Federal Reserve Bank of San Francisco

Community Development

Community Investments Vol 23, Issue 2
Research Briefs

Author(s):

Fall 2011

Community Investments

Economic Downturns and Inequality

More than two years into the U.S. recovery, researchers have started to look at how the recent recession may have impacted income inequality. How does an economic crisis impact earnings and income inequality, if at all?  What can we learn from previous recessions? What factors influence whether or not a financial crisis will increase inequality?

Carlo V. Fiorio and Catherine Saget survey the existing literature on global financial crises and find relationship between crises and changes in earnings inequality (i.e. wage distribution) but point out that in most cases income inequality (which takes into account income from capital and social transfers) decreases after a financial crisis.  Their findings suggest that each country’s institutional structure impacts how inequality changes after a financial crisis.  In Finland, for example, inequality levels remained basically unchanged despite a striking increase in unemployment from 1990-1993, which the authors attribute to a strong public benefit system that supplied generous unemployment benefits including training programs.  In contrast, the East Asian financial crisis of 1997-1998 correlated to an increase in inequality, potentially due to policies enacted after the crisis that promoted economic recovery by benefitting the corporate and financial sectors, while increasing poverty through cuts in social services.

Using Current Population Survey data, Fiorio and Saget find a minor increase in U.S. earnings inequality, but when they account for the unemployed (counting their wages as zero), the increase becomes much larger. They attribute this increase in inequality to low wage workers being more likely to lose their jobs during the recession and because social transfers and the wages from replacement jobs are both lower than earnings received by these workers prior to the crisis.

Fiorio, Carlo V. and Saget, Catherine. (2010). “Reducing or aggravating inequality? Preliminary findings from the 2008 financial crisis.” International Labour Office, Policy Integration Department, Geneva.

The Low Income Housing Tax Credit and Racial Segregation

The Low Income Housing Tax Credit (LIHTC) is an indirect Federal subsidy used to finance the development of affordable rental housing for low-income households.  The program is administered by the Internal Revenue Service (IRS) and has a provision that awards developers with higher tax credit allocations for siting projects in Qualified Census Tracts (QCTs), which are high-poverty neighborhoods that are often populated with a high concentration of minorities.  Despite the success of LIHTC in increasing the supply of affordable rental units, one oft-cited concern is that the program is contributing to racial segregation, but is this actually the case?

Keren Horn and Katherine O’Regan use data from HUD and the census, along with data collected on the racial composition of LIHTC tenants in three states, to addresses this question.  They examine three channels through which the LIHTC could potentially affect racial segregation: the siting of LIHTC units relative to other non-LIHTC units that serve low-income populations; the racial composition of residents in LIHTC projects; and changes in neighborhood composition in areas in which tax credit projects are built.  They find that LIHTC units are only slightly more likely to be located in high-minority tracts than other units occupied by near-poor and poor renters, and that neighborhoods of high minority concentration experience declines in minority representation over time, rather than an increase.  Additionally, Horn and O’Regan find that increases in the use of tax credits between 1980 and 2000 in metropolitan areas are associated with declines in racial segregation.

Despite the finding that the LIHTC program, on average, is not associated with an increase in racial segregation, the authors recognize that persistent racial segregation remains a challenge in this country.   They conclude that targeting criticism of the LIHTC on concerns of racial segregation may take efforts away from identifying other important areas of improvement for the program.  

Horn, Keren and O’Regan, Katherine. (2011). The Low Income Housing Tax Credit and Racial Segregation.  Furman Center for Real Estate and Urban Policy, New York University, Working Paper.  

Defaults and Saving among Low-Income Tax Filers

Previous research has demonstrated the powerful effect that default setting can have on financial decision-making, particularly in the area of 401(k) savings behavior.  By simply switching the default to automatic enrollment, requiring users to opt-out if they do not wish to save, participation rates in defined contribution plans tend to increase dramatically.  But do the effects of this type of nudge extend to other savings programs and populations?

The results of a recent study suggest that default setting does not impact savings behavior among low-income tax filers.  In 2009, a new initiative designed to increase retirement savings allowed tax filers to purchase U.S. Savings Bonds with their federal income tax refunds and advocates supported the policy’s “saveable moment” approach.  Erin Todd Bronchetti, Thomas Dee, David Huffman, and Ellen Magenheim conducted a field study at eight Volunteer Income Tax Assistance sites during the 2010 tax season to test whether default setting would affect the take up rate among low-income tax filers to receive some or all of their refunds in U.S. Savings Bonds.  They find that regardless of whether the default requires an opt-in or opt-out of the savings bond option, the participation rate in the savings program is roughly 9 percent.  The authors point out that the success of increasing saving among higher-income 401(k) participants through default switching should not be automatically generalized for other policy settings, particularly among lower-income populations.  One possible explanation for why the nudge was ineffective was that 75 percent of filers indicated they already had plans for how to spend the refund.  Nearly 70 percent of low-income filers stated that they had trouble paying bills and only 17 percent stated they had plans to save some of their refund, demonstrating the resource constraints facing this population.

The authors emphasize that, “401(k) defaults may be powerful because they coincide with the pre-existing intentions to save of relatively affluent individuals… To the extent that low-income filers do not have strong intentions to save at tax time, defaults may have little effect.”  One implication of these findings is that prior to implementing default switching interventions to impact the savings behavior of low-income individuals, more needs to be done to shift their savings expectations.  For example, matched savings programs have demonstrated that the poor can effectively alter their savings expectations and develop assets.  Further research is necessary to measure the impact of defaults for different populations under difference scenarios.

Bronchetti, E., Dee, T., Huffman, D., and Magenheim, E. (2011). When a Nudge Isn’t Enough: Defaults and Saving among Low-Income Tax Filers. NBER Working Paper 16887. 

Other articles in this issue