Investing in Poverty Reduction
After almost a year of accomplishing nothing, the Republican-led US Congress has managed to enact a far-reaching tax law and budget legislation that will shape the contours of future government spending. Neither will solve America's most pressing economic challenges, but each does include at least one sensible idea for tackling poverty.
BERKELEY – The tax legislation that US President Donald Trump signed into law last December will dramatically increase inequality and the federal budget deficit. Yet, hidden within it – and within budget legislation enacted in February – are two promising programs for helping state and local governments address the needs of disadvantaged Americans.
The new tax law creates generous incentives to encourage private investment in distressed urban and rural areas; and a provision in the budget package will establish a competitive grant program to help states fund “pay-for-success” contracts. Both ideas have their roots in the Democratic administrations of Presidents Bill Clinton and Barack Obama; but they attracted congressional Republican support because they empower state and local governments, rely on public-private partnerships, and encourage rigorous impact assessments.
The provisions in the tax law to encourage private investment in impoverished areas center on the creation of “Opportunity Zones” (a term coined more than 30 years ago by New York Governor Mario Cuomo). The OZ program grants US governors the authority to designate up to 25% of low-income census tracts – those with an individual poverty rate of 20% or higher, and median family income below 80% of the state or territorial average – as OZs.
Private investors are then granted significant tax incentives to reinvest their unrealized capital gains into OZs through “Opportunity Funds.” OFs can choose the nature of the assets (the risk/return profiles) they offer their investors, but must be organized as corporations or partnerships, which invest at least 90% of their capital in OZs.
Individuals who invest in OFs are eligible for several tax benefits. These include a temporary tax deferral on unrealized capital gains; a step-up in basis on the capital gains earned and reinvested in such funds; and a permanent exclusion from taxes on capital gains earned on fund investments held for ten years or more. A recent Brookings Institution report estimates that, “Individuals in a high-tax state and with short-term capital gains can avoid $7.50 in taxes for each $100 they invest, even before considering any return on their Zone investments.”
Still, the OZ program is not without risks, and much will depend on how it is implemented. It is possible that OFs will displace rather than develop low-income areas, and that the lion’s share of the benefits will accrue to investors and developers who already have stakes in locations that qualify for OZ designation. And the program’s emphasis on capital appreciation could result in rising property values, and thus higher rents that drive low-income tenants out of their homes.
Moreover, unlike the “Empowerment Zones” introduced by the Clinton administration in 1994, the OZ program does not include grants, loan guarantees, and other fiscal tools to finance investments in training, infrastructure, affordable housing, and local services. Investments in these areas are crucial for local socioeconomic development, even if they are not particularly attractive to private capital.
To ensure that the program benefits distressed communities, and not just wealthy investors, governors will have to choose wisely when designating low-income zip codes as OZs. Fortunately, California, Colorado, and several other states have already developed transparent and open processes to identify the neediest investment-ready areas. As other states and territories do the same, they should keep an eye on key factors such as child-poverty rates, the quality of education and training opportunities, and infrastructure and transportation conditions that affect local economic development.
States and territories will also need to bring their tax systems into line with federal law, especially if they are currently taxing capital gains as ordinary income, as California does. And, finally, they will need to provide for transparent and consistent reporting on outcomes, measuring not just financial returns, but also impact on economic development and poverty reduction. Leading “impact investment” firms such as DBL Partners, Omidyar Network, and Bridges already provide this kind of comprehensive reporting on their own investments; and the Impact Management Project, a corporate consortium, can offer additional guidance.
The new provision in the Bipartisan Budget Act of 2018 that holds promise for low-income communities is the Social Impact Partnerships to Pay for Results Act (SIPPRA), which establishes a $100 million federal fund to facilitate pay-for-success (PFS) contracts by state and local governments. In PFS contracts, a government raises private funds from investors and uses these funds to pay external organizations (often non-profits) to provide essential social services.
This approach enables government to raise private capital that would otherwise not be available to support such services, and to cut their costs by working with proven providers to achieve measurable outcomes. Taxpayers bear no financial risk, because the government pays a return to investors only if a contractor meets predetermined targets.
Beyond providing state and local governments with access to investable private capital, pay-for-success contracts encourage risk-free experiments in public policy. State and local governments, acting as “laboratories of democracy,” can pursue innovative solutions to persistent problems in impoverished communities. Some are already doing so with respect to recidivism, child and maternal health, homelessness, and workforce training.
Moreover, because pay-for-success contracts must be validated by metrics and independent evaluations, it is easy to tell which experiments have succeeded and which have failed. As it stands, an estimated $400 million in private capital has been invested in around 108 such projects in the United States and around the world. Of the 27 completed projects that have reported to date, only one has failed to achieve its target and pay a return to its investors.
