In testimony yesterday before a joint hearing of two House subcommittees, I urged Congress to modernize the nation’s social welfare programs to focus on early childhood, quality teachers, more effective work subsidies, and improved neighborhoods. One way lawmakers can shift their gaze is by considering the effects of combined marginal tax rates that often rise steeply as people increase their income and lose their eligibility for benefits.
While some talk about how we live in an age of austerity, we are in fact in a period of extraordinary opportunity. On a per-household basis, our income is higher than before the Great Recession and 60 percent higher than when Ronald Reagan was elected President in 1980.
A forward-looking social welfare budget should not be defined by the needs of a society from decades past. Two examples of how our priorities have shifted: Republicans and Democrats didn’t always agree on the merits of Aid to Families with Dependent Children (AFDC) or the Earned Income Tax Credit, yet they agreed on the need to shift from welfare to wage subsidies. Ditto for moving from public housing toward housing vouchers.
I sense that both the American public and its elected representatives are united in wanting to create a 21st century social welfare budget. That budget, I believe, should and will place greater focus on opportunity, mobility, work, and investment in human, real, and financial capital.
However, for the most part, our focus has been elsewhere. As I show in my recent book Dead Men Ruling, we live at a time when our elected officials are trapped by the promises of their predecessors. New agendas mean reneging on past promises. Even modest economic growth provides new opportunities, but the nation operates on a budget constrained by choices made by dead and retired elected officials who continue to rule.
For instance, the Congressional Budget Office and others project government will increase spending and tax subsidies by more than $1 trillion annually by 2025, yet they already absorb more than all future additional revenues—the traditional source of flexibility in budget making.
I am concerned about the potential negative effects of these programs on work, wealth accumulation, and marriage of combined marginal tax rate imposed mainly on lower-income households. To see how multiple programs combine to reduce the reward to work and marriage, look at this graph.
For households with children, combined marginal tax rates from direct taxes and the phasing out of benefits from universally available programs like EITC, SNAP, and government-subsidized health insurance average about 60 percent as they move from about $15,000 to $55,000 of income. This is what happens when a head of household moves toward full-time work, takes a second job, or marries another worker.
Beneficiaries of additional housing and welfare support face marginal rates that average closer to 75 percent. Add out of pocket costs for transportation, consumption taxes, and child care, and the gains from work fall even more. Sometimes there are no gains at all.
While there is widespread disagreement on the size of these disincentive effects on work and marriage, there is little doubt that they exist. One solution: Focus future resources on increasing opportunity for young households. Make combined tax rates more explicit and make work a stronger requirement for receiving some benefits.
This post originally appeared on TaxVox.
I’m pleased that politicians from both sides of the aisle are focusing on economic mobility. In life, the deck gets stacked fairly early and connections play a big role. In an open and democratic society like the United States, it’s not so much that a person can’t get a hit; it’s that one person steps up to the plate with three balls and no strikes, and the next with no balls and two strikes. The odds that the second person ends up with a higher batting average than the first after 10 times at bat is just about nil.
One reminder of how connections and early stacking of the deck reinforce each other came in the mail a few days ago: a chance to cast my vote for the officers of the American Economic Association (AEA). I’m supposed to select five people from nine candidates. The list shows some diversity along lines now somewhat demanded by society—that is, three women and one person of color. But, seven of the nine—and all six white males—have a connection with the Massachusetts Institute of Technology, or MIT (five PhDs and two faculty), so I have to vote for three MIT-connected economists at a minimum. Harvard lost its usual spot; only five of the nine have a major connection, including three with bachelor’s degrees from there. In fact, only one of the nine does not have a Harvard or MIT connection—though she has taught at Princeton, which usually gets at least token representation in this annual vote.
I know many of these candidates and have great respect for them. But I doubt that most of them believe fully in the hierarchical system from which they are now beneficiaries.
A number of years ago I had two colleagues who had done all but dissertations (ABDs) in history at the University of Virginia, ranked as one of the better schools in the country for that subject. Both were told by an adviser it wasn’t worth the trouble to write their dissertations. Jobs teaching college history and requiring a PhD, they learned, were so rare that they were already doomed: they were from too low-ranked a high-ranked university.
