Tax policy reads like a technical maze—something for accountants and lobbyists to fight over in windowless offices. But behind the jargon and line items, the U.S. tax code quietly picks winners and losers. Most of this redistribution never makes it to a ballot or a headline. It moves through deductions, credits, and rate structures that tilt the field toward certain groups, often intentionally. Declan Osei walks through the evidence on how the code pushes wealth upward, and why that fact stays hidden from most people.

On paper, the federal income tax is progressive. Higher earnings face higher marginal rates. But that’s just the cover story. What matters is the gap between the statutory rate and what households actually pay. Add in exemptions, the sweetheart deal for capital gains, and the payroll tax cap, and the effective rate flattens dramatically for those at the peak. In recent years, the richest 400 families paid an average effective rate of about 8.2 percent, according to White House estimates. That’s a figure well below what a middle-class family might guess.

The Quiet Power of Tax Expenditures

“Tax expenditure” sounds like something from a budget committee footnote. But it’s one of the government’s most effective tools for shifting resources. A tax expenditure is spending funneled through the tax code—an exclusion, deduction, or credit that shrinks someone’s bill. Unlike direct outlays, these benefits don’t need an annual vote. They sit in the law, compounding quietly, year after year, without public review.

For fiscal year 2023, the biggest tax expenditures were the exclusion for employer-sponsored health insurance, the reduced rates on long-term capital gains, and the mortgage interest deduction. Those three together cost more than $400 billion in forgone revenue—more than the entire Department of Education budget. Who collects? Mostly high-income households: people with employer-based coverage, sizable portfolios, and large mortgages.

The Upside-Down Subsidy

The mortgage interest deduction is a masterclass in invisible wealth distribution. Homeowners can deduct interest on up to $750,000 of mortgage debt. The pitch sounds reasonable—encourage homeownership. But the design guarantees the biggest checks go to those who need them least. A family in the 37 percent bracket with a jumbo loan saves far more per dollar of interest than a family in the 12 percent bracket with a modest mortgage. And because roughly 30 percent of filers itemize, many lower-income homeowners see zero benefit.

Economists have been saying for decades that the deduction doesn’t actually raise homeownership rates. It mostly inflates housing prices and nudges people toward bigger homes if they were buying anyway. Canada, the UK, and Australia get along fine without an equivalent. Their homeownership rates are similar to or higher than America’s. The U.S. policy survives not because of evidence, but because the beneficiaries form a politically muscular group—and they rarely see their tax break as a government handout.

The Capital Gains Preference

If one part of the tax code excels at pushing wealth uphill, it’s the treatment of capital gains. Profits from assets held longer than a year get taxed at a top rate of 20 percent, miles below the 37 percent top rate on ordinary income. Add the 3.8 percent net investment income tax, and the effective top rate reaches 23.8 percent. But even that overstates what the truly wealthy pay, because the tax only kicks in when an asset is sold.

The very wealthy can hold assets for a lifetime, borrowing against them tax-free to cover their expenses. At death, the “step-up in basis” wipes out the accumulated gain for heirs. That appreciation may never face an income tax. This isn’t some clever loophole; it’s a structural feature of the code. The Joint Committee on Taxation projects that the preferential rates on capital gains and dividends will cost about $200 billion in fiscal year 2025. Over 75 percent of that benefit lands with the top 1 percent.

The 401(k) Paradox

Retirement accounts get sold as a democratic wealth-building tool. The 401(k) and IRA deductions let workers defer taxes on savings until withdrawal. In theory, that helps everyone. In practice, the benefits tilt sharply upward. High earners are more likely to have a workplace plan and more able to max out contributions. Their tax savings are worth more because they sit in higher brackets. The Tax Policy Center found that in 2023, a family in the top 1 percent got an average benefit of over $13,000 from retirement incentives. The bottom quintile got less than ten bucks.

Meanwhile, the saver’s credit—meant to boost low-income retirement contributions—is nonrefundable. So it does nothing for workers who owe no income tax. The whole structure looks neutral, but it quietly amplifies the inequalities that are already there.

The Payroll Tax Cap: Where Progressivity Stops

For most American workers, Social Security payroll taxes are the biggest federal tax they face. The 12.4 percent levy (split between employer and employee) applies to wages only up to a cap—$168,600 in 2024. Beyond that threshold, no Social Security tax is owed. This makes the payroll tax sharply regressive. Someone earning $60,000 pays on every dollar. A CEO pulling in $2 million pays on less than 9 percent of their income.

