Hey Paul: What is the “ghetto tax”? I heard this mentioned on a blog about poverty in cities and how the poor are taxed more than others. Do we have a ghetto tax in Jessamine County?
The name “ghetto tax” is a bit misleading and it doesn’t necessarily apply to a “ghetto” and is definitely not a tax imposed by the government. The concept was popularized about a decade ago by a study conducted by the Brookings Institute. The study focused on the urban poor — “ghetto dwellers”. The main idea is that the poor often pay more for things because of lack of access to the same deals as the middle-class or rich.
The study listed the following ghetto taxes that are better described as poverty premiums and a tally of what it may cost the typical poor person:
- Check Cashing: Using a check cashing service rather than a personal checking account costs 1% to 5% of the check’s value. Suppose you cash $1000 in checks each month with a 2% fee – this would a $240 annual ghetto tax.
- Pay-day Lenders: The fees can be upwards of 15%. The larger problem with this type of loans is that they are a temporary solution that creates a permanent problem as the loans are rolled over. Suppose you take out just one pay-day loan for $400 to pay your winter heating bill and fortunately a Christmas miracle pays it off when due paying fees of $60.
- Tax Refund Services: The advance payments of the tax refund could have implied interest rates of 70% to 1800%! Suppose you are due a $1000 refund but take $800 for immediate cash – you are down $200.
- Car Prices, Loans, & Insurance: For the exact same car and driving record the poor paid $50 to $500 more, an extra 2% on car financing and $50 to $1000 more for auto insurance! For a modest $5000 car suppose you get a good deal on the price but have to finance at 10% rather than a customer with good credit who would get an 8% auto loan. This will cost you about $70 each year over a five-year loan.
- Home mortgages & Insurance: The poor pay on average about 1% more on mortgage rates and about $300 more for home insurance. Suppose your 30-year mortgage on a $100,000 home is at a 5% rate rather than 4%. This is costing you an extra $700 each year in housing payments.
- Furniture, Appliances & Electronics: Renting-to-Own any of these is an expensive proposition. One example cited in the Brookings study was that a $200 TV ended up costing $700 once the interest charges were factored into the cost. Suppose you got a widescreen TV and the finance charges are $100 a year for five years.
- Grocery Prices: The lack of personal transportation forced some urban poor to shop at local grocery stores that tend to be smaller and with higher prices. In Wilmore we’ve got the iconic Fitch’s IGA and in Nicholasville Walmart and Kroger’s each with competitive prices. So let’s suppose there is no ghetto tax on groceries.
The grand tally of the “ghetto tax” for this hypothetical poor Jessamine resident is $1370! Yes, it could be less if you do not “own” a home but it could easily be double or triple this amount if one finds himself in the throes of a pay-day-lender spiral or falls deeply into one of the other poverty premium traps.
So the answer to your question is yes, there is most definitely a ghetto tax that is subtly draining money off the local poor. Is there anything we can do to reduce or even completely avoid these financial dings? Yes, but it will require rethinking how we approach our finances.
A common theme through these poverty premiums is that the poor have to take on debt and then consequently pay higher rates due to weak credit scores or simply not shopping around for a better rate. My suggestion is plain and simple – if you do not have money to buy it with cash, then do not go into debt. This applies to cars, couches, appliances, electronics, clothes, and vacations. Buy used items or accept used furniture or appliances from Southland or one of many other local churches who pass along perfectly acceptable items.
A home is a bit different as very few will ever save up enough to pay cash; but if one can save enough to put down a 20% down payment and has no other debt then you may very well qualify for the best mortgage rates.
To save on tax processing you can do a few wise things. First, you should have no Federal or state taxes taken out of your pay check – it’s coming all back the following April if you are anywhere close to poor. In fact you can also be prepaid the Earned Income Tax Credit if you qualify. Second, do your own taxes using a free online software. If you can’t do this then bring your tax documents to the Jessamine public library early in the year for free tax filing sponsored by the AARP. You can file in early February and have your refund check within a week.
Finally open up a free or low cost ($5 a month) checking account. Talk to my friend Steve Smith at Town Square Bank or Jess Correll at First Southern National about an automatic savings strategy. Build up a $1000 emergency fund so you aren’t dragged under a pay-day-lender debt avalanche.
In summary by avoiding debt, not overpaying taxes, and using a bank for banking the poor and the rest of us can avoid the dreaded “ghetto tax”.