October 14, 2021

Investment Income and Racial Inequality


America has long taxed income from wealth more lightly than it taxes income from work. This makes it easier for those with substantial assets to build more wealth compared to those who earn most of their income from work. This report explains that a network of tax breaks and exceptions allows the wealthiest Americans to pay very little in federal income taxes compared to their total, true, income and that this contributes to racial inequity in the United States.[1]

The U.S. tax system has preferential rules for investment income, particularly for capital gains. These tax breaks include lower rates on capital gains, deferral of taxes on gains until an asset is sold (deferred taxes on unrealized gains), and the stepped-up basis rule, which allows unrealized gains to be exempt forever when a taxpayer leaves appreciated assets to their heirs.

It is well-known that tax breaks for capital gains mainly favor the richest 1 percent of Americans.[2] Besides locking in wealth inequality broadly, rules favoring investment income over labor income also worsen racial wealth inequality. Wealth in the United States is disproportionately held by white Americans, who, therefore, receive the greatest benefit from the tax breaks for this type of income.

White households are the biggest beneficiaries of special rules for capital gains

President Biden has proposed limiting the stepped-up basis rule and raising the rate on capital gains to match ordinary income for the wealthiest families. An ITEP analysis of the Federal Reserve’s 2019 Survey of Consumer Finances (SCF) shows that a disproportionate share of the unrealized capital gains that could be taxed under Biden’s proposal flows to white households.


The graph above uses the most recent data from the SCF to break down household distribution of accumulated unrealized capital gains (asset appreciation) in excess of $2 million. These are most of the gains that could conceivably be affected by the President’s proposal (which is explained in more detail further on).

White families comprise 65 percent of all families in the survey, yet they hold 89 percent of unrealized capital gains in excess of $2 million. Black and Hispanic families each hold about 1 percent of unrealized gains in excess of $2 million, despite making up 14 percent and 10 percent, respectively, of families in the survey. (The SCF assigns race to a family based on the race of the family's reference person. For the purposes of this report, we use the family, reference person, and race concepts in the Survey of Consumer Finances. These differ from Census bureau definitions of household and householder.[3])

Very few people of any race would be affected by the President’s proposal to tax unrealized gains at death. Only 2.5 percent of white families had unrealized gains in excess of $2 million in 2019 according to the SCF data, and only a fraction of those would be taxed given the exemptions built into the proposal, as explained further on. Only 0.2 percent of Black families and 0.3 percent of Hispanic families had unrealized gains in excess of $2 million, illustrating that they are far less likely to be affected by the proposal.

This data suggests that President Biden’s proposal to tax unrealized capital gains at death would primarily affect white families, but it would only affect extremely wealthy families of any race. The same is certainly true of proposals that would tax unrealized gains of extremely wealthy people each year as they accrue, an approach sometimes called the billionaire’s income tax, mark-to-market taxation or anti-deferral accounting, as explained further on.

The same can be said about proposals to limit tax breaks for capital gains generally, whether realized or unrealized. The SCF data also show white families are more likely to own the types of assets that produce significant capital gains (either realized or unrealized). In 2019, white families were about twice as likely as Black and Hispanic families to own a non-primary residential property, twice as likely to own equity in a nonresidential property, and two to three times as likely to own other business equities.[4]

The graph below illustrates the share of investment assets owned by white, Black and Hispanic Americans. White families make up 65 percent of families but own nearly 90 percent of corporate stock, nearly 90 percent of private business assets, and more than 76 percent of real estate holdings. Black and Hispanic families, in contrast, own 1.7 and 0.5 percent of corporate equities respectively, less than 2 percent of private business assets, and under 6 percent of real estate holdings. We can, therefore, assume that white families receive a disproportionate share of the income generated by stock (capital gains and stock dividends).


While white families are more likely to hold the types of assets that produce capital gains, the median value of these assets are modest for all race and ethnic groups. The median white family with these types of assets owns $250,000 in real estate, $99,000 in private business, and $50,750 in stocks and mutual funds. (The median values for each category represent the subset of families with assets greater than zero in that asset category.) While these values are higher for white families in each asset category than for Black or Hispanic families, they also highlight the fact that the average white family does not hold the level of assets that would lead to a substantial benefit from this system. On the contrary, the benefits largely flow to the wealthiest households with high amounts of investment income.