Though pay-for-success contracts remain in their infancy and can involve complex and lengthy negotiations, they have the potential to transform how state and local governments fund, deliver, and evaluate social-service programs. The hope now is that SIPPRA will accelerate this transformation.
Again, implementation will be key. SIPPRA requires that contracts be awarded on a competitive basis, and that applicants supply detailed outcome targets, cost-benefit projections, and their own matching funds; but it does not specify where funds should be invested. Those decisions will be left to the state or local governments applying for SIPPRA support.
Together, OZs and SIPPRA will increase the flow of private capital into programs to combat the problems confronting the most disadvantaged populations in the most distressed communities. We applaud these new policies, which build on America’s progressive history and federalist structure.
When Welfare Sabotages Lives
The United Kingdom’s new welfare program, intended to encourage recipients to seek employment, has had a rocky start. As leaders work to improve the "universal credit" approach, they should consider how scarcity and fear play into the decision-making of those on the receiving end of government support.
OXFORD – As Christmas approaches, the United Kingdom is accelerating the rollout of a social security scheme only Ebenezer Scrooge could love. The “universal credit” program replaces six different welfare benefits – such as the child tax credit and the housing benefit – with one. The goal is to incentivize employment, and to create an online system that is easier to use.
That’s the idea, anyway. Unfortunately, the new system’s rollout has been rocky. A minimum 42-day wait for the first payment has meant that some families have been left penniless for as long as six weeks. When money has arrived, many recipients have found that their benefits have been reduced. And in areas where universal credit has been widely implemented, referrals to food banks are increasing, as are evictions.
But, for all the dramatic headlines, there is a deeper, unreported problem with the UK’s welfare reform: rather than reduce poverty, it could actually exacerbate it.
In their pioneering 2013 book Scarcity: Why Having Too Little Means So Much, Harvard’s Sendhil Mullainathan and Eldar Shafir of Princeton University examined the conditions under which people make decisions regarding how they manage their jobs, families, and lives. Their study holds two lessons that should be considered in evaluating the latest overhaul of the UK’s welfare system.
The first lesson is that people – rich and poor – often make bad choices when they lack a key resource, like money or time. For example, ruinously expensive “payday loans” can be appealing to cash-strapped borrowers, even if the terms of these loans tend to push people deeper into debt.
This is not because people lack education. In controlled studies, Mullainathan and Shafir asked Princeton University students to play a timed computer game in which they were given the opportunity to “borrow” extra seconds, even though doing so would mean forfeiting double the number of seconds from their overall time. Many took the opportunity, leading Mullainathan and Shafir to conclude that poor decisions can result from conditions of scarcity and stress.
Britain’s latest welfare reforms will push many recipients into a similar calculus, given that many of the poor have had their support reduced. This was not the original goal of the “universal credit” system, but a government seeking to cut spending found slashing welfare to be irresistible. The result is a system that is £3 billion ($4 billion) less generous than the system it replaces.
It is estimated that some 1.1 million two-parent families will lose an average of £2,770 per year, while working single parents will lose an average of £1,350 per year. These reductions in benefits are likely to perpetuate a cycle of bad planning and decision-making. It is a vicious cycle; the more the poor are deprived of resources, the more damaging their decisions can become.
A second lesson from Shafir and Mullainathan applies to the limits of human “bandwidth.” We all know that drivers using mobile phones are far more likely to have accidents, or that students using laptops during lectures learn less. If people’s brainpower is distracted by a pressing concern, they perform worse in problem-solving situations.
Britain’s benefit system operates in a similar fashion; it is a voracious consumer of bandwidth. For example, the predecessor to the universal credit scheme, the Welfare Reform Act of 2012, created caps to local housing allowances and total benefits, and under-occupancy penalties. Disability benefits and eligibility tests were also dramatically changed. And all of these “improvements” followed dozens of other changes, creating a maelstrom of bureaucracy that strained bandwidth and tested resolve.
Now come the new changes, which, in effect, create debilitating distractions for beneficiaries, forcing the poor to spend even more mental energy navigating yet another system, with new rules and procedures. This is akin to forcing people to use mobile phones every time they drive. It is unclear how parents and workers navigating a system intended to “make work pay” are supposed to perform either role well.
Britain’s new program was championed as a way to reduce costs and incentivize better decisions, thereby moving more people into work and reducing benefit claims. But, so far, there is little evidence to support this rosy scenario.
