Fiscal Policy

Booker’s Bank-Breaking ‘Baby Bonds’ Won’t Close the Wealth Gap

Sen. Cory Booker (D-N.J.) during a Senate Foreign Relations Committee hearing on Capitol Hill, January 27, 2021. (Michael Reynolds/Pool via Reuters)
A wasteful handout tucked into the $3.5 trillion budget-reconciliation plan

The $3.5 trillion budget-reconciliation plan is already morphing into a bonanza for dubious spending and reckless tax increases. Provisions including green-energy tax breaks and “free” community-college tuition would disproportionately benefit the wealthy while leaving taxpayers holding the bill. And now, Senator Cory Booker (D., N.J.) is pushing for even more red ink. Booker wants the legislation to include his “baby bonds” proposal, which would grant every newborn American $1,000 to be tucked away in a savings account in which the government will regularly deposit additional money. However, this $60 billion-per-year proposal would only succeed in exacerbating income inequality while burgeoning the debt. Policymakers should keep “baby bonds” out of the budget bill and give Americans a break from runaway federal debt.

Senator Booker argues that seeding and depositing funds into babies’ savings accounts (which they wouldn’t be able to touch until adulthood) provides a novel way to erase America’s wealth gap. Fortunately, the country doesn’t need to resort to armchair theorizing and complicated economic models to figure out if that’s true. There is plenty of research that shows what happens when Americans suddenly find themselves with a windfall of spendable cash. One 2011 study appearing in The Review of Economics and Statistics analyzed whether lottery winnings (i.e., between $50,000 and $150,000) allow financially distressed Americans to avoid bankruptcy. The researchers found that “while these recipients are 50% less likely than small winners [who won less than $10,000] to file for bankruptcy immediately after winning, they are more likely to file for bankruptcy three to five years after winning.”

Five years on, the net assets and unsecured debt levels are virtually identical between large lottery winners and small winners. This likely would not be the case if winners of significant sums took their winnings and, say, parked them in index funds or used the dollars to further their educations. Unfortunately, this too often turns out not to be the case. The researchers suggest that “myopic behavior” such as quickly spending the winnings on material goods is to blame for these bankruptcy figures. That’s not to say that ordinary or struggling folks don’t know how to save money. The unfortunate truth is that many Americans are conditioned by their financial status to live paycheck to paycheck and spend income as it comes in. And as it turns out, people tend to be creatures of habit and don’t become investment gurus overnight. This simple insight explains why the lottery fails to make people healthier, happier, or wealthier over the long term.

Analyses of government cash-distribution programs tend to confirm that result. For example, the Alaskan government gives each state resident $1,000 to $1,600 per year based on oil revenues collected by the state. And, while the Alaska Permanent Fund certainly has its benefits (e.g., allowing recipients to buy more nutritious meals and thereby reducing obesity among the population), the payout system may actually increase income inequality. Summing up empirical results on the fund, University of Alaska professor Mouhcine Guettabi notes that dividend checks tend to widen the gap between rich and poor over the short and long term. Research suggests that if the money is “spent on non-durable goods by the lowest income groups but is saved or invested by the higher income, then it may gradually result in increasing disparities between the groups.” It’s hard to imagine that “baby bonds” wouldn’t have the same end result, since proposal language allows for adults to use baby-bond dollars as long as the spending constitutes an investment in “personal capital that provides long-term gains to wages and wealth. . . .” This, of course, can mean anything from a new car to swankier clothes to gym membership.

The obvious alternative is to offer means-tested subsidies geared toward specific, important purchases such as health insurance. The Affordable Care Act (aka Obamacare) already does this to some extent, but the program’s effectiveness is limited by mandates to buy insurance add-ons (e.g., smoking cessation, pregnancy-related care) that many consumers do not want or need. Empowering low-income Americans to purchase the private care of their choice without onerous requirements would go a long way toward bolstering health and increasing equity.

Similarly, education tax credits could go a long way to ensure that millions of students are not trapped in failing school systems. These sorts of targeted programs ensure that taxpayer dollars are used on important priorities without micromanaging which products and institutions Americans purchase and interact with. Policy-makers can lend a helping hand without breaking the bank and making inequality worse.

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