Brookings: Experts - R. Kent Weaver

Policy Leadership and the Blame Trap: Seven Strategies for Avoiding Policy Stalemate

R. Kent Weaver — Fri, 29 Mar 2013 00:00:00 -0400

Editor’s Note: This paper is part of the Governance Studies Management and Leadership Initiative.

Negative messages about political opponents increasingly dominate not just election campaigns in the United States, but the policymaking process as well. And politics dominated by negative messaging (also known as blame-generating) tends to result in policy stalemate. Negative messaging is attractive to politicians because people tend to pay more attention to negative information than positive information, and they are more sensitive to losses than equivalent gains. Political polarization, competitive, nationalized elections, increased fiscal stress and changes in campaign law and practice have all exacerbated pressures to engage in negative messaging in recent years. There are a number of strategies that allow politicians to maneuver around the “blame trap” and avoid policy deadlock in some circumstances, including passing the buck to non-elected bodies and putting in place triggering mechanisms that generate politically unpopular policy changes in the future. All of these strategies have limitations and disadvantages, however, so both blame-generating politics and policy stalemate are likely to be the “new normal” in American politics in the near future.

There are several strategic options for avoiding policy stalemate in a political environment dominated by negative messaging. Each of these options has distinctive advantages and limitations, and risks. None is suitable for all situations, but together they offer some important opportunities to avoid policy stalemate.

Passing the Buck: A first strategy that politicians can use to try to avoid the blame trap is to pass the buck to non-elected bodies—often temporary commissions—to reach deals behind closed doors without the pressure of staking out and defending partisan and ideological positions.
Grand Deals and Circling the Wagons: A related strategy to passing the buck is for Democratic and Republican leaders to negotiate behind closed doors to try to strike a grand deal on an issue like budgets and taxes or immigration, which they then sell jointly to the public and to rank-and-file legislators (“circling the wagons”) as the best deal that is achievable—and better than no deal at all.
Government by Autopilot: Another strategy for making difficult decisions is to set up a procedure under which reaching some trigger (e.g., deficit levels, or Social Security deficits) leads automatically to programmatic adjustments according to a formula set up in the original legislation unless Congress agrees to overturn it.
Feet to the Fire: This strategy starts with the same mechanism as policy by auto-pilot: policymakers set up an automatic mechanism that will trigger politically painful policy changes without politicians themselves pulling the trigger.
Experiment: On some policy issues where parties are divided, it may be possible to try out different approaches to policy before making a firm choice at the national level. This can be done in several different ways. One is to give more authority to states and localities to experiment with new policy options rather than having a uniform national policy.
Executive Action: If a hyper-partisan and divided Congress is unable to break policy stalemates, what about executive action as an alternative? There certainly are some opportunities for breaking stalemate through executive action, as President Obama showed in June 2012 when he suspended deportation of young illegal immigrants who had entered the country illegally.
Compromise: A final strategy for overcoming the blame trap is the oldest and simplest one: politicians can split the difference with their partisan foes and meet them halfway.

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But Will It Work?: Implementation Analysis to Improve Government Performance

R. Kent Weaver — Fri, 26 Feb 2010 11:53:00 -0500

Executive Summary

Problems that arise in the implementation process make it less likely that policy objectives will be achieved in many government programs. Implementation problems may also damage the morale and external reputations of the agencies in charge of implementation. Although many implementation problems occur repeatedly across programs and can be predicted in advance, legislators often pay little attention to them when programs are being enacted or overhauled.

This Issue Brief argues that the United States should adopt a program of Implementation Analysis for major legislative proposals in Congress. Implementation Analysis would be administered by the Government Accountability Office, and would draw on the Congressional Budget Office’s experience with budget scoring of legislative proposals. The Brief outlines major elements of an Implementation Analysis and argues that it could lead to major improvements in policy performance. Although Implementation Analysis would encounter both political and administrative obstacles, these obstacles are manageable. Implementation is critical to policy success in policy sectors ranging from homeland security to health care to welfare reform to climate change policy. The literature on policy implementation identifies a number of potential problems that may arise in the implementation process. Failure to anticipate implementation problems when a policy reform is being enacted may lead to failure to achieve programmatic objectives, excessive costs, and perhaps even a political backlash against the implementing organizations and policies.

Despite the high stakes in policy implementation, potential implementation problems in policy initiatives rarely receive sustained, systematic, detailed and visible attention before a decision is made on those initiatives. In part, this is because there is no simple and generally accepted methodology for performing such an analysis that falls within the skill set of a single profession and that can be reduced to a single indicator which policymakers can use (or misuse) easily. In part, as will be discussed below, it is because politicians supporting a program have few incentives to point out potential implementation problems during the legislative process. To address these problems, this issue brief lays out a set of common policy implementation problems that can be observed in a wide range of policy sectors, as well as a framework for organizing a systematic Implementation Analysis (IA) and a set of potential strategic responses to potential implementation problems identified by that analysis.

The most important advantage of employing a systematic framework for Implementation Analysis is the same as the advantage that Eugene Bardach argued in his classic discussion of a structured approach to policy analysis: “it reminds you of important tasks and choices that otherwise might slip your mind.” Even though Implementation Analysis does not provide a complete “cookie cutter” methodology for all types of proposals or a single quantitative indicator of a proposal’s feasibility, having a checklist of standards and concerns that can be applied when a policy proposal is being considered can highlight potential trouble-spots early in the policymaking process and improve government performance once an initiative has been enacted. Thus it can provide information that is useful not only in deciding whether to implement an initiative but also how to do so.

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Target Compliance: The Final Frontier of Policy Implementation

R. Kent Weaver — Wed, 30 Sep 2009 12:00:00 -0400

Abstract

Surprisingly little theoretical attention has been devoted to the final step of the public policy implementation chain: understanding why the targets of public policies do or do not “comply” — that is, behave in ways that are consistent with the objectives of the policy. This paper focuses on why program “targets” frequently fail to act in the way that program designers intended and wanted, even when it appears to be in their self-interest to do so. This is a question that can be asked for a broad array of government policies. The paper begins by briefly defining target compliance and the main approaches that governments may use to secure compliance. It then discusses the dominant theoretical approaches to understanding target compliance, and develops a general categorization of reasons for compliance or non-compliance and strategies that are generally used to cope with each of these causes. Finally, the author suggests some lessons about what program designers and implementers should do to address problems of policy non-compliance.

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Bridging the Social Security Divide: Lessons From Abroad

R. Kent Weaver — Thu, 19 Jun 2008 16:13:05 -0400

Executive Summary

Efforts by President George W. Bush to promote major reforms in the Social Security retirement program have not led to policy change, but rather to increased polarization between the two parties. And the longer we wait to address Social Security’s long-term funding problem, the bigger and more painful the changes will need to be.