Discriminatory economic policy has contributed to the racial wealth gap

Due to centuries of federal, state and local policies that advantaged white communities and systemically marginalized Black, brown and Indigenous communities, wealthy households in the United States are disproportionately white. All levels of government have created conditions for the racial wealth gap through policies that favor white families over families of color. One notable example is a policy known as redlining, through which the Federal Housing Administration subdivided metropolitan areas based on the portion of Black homeowners and refused to insure mortgages in areas where Black families lived. Homeownership is the most common way that households build wealth. FHA-insured mortgages expanded homeownership opportunities and helped build the white middle class while denying the same level of opportunity to Black families. The intergenerational effects of this policy are apparent today: only 45 percent of Black families own their homes compared to 74 percent of white families.[5]

Likewise, in policy and practice, the federal government and local program administrators excluded thousands of Black families from agricultural programs designed to build farm wealth. In 1965, the U.S. Commission on Civil Rights found that Black farmers were routinely denied access to the same USDA credit programs as white farmers, and the agency failed to offer them assistance from farm extension or soil conservation programs that would help to diversify and increase production. As a result of these policies, Black farmers lost 16 million acres, or about 90 percent of all the land they owned from 1910 to 1997.[6] To this day, Black commodity producers don’t have equal access to the billions of dollars that the federal government invests in supporting the agriculture industry.[7]

Discriminatory housing policies have had a direct and lasting effect on educational opportunities. Segregation and deliberate disinvestment in communities leaves them poorer, which means they have a smaller tax base to fund public services such as education. Less education funding leads to lower-quality K-12 schools, which creates a structural disadvantage for children in these schools that has lifelong effects, including accessing postsecondary education. As college degrees and technical training are drivers of lifetime income, inequitable educational opportunities that advantage white students have perpetuated differences in income and wealth.[8]

Our tax code gives preferential treatment to wealth income over labor income

A capital gain is appreciation (rise in value) of an asset. The nation’s tax system provides three major breaks for income that takes the form of capital gains. First, the income tax only applies to capital gains that are “realized,” which generally means an individual sells an asset. Second, even when gains are realized, they are subject to lower income tax rates compared to other types of income. (Stock dividends, another type of income from wealth, are also subject to the lower rates.) Finally, capital gains that are unrealized can be exempt forever from income taxes when an individual dies and leaves appreciated assets to their heirs.

These special tax rules are a substantial driver of wealth and income inequality in the United States. Low- to middle-income taxpayers of all races receive very little benefit from the lower rates for long-term capital gains and qualified dividends, as households making less than $100,000 earn about 78 percent of their income from salaries and wages and only about 1 percent from capital gains and qualified dividends. Households earning above $1 million earn about 29 percent of their income from salaries and wages and 38 percent from capital gains and qualified dividends.[9] Since these wealthy households are disproportionately white, the special tax breaks contribute to the racial wealth gap while also benefitting only a small share of white families.

Each of these three tax breaks for income from wealth requires its own solution.

1. Individuals can defer paying taxes on a capital gain until the asset is sold.

First, individuals defer paying taxes on their asset appreciation until capital gains are realized. This means that the individual enjoys an increase in wealth without having to claim any income. Under current rules, realization occurs when an asset is sold and the increase in its value becomes a profit. From an economic standpoint, unrealized gains are income, providing the recipient the ability to buy whatever they wish to buy, but they are not included in the tax code’s current definition of income. Unrealized capital gains are the main form of income for some very wealthy people, which means they are allowed to pay no income tax on most of their true income.

Data from the Survey of Consumer Finances makes plain how this tax break disproportionately favors white taxpayers. In 2019, 77 percent of white households held unrealized capital gains compared to 47 percent of Black households and 49 percent of Hispanic households. The average amount of these unrealized gains, while modest at the median for all races, was nearly twice as large for white households than for Black households. Large amounts of unrealized gains (potentially of the magnitude that might be affected by proposals under consideration in Congress) are even more concentrated among white households, as illustrated in the graph at the beginning of this report.[10]

A proposal known as “mark-to-market” would limit this tax break, at least for the very wealthy. Under this proposal, unrealized capital gains on publicly traded assets would be taxed the same way as interest earned on a bank account. Each year, the owners of assets like stocks and securities would calculate their capital gains and pay taxes on that income regardless of whether they sell the assets. This proposal makes sense for these types of assets, as the appreciation in value is easy to ascertain and a portion of the assets can be sold to pay the taxes. Most versions of this proposal would continue to allow taxpayers to defer paying income tax on unrealized gains from other types of assets that cannot be easily valuated or sold, but when they are sold, they would be taxed at a higher rate that would remove the benefit of deferring the tax.