The financial industry has an extensive old boy (and occasionally old girl) network with the Ivy League. One of my daughters went to Princeton; though a biology major, she was recruited to join Wall Street (she didn’t accept). A former research assistant I knew got an MBA from the University of Texas at Austin when it became well-known for its rigor. Despite doing quite well, he later complained that without the Ivy League connection he couldn’t even get interviews with Wall Street firms.
Richard Perez-Pena recently penned a piece for the New York Times detailing the lack of progress among elite colleges in enrolling low-income students (not yet a standard along which politically correct diversification levels are expected). For instance, studies out of the University of Michigan and Georgetown University find that at 82 schools rated most competitive by a Barrons profile, only 14 percent of the student population comes from the poorer half of the nation’s households.
Look at top appointees under this president and former ones. Many come from a very few colleges— particularly the ones with which the presidents are connected (Obama loves Harvard; his predecessor, Yale), or have parents who owned banks, or other crucial connections. Even in sports, which is relatively competitive, think of the quarterbacks (RGIII) or golfers (Tiger Woods) who got a start even before age 10 learning from a parent or other close contact. And do you really think that all the current Hollywood stars with famous actresses or actors as parents just came out of genetically superior material?
I could go on, and I’m sure there is not a reader among you who couldn’t expand the list. In fairness, I should add some of my own early and lucky links, such as attending St. Xavier in Louisville, KY, perhaps the top high school in the state, where my family had gone for generations.
Researchers today work long and hard at trying to figure out which policies could help create a more mobile society, one where of starting at the bottom still left decent odds of making it to the top, or where success didn’t get defined so intensely by early connections or the track on which one started. So far we haven’t been very successful, though there are clearly some government steps that can be made, such as creating more equal access to subsidies for saving. But much is still determined by how we organize ourselves socially outside of government and just what we expect from our institutions. And, in truth, a thriving society should want successful parents to teach their kids all that they can, so simplistic leveling policies can easily start to threaten both their freedom and the wider societal growth that their successful kids can generate.
Still, I think it clear that many of the ways we select and discriminate hurt our society and hinder many from achieving their potential. So do I vote for MIT, or for MIT, or not at all?
The 50th anniversary of President Johnson’s War on Poverty has led to a flurry of articles and debates about whether that war succeeded. That debate has been reenergized by Thomas Piketty’s best-selling book, Capital in the Twenty First Century, which argues that inequality is rising because returns to capital have risen relative to average economic growth. A solution to this inexorable force, Piketty claims, lies in some form of worldwide wealth tax.
In both cases, I find the political debate largely unproductive. Many conservatives and liberals pick at pieces of data and history to support their own forgone conclusions. Rather than seek practical margins for making progress, much of the discussion turns to thumbs up/thumbs down rhetoric or totally impractical solutions.
Here’s how the data play out. Since the late 1970s, market-based measures of poverty and the distribution of income (that is, measures of income before taking account of government redistribution through taxes and transfers) improved very little in the first case and got worse in the second. Both did much better a few decades earlier, including up to the mid-1970s. PIketty bases his broad historical conclusions about growing inequality largely on market measures. In turn, researchers ranging from Gary Burtless at Brookings to Tim Smeeding at Wisconsin to Richard Burkhauser at Cornell to Diana Furchgott-Roth and Scott Winship at the Manhattan Institute have shown greater reductions in poverty and less growth in inequality of income or consumption when market-based income is adjusted for government taxes and transfers.
These two different ways of looking at the data make for strange bedfellows as the debate turns political. Conservative critics of the War on Poverty combine with liberal world-always-getting-worse warriors, who like to cite Piketty, to form conclusions based largely on the before-tax, before-transfer measures. They unite to attack the status quo, with one suggesting fewer transfers (the war failed) and the other higher taxes on the rich (the tax system failed). Liberal defenders of social welfare programs and conservative opponents of higher tax rates, in turn, conclude that on an after-tax, after-transfer basis the world is a lot better off than the other side asserts. They defend the status quo.