But despite the current political stalemate, Social Security is a solvable problem. To be financially and politically stable, a future Social Security system will likely need several components, including a version of the current Social Security-defined benefit that becomes somewhat less generous over time; and a new universal, mandatory retirement savings component in low-cost individual accounts that is financed by Social Security payroll tax increases; and a reasonable minimum benefit for those with low lifetime earnings. Diversification of trust fund investments and new legislative mechanisms to facilitate early action as trust fund problems emerge would also be useful components of a Social Security reform package. Lessons from other countries point to common-sense ways to address these issues.

A new approach to Social Security reform also requires a different process of policy formulation and adoption. As a first step, the president and congressional leaders should agree on an overall mandate for a commission named through a bipartisan nominating process designed to generate a group that is likely to focus on practical, consensus-building solutions. Special procedures in each house of Congress would provide expedited consideration of the commission’s reform package and alternatives, while providing incentives for constructive congressional engagement in the reform process.

Policy Brief #166

Over the past three decades, population aging has led to profound changes in the public pension systems of most advanced industrial countries. Many countries have experienced multiple rounds of reform. The United States is an outlier: our main public pension program, Social Security, has remained virtually unchanged for a quarter century.

The last seven years have been particularly unproductive for Social Security reform. In 2001, President George W. Bush established a Social Security reform commission with a mandate to propose partial individual account opt-outs for Social Security. The commission’s final report, issued in the run-up to the 2002 midterm election, identified several alternatives but made no clear recommendation. It was roundly ignored by Congress. After his 2004 re-election, President Bush tried to put Social Security reform back on the agenda and failed to generate any enthusiasm among either politicians or the citizenry.

When Social Security has made it to the U.S. agenda, the outcome has been a hardening of positions and rhetoric rather a willingness to compromise. That is a pity for several reasons. First, with a long term shortfall in contributions relative to expected benefits of about 2 percent of payroll, Social Security is a solvable problem. Second, the longer we wait to address Social Security’s long-term funding problem, the bigger and more painful the changes will need to be. As the Pensions Commission in the United Kingdom recently pointed out, an aging population means that society’s only long-term options are later retirement, lower retiree benefits, devoting more tax resources to retirement income security, or increased savings. Third, delaying a Social Security fix diverts attention from health care financing, which is a much more difficult issue politically and economically.

The public pension reform experiences of other wealthy countries provide the United States with a panoply of potential reform options. The major problem in reforming Social Security is a political one. Finding a long-term solution to Social Security’s funding woes—indeed, having any outcome other than stalemate—requires liberals and conservatives to both put aside positions that are most unacceptable to those on the other side of the ideological divide and to accept some proposals from the other side with which they may strongly disagree.

What sorts of positions need to be put aside? Conservatives must drop efforts to “carve out” some portion of current Social Security payroll taxes to finance individual accounts, which liberals believe will undermine the current Social Security system as the core of U.S. retirement income policy. Liberals must recognize that conservatives will accept neither putting any more payroll tax resources into the current Social Security program nor injecting significant general revenues into the current Social Security program, except perhaps for very narrow, carefully delimited purposes.

As difficult as this is, it is the easy part: liberals and conservatives must also agree on a common overall vision for the future of the retirement income system in the United States including some provisions, backed by their opponents, that they strongly oppose. What might that vision look like? To be financially and politically stable over the long term, a future Social Security system will likely need to have several components, including a version of the current Social Security-defined benefit that becomes somewhat less generous over time; a new universal, mandatory retirement savings component in low-cost individual accounts; and an improved minimum benefit for those with low lifetime earnings. Future arguments should concern the relative size of those components rather than whether they should exist at all.

Two major substantive trade-offs are almost certain to be required in a comprehensive Social Security reform package. Conservatives will have to accept increased payroll taxes. They must further accept that the current Social Security-defined benefit will remain the biggest component of the retirement income system. In exchange, liberals will have to accept that all of those additional payroll taxes will go into a new system of low-cost individual accounts. Liberals will also have to accept cuts over time in Social Security’s guaranteed benefit. No agreement is likely to be reached unless both sides set as an objective that combined Social Security-defined benefit and mandatory savings will in the future replace something close to the same percentage of a retiree’s former earnings as the current Social Security system alone does now, and that it not lead to an increase in senior poverty among the most vulnerable groups of seniors.

In addition to a set of reform proposals that can address both fiscal and income security concerns, adapting Social Security for the new century requires: (1) a reform process that encourages compromise and protects politicians from their own predilection to cast blame rather than solve problems, and (2) a willingness on the part of politicians to compromise. The experience of other wealthy countries with aging populations suggests that a workable reform process can be created if politicians are willing to sacrifice some policy control over policy formulation, but it is unrealistic (and undesirable) to expect that they give up complete control. Once again, pragmatic compromise is needed.

Elements of a Reform Package

If the two sides of the ideological and partisan divide on Social Security are willing to work toward an agreement, rather than just bash each other for fun and political profit, a balanced reform package could be built from some or all of the following components:

Payroll Tax Increases and Individual Accounts: A key component of a reform package is likely to be an increase in the Social Security payroll tax of between 2 and 2.5 percent of earnings (split between employers and employees). All of the new contributions would go into individual accounts that would be mandatory for all workers, but no existing payroll taxes would be diverted to individual accounts. Workers would choose from a modest range of index fund options managed by private sector fund managers. Those managers would be selected in a competitive bidding process, as with the Thrift Savings Plan for federal workers. The Social Security Administration would manage the collection and flow of money from individual accounts into those funds and switches among fund managers in order to further lower administrative costs. At retirement, individuals could choose between annuitizing the funds in their individual accounts to guarantee a steady income stream or drawing the funds down by a set schedule. Lump-sum withdrawals would not be permitted.

Gradual Reductions in Defined Benefits: The initial Social Security-defined benefit would be reduced for future cohorts of retirees over time as the new individual accounts are phased in. Replacement rates will be set so that the combined “old” Social Security benefits and new mandatory savings accounts will roughly equal current benefits, given moderate estimates on rate of return for the mandatory savings component. Given the progressive nature of the current Social Security benefit formula, some changes in the Social Security benefit formula or injection of general revenues to finance benefits of low earners would be required. Workers would also need to receive better information about how working longer can lead to higher benefits, and about the increased risk posed by having their Social Security benefits depend partially upon the performance of individual investment accounts.

Alarm Bells and Fail Safes: Another potentially useful element of a Social Security reform package would be an "alarm bell" mechanism to focus attention and debate on future Social Security trust fund imbalances if they arise. One option would be a special procedure triggered by a finding of the Social Security actuaries in the trustee’s annual report that the Social Security trust fund was likely to be exhausted within thirty years.