Senate Finance Chair Ron Wyden has a proposal along these lines that he has described as a "billionaire’s tax,” which would apply to extremely wealthy households.[11] The Billionaire’s Tax is modeled off a 2019 mark-to-market proposal that would only apply to very wealthy households.[12] In 2020, Jeff Bezos’s wealth increased by $75 billion.[13] It is not known how much of this he reported as income to the IRS, but it is almost certainly far less than the full amount. Under Chairman Wyden’s proposal, Bezos would not have been able to avoid paying taxes on his true income.

2. Even when capital gains are realized, the tax rate is much lower than the tax rate on income from work.

Under current law, even when assets are sold and the gains are realized, they are taxed at lower rates than income from work. Capital gains on assets held more than a year are taxed at a top rate of 20 percent for individual filers with taxable income of more than $445,850 or married couples with taxable income of more than $501,600. This is substantially lower than the top rate of 37 percent for income from salaries and wages.[14] Under the qualified dividends rule, investors apply these same lower tax rates to income from most dividends distributed from U.S. stock and mutual fund holdings held for a certain period. In tax year 2018, 43 percent of all dividends claimed by individuals were classified as qualified dividends.

When the federal government allows income on wealth to be taxed at much lower rates than labor income (or not it all), it exacerbates wealth gaps between racial and ethnic groups as well as within those groups. Households with larger holdings of stock and mutual fund assets are more able to take advantage of long-term capital gains and qualified dividends rates. In 2019, 61 percent of white households owned stocks and mutual fund shares, compared to 34 percent of Black households and 24 percent of Hispanic households. Of those owning these assets, white households owned a median value of $50,750 compared to $15,000 for Black and Hispanic households.[15]  While white families were disproportionately likely to benefit from the lower tax rates, nearly 40 percent of white families did not benefit. And for the median white family who was able to take advantage, the special rate did not carry the same value on their $50,750 of stock holdings as it would for a wealthy investor who makes most of their income from capital gains.

President Biden has proposed to tax capital gains and dividends at the same rate as other income for those with taxable income exceeding $1 million. His proposal would raise the top income tax rate for "ordinary” income to 39.6 percent and would apply the same rate to all taxable income (whether capital gains, stock dividends or ordinary income) in excess of $1 million. Ways and Means Chairman Richard Neal has proposed a smaller increase on the top capital gains and qualified dividends rate to 25 percent plus a 3 percent surtax for taxpayers earning more than $5 million, in effect creating a new top capital gains and dividends rate of 28 percent.[16]

3. If an appreciated asset is passed to heirs, it may never be taxed.

If an individual dies and passes appreciated assets to heirs, then the family benefits from the “stepped-up basis” rule, which exempts all unrealized capital from the income tax forever. These gains would have been included in income for tax purposes if the decedent had sold the asset the day before their death, but they disappear forever from the tax system if the person dies before selling. The technical mechanism that accomplishes this is the rule that “steps up” the basis value of the asset for heirs to the value on the date of inheritance, rather than the value at which it was originally purchased. Combined with the option to defer taxes, the stepped-up basis rule allows ultra-wealthy people to pass on hundreds of billions of wealth to their children that will likely never be subject to any income tax.

The stepped-up basis rule aggravates the racial wealth gap by allowing wealthy, primarily white families to escape paying taxes on a large portion of their income when fortunes are passed down from one generation to the next.[17] Meanwhile, lower- and middle-income families who depend on income from labor must pay taxes year after year on all of their income. Eliminating or substantially reforming the stepped-up basis rule is a necessary component to reducing the racial wealth gap and to reducing gaps between the very wealthy and most other people.

The president’s plan would repeal the stepped-up basis rule by taxing unrealized capital gains when assets are passed to heirs. The plan would exempt the first million of unrealized gains for individuals and 2 million for married couples. Importantly, unrealized gains on family-owned farms and businesses that are passed on to family members and stay in operation would continue to be shielded from income taxes by the stepped-up basis rules. Chairman Neal’s proposal, however, did not include any solution to the stepped-up basis rule.

Congress has an opportunity to address the racial wealth gap

Centuries of racist policies have left Black and Hispanic households with lower wealth than white households. Today, the tax code gives special treatment to income from wealth over income from work. Wealthy households benefit from lower rates, opportunities to defer taxes, and the ability to pass on large amounts of income without ever paying income taxes. These special tax breaks disproportionately benefit white households, thereby perpetuating and expanding and the gap between white families and families of color.