By reducing benefits received by the poor, the government is ensuring that scarcity surges and poor decisions multiply. And by changing the system frequently and making it more complicated to access, Britain’s leaders are also forcing the poor to consume more mental bandwidth. Taken together, these factors are leaving welfare recipients worse off.
Policymakers should read Mullainathan and Shafir, and consider how their research could be applied to future welfare reforms. The goal should be benefits that are generous and stable enough to let people focus on finding work, while also helping their children with homework and looking after their own health. That type of system is possible to create. The alternative is a system that places additional burdens on those least able to bear them.
Getting Basic Income Right
Universal basic income schemes are receiving more attention these days, because they are seen as a solution to technology-driven economic disruptions. They certainly have their benefits, but making them work will require countries to strike the right balance between individual choice and social-policy guidance.
WASHINGTON, DC – Universal basic income (UBI) schemes are getting a lot of attention these days. Of course, the idea – to provide all legal residents of a country a standard sum of cash unconnected to work – is not new. The philosopher Thomas More advocated it back in the sixteenth century, and many others, including Milton Friedman on the right and John Kenneth Galbraith on the left, have promoted variants of it over the years. But the idea has lately been gaining much more traction, with some regarding it as a solution to today’s technology-driven economic disruptions. Can it work?
The appeal of a UBI is rooted in three key features: it provides a basic social “floor” to all citizens; it lets people choose how to use that support; and it could help to streamline the bureaucracy on which many social-support programs depend. A UBI would also be totally “portable,” thereby helping citizens who change jobs frequently, cannot depend on a long-term employer for social insurance, or are self-employed.
Viewing a UBI as a straightforward means to limit poverty, many on the left have made it part of their program. Many libertarians like the concept, because it enables – indeed, requires – recipients to choose freely how to spend the money. Even very wealthy people sometimes support it, because it would enable them to go to bed knowing that their taxes had finally and efficiently eradicated extreme poverty.
The UBI concept also appeals to those who focus on how economic development can replace at least some of the in-kind aid that is now given to the poor. Already, various local social programs in Latin America contain elements of the UBI idea, though they are targeted at the poor and usually conditional on certain behavior, such as having children regularly attend school.
But implementing a full-blown UBI would be difficult, not least because it would require answering a number of complex questions about goals and priorities. Perhaps the most obvious balancing act relates to how much money is actually delivered to each citizen (or legal resident).
In the United States and Europe, a UBI of, say, $2,000 per year would not do much, except perhaps alleviate the most extreme poverty, even if it was added to existing social-welfare programs. An UBI of $10,000 would make a real difference; but, depending on how many people qualify, that could cost as much as 10% or 15% of GDP – a huge fiscal outlay, particularly if it came on top of existing social programs.
Even with a significant increase in tax revenue, such a high basic income would have to be packaged with gradual reductions in some existing public spending – for example, on unemployment benefits, education, health, transportation, and housing – to be fiscally feasible. The system that would ultimately take shape would depend on how these components were balanced.
In today’s labor market, which is being transformed by digital technologies, one of the most important features of a UBI is portability. Indeed, to insist on greater labor-market flexibility, without ensuring that workers, who face a constant need to adapt to technological disruptions, can rely on continuous social-safety nets, is to advocate a lopsided world in which employers have all the flexibility and employees have very little.
Making modern labor markets flexible for employers and employees alike would require a UBI’s essential features, like portability and free choice. But only the most extreme libertarian would argue that the money should be handed out without any policy guidance. It would be more advisable to create a complementary active social policy that guides, to some extent, the use of the benefits.
Here, a proposal that has emerged in France is a step in the right direction. The idea is to endow each citizen with a personal social account containing partly redeemable “points.” Such accounts would work something like a savings account, with their owners augmenting a substantial public contribution to them by working, studying, or performing certain types of national service. The accounts could be drawn upon in times of need, particularly for training and re-skilling, though the amount that could be withdrawn would be guided by predetermined “prices” and limited to a certain amount in a given period of time.
The approach seems like a good compromise between portability and personal choice, on the one hand, and sufficient social-policy guidance, on the other. It contains elements of both US social security and individual retirement accounts, while reflecting a commitment to training and reskilling. Such a program could be combined with a more flexible retirement system, and thus developed into a modern and comprehensive social-solidarity system.
The challenge now – for the developed economies, at least – is to develop stronger and more streamlined social-solidarity systems, create room for more individual choice in the use of benefits, and make benefits portable. Only by striking the right balance between individual choice and social-policy guidance can modern economies build the social-safety programs they need.