When this alarm bell is triggered, the president would be required to make a report to Congress within a specified amount of time proposing specific legislative steps to address that shortfall. Each house of Congress would then be given a window of time to consider the president’s recommendations under special rules limiting debate and prohibiting amendments. This procedural vote would require a special majority of 60 percent of members voting in each chamber. Final approval of the president’s plan would require a normal majority vote in each chamber. The procedural vote hurdle would hopefully encourage the president to submit a plan that could win broad support.

Stronger “fail-safe” mechanisms—for example, automatically putting in place a combination of automatic tax increases and benefit cuts in specified proportions if the alarm bell is triggered and the president’s reform package fails to win approval—could also be employed. Sweden, Canada and Germany all have enacted various forms of fail-safe mechanisms that vary in their balance between benefit reductions and payroll tax increases. Sweden’s automatic balancing mechanism, which operates entirely on the benefit side, fully adjusts for adverse trends in demography and economic growth. But congressional and interest group resistance to adopting such a stringent fail safe would undoubtedly be very high, making it unlikely to win adoption.

Improvement of Minimum Benefits: Despite major progress over the past 40 years, the U.S. has one of the highest rates of relative senior poverty among the advanced industrial countries. Poverty is especially serious among elderly widows. Many privatization proposals could make this very vulnerable group even worse off.

To address this problem, Congress should include in a Social Security reform package a more generous minimum benefit for retirees who have worked (or whose spouse has worked) long careers at low wages in the United States. This benefit should be paid for out of general revenues. The current safety net income program for the elderly, Supplemental Security Income, serves very few people because its benefit levels are low and its assets tests are extraordinarily stringent.

International experience suggests that it is almost impossible to eliminate poverty among the aged without increased reliance on some form of means-tested program. In Canada, close to 40 percent of seniors receive the Guaranteed Income Supplement, which has moderate income tests, no assets tests, and streamlined re-application procedures designed to reduce stigma and increase take-up among those who are eligible. Using this approach, Canada has virtually eliminated senior poverty at a modest cost. Both Sweden and Germany included improved safety net pensions in their recent pension reform packages. To reduce costs, this new minimum benefit should not confer automatic eligibility for Medicaid, which would raise program costs substantially, but SSI-qualified seniors receiving the new benefit could still get Medicaid.

Help for Families with Young Children: Another potential component of a reform package, pioneered in many European countries, is a requirement that government make contributions to Social Security and mandatory savings accounts on behalf of a custodial parent of very young children who is out of the labor force or has only minimal labor force participation during his or her children's first years of life. These contributions would be paid at (or topped up to) a flat rate, perhaps 60 percent of average earnings, and paid for out of general revenues. This benefit would disproportionately aid women, who are still much more likely than men to spend prolonged periods either outside the paid labor force or in part-time paid work because they bear a disproportionate share of the burden as caregivers to children and elderly parents. Making modest contributions on behalf of caregivers—at least for very young children—would recognize the social value of their work and help even out the balance of incentives in current government policies, which social conservatives have argued currently favor mothers going into the labor force rather than staying home with their children.

Diversification of Trust Fund Investments: Currently, Social Security trust fund surpluses are invested only in U.S. Treasury securities. Canada, New Zealand, Norway and Sweden all invest part of the public pension funds in equity, corporate bonds and other assets through independent entities in order to gain higher returns. These funds are clearly charged with maximizing fund assets for retirees rather than social investment criteria. The U.S. should consider doing the same thing. As in other countries, these funds should have a strict legislative mandate to maximize return for retirees. The U.S. could use multiple funds of limited size with heavy reliance on private fund managers, to prevent any disruption of capital markets. This approach not only would increase returns on Social Security contributions, it would ease the cash flow transition expected to occur in 2017 as Social Security shifts from serving as a source of financing for the federal government to being a drain on government revenues.

A Process and Timetable for Reform

Social Security reform can only succeed if it is built on a process that involves both Democrats and Republicans, and both the president and Congressional leaders. Equally important, both sides must be constrained from pinning the blame on the other for painful elements of a reform package. Given the political sensitivity of benefit cuts, retirement age increases, payroll tax increases, partial privatization and other reform proposals, an ever-present fear of blame-generating attacks from the other party gives politicians an incentive to criticize proposals from the other party without offering their own alternatives (as Democrats did in 2005), as well as incentives to play to your political bases by being intransigent in policy positions. These political risks make the prospects for stalemate very high.

Several countries with pension funding problems much more severe than the U.S. have found ways to insulate their pension reform process from such pressures leading to stalemate, although the steps taken have understandably reflected individual national political environments. In Sweden, a multi-party negotiating group appointed by a conservative coalition government in the early 1990s succeeded in large part because it was made up of politicians who were committed to reform and to working together and who resisted taking intransigent policy stands. Representatives of two small parties who rejected reform dropped off the working group. The parties remaining on the working group were committed to finding a solution that compromised on key issues, such as the inclusion of individual accounts, and defended their proposal against opposition from interest groups. In the U.K., a recent independent commission built public awareness of the need for pension reform in preliminary reports before issuing its final reform recommendations.

These national experiences suggest several lessons for design of a reform process in the U.S.. First, a partisan process, or a process that appears to give an advantage to one party, must be avoided. Second, a direct interest group role should be avoided. Finally, the government should take time to inform the public rather than try to push a reform package through quickly.

In the round of reform that culminated in the 1983 Social Security reform package, the president and congressional leaders shared responsibility for appointing members of a bipartisan commission. Enactment of that package was aided by two factors. First, doing nothing was not an option: unless a package was passed within a few months, there would not be enough money to pay promised benefits. Second, one of the most difficult changes, an increase in the standard retirement age added by Congress to the commission’s original package, did not need to go into effect immediately; it was delayed almost two decades into the future. Neither of the conditions that facilitated passage of the 1983 reform package exist today: there is no immediate funding crisis to force immediate action, and making a major dent in the long-term Social Security deficit will require phasing in changes sooner rather than later.

Given the absence of an immediate action-forcing mechanism and the need to phase in some painful changes in Social Security fairly quickly, what sort of reform process might work in the United States? One possibility is the procedure used to close military bases and ratify presidentially-negotiated trade agreements: Congress is presented with a package on which it must vote either up or down (with no option to add amendments) by a specified deadline. These procedures prevent bold reform packages from suffering “the death of a thousand cuts.” However, it is unlikely that Congress would limit its authority so severely on an issue that is as politically contentious and has such high political stakes as Social Security.

In the absence of up-or-down fast track authority, what sort of process has the best prospects for facilitating agreement leading to bold and relatively rapid policy change? One possibility is to have a four-step process of policy formulation and adoption that is partially insulated from political pressures, but gives politicians incentives to engage constructively in Social Security reform.

