Can the American Dream Be Saved?
There is a sense in our country that the American Dream is not what it used to be. Journalists routinely cite research claiming that there is now less opportunity and economic mobility in America than in many European countries. Some studies conclude that it is harder than ever for young Americans from poor households to move up into the middle class. And many Americans believe that a decline in economic mobility is in fact driving an increase in income inequality. These observations — and the conclusions drawn from them — will surely shape the debate over America's economic and social policy in the years ahead.
That debate essentially involves two competing visions of the nature of opportunity in American life, and of how to provide it. One holds that a widening inequality of incomes threatens both fairness and opportunity and that focused government action and investment in people are the keys to giving all Americans a fair shot at success. The other holds that making the American Dream real for the less fortunate requires ordinary Americans to take the lead in strengthening bedrock civil-society institutions and fostering a culture of success. Under this vision of opportunity, government action can sometimes support such efforts — but it can never fully substitute for them, and often undermines them.
The debate is, in other words, about two distinct understandings of the relationship between equality and mobility. The insistence on confounding and confusing the two diverts our attention from the very real problems plaguing lower-income communities — problems that really should raise alarm.
Our concerns about the American Dream, then, should not point us in the direction toward which the public conversation often turns: arguing for more government spending on wealth transfers. Instead, they should drive us to search for ways in which the poor in America might be empowered to benefit from the opportunities this country affords — and which it still affords to a degree that no other nation can match.
UNDERSTANDING INEQUALITY
We all know the familiar story of a growing "income gap" in America. Census Bureau data are often cited as evidence of this divide. They show that, between 1967 and 2010, the share of national income going to the bottom 20% of households declined from 4% of the total to 3%, while for the top 20% of households during the same period, it rose from 44% to 50%. The concern for many is not just that there could be something inherently unfair about this distribution, but that it may indicate that a concentration of income and wealth at the top is making it increasingly difficult for people to move up.
This story, however, is both exaggerated and misunderstood. As a result, our public debate about income inequality is often misguided. To begin, three aspects of measuring income are too often overlooked when we consider inequality.
First, cash earnings — which are generally how income inequality is expressed — significantly understate total household income. The main reason is that these figures ignore the growing proportion of compensation that takes the form of fringe benefits, such as employer-sponsored health insurance. The Census Bureau's income-inequality data also do not include non-cash government benefits, such as food stamps and Medicaid. Nor do they take account of taxes — both the disproportionally large bills paid by higher earners, as well as the benefits distributed through the tax code itself (such as the various credits that often accrue to lower-income Americans).
Second, the fact that these cash earnings are measured as household income exaggerates the differences between rich and poor. Over time, the median household size has become relatively smaller for those at the bottom end of the income scale, thanks in large part to the growth in single-parent families. The Census Bureau in fact reports that the top 20% of households now account for more than twice as many individuals as the bottom 20%. Household incomes at the top therefore support more people.
Finally, the government uses different inflation indices to measure income and labor productivity over time. The indices include different items and use different mathematical formulas, and they therefore produce different results. For instance, the Consumer Price Index, used to adjust wages, has risen by 420% since 1973, while the primary inflation index, used to measure output and productivity, has risen by only 270%. Using the two indices to compare wages and productivity gives the false impression that employers are somehow shortchanging workers. But if we take the more commonsense approach of applying the same inflation index to both income and productivity, the data reveal that compensation has in fact risen in line with worker productivity over many years.
If we adjusted for these three factors, the assumptions underlying our inequality debate would change significantly. Such adjustments would show that, for example, rather than falling from 4% of total income to 3% over the past four decades, the share of income going to the bottom fifth of the population actually more than doubled. Meanwhile, the proportion going to the top fifth of Americans edged down from 44% to just below 40% — rather than rising to 50%.