Here are the statistics that I ponder. In real terms, social welfare spending averaged about $7,500 per household at the time the War on Poverty was declared. By the time that Ronald Reagan was inaugurated in 1981, spending per household had grown to $15,000. And today it has doubled again from the start of the Reagan administration to about $32,000. (These figures do not even include tax expenditures for social welfare, such as pension, housing, and wage subsidies, which averaged about $7,000 per household in 2013.) Meanwhile, GDP per household grew from about $70,000 in 1964 to nearly $140,000 today.
Over this same 50 years the official thresholds for measuring who is in poverty have not grown one dollar in real terms. These measures, adjusted only for inflation, in a sense, are based on absolute poverty, unadjusted for the new goods and services a growing economy provides or, said another way, for whether a household’s income keeps up with average or median income in the economy. For a family of four, for instance, the nonfarm poverty threshold is crossed when a household’s income falls below roughly $23,550 today, essentially the same level as in 1964. For a single person, the poverty threshold equals $11,490
“Wait a second,” you may think. The government spends far more on social welfare than would be required to give every household support above poverty levels. And in almost every year there have been substantial real increases in the amount of transfers made. Why, then, has the poverty rate not fallen more?
There is no single answer. Here are four pieces of the puzzle:
Huge gains at the top. Inequality in market-based income DID grow substantially since the late 1970s, the period when progress against poverty slowed. The ability of high-income individuals at the top of a winner-take-all economy to capture much of the extra rewards that derive from monopoly or oligopoly settings does help explain some of the stagnation in earnings growth for those with average or low earnings.
It doesn’t explain why the public supports, which have continued to grow, haven’t made greater headway in improving the skills of the population enough that their market incomes would rise more. That brings us to the next three pieces of the puzzle: the extent to which the public money has been spent to help providers, help the middle class, and pay for health care.
Providers. Beneficiaries include providers who have captured large portions of government, not just private market, money. Before you start looking elsewhere, just remember that providers include, among others, doctors, drug manufacturers, social workers, lawyers, lenders, other financial intermediaries, builders, housing officials, software developers, tax preparers, government contractors, and, for that matter, researchers like myself.
The Middle Class. The middle class rather than the poor has also captured very large portions of the social welfare budget, largely in ways that have for decades encouraged them to retire and work less for greater portions of their lives. Early growth in Social Security benefits, for instance, did a good deal to reduce poverty, but in more recent decades has made less progress because growth—the marginal increase in payments—has been concentrated preponderantly on more years of support and higher levels of benefits for everyone, from rich to poor alike. Remember that a program can on average be successful in meeting some objectives, yet still target its incremental budget poorly. Incremental spending in our public retirement programs in the modern age increasingly operates to decrease the market incomes of the middle class and, despite billions of additional dollars spent each and every year, only modestly increases the transfers received by the poor.
Health Care. A large share of the growth in the income of almost everyone but the rich has come not in cash but in the form of government and employer-provided health care and insurance. One-third of per capita income growth in our economy from 1990 to 2010, for instance, went simply to pay for real increases in health care, as average annual health care spending per household from all sources ballooned to approximately $24,000. Measures of both market income (e.g., Piketty) and most measures of after-transfer income (e.g., the official poverty measure) fail altogether to count this major source of income. Yet for many, particularly those below median income, that item has dominated the way their income has grown for perhaps three decades. The CBO has tried very recently to count health insurance received as income in some of their work, but its efforts are an exception to the rule.
These four pieces interlock in various ways. For instance, more years and money in Social Security support, particularly as people live longer, has encouraged the average worker to retire for more than a decade longer than in 1940, when benefits were first paid, thus reducing their market income. Because many of the government’s expenditures on health care have been captured by providers, the public’s gain in benefits comes out to only a fraction of each additional $1 the government spends, while in the private sector cash compensation stagnates to pay for higher costs of health insurance.
In sum, the debate over poverty and inequality deserves renewed attention. However, it provides a quandary to many in both major political parties, who are largely mired in mid-20th century debates and fighting the thumbs-up, thumbs-down battles that blocks improvement from either side. The times beg for a 21st century agenda (an issue I try to address in my new book, Dead Men Ruling).