As a first stage, the president and congressional leaders of both parties should agree on a very general overall mandate for a reform commission. Unlike the 2001 president’s commission, the mandate for the new commission should not require members to sign on to endorse a particular substantive direction for reform. On the contrary, they should commit themselves to consider all reasonable alternatives. Second, members of the commission should not be named directly by politicians, but rather by a seven-person nominating body with two appointments by the president, one each by the House speaker, the Senate majority leader and the House and Senate minority leaders, and a chair jointly agreed to by the president and House Speaker and minority leader. The nominating body should be instructed to choose a seven-member commission that includes members with a combination of substantive Social Security expertise and general political and economic expertise. The slate of seven commission members, including the chair, would require the approval of six of seven members of the nominating body. This process should generate a body that is likely to focus on practical, consensus-building solutions.

Third, the commission would be charged with writing two reports. The first, to be published within eight months, would lay out the seriousness of the Social Security financing problem for the public and discuss the major options for change with their social and financial implications. After this report, the commissioners would hold a series of public hearings and publish a second report containing a specific legislative proposal within six months. After conversion to specific legislative language, that proposal would proceed to the fourth stage: debate followed by votes under special procedures in both the House Ways and Means and Senate Finance committees and on the floor of the House and Senate. In these committees, an initial vote would pit the commission’s proposal against an alternative posed by the committee’s ranking minority member, followed by the winner of that vote against an alternative proposed by the committee chair. The bill approved by the committee (if it approved one of the alternatives) would then go to the chamber floor, where after debate the ranking minority member and the committee chair would once again have sequential opportunities to pose alternatives, followed by an up-or-down vote on the winner of that competition. If bills passed by the two chambers differed, the normal conference committee process would be used to try to reconcile them. If a reform package was passed by Congress and signed by the president, it would become law. If no package won enactment, the commission could try again with another proposal within six months that would follow the same congressional ratification process, after which point it would go out of existence. Even if this process failed, it would force congressional leaders to come to grips with Social Security, generating both concrete reform proposals and a momentum for reform.

Willingness to Compromise

None of the specific reform proposals outlined above, individually or collectively, is a panacea for Social Security’s problems. Nor is the proposed reform process. But if politicians truly want to solve Social Security’s funding problems rather than score political points and pander to their political base, it should be possible to assemble and enact a balanced reform package that has elements appealing to both sides of the ideological divide, using reform processes that encourage consensus and minimize blame-generating.

Seeking a middle-of-the-road solution for Social Security is not easy. Texas politician Jim Hightower once wrote a book titled There’s Nothing in the Middle of the Road but Yellow Stripes and Dead Armadillos. That has certainly has been true of the recent debates on Social Security. If it remains true, it will be to the detriment of future generations of workers and retirees, and to the shame of today’s politicians. Social Security is a solvable problem, but only if policymakers exhibit both political courage and willingness to compromise.

R. Kent Weaver is a Senior Fellow in Governance Studies at the Brookings Institution and a Professor of Public Policy and Government at Georgetown University. He is the author of the forthcoming book Reforming Social Security: Lessons from Abroad.

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Social Security Smorgasbord? Lessons from Sweden's Individual Pension Accounts

R. Kent Weaver — Wed, 01 Jun 2005 00:00:00 -0400

President Bush has proposed adding optional personal accounts as one of the central elements of a major Social Security reform proposal. Although many details remain to be worked out, the proposal would allow individuals who choose to do so to divert part of the money they currently pay in Social Security taxes into individual investment accounts. Individuals would have a choice of fund managers, and the return that they earn from those accounts would then partially determine the Social Security benefit they receive when they retire.

Individual accounts pose a number of important and complex design and implementation issues, including how to lower the cost of administering accounts so that they do not erode the value of pensions that individuals receive when they retire, how many and what kinds of fund choices should be offered, and how to engage workers in choosing funds.

In the late 1990s, Sweden added a mandatory individual accounts tier to its public pension system. This policy brief examines the Swedish experience and lessons it suggests for the United States about the design and implementation challenges of individual accounts.

POLICY BRIEF #140

Sweden's New Pension System

Sweden has one of the oldest and most comprehensive public pension systems in the world. But by the 1980s, several problems with the system were becoming evident, including current funding deficits and a very large projected funding shortfall as Sweden's population, which is among the oldest in the world, continued to age.

Between 1991 and 1998, Sweden adopted a new pension system built on three fundamental elements. A new "income pension" is intended to tie pension benefits more closely to contributions made over the entire course of an individual's working life, while lowering the overall cost of the system; it is financed entirely by a 16 percent payroll tax. A "guarantee pension" provides minimum income support for workers with low lifetime earnings. It is financed entirely by general government revenues and is income-tested against other public pension income.

The third element is a "premium pension" financed by a 2.5 percent payroll tax. These funds are placed in an individual investment account. Individuals have a wide variety of fund choices. To lower administrative costs, and the administrative burden on employers, collection of premium pension contributions and fund choices are centrally administered by a new government agency, the Premium Pension Authority (Premiepensionsmyndigheten, or PPM). Deposits into pension funds are made only once a year, after complete wage records for a calendar year are available from the state tax authorities. Employees choose up to five funds from a list of funds approved by the PPM. Swedes can change their fund allocations as often as they want without charge, but the system is not designed to facilitate "day trading"—switching funds often takes several days.

The new pension system's planners recognized that many workers might not make an active pension fund choice. They created a Seventh Swedish National Pension Fund to offer a default fund, called the Premium Savings Fund, for those who do not choose a fund or simply prefer to have the government invest for them. Because Sweden's non-social democratic parties wanted to limit the role of the state in the Premium Pension system, special rules were imposed on the default fund:

Individuals cannot actively opt for the default fund—they can only get in by making no active fund choice;
The default fund cannot be marketed to potential "customers";
Individuals who opt out of the default fund are prohibiting from opting back into the fund;
The fund does not exercise its role as a shareholder when companies bring issues such as re-electing the board of directors to a vote.

System Administration and Costs

The PPM is administered by just 200 employees. Costs are also kept down through automation, bulk trading of fund switches, and once-a-year transfer of funds into accounts.

In 2004, premium pension account holders paid 0.27 percent—which was automatically deducted from their accounts—to cover the costs of PPM administration, and PPM's goal is to reduce that fee to 0.1 percent within fifteen years. Account holders also pay an annual fee to fund managers, although fund management companies must agree to pay a rebate to PPM of their usual fees. In 2002, individual fund managers charged an average of 0.44 percent in 2002, but charges should fall as the system matures.