The cap exists because Social Security benefits are also capped, which keeps up the story of a contributory insurance system. But the redistributive effect is straightforward: it pushes the overall tax burden downward. When you combine payroll taxes, state and local taxes, and federal income taxes, the total system is only mildly progressive across most of the distribution—and it turns regressive right at the top, where capital income rules.

Why Invisibility Matters

These policies stick around because they’re easy to miss. Direct spending programs—Medicaid, food assistance, housing vouchers—get debated in public, picked apart by the media, and often carry stigma. Tax expenditures do similar work but get coded as private market activity. A family pocketing a $2,000 mortgage interest deduction doesn’t feel like a beneficiary of government largesse. They feel like a homeowner catching a break.

This framing has real consequences for inequality. A 2022 study in the National Tax Journal found that tax expenditures boost the after-tax income of the top quintile by over 5 percent. The bottom quintile sees a bump of less than 1 percent. Because these benefits are baked into the baseline, they dodge the yearly appropriations fight—and the public attention that comes with it.

The Racial Dimension

Tax policy also sorts wealth along racial lines, even though the code itself is colorblind. The mortgage interest deduction overwhelmingly helps white households, who have higher homeownership rates and more home equity. The capital gains preference flows to those with inherited wealth or stock portfolios—assets disproportionately held by white families. A 2021 Urban Institute analysis showed that white families collect roughly three times the benefit of tax expenditures per household compared to Black or Latino families.

These gaps aren’t random. They’re the accumulated result of decades of policy choices that favor asset ownership over wage income, embedding subsidies along existing wealth patterns. The invisibility of these mechanisms makes them especially hard to reform.

What Reform Could Look Like

Shifting the tax code to dial back hidden upward redistribution doesn’t demand a full overhaul. A handful of evidence-backed changes could realign the system with its stated progressive goals. Capping the value of itemized deductions at a fixed share of income, as some economists suggest, would curb the upside-down subsidy effect. Turning the mortgage interest deduction into a flat credit would spread the benefit more evenly. Taxing capital gains at death, instead of allowing the step-up in basis, would close one of the biggest roads for untaxed wealth transfer.

The 2021 American Families Plan pitched several of these ideas, including treating capital gains as ordinary income for those earning over $1 million. The political blowback was fast—not from the general public, but from industries and donors who understood exactly what was at stake. That episode showed how concentrated the benefits are and how organized the opposition to reform remains.

Transparency alone could shift the politics. Requiring the Treasury to publish an annual “tax expenditure budget” alongside the regular budget, with a distributional breakdown, would make the hidden spending visible. Some countries already do this. In the U.S., the information sits in technical appendices and rarely breaks into public awareness. A dedicated, plain-language report could move the conversation from “who pays taxes” to “who benefits from tax breaks.”

Frequently Asked Questions

What is a tax expenditure, and how does it differ from government spending?

A tax expenditure is a provision in the tax code that reduces liability for specific activities or groups—think the mortgage interest deduction or the lower rate on capital gains. It works like government spending because it delivers financial benefits through the tax system. The big difference: tax expenditures don’t need annual congressional approval. They stay in place until the law changes, so they’re far less visible than direct spending programs that must be funded each year through the appropriations process.

Why do tax policies that favor the wealthy stay in place despite public support for higher taxes on the rich?

Polls routinely show majority support for raising taxes on high earners and corporations, yet plenty of regressive tax breaks survive. One reason is low visibility: most people don’t see how much they indirectly subsidize wealth-building for others. Another is political framing—tax breaks get defended as incentives for investment or homeownership, not as government benefits. Finally, the beneficiaries are highly organized. Industries like real estate and private equity lobby hard to protect their advantages, while the broader public that bears the cost has less concentrated influence.

Does the U.S. tax system actually reduce inequality?

The federal income tax is progressive and does shrink inequality a bit compared to a world with no taxes and transfers. But when you fold in payroll taxes, state and local taxes (which tend to be regressive), and the distribution of tax expenditures, the overall effect is smaller than most people think. A 2023 study by Federal Reserve economists found that the U.S. tax-and-transfer system reduces the Gini coefficient by about 25 percent—less than most peer countries. The main engine of inequality reduction isn’t taxes; it’s direct transfers like Social Security and refundable tax credits, which are highly visible and politically contentious.