Europe’s Poverty Time Bomb
Poverty, especially among the young, has been a growing problem across many European countries since the 2008 financial crisis. And now political leaders in hard-hit countries like Italy are calling attention to the issue in the worst way possible: by promising quick fixes that won't work and would jeopardize government budgets.
MADRID – The poor don’t often decide elections in the advanced world, and yet they are being wooed heavily in Italy’s current electoral campaign. Former Prime Minister Silvio Berlusconi, the leader of Forza Italia, has proposed a “dignity income,” while Beppe Grillo, the comedian and shadow leader of the Five Star Movement, has likewise called for a “citizenship income.”
Both of these proposals – which would entail generous monthly payments to the disadvantaged – are questionable in terms of their design. But they do at least shed light on the rapidly worsening problem of widespread poverty across Europe.
Poverty represents an extreme form of income polarization, but it is not the same thing as inequality. Even in a deeply unequal society, those who have less do not necessarily lack the means to live a decent and fulfilling life. But those who live in poverty do, because they suffer from complete social exclusion, if not outright homelessness. Even in advanced economies, the poor often lack access to the financial system, struggle to pay for food or utilities, and die prematurely.
Of course, not all of the poor live so miserably. But many do, and in Italy their electoral weight has become undeniable. Almost five million Italians, or roughly 8% of the population, struggle to afford basic goods and services. And in just a decade, this cohort has almost tripled in size, becoming particularly concentrated in the country’s south. At the same time, another 6% live in relative poverty, meaning they do not have enough disposable income to benefit from the country’s average standard of living.
The situation is equally worrisome at a continental level. In the European Union in 2016, 117.5 million people, or roughly one-fourth of the population, were at risk of falling into poverty or a state of social exclusion. Since 2008, Italy, Spain, and Greece have added almost six million people to that total, while in France and Germany the proportion of the population that is poor has remained stable, at around 20%.
In the aftermath of the 2008 financial crisis, the probability of falling into poverty increased overall, but particularly for the young, owing to cuts in non-pension social benefits and a tendency in European labor markets to preserve insiders’ jobs. From 2007 to 2015, the proportion of Europeans aged 18-29 at risk of falling into poverty increased from 19% to 24%; for those 65 and older, it fell from 19% to 14%. The share of young people now experiencing severe material deprivation, at 12% of the total population, is almost twice that of the elderly. As Christine Lagarde, the International Monetary Fund’s managing director, noted at the World Economic Forum’s meeting in Davos this year, young Europeans “are putting their dreams on hold.”
Although the current economic upswing could partly reverse the trend in youth poverty, the structural factors underlying the problem will remain. Workers’ skills can deteriorate irreparably during stints of long-term unemployment, or can suddenly be rendered obsolete by rapid advances in technology. For many poor people, re-joining the workforce will either be impossible, or it will require them to settle for precarious, low-paid jobs that leave them vulnerable to the next downturn. According to the OECD, 14% of the working-age population in Spain and Greece in recent years was employed but still in poverty.
In unequal societies, resources can be redistributed from the very rich to the rest through progressive taxation, monetary transfers, and salary caps. But eliminating poverty requires more than merely reapportioning the economic pie. The poor also must be re-empowered and reintegrated into societies that have pushed them to the margins. Ultimately, it is not just a matter of political stability and economic fairness, but of human dignity.
Looking ahead, Europe’s welfare states will need to be reformed to address current realities. The elderly are no longer the most economically vulnerable members of European society, but they still receive the largest slice of the pie. Governments should reduce pension benefits in favor of the poor, the unemployed, and the young. These three groups, which often overlap, are in desperate need of financial assistance, skills training, and family-friendly policies.
European governments should also overhaul their tax systems to make older workers contribute more, offer fiscal incentives to companies that hire disadvantaged workers, and move toward establishing an EU-wide poverty-insurance scheme. And entrepreneurs and private firms should invest more in social programs in the communities where they are active.
While Berlusconi (who is barred from running for office) and Grillo have homed in on the problem of poverty, their proposed solutions are nothing more than short-term fixes. A basic-income scheme might provide some immediate financial relief to the poor, but it would not address the structural causes of poverty. Even worse, because neither proposal seriously encourages the unemployed to seek work or training programs, the poor could end up reliant on state assistance forever. And it is not as if such policies would be budget-neutral. Rather, they would have to be funded by politically unpopular tax increases or spending cuts.
Still, as Berlusconi and Grillo have made clear, Europe’s leaders can no longer afford to ignore the poverty problem. They will have to offer real solutions, not simplistic schemes. As oblivious elites often learn the hard way, the poor will endure their lot only for so long.