I love the NCAA tourneys. I grew up in Louisville at a time when basketball was synonymous with Kentucky, Ohio, and Indiana. I give the NCAA and the networks credit for building up the excitement, tension, and attention in this national event. This year, my interest was especially piqued because five family alma maters (including mine) made it to the Sweet Sixteen of the men’s tourney: Dayton, Wisconsin, Louisville, Kentucky, and Virginia.
My undergraduate school, Dayton, was among the elite in college basketball in the 1950s—and, to some extent, the 1960s. Dayton fell in status over time because, at least relative to some other schools, it started stressing academics more and athletics less. These experiences color the lessons on economic competition, both positive and negative, that I draw from the tournaments each year.
When competition flourishes, it’s hard to establish a monopoly.
Okay, Harvard did make it to the men’s tourney this year, but credentials don’t go very far when your accomplishments determine whether you get ahead. This stands in contrast to the politics of academia. High school seniors focus intensely on college admissions because they correctly sense that future success depends not simply on what they learn than but where they can make connections to get onto a faster career track. If you’re an economist, for instance, your odds of a top job in either a Democratic or Republican administration multiply one-thousand-fold if you have a Harvard connection at some point in your education as opposed to, say, a University of Connecticut one. It’s tough finding a job teaching history almost anywhere if your PhD is not from a ranked university, no matter the brilliance of your work. The NCAA appeals to the common person, I think, because we identify with any field where anyone with enough talent and effort can succeed.
Create a level playing field (court), and you’d be amazed at the amount of upward mobility.
Many of my fellow social scientists despair of the lack of upward mobility in American society, with young black men especially singled out as left behind. Yet notice their success in basketball, where there’s pretty much a level playing field from the time of birth. If you can run circles around me on the court, I can’t rise above you by turning to Daddy’s friends or the connections available only in higher-income communities. (Then again, maybe I can succeed in athletics by convincing the Olympic Committee to adopt some new sport played by an elite few. How many kids in inner-city Detroit have access to $100,000 bobsleds or a “playground” for luges?)
Money still matters—a lot.
As the tourney goes on and my position in the office bracket pool falls lower, I start turning to my cynical side and some negative lessons. Though there’s close to true competition among athletes, schools still compete on more than talent. Large state schools have done quite well in recent decades with the move toward big-money sports and huge TV rewards, perhaps even more so in football than basketball because of the expense involved. Multimillion-dollar coaching salaries, extraordinary facilities, the latest in physical therapy, and multiple support staff to develop statistics or simply run around as lackeys—you name it, each of these can add to the probability of success. Given this world, I shouldn’t admit that I’m still thankful to former Wisconsin chancellor Donna Shalala for bringing big-time sports success back to Wisconsin; it’s not surprising that Miami hired her away after her stint in the Clinton administration.
Those who take maximum advantage of the letter of the law often do well.
Consider the new Kentucky style of “one and done”: recruiting players who never intend to study or complete more than a year of school once they become eligible for the NBA draft. It works. It’s easy to cast Kentucky coaches in the same light as those traders on Wall Street who gain by faster computerized trading or better access to soon-to-be public information. Or multinationals that shift their profits with the flip of a switch to some low-tax country. It may all be legal (or almost legal), but dodges like these don’t generate growth in a capitalist economy or additional value for watching sporting events. In many ways, the relative advantage for these winners comes mainly from avoiding having to compete under the same rules as everyone else.
The working stiff still gets shafted.
Everyone knows that there’s big money to be made in major college sports. One way to get rich is to leverage the work of others, then claim a large share of the total rewards from the enterprise for yourself. Perhaps the few college basketball players who make it to the NBA might claim that their college training was a good investment. For many other big-time college sports athletes, the reward can be a 50+ hour workweek at almost no pay and a loss of other educational opportunities (see Joe Nocera’s take on unionization of players as employees).
Suppose society is willing to pay $1 billion to be entertained by the NCAA tournament. The players can’t get paid, though they might get some very nice meals or plush accommodations, so much of the $1 billion is up for grabs by coaches, athletic department personnel, and others—some of whom walk away with huge rewards at their athletes’ expense. The NBA also gets a free training ground and media promotion of its future players.
To be fair, the school receives some of the profits, and it divides the funds among money-losing athletics or (god forbid) academics. Still, the working stiff doesn’t have much say in the matter one way or the other.
