Invest in Children and Equality: Hand Out Baby Bonds

(Bloomberg Opinion) -- A consensus is emerging around an idea Americans used to scorn: That government cash payments are a good way to help struggling citizens and give the economy a boost.

President Joe Biden's $1.9 trillion pandemic relief law is on its way to giving 159 million households $1,400 or more apiece, no strings attached. Some localities are experimenting with universal basic income plans, and politicians are finding them popular enough to advocate their expansion.

But there's a smarter way to hand out government money, one that could target pressing social problems like inequality of wealth and educational opportunity, and at much lower cost: baby bonds.

Baby bonds are government grants deposited into interest-bearing accounts. If issued to all low- and middle-income children, they could eventually cover most of the costs of a four-year education at a public college or the down payment on a home. Assuming average interest rates of 2%, an investment of $1,000 at birth, plus $2,000 annually, would yield about $44,000 at maturity, when the recipient reaches 18, according to Kent Smetters, Professor of Business Economics and Public Policy at the University of Pennsylvania’s Wharton School.

Variations on the idea, which dates to the American Revolution, have been appearing across the political spectrum. The latest proposal comes from Shaun Donovan, a candidate for New York City mayor. In 2020, the concept was part of Senator Cory Booker’s failed Democratic presidential primary campaign and made it into Governor Phil Murphy’s 2020 New Jersey budget proposal before being dropped.

The recent wave of baby-bond policy proposals follows two related ideas: state-sponsored college savings accounts and universal basic income. Maine, Nevada and Rhode Island are among the first states to deposit funds via 529 college-savings plans for very young children — Maine’s $500 deposit for newborns is among the most generous.

The problem with these plans, most of which involve relatively small one-time payments, is that they focus on building a culture of saving, a laudable but unrealistic goal for the poorest families. Many also rely on philanthropic seed money, an unreliable source of long-term funding.

Meanwhile, other proposals, including the universal basic income plan touted by another New York City mayoral candidate, Andrew Yang, and Senator Mitt Romney’s universal child allowance, would probably be paid for by eliminating a slew of government entitlements and tax credits, which could leave poor families worse off. (That said, an experiment in Stockton, California suggests that cash payments to poor families, on top of other benefits, can increase full-time employment as well as the mental and physical health of recipients.) But giving each U.S. adult (about 328 million people) say, $1,000 monthly would be vastly more expensive than the roughly $150 billion it might take to pay for a baby-bond program that covered every American child.

Not only would baby bonds be cheaper, they would target the biggest source of inequality among White, Black and Latino Americans: the wealth gap. While baby bonds would not be a substitute for the welfare system — they would do nothing for poor families now — they’d be likely to sharply cut future welfare expenditures by boosting college attainment and home ownership, key factors in building household wealth.

The wealth gap is actually a chasm, with median White households holding nearly eight times the assets of Black households. It makes Black families more vulnerable to economic shocks, such as the Covid-19 pandemic, and helps explain the recent plunge in the number of poor students, especially Black youths, who enrolled in college straight out of high school. While high school graduation rates held steady, college matriculation was down 21.7% in 2020 compared to 2019, but for students from low-income and high-poverty schools, the drop was over 30%.

Baby bonds could make college affordable again for low-income students, augmenting Pell grants, which were until recently a key to college affordability. Pell grants, federally funded need-based grants for low-income undergraduates, have been covering a shrinking share of college costs; the maximum grant during the 2020-2021 school year was just $6,495. A combination of economic and political forces — including a sharp drop in state funding for public colleges, which has driven up tuition costs, and the vagaries of annual federal appropriations — have eroded the share of total college costs covered by Pell grants to just 29%, down from about 80% in 1975.

To make the most of baby bonds, proceeds should be restricted to proven investments, such as higher education, including enabling students to take unpaid internships, and home ownership. The money should not be used for speculative purposes, such as funding a business — though a budding entrepreneur could post a baby-bond-financed home mortgage as collateral for a loan, thus allowing banks to vet business plans.

As part of any baby-bond legislation, states and local school districts should require schools to teach a personal-finance unit that encompasses compound interest, the magic behind baby bonds.

By giving low-income students a leg up where it matters most, baby bonds could pay big economic and social dividends. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Gabor, a former editor at Business Week and U.S. News & World Report, is the Bloomberg chair of business journalism at Baruch College of the City University of New York and the author of "After the Education Wars: How Smart Schools Upend the Business of Reform."

©2021 Bloomberg L.P.