Sweden deliberately chose a policy that would allow a broad array of fund choices. In the first round of fund choice in the fall of 2000, individuals had to choose from a staggering array of 465 funds. By 2004, there were 664 funds. Choices include a broad array of Swedish equity funds, regional and global equity funds, country equity funds (e.g., Japan, U.K.), funds focused on specific sectors such as technology and communications and pharmaceuticals, "mixed" funds that combine equities and interest-bearing securities, "generation" funds that offer differing mixes of equities and interest-bearing securities depending on years to retirement, and funds concentrated in interest-bearing securities. Within these categories, funds offer a variety of special features, such as active versus index-based management, ethical investment criteria, and more or less aggressive growth strategies.

Given the staggering array of potential choices facing contributors, Sweden's Premium Pension Authority tries to make at least minimal information available about fund choices available to potential contributors. In each round, it has published and sent new entrants to the system a very detailed booklet on how to go about making fund choices, as well as a fund catalogue listing all funds (broken down into categories and subcategories), a brief description of each fund, its total capital, fund management charges, returns for each of the last five years as well as a total five-year return (where applicable), and a measure of fund risk.

Choice and Non-Choice

In the initial round of fund choice in 2000, about two-thirds of those eligible to choose funds did so. This fairly high level of participation can be attributed in part to the fact that the amounts of money were relatively large, since four years of accrued contributions (for 1995-1998) were to be placed. Moreover, a substantial media campaign was mounted not only by the PPM, but also by many fund companies, calculating that once individuals had made their choices, they were likely to stick with them.

A recent study by Stefan Engström of the Stockholm School of Economics and Anna Westerberg of the National Social Insurance Board shows that those who had prior experience in financial markets and were married were substantially more likely to make an active choice in the initial 2000 round. Advanced education, higher income, and female gender also made individuals more likely to make an active choice, although less so than the first set of factors. Proximity to retirement (age 58-62) and having been born in a non- Nordic country substantially decreased the odds of active choice—the latter likely related to the fact that many PPM materials were available only in Swedish.

Fund choice fell dramatically in the five following rounds held for recent labor market entrants: fewer than 10 percent of those eligible in each of the last three rounds (2003-2005) chose a fund. There were several reasons for the drop-off in choice. Participants in later rounds were mostly younger workers who had a very long time until retirement and low earnings, all of which limited the perceived importance of fund choice. New entrants after the first round also faced a growing array of fund choices.

These factors alone or together are implausible as sufficient explanations of the dramatic drop-off in active choice, however, since most young workers made an active choice in the initial 2000 round, and the number of fund options was already large in that year.

Several other factors almost certainly had a greater impact on the drop-off in active choice. One was the absence of a "contagion effect" that was present in the initial round of fund choice, which involved the vast majority of adults in Swedish society under the age of 65, and was widely discussed among families and friends. In addition, while the PPM mounted substantial outreach campaigns in the initial rounds and tried to increase Internet accessibility for making choices, the fund companies, recognizing both the small sums at stake and the very broad field of funds available, did not mount substantial campaigns in later rounds. The media also paid much less attention to pension fund choice in the rounds held after 2000.

The widespread publicity given to the negative returns experienced by most Premium Pension savers—especially those in many of the most popular fund choices—may have diluted enthusiasm for making an active choice. The first round of PPM choice took place near the peak of the run-up in global equities markets. Later rounds have occurred against a backdrop of losses by most PPM account holders.

A final factor that may have contributed to the decline in active choice is the availability of the Premium Savings Fund as a default. It was widely perceived, at least initially, to be a safe as well as low-cost alternative to privately managed funds. Moreover, the default fund has outperformed the weighted average of activelyplaced funds in recent years, which may further have increased the attraction of non-choice.

Patterns of Choice and Risk

Given the poor performance of equity funds in the initial two years of the Swedish individual account system, it should not be surprising that there was a shift away from equity among active choosers in the 2003 round. However, this trend among active users has been overwhelmed in its effects by the shift away from active choice toward passive investment in the equities-heavy default fund, which essentially functions as a global equities fund.

A small minority of active choosers do appear to be over-concentrated in highrisk funds with high recent returns, despite the high risk generally associated with such investments. For example, the most commonly chosen fund overall in the initial round was the high-tech Roburs Aktiefond Contura, which had a 534.2 percent return over the past five years (after fund charges), according to the PPM's 2000 catalogue. But the Roburs Contura fund lost 32 percent of its value in 2001. In the 2004 round, the two most frequently chosen funds were Russian equity funds, reflecting very high returns reported for those funds reported in PPM's fund catalogue.

One potential risk that does not seem to have materialized, however, is excessive trading by account holders attempting to make gains through market timing or who panic in response to short-term market fluctuations. Fewer than 6 percent of all premium pension savers made even a single fund switch in 2004. Moreover, only a little over 600 account holders out of more than 5.3 million were very frequent traders (more than twenty fund switches during the year), while two-thirds of those who switched funds did so only once.

The Default Fund

The Premium Savings Fund has said that "People who do not have a fund manager, for whatever reason, should receive the same pension as others—that is our goal." But what does this goal mean in practice? Should a default fund minimize risk, seek growth, or simply keep administrative costs low?

The Seventh AP Fund clearly has placed a high priority on keeping fund management charges low. In 2004, its charges after rebates to the Premium Pension Authority were 0.15 percent of invested funds, compared to an average of 0.60 percent for equity funds in the premium pension system. Administrative costs remain low—the fund has only thirteen employees and contracts out most fund management functions to Swedish and foreign fund management companies, and there is a heavy reliance on index funds.

The experience of the Seventh AP Fund also shows, however, that there is likely to be tension in any default fund between the objective of fund security and high returns. Achieving high returns over the long term requires heavy weighting toward higher-yielding equity investments. The Seventh AP Fund has strongly stressed the objective of higher long-term returns, with a current target portfolio of 10 percent in inflation-indexed securities, 17 percent in Swedish equities, 65 percent in foreign equities, 4 percent in private in equity funds, and 4 percent in hedge funds. In the short term, this strategy has led to high volatility in account values and losses for those who entered in early rounds.

The Swedish experience with the premium pension also suggests that a default fund may become involved in debates over domestic, ethical, and environmental investment practices. Indeed, the Seventh AP Fund took an even more aggressive stand on these issues than the other state pension funds, in part because it is not allowed to vote its shares. It instead decided to disinvest in companies that had been found guilty by impartial tribunals of violating international conventions to which Sweden had adhered, including conventions on human rights, labor, the environment, bribery, and corruption. In 2004, thirty-eight companies were on the investment exclusion list for all or part of the year.

Lessons for the United States

If U.S. policymakers move ahead with President Bush's proposal to establish an individual account system, the Swedish experience offers several lessons on implementation and design.