The 50th anniversary of “the March on Washington”—so famous and, in many ways, so successful that “the” is sufficient to define it—brought forth a gusto of stories about what had been achieved since then, including some very interesting blog posts by my colleagues. Several turned to data on the distribution of wealth, including some studies in which I participated, noting the lack of gains—especially in the past few decades—in the wealth and income of blacks and Hispanics relative to whites.
Those aggregate, raw figures on wealth and income act as a form of performance test on one aspect of government policy. They state rather emphatically that, whatever its merits, such policy was not sufficient to move the needle on wealth mobility across and among racial and other classes. Some simply draw the conclusion that we must redouble our efforts on programs that they have favored for a long time. Spend more on Medicare or Medicaid or cut tax rates or whatever. But what if that focus is wrong? What if the dominant liberal and conservative agendas over the past 50 years, at least when it came to social policy and taxes, never really had much to with mobility? What if the data compel us to adopt more dynamic, yet realistic, policies that put mobility and opportunity more at the forefront of policy in the 21st century?
Over these past few decades, liberal agendas have focused largely on the positive effects of ensuring that people had adequate income, food, health care, and so on—that is, consumption. Conservative agendas have focused largely on the negative effects of high income tax rates, particularly at the top of the income distribution. Often raising legitimate concerns about poverty or incentives, respectively, in many ways, each side has won its battle. Redistributive and other social welfare policies now dominate the $55,000 in federal, state and local spending, including tax subsidies, now spent on average per household, while tax rates at the top tend to be about half what they were from World War II to the early 1960s.
Relative to 50 years ago, fewer people are without food or food assistance, people can now retire on Social Security for many more years, health care has become far more life-sustaining, more people go to college, and, while economic growth hasn’t been great lately, we’re still about three times richer than we were. So the record isn’t all that bad, despite current travails. But, once again, those successes largely did not carry over to mobility among and across classes.
Here are just a few examples of how policies have given limited attention to mobility:
- Current welfare policy helps feed and house people, but it often discourages work by imposing very high costs on moderate-income households with children, as they can lose hundreds of dollars of benefits for each $1,000 they earn.
- Even while single parenthood remains a major source of poverty for many, that same welfare policy now penalizes—on the order of hundreds of billions of dollars—low-income couples with children who decide to get or remain married.
- Although investing in quality early childhood education appears to have a high payoff, the means testing of Head Start and other programs re-segregates our schools, with poorer kids often clustered together in classrooms separate from middle-class kids.
- Housing rental subsidies help people live in decent housing, but they also discourage home-buying and paying off a mortgage along the way, keeping lower-income families away from that classic and, for large segments of the population, most important mechanism for saving.
- Our retirement policies help most Americans live their later years in some comfort. But by encouraging early retirement, Social Security and other programs lead to an increased wealth gap among the elderly as richer classes retire later—hence, work and save longer—than poorer classes.
- Low tax rates may encourage entrepreneurship, but when they don’t raise enough revenue to pay our bills, they add to interest costs on the debt, gradually eroding support for investments in people, education, and similar efforts.
It’s not that liberals and conservatives advocating these older agendas don’t care about mobility. They’ll tell you that people with more sustenance will be able to work and study harder and entrepreneurs facing lower tax rates will create more jobs. But they try to claim too much for agendas that, though successful on some fronts, did not improve mobility in recent decades. The proof is in the pudding.
Raising these issues threatens those who fear that acknowledging failure on any front merely empowers those who advocate for the opposing agenda. And in today’s chaos that passes for policymaking, that is probably true. I don’t even know in what galaxy to place debates over previously nonpartisan issues like extending the debt ceiling so Congress can pay off its bills.
For me, it isn’t about abandoning the past. It’s simply about moving on.
Worried about the stagnation of income among middle-income households? Or about the growth in health care costs? The two are not unrelated. In fact, middle-income families have witnessed far more growth than the change in their cash incomes suggest if we count the better health insurance most receive from employers or government. But is that all good news? Should ever-increasing shares of the income that Americans receive from government in retirement and other transfer payments go directly to hospitals and doctors as opposed to other needs of beneficiaries? Should workers receive ever-smaller shares of compensation in the form of cash?
