Baby Bonds: An Investment In Our Future
Since the 2008 financial crisis, income and wealth inequality has become a prominent subtext of our national conversation. Politicians, ranging from President Obama and local city governments, as well as social movements, including Occupy Wall Street and the Fight For $15 (which has successfully fought for a $15 minimum wage in several dozen cities and states), have drawn attention to the nation’s highly uneven private monetary distribution.
Considering that in 2014, the top 0.1% of earners brought in 184 times the income of the lower 90% of Americans combined, while members of the Forbes 400 (the 400 wealthiest Americans, or just over 0.000001% of the population) held greater aggregate wealth than the bottom 61% of Americans, this debate is unlikely to cease anytime soon.
A range of potential solutions have been floated, including raising capital gains taxes (assessed on various types of investments), increasing the income tax on high earners, and reforming the estate tax (levied on inheritances of a certain size), to dampen the effects of the intergenerational transfer of wealth.
Each of these approaches is focused on altering the post-earnings distribution of income and wealth, through the use of taxes. There’s nothing per se wrong with that method; after all, tax policy is one of the primary mechanisms through which government can influence economics.
Yet, what if policymakers try to tackle this issue from a different angle, by working to shift the pre-tax distribution of income and wealth? Such a strategy would involve crafting solutions which empower those from families who make less money, and sit at the lower end of the wealth spectrum, to increase their incomes, and build wealth.
In the past several years, studies have shown that economic mobility, in terms of income, has not changed much over the past several decades. That is, the chances of moving up to the top 20% of earners as an adult, given a childhood background where one’s family was in the bottom 20%, has remained relatively consistent. Yet, the numerical odds are still rather low: only 8.4 to 9% of Americans will make this jump.
Much of this has to do with educational achievement. There is a strong correlation between education and earnings, yet just 5% of Americans whose parents did not finish high school (and are thus more likely to be clustered amongst the poorest 20% of the population), complete college. More broadly, of those aged 25–34 (in 2014), only 20% of men, and 27% of women, achieved a greater level of education than their parents.
An obvious reason for this unfortunate reality, is that children born into poverty face a range of disadvantages before they even begin school, including lower exposure to vocabulary and conversation, to malnutrition, and the presence of violence and drug use. These children often attend schools where fellow pupils also hail from socioeconomically challenged backgrounds, teacher quality tends to be lower, and an inequitable distribution of public funds leads to a lack of other resources.
As if all of this weren’t enough, those who do make it to college often face rising educational costs. A landmark 2007 study found that the impact of family income on college attendance, grew markedly from the early 1980’s to the early 2000’s. Why? In part, the study suggested, rising educational costs are harming those who are “borrowing constrained”, that is, less affluent students, who often must accept the maximum amount allowed from student loan programs (sometimes while facing other financial pressures, like assisting their families), also lack other sources of funding.This is an unfortunate Catch-22, since higher education is often required in order to escape poverty, yet, it often simply costs too much.
Now, let’s consider the wealth gap. The wealthiest 20% of American households hold just under 90% of all wealth in the nation, while the bottom 40% of households actually have negative wealth, that is, they actually owe more than the total value of their assets, i.e., such households are in debt.
For those on the lower end,of the wealth curve, breaking out of this cycle is even more challenging than outearning their parents (i.e.narrowing income inequality). Since so much wealth in the United States is transferred intergenerationally, even if someone from a poor background completes advanced schooling, and earns far more than his or her parents, he or she is already at a substantial disadvantage, compared to peers from wealthier families, whose families might have helped pay for school, provided the down payment for a home, or helped fund a new business. This chasm remains for generations to come.
Yet, wherever we face major challenges, solutions are never too far away. One of the most fascinating approaches to bridging the wealth gap, is the idea of “baby bonds.” This phrase, coined by late historian Manning Marable, came into prominence thanks to a 2010 paper, published by economists Darrick Hamilton of The New School and William Darity Jr. of Duke University.
Hamilton and Darity’s work sought to address racial disparities in the distribution of wealth. According to a 2013 study from the Institute for Policy Studies, the average white household was almost 7.7 times as wealthy as it’s African-American counterpart, and had almost 6.7 times the wealth of the average Latino household.
Why is this? Hamilton and Darity cite to a study by economists Maury Gittleman and Edward Wolff, which found that, once controlled for income, African-Americans and whites have similar savings rates, eliminating one source of this wealth disparity. However, inheritances play a large role in raising the wealth levels of whites, relative to African-Americans. This effect is so pronounced that the median wealth of an African-American household headed by a college graduate, is lower than that of a white family whose primary earner dropped out of high school. Hamilton and Darity also note that lending and housing policies have been disproportionately harmful to African-Americans, which has an added impact on wealth creation.