Centralized Administration

The Swedish model of centralized administration minimizes the additional paperwork burden for employers, facilitates broad fund choice, and allows the government to negotiate reduced management fees by fund providers. But a centralized administration system is not without problems. Individual pension account holders have a long wait before their accounts are credited for contributions. And Sweden's decision to pass on the start-up costs of the centralized

Should the U.S. government create a new agency to administer individual accounts? Given the relatively limited level of fundchanging activity in Sweden, as well as the need for close integration of account management and reporting functions with the roles performed by the Social Security Administration (SSA) in the United States, it might make more sense to keep management of individual accounts within SSA. But this approach could lead to pressure on local SSA offices to deliver services that they are not set up to deliver (e.g., helping people make fund changes at a time of financial panic) as well as services that it would be inappropriate for them to provide at all (e.g., advice on choice of individual funds).

If account management were retained within SSA, the U.S. government would have to convey to the public a clear message that fund-switching services were only available through other mechanisms and that no advice on choice of individual funds could be provided by SSA. This would require a major—and ongoing—campaign of public information. But some misunderstanding is almost inevitable, and it could be damaging to the agency's image and morale.

Swedish experience also suggests that it takes a long lead time to get a new central administrative organization up and running. The information technology requirements for such a system are especially daunting. Indeed, Sweden's scheme had to be delayed in order to make sure that the technology would work, and the PPM ended up having to pay more than $25 million dollars for a computer system that it never used after cancelling a contract with the system's vendor. Attempting to roll out an individual account system too quickly could cause serious implementation problems and undermine public confidence in the system.

Entry Barriers for Fund Providers

Swedish experience suggests that the number of fund options in an individual account system can be very high—and grow over time—unless there are meaningful entry barriers. The large number of choices in the Swedish system almost certainly discourages active choice by overwhelming potential entrants. A better option for the United States is to offer a much smaller range of "generic" funds—perhaps five to twenty—that offer investors a range of choices: equities versus fixed return investments, for example, or domestic versus international exposure. But having a government pension authority choose fund managers raises difficult issues for the body doing the picking, since the fees generated for fund providers will presumably be very large. The federal government's Thrift Savings Plan has managed these issues with little controversy, but the stakes in a society-wide individual account scheme would be much greater.

Limiting Risk

Swedish experience also suggests that some constraints on the content of fund options should be imposed in an individual account system. The ten worst performing funds in the first year of the Swedish premium pension—all stock funds with a technology focus—lost an staggering average of 76.6 percent of their value. While most investors probably did not put all their money into such funds, there were no legal constraints on doing so. Limitations should be imposed on sector-specific as well as country- and region-specific funds.

Engaging Workers in Fund Choice

The Swedish experience with individual accounts highlights the difficulties engaging young workers in choosing a fund, especially after a first round of choice when media attention is high and virtually whole labor force is making a choice simultaneously. These problems are likely to especially severe for workers who are fluent in English. The government would need to provide multi-lingual materials boost fund choice among this group.

A Default Fund

The Swedish experience clearly suggests the importance of a default fund for nonchoosers if the United States moves to a system of universal rather than optional individual accounts. In the United States, establishing a new government-affiliated management entity for the default fund would be both costly and politically controversial. Contracting out management of a default fund to several different fund management firms by competitive bidding would likely spark less opposition.

At least as important as who administers the default fund is the question of how the default option is designed. The experience of the Swedish Seventh Pension Fund's Premium Savings Fund shows that there are very real trade-offs between long-term growth and protection of investment capital for those who, for whatever reason, abstain from making a fund choice. There is no obvious "correct" answer to the growth-versus-security trade-off, but it is probably best to offer different defaults for younger and older workers, and to progressively move the funds of older "abstaining" workers into more secure investments.

If a government-operated default fund were to be set up as part of an individual account tier in the United States, Swedish experience also suggests that it would not be free of controversies over environmental, ethical, and domestic investment criteria. Of course, such criteria would not necessarily be adopted in a political system that is much more conservative than Sweden's—or there might be pressures for a different set of criteria.

For example, should equity funds exclude companies that manufacture tobacco products, firearms or alcoholic beverages? Companies that employ or contract with suppliers using sweatshop labor? Companies that invest in countries with unusually repressive regimes? The experiece of the Swedish default fund shows that individual companies can be excluded with little or no increase in fund management costs—which could make it more difficult to avoid political battles over whether to do so, and what criteria to use in making those decisions.

Conclusion

The Swedish experience with a system of centrally-administered individual retirement savings accounts suggests that such a system can provide great opportunities to save on administrative costs without restricting fund choice. But it also suggests that allowing open entry of fund managers may overwhelm participants and cause more participants to opt for the default fund where one is offered. Allowing active choice of fund managers will not automatically lead to active choice, especially among new labor market entrants and immigrants. Moreover, those who do choose will not always choose wisely. And how the funds of those who do not make an active choice should be invested is far from self-evident. In the design of individual account systems, as with most other policy sectors, the devil is in the details, and those details require at least as much attention from policymakers as the decision on whether or not to set up a system of individual accounts.

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R. Kent Weaver

The Structure of the TANF Block Grant

R. Kent Weaver — Wed, 03 Apr 2002 12:00:00 -0500

The 1996 welfare reform legislation replaced the Aid to Families with Dependent Children (AFDC) program with a new Temporary Assistance for Needy Families (TANF) block grant that is very different than its predecessor. In the old AFDC program, funds were used almost entirely to provide and administer cash assistance to low-income—usually single-parent—families. The federal government matched state expenditures, with poorer states' expenditures matched at a much higher rate than wealthier states. AFDC caseloads tended to go up during recessions and down during good economic times (although the linkage was not nearly as close as with the Food Stamp Program), so federal expenditures on TANF also showed some cyclical variation.

In the new TANF program, by contrast, federal expenditures are, with a few modest exceptions, fixed at $16.5 billion dollars a year for fiscal years 1997-2002. Thus they neither adjust for inflation nor rise and fall with economic cycles or the size of the caseload. Individual states' share of the total block grant is based on the amount they received from the AFDC program in the mid-1990s (states could choose the most advantageous from three alternative base periods). And unlike AFDC, in which federal expenditures matched state expenditures at a fixed rate, under TANF states are required to spend 75 percent of the amount they spent from state funds in 1994 (80 percent if they fail to meet federal work participation rate targets).

During the reauthorization debate, Congress and the administration will face six major issues concerning TANF block grants. First, how much money should the federal government spend on TANF? Second, should an inflation adjustment be built into the TANF block grant to keep its real value from being eroded over time? Third, should the current allocation of TANF funds across states—which gives much more money per low-income child to wealthier states than to poor ones—be revised? Fourth, should the TANF block grant include a counter-cyclical element so that states get more money during recessions, when need rises and state budgets are extremely tight? Fifth, should the "maintenance of effort" requirement that states spend at least 75 percent of the amount spent in 1994 be revised? Finally, should the structure of the performance bonuses associated with the TANF block grant be revised?