The stagnation of cash incomes in the middle of the income distribution now goes back over three decades. Consider the period from 1980 to 2011. Cash income per member of a median income household, which includes items like wages and interest and cash payments from government like Social Security, only grew by about $4,300 or 27 percent over that period, when adjusted for inflation. From 2000 to 2010, it was even negative. Yet according to data from the Bureau of Economic Analysis, per capita personal income—our most comprehensive measure of individual income—grew 72 percent from 1980 to 2011.
How do we reconcile these statistics? By disentangling the many pieces that go into each measure.
Growing income inequality certainly plays a big part in this story: much of the growth in either cash or total personal income was garnered by those with very high incomes. So the growth in average income, no matter how measured, is substantially higher than the growth for a typical or median person who shared much less than proportionately in those gains. But personal income also includes many items that simply don’t show up in the cash income measures. Among them is the provision of noncash government benefits, such as various forms of food assistance.
Health care plays no small role. In fact, real national health care expenditures per person grew by 223 percent or $6,150 from 1980 to 2011, much more than the growth in median cash income. If we assume that the median-income household member got about the average amount of health care and insurance, then we can see how little their increased cash income tells them or us about their higher standard of living.
Getting a bit more technical, there’s a danger of over-counting and under-counting health care costs here. Some of the median or typical person’s additional cash income went to extra health care expenses, so the additional amount he/she had left for all other purposes was even less than $4,300. However, individuals pay only a small share of their health care expenses; the vast majority is covered by government, employer, or other third-party payments. So, roughly speaking, typical or median individuals still got well more than half of their income growth in the form of health benefits.
The implications stretch well beyond middle-class stagnation. Employers face rising pressures to drop insurance so they can provide higher cash wages. For instance, providing a decent health insurance package to a family can be equivalent roughly to a doubling of employer costs for a worker paid minimum wage. The government, in turn, faces a different squeeze: as it allocates ever-larger shares of its social welfare budget for health care, it grants smaller shares to education, wage subsidies, child tax credits, and most other efforts. Additionally, the more expensive the health care the government provides to those who don’t work, the greater the incentives for them to retire earlier or remain unemployed.
In the end, the health care juggernaut leaves us with good news (that our incomes indeed are growing moderately faster than most headlines would have us believe) as well as bad news (that health care remains unmerciful in what it increasingly takes out of our budget).
COAUTHORED WITH DOUG WISSOKER
A recent paper by Bayer, Ferreira, and Ross on mortgage delinquencies and foreclosures finds that people of color had greater problems once Recession hit than did many others in roughly equal circumstances, such as income and location, but with different racial backgrounds. We believe this is a useful, though not surprising, finding in ongoing studies of the impact of the Recession on different types of households. Yet we worry about how its results get extrapolated into policy recommendations.
The paper concludes that their research “raises concerns about homeownership as a vehicle for reducing racial wealth disparities”. We believe that one needs to be very careful in extrapolating lessons from the market of the mid-2000s to any market and to policies that would apply over time. Paying off mortgages is the primary means by which the majority of households, particularly low and moderate-income households, save over time. Discouraging such saving could easily add to already unequal distribution of wealth in society.
First, a quick summary of the findings. Combining several sources of data to look at racial differences in delinquent payments and foreclosures for mortgages for purchases and refinances originated between 2004 and 2008, the authors find that black and Hispanic borrowers had substantially higher delinquency and foreclosure rates than whites and Asians, even controlling for differences in circumstances such as the borrower’s credit score, the size of the interest rate spread of the loan, and the identity of the lender. In addition, the authors conclude that the racial gap in delinquent payments and foreclosures peaked for loans originating in 2006. From this, they conclude that people of color entering the market at the peak of the housing boom were particularly vulnerable to adverse economic conditions.
The authors attribute the racial difference found for blacks and Hispanics, even after trying to control for income or other differences, to items they couldn’t measure, including lower wealth and an accompanying lack of a financial cushion. This seems crucial to us and is also consistent with studies that income an incomplete predictor of upward or downward mobility. Work from the Urban Institute (here) shows that wealth differentials by race are much greater than income differentials. These differentials can play out in multiple ways across generations. For instance, wealthier families provide more inheritances and intergenerational transfers that support homebuying and downpayment levels that reduce foreclosure risk.