Still, while the distribution data do not support much of the left's inequality narrative, there are two striking features of the data that should cause us alarm. The first is that one of the most significant factors determining a household's level of income is the number of household members who work. In 2010, for instance, the Current Population Survey produced by the Census Bureau and the Bureau of Labor Statistics showed that roughly 75% of households in the top income quintile had two earners. Meanwhile, in the bottom quintile, only 5% had two income earners; 95% had one or none. Thus the unifying feature of those households at the bottom of the income ladder is the absence of paying work, or at least the absence of the two paychecks now typically needed for a family to begin moving up the economic ladder.
The second disturbing feature of the data is the low productivity of many of the lower-income Americans who do work. In his recent book So Rich, So Poor: Why It's So Hard to End Poverty in America, Peter Edelman complains that the American economy doesn't create enough good-paying jobs — as though this were a perverse or even malicious feature of American industry. But like so many others, he confuses cause and effect. In a market economy, the compensation levels for workers in various industries rise and fall over time. There are of course many reasons for this, but one important cause is the value of the workers' output. That in turn is affected by each worker's skills. If these skills do not adjust and keep up with the requirements of the evolving economy, a worker's labor will command a lower wage. The long-term problem evident today is that the low skill levels and work aptitudes of millions of Americans ensure low productivity and low potential earnings, in turn guaranteeing increased inequality and limited upward mobility.
The taxation and income-redistribution strategies favored by liberals such as Edelman may help to paper over the skill and productivity problem by increasing post-tax and transfer income for Americans at the bottom (albeit at the cost of discouraging work and slowing job creation). But redistribution does nothing to address the low productivity and work-participation rates that are keeping low-income Americans poor. The problem we face, in other words, is not one of inadequate equality, but one of inadequate mobility. And addressing that problem requires us to think differently about the sources of wealth and poverty in America.
UNDERSTANDING MOBILITY
To understand the supposed problem with the American Dream, we must be clear about what we mean by "economic mobility." To most Americans, the term "mobility" suggests a situation in which a person can expect to see his standard of living improve over time, in line with his skills and effort, and in which the general standard of living for people at the same stage in life should improve from one generation to the next. Analysts call this "absolute mobility," and by this measure, mobility in America has been fairly robust. For instance, median family income for Americans in their forties and fifties today is about 30% higher in real terms than for the previous generation at the same age.
Analysts use another term, "intergenerational mobility," to compare the inflation-adjusted incomes and wealth of individuals with those of their own parents. That kind of mobility, too, is robust. According to the Pew Charitable Trust's Economic Mobility Project, an average of 84% of Americans today, across all levels of the income distribution, have higher incomes than their parents did at the same age, adjusted for inflation. Moreover, 93% of Americans whose parents were in the bottom quintile exceed their parents' incomes as adults today.
What troubles some analysts and resonates with many Americans, however, is the idea of "relative mobility," in which the income of a household over time is compared with that of other households. Relative mobility captures the ease with which a family can move from, say, the 18th percentile of the income distribution to the 71st. Put another way, the more a society is characterized by relative mobility, the more likely it is to produce rags-to-riches stories.
It is by using this relative measure that analysts conclude that, compared with other developed countries such as Canada and Denmark, Americans are less likely to move up or down the ladder in relative terms. Americans' incomes, the analysts argue, are more likely to be linked closely to the incomes of their parents. For example, in 2006, a team led by Markus Jäntti found that, in the case of Danish men whose fathers were in the bottom fifth of the earnings distribution, 14% eventually made it to the top fifth and only 25% remained at the bottom. In the United States, by contrast, 42% languished at the bottom while only 8% made it to the top fifth. Incomes at the ends of the scale are "stickier" in the U.S., meaning that children here are more likely to inherit the relative economic status of their parents. This pattern causes some to worry that the economic prospects of American children depend more on their parents' money, and less on the children's own abilities and effort, than is the case for children in other nations. According to this view, many countries offer more opportunity and economic mobility than the United States does, particularly the countries of Northern Europe. America, in other words, is no longer the best provider of the American Dream.