This debate will occur in an environment of tight fiscal constraints. The rosy budget forecasts of recent years have changed dramatically. Because of the recession, the tax cut of 2001, and increased spending on defense and homeland security, the federal government now faces a future of red ink. The states are facing large budget shortfalls themselves, and almost all of them have constitutional requirements to balance their budgets. They will be looking to Washington for fiscal relief, or at least to avoid cutbacks in the flow of funds from Washington.

The Size of the Block Grant

Perhaps the most fundamental question that Congress will face this year concerns the overall size of the block grant. Current annual funding of $16.5 billion expires at the end of fiscal year 2002. Congress must act—if only to pass a continuing resolution embodying current law and funding levels—to sustain the flow of funds to the states beyond September 30. But state governments would prefer more than a temporary extension of TANF: they want the stability of a multi-year funding stream to be able to make their own programmatic commitments for the new array of services being offered under TANF.

Some critics argue that funding levels in the block grant ought to be reduced. They note that current levels were set when TANF caseloads were more than twice the level they are today. Moreover, a number of states have not spent their full block grant allocations, especially in the early years of the TANF program. By 2001, however, most states were spending almost all of their current TANF allotments, and many had begun to draw on reserves from past years. Indeed, data from the U.S. Treasury Department show that for the first time in 2001, states actually spent more than the annual TANF allocation of $16.5 billion.

Defenders of current or even increased funding levels pose several counterarguments. First, because the TANF block grant has no built-in inflation adjustment, it has been declining in real terms for six years—roughly 12 percent between 1997 and 2002. More importantly, they argue that the caseload number is no longer a meaningful indicator of states' funding commitments under TANF. States spend less than half of their TANF funds on cash benefits to those officially on the TANF caseload; the rest is spent primarily on child care, transportation, job search, and other work supports for the working poor and the hard-to-employ who may or may not be on the TANF caseload. Thus, states need the entire block grant amount because they are now running two programs—a cash welfare program and an employment program—with the same amount of money they had under AFDC.

Inflation Adjustment for the Block Grant

The decline in real purchasing power of the TANF block grant will continue, and is projected to be around 22 percent lower in 2007 than it was in 1997, if TANF funding remains at $16.5 billion. As a result of the decline in real dollars, states that have increased their spending on work supports in recent years will face difficult trade-offs between cutting cash benefits, cutting work supports, or increasing their own spending on TANF-financed programs. To avoid this financial squeeze on states, Congress can increase the TANF basic funding level to account for past inflation, build an inflation mechanism into TANF to take account of future inflation, or both. If Congress enacts a five-year extension of TANF, about $18 billion in extra funding over the 2003-2007 period would be required to account for inflation between 1996 and 2007; about $6.5 billion would be required over that period to account only for anticipated future inflation between 2002 and 2007.

See Figure 1

Allocation of TANF Funds Across States

As noted above, TANF block grant allocations are based on states' historical spending levels under the AFDC program. Even though poor states enjoyed a much more advantageous match rate than wealthier states, their benefits were generally much lower, so the flow of federal funds per low-income child was much lower. This pattern carried over to the TANF block grant, as shown in figure 1. The lower part of each bar graph shows the TANF block grant dollars received per child living in a low-income family for each state in fiscal year 2002. As the figure clearly shows, there are immense disparities across states in the block grants received per low-income child. In the ten states receiving the least generous federal grant, the TANF block grant provides only $429 per low-income child, while in the ten states receiving the most federal dollars, TANF provides around five times as much. The disparities in TANF block grant funding are exacerbated by the fact that states that receive higher federal allocations also are required to spend more of their own money to meet federal "maintenance of effort" requirements. Thus, the actual funding disparities across states, shown by adding the upper and lower sections of the bars in figure 1, are actually much greater-more than a six-to-one disparity between the highest and lowest ten states.

There is little justification for the dramatically uneven levels of funding per low-income child, especially because the federal government provides fewer dollars to poorer states. However, it is much more difficult to come up with an acceptable resolution of the problem. Defenders of the status quo argue that reopening the allocation formula could destroy political consensus on TANF and lead to lower overall funding levels. Indeed, a formula fight helped to delay Senate consideration of welfare reform legislation in 1995. The reallocation fight would be particularly intense if it involved a zero-sum game in which richer states lost money so that poorer states could get more. The simplest change in allocation would be to gradually adjust the funding formula to give more money to states with low federal funding per low-income child. But even with a lengthy phase-in, such zero-sum funding changes would be opposed by large and powerful states that would lose money.

In short, changing the current allocation would be problematic unless all states are at least protected against a drop in the nominal value of their current allocation. But in a time of tight budgets, a major increase in funds is also difficult. The most likely candidate for increased funding is restoration of the TANF supplemental grant which gives increased funding to about one-third of the states with historically low AFDC grants per low-income person and/or fast-growing populations. The supplemental funding pot was only $319 million in 2001. Because the supplemental grant is not assumed to be included in the budget baseline, renewing it for 2003 and beyond will require offsetting savings or new revenues. The middle parts of the bars on figure 2 show the very modest impact on state grant levels of restoring the supplemental grant and reallocating it so that each state getting a grant below the national average of $1,114 per low-income child would have an equal percentage of the gap filled between its current level and the national average. Because the funding gap is so large—it would take $4.1 billion in 2002 to bring all states up to the current national average—the supplemental grant would make only a modest dent in achieving this goal, filling about eight percent of the gap.

Far more effective in filling the gap would be increasing the current TANF block grant for inflation since 1996, on top of restoring supplemental grant funding and devoting the entire amount to increasing benefits in low-grant states. These two steps together would permit filling 60 percent of the gap needed to bring below-average states up to the national average (top portion of bar graphs in figure 2), but would cost $2.5 billion in 2002 or $12.5 billion over five years.

See Figure 2

A less expensive strategy for partially equalizing revenues across states would be to preserve nominal grant levels for richer states, while using future inflation adjustments to the TANF block grant (if Congress enacts them) primarily to bring grants for low-grant states closer to the national median or average. However, so long as inflation rates remain low, it would take many years for inflation adjustments alone to make a substantial impact on low-grant states. Moreover, it is unlikely that the entirety of an inflation adjustment could be used in this way for more than a few years.

Even if additional funding can be found for states with low TANF grants, additional problems exist. Two in particular are notable. First, any approach to filling the gap between low-grant and high-grant states will give almost one-third of the money to Texas, a very large state with a very low TANF grant. Concentrating such a high percentage of the gains on one state might be politically problematic.