However, the authors’ concern about homeownership as a vehicle for reducing racial wealth disparities does not follow logically. Evidence here is at best circumstantial. Among other sources of disparate outcomes, consumer groups would point out that these types of findings more than anything highlight the disparate impact of abusive lending at the height of the housing boom.
Portfolio theory requires looking across different types of assets and debts, along with their associated expected returns and risks. Homeownership has risks, but so does renting. In fact, rental rates at times rise faster than the costs of homeownership, and in many parts of the country it has become cheaper to own than rent for those likely to be in a home long enough that transactions costs do not eat away at the ownership returns. Similarly, a household often must choose among debt instruments. Mortgages tend to have lower interest charges than most other forms of debt.
Most vehicles for getting a decent return on investment involve some risk. Saving accounts now paying negative, after-inflation, returns only prove the point in spades. If saving were proportionate to income, for instance, but lower-income individuals invest only in low or negative return assets, then wealth inequality necessarily would grow to be much greater than implied by levels of saving, potentially compounding adverse outcomes over time. Conversely, without discounting lessons from the Great Recession, low-cost, well-structured mortgages continue to be supported by the government (whether through FHA or the GSEs) partly for the very purpose of diversifying risk and effectively spreading wealth ownership.
This study is based on patterns of delinquency and foreclosure rates observed during a limited time period with unusually high foreclosure rates. But, wealth accumulation occurs over a very long time. Thus, even on this paper’s own terms, it’s not clear that reduced rates of homeownership would make low-income households or people of color better off over extended periods. We have found that most homeowners buying a decade or so before the Great Recession came through the longer period in good shape. Our own work also tends to show that black homeownership rates, even after controlling for income, are disproportionately low in both good and bad markets, raising serious questions about whether they are missing out on opportunities available to others.
Regardless of the effect on the difference in wealth disparity by race, homeownership is an effective way for many, though certainly not all, low- and moderate-income households to save. Equity in a home is the primary asset owned by low- and middle-income households, including blacks and Hispanics, by the time of retirement. Paying off a mortgage is the primary mechanism by which these households save, with all the virtues of a more automatic and regular saving vehicle. Reductions in the already low homeownership of people of color would almost certainly exacerbate over time the unequal distribution of wealth.
While the income inequality among different racial and ethnic groups is significant, it is nothing compared to wealth inequality. In 2010, whites had six times more average wealth than blacks and Hispanics ($632,000 versus $103,000). The income gap, by comparison, was twofold ($89,000 versus $46,000).
In a recent study, several colleagues and I examine in more depth how these ratios are affected by wealth accumulation over a person’s lifetime. Early in wealth-building years (when adults are in their 30s), white families have 3.5 to 4 times the wealth of families of color. As adults age these initial racial differences grow both absolutely and relatively. Whites in the cohort we examined started with about three and a half times more wealth than blacks in their 30s but had seven times more wealth in their 60s. Compared with Hispanics, whites had four times more wealth in their 30s but nearly five times more wealth three decades later.
Or consider how ratios would vary if each family saved the same share of its income and earned the same rate of return on those savings. Ignoring inheritances, the wealth gap should resemble the income gap, not be three times as large.
While the Great Recession didn’t cause the wealth disparities between whites and minorities, it did exacerbate them. The 2007–09 economic slowdown brought about sharp declines in the wealth of white, black, and Hispanic families alike, but Hispanics experienced the largest decline. Lower net equity in homes accounts for much of Hispanics’ wealth loss, while retirement accounts are where blacks were hit hardest.
Something is definitely going on. Whatever other conclusions one may draw, I think our tax and social policies are doing a pretty poor job of helping individuals attain the types of protections that private wealth-holding offers. In fact, wealth disparities among races have expanded over the past 27 years, which should have liberals and conservatives alike questioning the unintended consequences of their policy victories, or at least their policy focus, over that period.
For more analysis of the wealth gap between whites and minorities, read the brief Less Than Equal: Racial Disparities in Wealth Accumulation or watch The Racial Wealth Gap in America. This work has been cited in the New York Times.