There are many reasons to question the methodologies of such international comparisons, including important differences in the collection and measurement of earnings data. But even if we were to take the data at face value, what would they really tell us? To be sure, inherited or gifted money is a very helpful asset in America, as it is everywhere. But the more important feature of America's market economy is that it rewards other traits typically passed from parents to children — traits like perseverance, far-sightedness, love of education, prudent risk-taking, and raw intelligence. The transmission of these crucial qualities, rather than simply silver spoons in children's mouths, explains why success in America is tied so closely to one's parentage. In many other countries, one's economic advancement is determined much more by factors less related to upbringing, such as conformity to social norms and seniority in the workplace. Because of these different priorities, the correlation between a parent's success and his child's is much weaker in these other countries. It is for this reason that they are said to offer more economic mobility.
The fact that parents who provide assistance and impart positive traits to their children can help them prosper in America is, on the whole, not bad news but rather good news. One does not have to be wealthy to learn what it takes to succeed in America. One does, however, need parents who can teach those lessons — and especially parents who can teach by example. And this can be bad news for all too many Americans without that kind of support, especially among the poor. Parents who lack the personal qualities required for success — thrift, honesty, perseverance, a strong work ethic, and so on — often have children who lack them, too.
It is this "stickiness" of habits that contributes to the causes of poverty and low income mobility. This stickiness, rather than income inequality as such, is what should worry us. According to analysts like the American Enterprise Institute's Charles Murray and Harvard's Robert Putnam, households at the bottom of the income scale in America are fast forming a distinct class. And its members and their children are less and less able to rise beyond a low level of wealth and achievement. Of course, the idea of an "underclass" has long been discussed in America and in other countries, often referring to drug addicts, the homeless and mentally ill, street criminals, and others stuck at the very bottom of society. But what Murray, Putnam, and others see is a wider group of people, predominantly working-class Americans, in whose communities the key building blocks of economic advancement — including industriousness, marriage, and civic associations — are crumbling or practically non-existent. They point to a growing chasm dividing American society, with those on one side of it facing much lower relative incomes and a sharp decline in future economic mobility.
It is thus the question of what to do about these deeper cultural trends — rather than how to close the income gap between the rich and poor — that should shape our domestic-policy debates in the years to come. And in order to answer that question, we must first come to understand how people gain the character traits and skills they need to succeed in America today.
THE THREE FORMS OF CAPITAL
A useful way to think about the traits and assets that enable some people to move up the economic ladder while others do not is to view them as forms of "capital." And that "capital," as a general rule, takes three different forms: social, human, and financial.
"Social capital" refers to the social networks surrounding a person, including family and community, that enhance or detract from that person's ability to exploit the opportunities available to him. "Human capital" involves not just natural intellectual ability and the acquisition of skills through education, but also the complex and critically important set of personal traits and behaviors we often refer to as "character." The last, "financial capital," refers to the savings and other economic assets that a person accumulates.
These forms of capital are interdependent. For instance, the probability that someone will save money depends on much more than just his or his parents' income. It is heavily influenced by the culture of his community and by learned character traits, themselves influenced by social capital. The interactions among these kinds of capital are complicated, which is one reason why government programs tend to be ineffective at promoting mobility. Distant, unwieldy government bureaucracies are not capable of identifying precisely which cultural influences need to be changed, or of changing them in ways that address local circumstances and guarantee improved outcomes for the poor. Indeed, as the history of welfare and other income-support projects indicates, expanding government programs may address basic needs — but at the same time also often creates perverse incentives and traits that weaken or crowd out critical social institutions, thereby hindering economic mobility.
Of these three forms of capital, social capital is surely the most important. As Murray and Putnam have shown, the reason many once-stable working-class communities are falling behind is that their institutions and cultures are crumbling. Researchers have learned a great deal about the critical function of social institutions in enabling people to succeed throughout their lives. And the most important such institution in our society, especially at the critical formative stage, is the family.
