensive homes and underassessment of more expensive homes — which leads local governments to place a disproportionate fiscal burden on racial and ethnic minorities.

The study found, controlling for jurisdictions and property tax rates, black and Hispanic residents face an average 10–13% higher tax burden for the same bundle of public services.  The assessment gap is attributable to two factors.  First, residential racial sorting creates different neighborhood characteristics which are captured by market prices but not as readily by assessments which focus on home attributes.  Second, assessment appeal behavior and outcomes differ by race.  Using administrative court records researchers found minority homeowners were less likely to appeal their assessment, less likely to win their appeals, and even if the appeal was successful would receive a smaller reduction than non-minority residents.

Can these disparities be fixed?   Commenting on the assessment gap problem, Fed researchers concluded market prices “can be so sensitive to geographic variation and property prices so temporally unpredictable, even the most skilled and attentive assessor’s office would not be able to equalize tax burdens by racial status.” As a proposed solution, researchers recommended generating assessments that incorporate small-geography home price indexes. They estimated simply linking assessment growth to zip-code-level indexes would reduce racial inequality by 55–70% with further reductions available using house price indexes that are more carefully calibrated to local geographies.

Another study, from the University of Chicago Center for Municipal Finance also focused on the racial disparities in property assessments and its implications.[3]  Based on a national analysis of assessment ratios and tax rates relative to sale prices for a sample of 26 million residential sales, the researchers found that assessments are typically regressive, with low-priced properties being assessed at a higher value, relative to their actual sale price, than high-priced properties. Within a jurisdiction, homes in the bottom decile of sale price face an assessment level, as a proportion of sales price, that is twice as high as that faced by homes in the top decile, on average.   This regressivity was found to be evident throughout the U.S. and again is linked to limitations in the data and methods used by assessors.   In short both found widespread racial inequalities in the distribution of U.S. property tax burden.

How does Minnesota’s property tax assessment and administration grade out in these investigations?  The Federal Reserve paper offers little granularity on Minnesota’s performance at either the state, county or jurisdictional level.   Eyeballing a bar chart of state level estimates of the assessment gap, it appears Minnesota slightly outperforms the average — around an 8%-9% assessment gap for black residents.   The University of Chicago Center for Municipal Finance offers more detail on its findings through a web-based tool providing a look at assessment to sales price ratio at the state, county, city and census tract levels with additional school district information.   The table below presents some key property tax equity measures (for 2016, the most recent year available) for Hennepin and Ramsey counties which have the two largest black population shares.

In both counties both the most expensive and least expensive homes were considerably under assessed relative to their sales prices — likely reflecting annual assessments unable to keep up with a “hot” Twin Cities real estate market affecting all home values.  Although the least expensive homes were under assessed by a greater amount, effective tax rates were higher as home value differentials offset assessment differentials.   As indicated by PRD values less than 1.0, expensive homes in both counties were assessed at higher rates than less expensive homes.  Both counties are substantially below the U.S. county median on the PRD measure.

This comparison of home selling prices with their assessed value at the time of sale suggests Minnesota property tax assessment and administration offers far greater property tax equity and fairness than most states.  However, it’s important to recognize county level aggregate summaries can mask disparate racial effects at much smaller geographical levels.  By clicking on a county report on the website tool one can drill down to the colorized census tract level which includes non-white population share information.  This allows users to see how “neighborhood” level sales ratios may differ by racial composition. (Such an analysis was far beyond the scope of this article.) 

Where Do We Go From Here?

We don’t expect another exchange similar to what occurred in the tax committee several weeks ago, but we do believe racial equity is now established as part of state tax policy debate and will continue to be an influential undercurrent and force in how we think and talk about taxation.   The question is how will it manifest itself.

One possibility is reflected in two recent articles published by State Tax Notes under Tax Analysts’ new feature, “The Search for Tax Justice.” In one contribution entitled, “U.S Tax Systems Need Anti-Racist Restructuring” three law scholars ascribe a legacy of racist motivation and intent with regards to our tax system.   The authors group the U.S. tax system with slavery, Jim Crow laws and lynching as “constituting and perpetuating white advantage and black disadvantage.”  They argue any anti-tax sentiment is “a manifestation of pervasive and continuous racism” and “tax systems are both a symptom of and instrument of systemic racism.”  Another contribution entitled “More for Less: How Property Taxes Fuel Racial Inequality” argues the administration of the local property tax as we know it is essentially irredeemable saying it “stands at the heart of a vicious cycle that perpetuates racial inequities in housing markets and schools.”  The scholar’s proposed fix is to take property tax collection and distribution out of the hands of local governments (and presumably give it to the state) which we can confidently declare would be an unmitigated disaster for local control, transparency, and revenue predictability.  

The other is using time-tested sound tax policy principles like transparency, simplicity, neutrality and fairness to guide our thinking to advance this objective in the pursuit of better state and local tax systems.  For example, the House omnibus tax bill includes the creation of a new tax expenditure review commission to study the impacts and policy merits of the ever-growing number of incentives and subsidies running through our tax code. Tax expenditures are an especially ripe area of investigation since racial minorities may be disproportionately unable to access these tax favored choices/actions due to lower levels of income or wealth.  For tax expenditures which are determined to support an important public policy purpose, there may be modifications to consider like replacing deductions, exemptions and exclusions with proportional credits to provide equal benefit for all income levels from the same tax-favored activity.  

Although it remains to be seen how the discussion and debate will unfold in this state, we have a pretty good sense of which approach is likely to be more productive. 

[1] “Should the IRS Know Your Race? The Challenge of Colorblind Tax Data, Jeremy Bearer-Friend, Tax Law Review, Volume 73 Fall 2019

[2] “The Assessment Gap: Racial Inequalities in Property Taxation,” Avenancio-Leon and Howard, Federal Reserve Bank of Minneapolis, Opportunity & Inclusive Growth Institute, Working Paper 34, July 2020

[3] “Reassessing the Property Tax” Christopher Berry, The University of Chicago Center for Municipal Finance, Harris School of Public Policy, Working paper draft February, 2021