Inequality in the Twenty-First Century
As inequality continues to deepen worldwide, we do not have the luxury of sticking to the status quo. Unless we confront the inequality challenge head on – as we have just begun to do with another existential threat, climate change – social cohesion, and especially democracy, will come under growing threat.
MUMBAI – At the end of a low and dishonest year, reminiscent of the “low, dishonest decade” about which W.H. Auden wrote in his poem “September 1, 1939,” the world’s “clever hopes” are giving way to recognition that many severe problems must be tackled. And, among the severest, with the gravest long-term and even existential implications, is economic inequality.
The alarming level of economic inequality globally has been well documented by prominent economists, including Thomas Piketty, François Bourguignon, Branko Milanović, and Joseph E. Stiglitz, and well-known institutions, including OXFAM and the World Bank. And it is obvious even from a casual stroll through the streets of New York, New Delhi, Beijing, or Berlin.
Voices on the right often claim that this inequality is not only justifiable, but also appropriate: wealth is a just reward for hard work, while poverty is an earned punishment for laziness. This is a myth. The reality is that the poor, more often than not, must work extremely hard, often in difficult conditions, just to survive.
Moreover, if a wealthy person does have a particularly strong work ethic, it is likely attributable not just to their genetic predisposition, but also to their upbringing, including whatever privileges, values, and opportunities their background may have afforded them. So there is no real moral argument for outsize wealth amid widespread poverty.
This is not to say that there is no justification for any amount of inequality. After all, inequality can reflect differences in preferences: some people might consider the pursuit of material wealth more worthwhile than others. Moreover, differential rewards do indeed create incentives for people to learn, work, and innovate, activities that promote overall growth and advance poverty reduction.
But, at a certain point, inequality becomes so severe that it has the opposite effect. And we are far beyond that point.
Plenty of people – including many of the world’s wealthy – recognize how unacceptable severe inequality is, both morally and economically. But if the rich speak out against it, they are often shut down and labeled hypocrites. Apparently, the desire to lessen inequality can be considered credible or genuine only by first sacrificing one’s own wealth.
The truth, of course, is that the decision not to renounce, unilaterally, one’s wealth does not discredit a preference for a more equitable society. To label a wealthy critic of extreme inequality as a hypocrite amounts to an ad hominem attack and a logical fallacy, intended to silence those whose voices could make a difference.
Fortunately, this tactic seems to be losing some of its potency. It is heartening to see wealthy individuals defying these attacks, not only by openly acknowledging the economic and social damage caused by extreme inequality, but also by criticizing a system that, despite enabling them to prosper, has left too many without opportunities.
In particular, some wealthy Americans are condemning the current tax legislation being pushed by Congressional Republicans and President Donald Trump’s administration, which offers outsize cuts to the highest earners – people like them. As Jack Bogle, the founder of Vanguard Group and a certain beneficiary of the proposed cuts, put it, the plan – which is all but guaranteed to exacerbate inequality – is a “moral abomination.”
Yet recognizing the flaws in current structures is just the beginning. The greater challenge is to create a viable blueprint for an equitable society. (It is the absence of such a blueprint that has led so many well-meaning movements in history to end in failure.) In this case, the focus must be on expanding profit-sharing arrangements, without stifling or centralizing market incentives that are crucial to drive growth.
A first step would be to give all of a country’s residents the right to a certain share of the economy’s profits. This idea has been advanced in various forms by Marty Weitzman, Hillel Steiner, Richard Freeman, and, just last month, Matt Bruenig. But it is particularly vital today, as the share of wages in national income declines, and the share of profits and rents rises – a trend that technological progress is accelerating.
There is another dimension to profit-sharing that has received little attention, related to monopolies and competition. With modern digital technology, the returns to scale are so large that it no longer makes sense to demand that, say, 1,000 firms produce versions of the same good, each meeting one-thousandth of total demand.
A more efficient approach would have 1,000 firms each creating one part of that good. So, when it comes to automobiles, for example, one firm would produce all of the gears, another producing all of the brake pads, and so on.
Traditional antitrust and pro-competition legislation – which began in 1890 with the Sherman Act in the US – prevents such an efficient system from taking hold. But a monopoly of production need not mean a monopoly of income, as long as the shares in each company are widely held. It is thus time for a radical change, one that replaces traditional anti-monopoly laws with legislation mandating a wider dispersal of shareholding within each company.
These ideas are largely untested, so much work would need to be done before they could be made operational. But as the world lurches from one crisis to another, and inequality continues to deepen, we do not have the luxury of sticking to the status quo. Unless we confront the inequality challenge head on, social cohesion and democracy itself will come under growing threat.