Moreover, within family types, the preponderance of evidence shows that having two continuously married adults in the home is most helpful to a child's later outcomes. On this point, researchers across the ideological spectrum have been reaching a consensus. Children with continuously married parents do much better in school and achieve higher levels of education — itself a powerful factor in mobility. They are far less likely to fall into poverty, to drop out of school or college, to become teenage parents, or to end up in jail. Two paychecks help on this front, of course, though they are by no means the most important factor. In his review of the relevant research in How Children Succeed: Grit, Curiosity, and the Hidden Power of Character, Paul Tough found remarkable and lasting correlations between early parental nurturing and support and a child's later ability to deal with stress and setbacks and to exhibit the characteristics linked to future success. It is obviously less likely that a child will receive such support when there is only one parent in the home, especially when that parent is working.
The surrounding community and culture beyond the family also play a critical role. Strong, trusted, and positive organizations, such as churches and volunteer groups, are very helpful. A positive community network and culture can reinforce the positive effects of families, and they can emphasize moral expectations and inculcate self-improving behavior. They can also help compensate for a less functional family, instilling in a child the habits essential for success even if his parents do not.
A broken community, meanwhile, can undermine even good family influences. If a child is brought up in a single-parent household in a neighborhood with few institutions of social support, the odds are heavily against his future success, regardless of what income support or other programs are provided by the government. If the neighborhood has few people who work and many who are on welfare, a young person sees little purpose to working and receives little encouragement to work himself. If the culture at a high school encourages immediate gratification rather than studying and working for good grades, or if gangs in a neighborhood are strong while churches and other supportive associations are weak, the research indicates that a young person is very unlikely to do well in life.
As Murray catalogs in Coming Apart, and as Putnam shows in his own work, there has been a startling decline in the investments made in these essential institutions — family and community — among Americans in the bottom quintile of the income distribution. Since the early 1970s, parents in this group have devoted less time and money to children, church attendance, social connectedness, and even volunteering. What's especially alarming is that the situation is likely to get much worse, as generation-to-generation patterns become more pronounced and reinforce these trends. Labor-force participation among less educated males — or "industriousness," as Murray describes it — has been steadily declining. Adults who have obtained only a high-school diploma (or who dropped out) are now more likely to marry people with the same education; in the past, they might well have "married up," thereby increasing their families' chances of upward mobility. In lower-income communities, marriage rates have fallen sharply and divorce rates have increased; the out-of-wedlock birth rate, meanwhile, has risen dramatically.
Why has this been happening over the past 40 years? Murray and others argue that a major factor is culture. Beginning in the 1960s, attitudes changed; industriousness, honesty, marriage, and religiosity were no longer prized as they once had been. The very behaviors that weaken social capital — and thereby diminish economic mobility — were increasingly tolerated, and even came into vogue.
But an enormous amount of the blame rests, ironically, with the very Great Society initiatives intended to help low-income Americans. It is of course true that the War on Poverty's social programs distributed material assistance to millions in need. Creating a strong and consistent safety net was important. At the same time, however, these programs undermined the social capital needed to help lift families out of poverty over the long term. For instance, targeting the programs to the neediest Americans made budgeting sense — but it also meant that benefits were reduced if a recipient improved his condition through employment or marriage. In this way, the programs' design created perverse incentives, actually discouraging people from taking jobs or getting married — thereby accelerating the disintegration (and discouraging the formation) of married households among the poor.
The growth in government programs has also undercut or displaced the array of voluntary institutions serving the needy and the culture that supported them, from church-based social-welfare programs and grassroots outreach to mutual-aid societies. This process occurred in multiple ways. One element was often well-meaning regulation intended to improve quality of services. Such regulations, like licensing and certification requirements, weakened or debilitated some longstanding and remarkably effective local organizations. For instance, the San Antonio-based Victory Fellowship, which over the course of 40 years freed more than 13,500 men and women from drug and alcohol addiction, was nearly closed down in 1992 by the Texas authorities because it employed ex-addicts and a faith-based strategy instead of using state-approved medical personnel and their preferred therapies. And as historian David Beito recounts in From Mutual Aid to the Welfare State, increased state regulation raised costs and eventually undermined the once-rich array of African-American and other fraternal health associations in the South that had operated at low cost, supported by the modest contributions of their members.
