Tax Cuts and Jobs Act of 2017 Reduced Wealth Inequality

(Illustration from New Scientist)

Despite all you may have heard from progressives ("The TCJA overwhelmingly benefited the rich and corporations while overlooking working families"), the Tax Cuts and Jobs Act of 2017 reduced wealth inequality: [bold added]

After showing steady rises in wealth inequality for nearly three decades, the data in the Federal Reserve’s Survey of Consumer Finance showed a decline in 2019, the first year that it was measured after the Tax Cuts and Jobs Act went into effect — suggesting there may be a connection.

“Every three years, the Federal Reserve releases detailed survey data on household assets and liabilities,” explained Jorge Barro, a fellow in public finance at Rice University’s Baker Institute. “This provides one of the best indications of the state of wealth inequality in the U.S. The data — the Survey of Consumer Finances — showed a persistent rise in wealth inequality between 1992 and 2016. A lot of people expected the TCJA to exacerbate wealth inequality, but the measurement in 2019 showed a contraction.”

“It’s low-frequency data,” said Barro. “The last observation was in 2016, before the TCJA. A lot of people expected the TCJA to exacerbate wealth inequality, but what happened is that wealth inequality contracted.”

A deeper look into household assets suggests a relative appreciation of lower-income housing values, according to Barro: “While financial wealth comprises a large share of capital, for many households the home is one of the largest components of wealth. As a result, shifts in relative home values can affect the distribution of wealth.”

“That’s exactly the shift that occurred between 2016 and 2019, as the share of total U.S. housing wealth declined for higher-income households,” he continued. “In particular, the top income quintile experienced a moderate decline in the share of housing wealth, while the bottom 40% of households, who were not as inclined to benefit from itemized deductions, experienced a relative improvement in the distribution of housing wealth.”

A number of measures in the TCJA had an effect on relative home values, according to Barro. These included the near doubling of the standard deduction, the reduction in the cap on mortgage interest deduction, and the SALT cap. “Together, these reduced subsidies related to home ownership and home valuation in a way that disproportionately raised the effective costs of homeownership for higher-income households,” he said.

“The availability and effectiveness of itemized deductions grows with the level of economic activity, and this tends to correlate positively with household income,” explained Barro. “Consequently, the increased standard deduction resulted in reducing the share of households benefiting from itemized deductions, and dampening the corresponding economic incentives. And the $10,000 cap on the deduction of taxes paid to state and local governments similarly affected the value of higher-income households disproportionally, especially given the huge property tax component in the SALT deduction. Likewise, the reduction in the maximum deductibility of interest on a mortgage loan from $1 million to $750,000 raised the effective cost of home ownership for higher-income households.”

Using IRS Statistics of Income data, Barro calculated the size of housing-related deductions as they changed with adjusted gross income. The results show that “higher AGI groups experienced larger relative declines in their average housing subsidies,” he said.

The SALT deduction is currently back in play in legislative proposals, Barro noted: “Some members of the Senate have said they wouldn’t favor any legislation unless the SALT cap were relaxed, so we can anticipate negotiations leading to a good chance of implementation in whatever bill gets passed. If it is passed it could once again exacerbate wealth inequality by reinstituting regressive housing subsidies.”

Comments:

Wealth is not income, the former being a more accurate measure of economic well-being. Here's one of many examples we could use to illustrate this point: assume a person has $10 million in cash but is ultra-conservative about risk. She invests all of the cash in 3-month Treasury bills, which yield .05% today. If she maintained that investment throughout the year (and the rates stayed the same), she would have annual interest income of slightly over $5,000 (assuming reinvestment), well below the income poverty line. Under no stretch of the imagination would she be considered poor, yet income measures would say she is.

The rich did get richer during the Trump years, but the poor, for the first time in three decades, started closing the gap. Isn't this the best way to lower inequality---not taking from Peter to pay Paul, but having poorer Paul catch up to Peter, who is also prospering?

The TCJA lowered the value of homes in high-tax coastal states on a relative basis to lower-cost homes in low-tax states. (Note the word "relative": the absolute price of homes in California is not going down, while home prices went up in the "flyover" states. Note also that this phenomenon began before the COVID-19 migration.) Housing is a much more significant component of wealth to lower-wealth households. Mr. Barro attributes the SALT limitation as a primary factor in shrinking the difference in housing wealth and therefore overall wealth.

Amidst all the tax increases proposed by a Democratic President and a Democratic Congress, a tax break for higher-income households in the infrastructure legislation is a repeal of the SALT limitation. The Democrats and their Progressive wing speak incessantly against inequality, yet they want to eliminate the SALT limitation, the most effective tax measure to reduce inequality in decades.

Full disclosure: the SALT limitation costs your humble blogger thousands of dollars in additional Federal taxes per year, yet I wish all of the politicians would go home for the rest of 2021 and not try to "help" us by spending any more money or tinkering with four-year-old tax changes that we haven't even figured out yet.