While the Internal Revenue Service (IRS) doesn’t ask taxpayers about their race and ethnicity, the impacts of the federal income tax system are not race neutral.

A new Urban Institute feature explores how seemingly “colorblind” federal tax policies and practices can reinforce long-standing structural barriers to economic opportunity for communities of color.

Overall, the federal income tax system is progressive: those with higher incomes typically pay more in taxes than those with lower incomes. This helps reduce income inequality and raise trillions of dollars in federal revenue to fund critical social safety net and health care programs. However, some income tax breaks disproportionately benefit White taxpayers, reinforcing racial disparities in economic opportunity.

The federal income tax can be a powerful tool for reducing racial inequities. As designed, it often falls short of its promise. To help advance racial equity, policymakers should consider how existing tax policies and future reforms may exacerbate racial disparities in wealth and income.

Here are four ways policymakers could reduce racial inequities in the federal income tax system and support the prosperity of all families.

Note: In this post, we capitalize the term “White” to match the associated feature and to avoid perpetuating the notion of Whiteness as the standard or norm to which all other races and ethnicities are compared.

1. Reform preferential tax rates for capital gains.

Capital gains—profits from sales of assets such as business investments or real estate held for a year or more—are taxed at lower rates than income from wages and salaries. In addition, capital gains are taxed only when the underlying asset is sold and not taxed at all if the asset is held until death. When someone sells inherited capital, they pay taxes only on the amount the asset has increased in value since it was inherited.

These lower tax rates can incentivize investments that spur economic growth, but economists disagree on the magnitude of their effects.

The preferential tax treatment of capital gains largely benefits White families, who not only hold almost every type of financial asset at higher rates than families of color but who also are more likely to be wealthy and receive inheritances.

The US Department of the Treasury estimates that 92 percent (PDF) of the tax value of the preferential rates on long-term capital gains and dividends went to White families in 2023. Recent research shows that capital gains have helped widen the racial wealth gap since the 1980s.

To help ensure tax policy doesn’t further exacerbate racial disparities in wealth and income, policymakers could tax all capital gains, including inherited assets, at the same rates as income from wages and salaries.

2. Target homeownership tax subsidies toward first-time homebuyers and taxpayers with low incomes.

In the US, homeownership is one of the most common ways families build wealth. Several tax breaks are designed to reduce the cost of homeownership, such as deductions for mortgage interest payments and local property taxes, and an income exclusion for profits made selling primary residences.

Because of racial and ethnic disparities in homeownership, these tax breaks end up disproportionately benefiting White families. In 2022, 73 percent of White families owned homes, compared with 51 percent of Latine families and 46 percent of Black families. And homes owned by Black families are valued lower than those owned by White families.

Today’s racial homeownership gap reflects centuries of racist policies and practices—such as residential segregation, discriminatory government and private-sector lending practices (PDF) against Black residents, the murder and displacement of Native Americans, and laws prohibiting Asian immigrants from purchasing land—that have severely limited access to homeownership for families of color.

Evidence suggests these tax subsidies have likely not increased homeownership. Instead, they have supported those with middle and higher incomes who are already more likely to own homes and spend more on housing.

To advance racial equity and help families of color build wealth through homeownership, policymakers could consider targeted income tax breaks for first-time homebuyers and taxpayers with low incomes.

3. Make tax credits for families more inclusive.

Each year, the child tax credit (CTC) and the earned income tax credit (EITC) lift millions of people out of poverty, delivering thousands of dollars in tax refunds to eligible families. Combined, these credits disproportionately benefit families of color (PDF).

However, these credits could deliver more benefits to families with the lowest incomes. Both credits are designed to phase in with earnings and phase out as income rises. The CTC also has a minimum earning requirement of $2,500. Families with complex living arrangements and mixed immigration statuses can face added barriers in qualifying for the EITC.

In 2022, nearly 19 million children did not receive the full CTC ($2,000 per child) because their families earned too little. In effect, the minimum earning requirement and phase-in of benefits act as a form of work requirement—often reflecting racially biased ideas of poverty and “individual deservingness.” These design choices can prevent grandparent caregivers, parents with disabilities, and parents unable to access child care from receiving CTC benefits.

They can also magnify past and present racial and ethnic inequities. Black, Latine, and Native American families face the highest levels of unemployment and tend to hold the lowest-paying jobs because of structural racism in the labor market. In 2018, only about half of Black and Latine children were eligible for the full CTC, compared with three-quarters of White children.

To promote the economic prosperity of more families, policymakers could consider changing the phase-in of benefits for both credits and removing the CTC’s minimum earning requirement. The Tax Relief for American Families and Workers Act of 2024, which would temporarily expand the CTC, includes some reforms to the phase-in of benefits, but more could be done to support families with low incomes.

4. Change the IRS’s audit priorities.

Auditing is just one tool the IRS can use to reduce the $688 billion tax gap. Over time, however, staffing and budgetary shortfalls have constrained the IRS’s audit capacity. As a result, audits of all taxpayers have fallen in recent decades, with audits of higher-income taxpayers—who tend to have more complex tax returns—decreasing most significantly.

According to recent estimates, Black taxpayers are more likely to be audited than other taxpayers at every income level. The IRS does not collect taxpayers’ race and ethnicity information, so the source of these disparities is still being evaluated.

The IRS has acknowledged these disparities and announced plans to revise how it selects which tax returns to audit. Recent research suggests auditing higher-income taxpayers is most cost-effective for the IRS. Utilizing new funding included in the Inflation Reduction Act to focus audits on higher-income taxpayers could help the IRS generate more revenue, combat tax evasion, and avoid exacerbating racial disparities.