Local organizations were eroded, too, simply by the presence of low-cost or free competing government services. For instance, the mutual-aid health organizations could not maintain their neighborhood support when local people could instead turn to free Medicaid available from major hospitals and government-paid doctors. And while Great Society programs and other outside assistance certainly delivered much-needed help, they also often had the unfortunate side effect of weakening the reciprocal relationships and expectations needed for robust social capital. For instance, the elaborate welfare system launched in the 1960s helped weaken marriage by providing financial help to young unwed mothers without passing judgment and by essentially reserving the highest assistance levels for unmarried women who did not work. In these ways, rather than augmenting civil-society institutions, many federal anti-poverty efforts had the effect of dismantling the community support structures and behavioral expectations that could otherwise have helped compensate for the rise of dysfunctional families.
Unfortunately, neither the post-1960s cultural changes nor the harmful effects of the welfare state are likely to be reversed easily or quickly. So what can be done to rebuild social capital? Among those who champion government as the primary tool for addressing our social problems, the preferred solution seems to be more funding and a sharper focus. They say that by extending public assistance more "surgically" — even using government funds to replicate the successes of private charity — government can correct its past mistakes and more efficiently serve people in need.
But having government mimic private charity is never as simple as it sounds. One popular (and privately led) success story is the Harlem Children's Zone, which provides a top-notch education to the children in its care and has created a positive community environment in a once-notorious part of New York City. Zone staff and volunteers achieve these results by working with parents and neighborhood residents to raise expectations and increase community engagement. The Obama administration decided it wanted to copy the organization's model and spread it to other communities; through the Department of Education, it launched the Promise Neighborhoods program to provide funding to schools and non-profits to do similar work. The problem, however, is that there is no simple, universal formula for replicating success when it comes to re-making an entire community. Those transformative efforts that do succeed are developed locally; they emerge from the communities themselves, developed by innovators who know the people and their particular concerns. And they require strong and trusted local leaders who can demand high standards of behavior. Neighborhood turnarounds are not one-size-fits-all; solutions to the breakdown in social capital cannot be pre-fabricated by the federal government, packaged with grants, and parachuted successfully into neighborhoods at will.
To the extent that government can help, it is by linking positive incentives to assistance and by removing obstacles that hinder the formation of social capital. To begin, the federal government and the states can help by encouraging two indispensable practices: marriage and work. Rather than remain neutral toward marriage, as it is today, government should actively promote marriage through advocacy and improved program design.
At the same time, Washington should apply work requirements to more anti-poverty programs, such as those providing public housing and food stamps. An emphasis on reciprocity is in fact a hallmark of successful grassroots assistance programs. Neighborhood leaders understand that requiring something in return for benefits is not a burden but a starting point for self-sufficiency. As Pastor Shirley Holloway of Maryland's House of Help City of Hope puts it, "Compassion without expectation is enabling." So requiring work in exchange for benefits is critical to reviving the idea of reciprocal expectations — an idea that is essential to building the culture of self-improvement, and thus to improving mobility.
It is also important to clear some of the red tape faced by businesses and social entrepreneurs attempting to reverse community breakdown. Lawmakers could, for instance, make it easier to shift more management control (or even ownership) of public housing to tenants, which would boost resident associations as stabilizing institutions. They could also turn depressed neighborhoods into enterprise zones with reduced regulations and property taxes, thereby making it easier for local businesses to emerge from the underground economy and create jobs for area residents.
In addition to strengthening the institutions within communities, governments must also recognize that some families have no choice but to get out of toxic neighborhoods. If a parent decides his child's only shot at success is in a more positive social environment or a better school, he should be empowered to move. Shifting away from a system of housing projects and toward housing vouchers would be a great help on this front. So would state action to make it much easier to establish more lightly regulated charter schools (and to increase school choice more generally).
But the surest way to rebuild social capital over the long term would be to initiate what Murray calls a new Great Awakening — a movement to promote the civic virtues of industriousness, marriage, religiosity, and work. Murray argues that such an awakening should come through the moralizing exhortations of affluent Americans, though it would actually be more likely to succeed if promoted by local people of influence — ministers, teachers, and businesspeople — with reinforcement from the president's bully pulpit and others with high-profile platforms. Without some revival of the civic virtues eroded by the culture of the '60s, it is difficult to see how we can ultimately restore social capital and economic mobility where they are needed most.