Thus far, we have established that the wealth gap in the United States is direly large, stems largely from the passage of wealth through inheritance, and has a significant racial component. So, what does all of this have to do with baby bonds?
As Hamilton and Darity see it, the “post-racial” narrative, which argues that racism and discrimination are no longer major factors in holding back African-Americans, has become increasingly prevalent, particularly since the election of President Obama. Under this view, African-Americans must assume greater personal responsibility for their social and economic conditions, rather than looking to the larger society, or the federal government. Advocates of post-racial politics also believe that African-Americans ought to focus on supporting programs designed to uplift Americans of all races, rather than racially focused remedies.
While Hamilton and Darity aren’t swayed by claims of post-racialism, they seem to acknowledge that these arguments have gained considerable traction, such that there is unlikely to be much support for “race specific social policies” to bridge the racial wealth gap, or other disparities.
Here’s where baby bonds offer a solution. Around 1990, a few small pilot programs were established to narrow the wealth gap. Amongst these was the Savings for Education, Entrepreneurship and Down-payment (SEED) initiative, which funds Children’s Development Accounts (CDA), basically, savings accounts to help children build wealth, starting at birth.
Hamilton and Darity argue for widespread implementation of a program like SEED. Under their approach, around 75% of American newborns would be allocated an initial principal amount, based on familial wealth (rather than income). Children born into the least wealthy households would recieve a larger allocation (perhaps $50,000 to $60,000), while those from wealthier families, who are capable of passing on greater wealth, would recieve progressively smaller amounts (babies from the wealthiest households would recieve no baby bonds, given their not-insubstantial existing wealth). Overall, Hamilton and Darity foresee around 3/4 of children born every year, participating in this program.
These funds would be placed in federally managed accounts, with a guaranteed annual return of 1.5% to 2%, such that by the time a child from one of the poorest families turns 18, he or she would have $78,000. This money would then be directed towards a “clearly defined asset enhancing activity,” that is, an avenue which will empower recipients to build wealth. Examples offered by Hamilton include financing (partially) debt-free higher education, investing in a business, or purchasing a home (given housing costs in much of the country, probably by just providing a down payment).
While bond holders have their choice of how exactly to allocate these funds, monies must be spent on some sort of activity which builds long-term wealth. As Hamilton noted, in many poorer families, relatives often need financial assistance, to cover various expenses. Such uses, however commendable, will not be permitted, since these funds won’t strengthen the long-term finances of bond beneficiaries. Additionally, vigorous regulations would be implemented, to ensure that beneficiaries are not defrauded by those who see a young person looking to improve his or her life, as an easy target for theft.
Of course, whenever a proposal for government spending is offered, the inevitable question arises: How will we pay for this? In their paper, Hamilton and Darity projected that the baby bonds program would cost about $60 billion per year. Assuming costs have stayed fairly consistent (a reasonable assumption, given birth rates), this amount is just over 10% of the yearly allocation to the Department of Defense (which is already rife with bureaucratic waste) . It is also less than the considerable tax revenue lost yearly to the mortgage interest deduction, a largely ineffective policy. Funding baby bonds is possible, if lawmakers are willing to make some reasonable fiscal adjustments, for a program that holds considerable promise.
Ultimately, it will be possible to finally lessen a yawning wealth gap, which stems in major part from decades of wealth transfer between generations, rather than uniquely meritorious behavior, of those who possess (often, inherit) wealth . Baby bonds can directly impact the college completion rates of poorer Americans (recall the aforementioned discussion of borrowing constraints), given that promising students (based on test scores) of lesser means, complete college at about the same rate as wealthy youngsters with considerably weaker academic skills.
What’s more, those baby bond recipients who do complete college, will be graduating with a lighter debt load, and greater earnings potential, than their counterparts who did not finish school. This will not only reduce income inequality, but allow baby bond program participants to build (and bequeath) wealth at a faster pace. Over time, this virtuous cycle will (partially) offset unearned differences in wealth.
Baby bonds are not a panacea for the complex challenges we face, in terms of wealth and income inequality. Changes to the tax code, better K-12 schools, strong antipoverty efforts, improved financial education, can all play important roles in overcoming these challenges. What’s more, in an era where technological innovation (specifically, artificial intelligence, machine learning, deep learning and robotics), will replace lots of blue collar as well as higher skill jobs, inequality will likely remain an issue for decades to come.
Yet, we must make an earnest effort to build a fairer economic system, one where the birth lottery does not play such a large role in determining one’s income and wealth, not to mention that of future generations. Baby bonds are a clear step in that direction.