Increasing the tax rate on capital gains would help to equalize the treatment of income from wealth and income from work, but it is not enough without addressing stepped-up basis and deferral of taxes on unrealized income. Congress has a historic opportunity to fix the way the preferential treatment of investment income widens the racial wealth gap and to strive toward a racially equitable tax code.



[1] Jesse Eisinger, Jeff Ernsthausen and Paul Kiel, ProPublica, “The Secret IRS Files: Trove of Never-Before-Seen Records Reveal How the Wealthiest Avoid Income Tax.” June 2021. https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax

[2] Steve Wamhoff, ”Congress Should Reduce, Not Expand, Tax Breaks for Capital Gains,“ Institute on Taxation and Economic Policy, February 1, 2019. https://itep.org/congress-should-reduce-not-expand-tax-breaks-for-capital-gains/

[3] For more information on the definition of ”Family,” see Neil Bhutta, Jesse Bricker, Andrew C. Chang, Lisa J. Dettling, Sarena Goodman, Joanne W. Hsu, Kevin B. Moore, Sarah Reber, Alice Henriques Volz, and Richard A. Windle. 2020. "Changes in U.S. Family Finances from 2016 to 2019: Evidence from the Survey of Consumer Finances (PDF)," Federal Reserve Bulletin 106(5). https://www.federalreserve.gov/publications/files/scf20.pdf

[4] Federal Reserve Board, Survey of Consumer Finances, 2019. https://www.federalreserve.gov/econres/scf/dataviz/scf/table/

[5] United States Census Bureau, Quarterly Residential Vacancies and Homeownership, Second Quarter 2021, July 27, 2021. https://www.census.gov/housing/hvs/files/currenthvspress.pdf

[6] Nathan Rosenberg and Bryce Wilson Stucki, The Counter, “How USDA distorted data to conceal decades of discrimination against Black farmers.” June 2019. https://thecounter.org/usda-black-farmers-discrimination-tom-vilsack-reparations-civil-rights/

[7] Nathan Rosenberg and Bryce Wilson Stucki, The Counter, ” USDA Gave Almost 100 Percent of Trump’s Trade War Bailout to White Farmers,” July 2019. https://thecounter.org/usda-trump-trade-war-bailout-white-farmers-race/

[8] Thomas Shapiro, Tatjana Meschede, and Sam Osoro, Brandeis University, “The Roots of the Widening Racial Wealth Gap: Explaining the Black-White Economic Divide.” February 2013. https://heller.brandeis.edu/iere/pdfs/racial-wealth-equity/racial-wealth-gap/roots-widening-racial-wealth-gap.pdf

[9] IRS Statistics of Income, Individual Statistical Tables, Table 1.4. https://www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjusted-gross-income

[10] Federal Reserve Board, Survey of Consumer Finances, 2019. https://www.federalreserve.gov/econres/scf/dataviz/scf/table/

[11] United States Senate Finance Committee, “Wyden Statement on White House CEA Report on Billionaire’s Tax Rate.” September 23, 2021. https://www.finance.senate.gov/chairmans-news/wyden-statement-on-white-house-cea-report-on-billionaires-tax-rate

[12] United States Senate Committee on Finance, ”Wyden Unveils Proposal to Fix Broken Tax Code, Equalize Treatment of Wages and Wealth, Protect Social Security.” September 12, 2019. https://www.finance.senate.gov/ranking-members-news/wyden-unveils-proposal-to-fix-broken-tax-code-equalize-treatment-of-wages-and-wealth-protect-social-security-

[13] Bloomberg Billionaires Index, retrieved September 27, 2021. https://www.bloomberg.com/billionaires/profiles/jeffrey-p-bezos/?sref=p7zS9UoY

[14] High-income people also pay an additional 3.8 percent tax to fund health care on both earned income and investment income like capital gains, so, including that, the top rates are 23.8 percent for capital gains and 40.8 percent for other types of income.

[15] Federal Reserve Board, Survey of Consumer Finances, 2019. https://www.federalreserve.gov/econres/scf/dataviz/scf/table/

[16] United States House of Representatives Committee on Ways and Means, ”Chairman Neal Announces Additional Days of Markup of the Build Back Better Act,” September 13, 2021. https://waysandmeans.house.gov/media-center/press-releases/chairman-neal-announces-additional-days-markup-build-back-better-act

[17] Thomas Shapiro, Tatjana Meschede, and Sam Osoro, Brandeis University, “The Roots of the Widening Racial Wealth Gap: Explaining the Black-White Economic Divide.” February 2013. https://heller.brandeis.edu/iere/pdfs/racial-wealth-equity/racial-wealth-gap/roots-widening-racial-wealth-gap.pdf