CHARACTER AS HUMAN CAPITAL
Social capital complements and helps develop another form of capital required for mobility: a person's natural aptitudes and acquired skills, or human capital. Clearly, raw cognitive ability — the inheritance of genes — is important to success in the modern economy. But the precise degree to which raw intelligence determines a person's economic trajectory is in dispute (as is the degree to which cognitive ability is influenced by family environment and other factors that fall under "social capital"). In fact, research shows that the marker of human capital most useful in explaining whether someone moves up the income ladder is not raw intelligence, but rather the level of education he acquires.
Consider the increased importance that educational credentials have assumed in recent years. A few decades ago, a high-school diploma was the benchmark qualification needed for entry into the middle class. Today, the bare-minimum credential is a college degree. Census Bureau data indicate that the median income for a young college graduate is some 60% more than the median income earned by a person of the same age who has only a high-school diploma. Over the course of their working lives, that gap will widen.
Illustrating how social and human capital interact, in today's America, education runs in the family. Recent U.S. Department of Education statistics show that just 5.9% of high-school sophomores whose parents were high-school dropouts went on to complete a bachelor's degree or higher, while well over half of such sophomores born to parents with a bachelor's degree or higher went on to obtain college degrees themselves. This connection is not the result of more educated parents' being better able to afford education for their children: Financial support for college — from both public and private sources — is widely available, and in fact becomes more generous as one moves down the income scale. Nor can the link be explained by inherited intelligence. Rather, it seems that a child's educational success is determined most by non-cognitive forms of human capital, such as perseverance, self-discipline, and curiosity — what we typically call "character." The research on these traits indicates that they in fact drive the large differences in schooling, marriage, and successful child-rearing observed between the children of parents with college degrees and those of parents without them.
This research helps to show why the conventional approaches to improved schooling in poor neighborhoods — most of them involving vastly increased government spending — are unlikely to succeed. The District of Columbia, for instance, could pour hundreds of millions of dollars into upgrading school infrastructure and raising per-student spending (as it has in recent years). But if the city's schools do nothing to help develop these essential character traits in their students, they are unlikely to see increased achievement. A much better approach is exemplified by the city's charter schools, the most successful of which focus intensely on character education. It is surely no coincidence that, even as the city's school district shutters traditional public schools, the enrollment in charters is soaring — and is on track to surpass that of the traditional public schools within the decade.
Part of why charters have proved so successful is that they are built on the premise that children who can develop beneficial character traits between birth and high school are more likely to transition well into college and the work force. Innovative and effective charter schools like the Knowledge Is Power Program (also known as KIPP) recognize this link, and are in fact working closely with the colleges favored by their students to identify the specific traits that contribute most to completing a degree.
Still, even a young person with high academic potential and strong personal traits may find it difficult to attain a bachelor's degree if college is far too expensive, or if the school's requirements do not match his learning needs and circumstances. A four-year, full-time program with an on-campus residency requirement, for instance, is not an option for a student who must work and live at home to help support his parents. Fortunately, there are radical changes underway in higher education — from the expansion and increasing sophistication of online courses to a fundamental revision of the college business model. These could soon mean sharply lower tuition and more customized higher education (assuming accreditation and other government regulations do not obstruct innovation).
But it is worth stating the one significant feature that these educational innovations — developments that can open up new paths to social mobility — have in common. From free online university courses to inner-city charter schools, these initiatives have emerged from the bottom up. They are the products of civil society and the private economy, not massive federal interventions.
FINANCIAL CAPITAL
The third crucial form of capital associated with economic mobility is, not surprisingly, money. The children of parents whose wealth is above the national average tend to accumulate more wealth themselves and move higher up the economic ladder. Even so, there is evidence to suggest that the key to mobility may not be wealth but rather the habit of saving — a practice that can improve children's economic prospects regardless of their parents' income. According to the Pew Economic Mobility Project, 71% of children born to high-saving but low-income parents move up from the bottom quintile over a generation, compared with only 50% of children from similarly low-income households whose parents do not save.
