America Needs Federal ‘Baby Bonds’ – WSJ

America Needs Federal ‘Baby Bonds’ – WSJ.

by David M. Smick · April 15, 2018
Speaker Paul Ryan has announced his retirement, but he still has time to pass legacy-defining legislation. He should focus his final months in office on alleviating the poverty trap, wherein people who try to leave welfare become cornered as they face a loss of benefits and unduly high marginal tax rates.

Previous efforts at reform have been halted by demagoguery, but a bipartisan plan that also addresses the U.S. economy’s means of wealth distribution has a chance of success. Call it the Escape From Poverty Plan.

A large portion of wealth creation today is distributed through equity markets. Since it hit bottom in 2009, the S&P 500 stock index has nearly quadrupled, but tens of millions of Americans don’t own stocks. For those at the bottom, stock ownership is largely nonexistent. Meanwhile, wages have remained relatively flat.

In coming decades, an increasing portion of the world’s economic dynamism will be powered by the tech revolution, much of which will occur outside the U.S. Many of the fastest-growing economies are in Africa. India could become a 21st century juggernaut.

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Affluent Americans whose stock portfolios include a global component will tap directly into this wealth creation. Mere wage earners and those at the bottom economic rungs will not. The challenge is to enable more Americans to own securities.

Less than a decade ago, Congress was close to taking a modest first step. A remarkable bipartisan coalition in the Senate—from Jeff Sessions to Chuck Schumer—backed legislation that would have established “American Birthright Accounts.” These accounts would have given newborn Americans a $500 “baby bond.” But the proposal fell to the wayside.

Congress should consider a revamped version of this initiative that offers future Americans the opportunity to become stockholding capitalists. The federal government could set up a tax-free stock-investment account for each child born in the U.S. It would begin with, say, a $5,000 low-interest loan as seed capital, to be paid back in 50 years. The loan would include a modest interest rate, with the interest balloon payment due at the end of the loan period. (A lot of details would need to be established to prevent abuse of the program and to protect participants.)

The plan should offer a small selection of diversified U.S. and global index fund investment choices, all overseen by the U.S. Treasury. Within strict limits, an account holder could use some of the profits for education after turning 18. On the government’s books, the transaction would be a loan, not an expenditure.

Big Wall Street banks were offered massive amounts of low-interest loans to repair their balance sheets during the financial crisis. Why not do the same for children of working-class families? Those families earning less than $60,000 in joint income should also pay no federal tax on any stock or bond investment income. And Congress should explore better ways to encourage companies, large and small, to initiate or expand employee investment programs.

There are no guarantees here. Equity markets correct and sometimes collapse. Birthright accounts alone are no magic formula for ending poverty. Still, since 1930 the U.S. stock market—even factoring in the Depression-ridden 1930s and stagflation-plagued 1970s—increased by an average annual rate of about 7% after inflation. In the future Warren Buffett predicts average annual long-term equity market returns, including reinvested dividends, of up to 7%. It would be reasonable to expect that a global, indexed birthright investment account could, after decades of compounding, become a sizable nest egg.

Can index funds capture global, tech-driven wealth creation? Mr. Buffett’s recent public bet showed the return on index funds to be superior to those achieved by the best, most specialized traders. And the bull market of recent years has demonstrated one thing: A relatively few tech stocks can drive the broader indexes.

Some conservatives may object, but there is a precedent for this approach. The Homestead Act of 1862, signed by President Lincoln, gave out public land grants at little or no cost, setting the stage for mass property ownership that underpins American democracy. It may be the most important piece of economic legislation in U.S. history.

To expand opportunity, average Americans must have better access to the financial-market growth wave. In a global economy in which digitization and artificial intelligence could produce significant economic disruption, families on the lower rungs need a user-friendly way to tap into the world’s future wealth generation. They need to become more familiar with the investment economy.

Combining welfare and entitlement reform with some form of birthright accounts could be a first step toward a policy that brings that economic security to all Americans—while eliminating poverty traps.

Mr. Smick, chairman and CEO of Johnson Smick International, is author of “The Great Equalizer: How Main Street Capitalism Can Create an Economy for Everyone” (PublicAffairs, 2017).

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