It is not hard to see why savings are helpful to mobility. For one thing, adequate savings can prevent a setback, such as losing a job or encountering unanticipated bills, from becoming a catastrophe. And a great deal of research shows that, from early childhood on, successfully withstanding setbacks — rather than being paralyzed by them — is associated with building the perseverance needed for long-term success and mobility. In addition, savings allow people to take advantage of opportunities for economic mobility, such as moving to a new neighborhood or buying a car in order to take a better job. Savings also make it easier to invest in acquiring human capital, such as education, or in starting a business — a step also likely to increase economic mobility.
In a review of multiple studies, University of Pittsburgh professor William Elliott has found that forming the habit of saving regularly early in life, even in small amounts, is connected with later success in completing college. Interestingly, the impact of the saving habit is most pronounced for children from low- to moderate-income households.
Still, lower-income households are less inclined to save even modest sums today than they were in the past. The obvious explanation would seem to be a lack of disposable family income, but it turns out that other factors are at play. For example, among households with similarly low incomes, there are wide differences in the rates of saving among some social and ethnic groups. Modest-income Asian-Americans and whites, for instance, are much more likely to enroll in 401(k) plans than are African-Americans or Hispanics with similar incomes. Culture and habit seem to matter greatly. Indeed, savings rates are consistently higher in many other countries.
Moreover, a 2008 study by the Commission on Thrift of the Institute for American Values found that U.S. households with incomes below $12,400 still have enough to "invest" in their future an average of $645 a year, or upwards of 5% of their incomes — but they do it in the form of lottery tickets. The Tax Foundation estimates that investing that amount annually in stocks for 40 years would realize more than $87,000. So even households in the lower quintiles often have the capacity to save at least modestly, but they lack the discipline or desire to do so.
This absence of good financial habits has many probable causes. One is the growing use of credit cards (though this is less of an issue among the poorest households). A more serious factor is the spread of lotteries in recent decades, as well as the growth of other anti-thrift institutions. Foremost among these are payday lenders, who can charge as much as 300% to 400% in interest for short-term cash advances. In just a four-year span — between 2000 and 2004 — the number of payday lenders in America doubled, reaching more than 20,000. Payday lenders now outnumber McDonald's franchises in four of the five most populous states.
Another factor is the increase over time in the payroll-tax rates for Social Security and Medicare. Even if workers' earnings place them below the threshold for paying federal income taxes, they nevertheless see more and more of their paychecks going to what are widely perceived as "savings" programs. But Social Security and Medicare do not create nest eggs for recipients, and the effective Social Security rate of return is low and declining. For some groups with relatively low life expectancies, such as African-American males, the return on Social Security is negative.
Moreover, the act of saving is invisible, in the sense that, unlike going to church or volunteering in an association, people in a community don't know who is saving and who isn't. This invisibility means that there is little or no social inducement to save. Interestingly, some research indicates that merely informing low-income households about what others are saving actually increases each household's savings. Unfortunately, savings clubs have largely disappeared in schools and local associations; we rarely encounter examples like the savings program this author participated in as an elementary-school student in 1950s Britain, where students lined up to have their "surplus" pocket money duly registered and invested by the teacher.
Given these circumstances, how might we change the culture of savings in lower-income households? How might we build financial capital that could complement social and human capital and thereby increase mobility? Like the other forms of capital critical to mobility, much turns on cultural factors that government can influence only at the margins. While policy reforms to end the multiple taxation of savings and to expand and liberalize tax-deferred savings vehicles (like IRAs and 529 education accounts) would encourage savings generally, such incentives would have little impact on those Americans — nearly half of working-age adults — who pay no federal income tax. This has led some policymakers to argue for special tax credits for saving, federal matches for low-income savers, and other inducements. Particularly helpful would be proposals to create true savings accounts within the Social Security system by earmarking some of the payroll tax for that purpose, rather than simply continuing to issue full retirement annuities.
Our improved understanding of behavioral economics, too, should play a role. People face nearly infinite options for what to do with their money; making savings the default, for instance, uses inertia positively. This is why workplace automatic-enrollment savings programs — in which part of an employee's paycheck is put into an investment account unless he declines in writing — have had the effect of boosting savings.
Employing such behavioral economics could even help us redirect the lottery player's gambling instinct to yield a potentially huge increase in savings among low-income households. Lotteries offer the thrill of risk-taking and the appeal of short-term gratification; for people drawn to these games, regular saving — with modest and predictable returns — is boring in comparison. To make responsible saving more exciting, in 1956, the British government sponsored an organization to create a new savings vehicle called "Premium Bonds." The twist was that, rather than paying regular interest, an equivalent amount would be distributed as a range of "prizes" in regular drawings, including televised jackpots. There is no return on invested principal, just the chance to win a prize. The result? Even though the likelihood of winning is low, there are now more than 26 million bondholders — more than half of the United Kingdom's entire adult population — with nearly $70 billion in holdings.
Recently, a similar (if more modest) program was introduced in the United States. In Michigan in 2009, credit unions started a venture whereby part of the return on CD-style savings would be distributed in monthly drawings and in annual "prizes" of up to $100,000. By 2011, more than 16,000 credit-union members had saved more than $37 million under the program. Unfortunately, it is not now possible to spread these savings vehicles more widely: In most states, it is illegal to link prizes to saved money. Lawmakers, it seems, prefer to require people to throw their money away in order to reap any winnings. Here, a simple fix at the state level — legalizing savings programs like the Michigan credit unions' — could help improve mobility for a vast number of low-income American households.
But if a true culture of saving is to be revived, the change will most likely come from the institutions of civil society. These organizations, especially those with a local focus, can help produce some of the peer influence once generated by the old savings clubs. For example, in many Asian-immigrant communities, revolving loan funds allow for pooled savings and serve as a source of small-business capital. Several non-profits and community organizations — like the San Francisco-based group EARN — have been quite successful in piloting approaches that emphasize financial education and easier and regular savings strategies. Churches in the African-American community have also become involved, in many ways reviving the religious social-welfare and financial institutions that used to be the hallmark of that community. One leader in this effort is the Reverend DeForest "Buster" Soaries, Jr. — senior pastor of the 7,000 member First Baptist Church of Lincoln Gardens in Somerset, New Jersey — who has launched a campaign to get church members out of debt by making them regular savers. In so doing, he has provided yet one more example of how the best solutions to our economic-mobility problems will come not from government, but from the actions of concerned citizens.
THE WAY FORWARD
The research on economic mobility underscores the importance of culture in providing the essential infrastructure for economic growth. The problem in many communities in the United States — and particularly in what were, until quite recently, modest-income working-class neighborhoods — is that this infrastructure has been rapidly eroding. And that deterioration has been caused, in no small part, by the corrosive effects of government programs designed to help the poor achieve the American Dream.
The solutions to our problems of mobility are therefore not to be found in more government. Income redistribution and new federal programs designed to replace dwindling social capital with greater intervention by the state are not the answers. At best, they will only paper over deeper problems by spending money the country doesn't have. At worst — and more likely — they will accelerate the social disintegration begun by the previous generation of welfare programs, introducing new disincentives for self-improvement.
As Niall Ferguson has remarked (reflecting on Tocqueville), "The notion that you could achieve greater social cohesion by increasing the power of the state at the expense of civil society [is] a great illusion." The answer to our concerns about inequality and mobility is to foster a broad commitment to strengthening the institutions of civil society, particularly the family. It requires local and national leaders to call for a reaffirmation of the virtues of industriousness, honesty, marriage, and religiosity in the communities from which they have been disappearing. The best, and indeed the only fruitful, way for government to participate in this effort is to remove the obstacles and perverse incentives of its own making — and to foster an environment in which our charitable and social institutions are free to form citizens of the high character a great nation demands.