Second, Congress would have to decide whether states receiving the funding boost would be required to increase their own spending levels to qualify for the money. Legislators from richer states would undoubtedly argue that it is not fair that they have to maintain their spending efforts at relatively high levels while poorer states get more money with no additional effort over their already very low spending levels. But it is not clear that low-grant states would be willing to spend more of their own money. After all, the reason that TANF grants are so low now in these states is that under the AFDC program, they were very reluctant to spend their own funds on poor families.

Politicians will be tempted to simply ignore the TANF allocation formula or reinstate the supplemental grant in its old form to avoid these political problems. Given the magnitude of the funding disparities, and the limitations they impose on the capacity of low-income states to provide adequate benefits and employment services to their citizens, retaining the current formula would be an unfortunate outcome.

Adjusting TANF for Recessions

Unlike the old AFDC program, the TANF block grant is a fixed funding stream to the states that does not respond to economic conditions. Nevertheless the law includes several provisions that are intended to help states that run into problems during recessions. First, states can carry over unspent TANF funds to future years. Second, states can borrow up to a total of $1.7 billion from the federal government, repayable at market rates of interest. Third, the 1996 law created a federal contingency fund of $2 billion that states could draw upon when they had substantial increases in unemployment or food stamp use; however, the increases necessary to trigger benefits from the fund were so stringent that states could not access these funds except in a very deep recession. Moreover, to qualify for contingency funds, states have to boost their own spending from 75 percent to 100 percent of the 1994 level, despite the fact that states often cannot find such additional funds during a recession.

Critics of these arrangements argue that states will have difficulty maintaining both increased cash assistance and needed work support commitments during a recession. While a number of states have carried over TANF funds from the good economic times of the late 1990s, they have been reluctant to carry over too much because of signals from Congress that they would lose the funds if they did not use them. Moreover, states are unlikely to borrow funds from the federal government when facing a budget squeeze. One option currently under discussion for dealing with a recession is improvement of the contingency fund, with changes in eligibility criteria and the state spending requirement to make it more accessible for states. Other options include giving states increased control of carry-over funds so that they do not fear the funds will be lost if they are not spent, and making the TANF block grant explicitly counter-cyclical by, for example, tying grant levels to the unemployment rate (see Welfare Reform & Beyond Policy Brief #7, by Rebecca M. Blank for an extended discussion of options for dealing with recessions).

Requirements for State Spending

The old AFDC program required states to contribute their own funds to finance cash benefits. About 45 percent of the total costs of AFDC were paid by states. The TANF program continued this tradition by requiring states to spend 75 percent of the amount they spent on AFDC and related programs in 1994 (80 percent if the state failed to meet required work participation rates). This provision was a subject of great controversy during the 1995-96 welfare reform debate. Some states lobbied to drop all requirements on state spending. Child advocates argued that if there was to be no individual entitlement, the TANF program should at least guarantee that a specific amount of money be available for a cash safety net program and for welfare-to-work activities.

There have been no prominent proposals during the debate on TANF reauthorization to reduce state maintenance of effort spending. But the intense budget pressure faced by Congress could lead members of the congressional budget committees to look for cuts in the $16.5 billion TANF block grant. Cuts of this sort would lead, in turn, to a call from the states to allow them to reduce their own spending. The most likely outcome, however, is that both the federal block grant amount and the state 75 percent "maintenance of effort" requirement will be retained.

Changing Performance Bonuses

In addition to the basic TANF block grant, the federal government offers two sets of bonus grants to states that have achieved superior performance on goals defined by the federal government. One bonus offers a total of $100 million per year to up to five states that have achieved the highest reductions in the ratio of non-marital births to total births in the past year while reducing abortions. The second bonus offers $200 million per year to states that have met at least one of several performance criteria established by the Department of Health and Human Services. In its original form, the second bonus was awarded for job entry, job retention, and wage progression by TANF recipients. Starting in 2002, bonuses are scheduled to be added to reward states for success in enrolling eligible low-income families in food stamps and Medicaid or the State Children's Health Insurance Program, as well as for child care affordability, accessibility and quality, and for increases in the number of low-income children living in two-parent families.

In order for a bonus system to have the intended effect of boosting a state's effort to perform well, states must believe that their efforts can actually have a direct impact on the particular outcomes measured by the bonus system. But in the case of the illegitimacy bonus, high performance in reducing illegitimacy rates appears to have resulted largely from demographic factors that are not under state control rather than from any new state effort. Moreover, the underlying rationale of a bonus system is that it can encourage states to mount new programs to achieve the desired improvement in performance. New programs generally cost money. As we have seen, there is a wide discrepancy between states in the amount of money they receive from the basic TANF grant. Thus, wealthy states have an advantage in mounting new programs aimed at winning bonus payments simply because they have more money to invest.

The illegitimacy bonus appears to enjoy only weak support in Congress primarily because it is difficult to identify a clear relationship between states that have actually won the bonus and the efforts those states put forth to win the bonus. By contrast, there is considerable support for the performance bonus. To date, the performance bonuses have been awarded based on state success in placing and keeping recipients in jobs. Most observers believe that states can obtain reliable measures of job placements and job retention and that state programs seem to have an impact on state performance.

In a year in which money is tight, it might be expected that proposals to use bonus money for other purposes will be forthcoming. In fact, the Bush administration has already proposed to end the illegitimacy bonus and part of the performance bonus in order to use the money to provide funds for a marriage initiative. The bill introduced by Representative Benjamin Cardin, the ranking Democrat on the Ways and Means subcommittee responsible for welfare, would also eliminate the illegitimacy bonus. The illegitimacy bonus seems unlikely to survive; what happens to the performance bonus remains to be determined.

Additional Reading

General Accounting Office. 2001. Challenges in Maintaining a Federal-State Partnership, GAO-01-828.

Neuberger, Zoë, Sharon Parrott, and Wendell Primus. 2002. Funding Issues in TANF Reauthorization. Washington, D.C.: Center on Budget and Policy Priorities.

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R. Kent Weaver

State Policy Choices Under Welfare Reform

R. Kent Weaver and Thomas Gais — Tue, 02 Apr 2002 12:00:00 -0500

The 1996 federal welfare reform law joined two approaches to changing welfare policy in the United States. The law put in place many policies reflecting a conservative approach to the goals of work, independence, and marriage. These included time limits on assistance, stricter work requirements, and demands that teen mothers live with their parents and finish school. The law also strengthened requirements that clients cooperate with child support enforcement efforts and established stronger sanctions for noncompliance.

However, the law also created a block grant giving states flexibility in fashioning their own policy and administrative strategies to achieve the goals of the law. State innovation and experimentation are seen as critical ingredients of policy change. Federal time limits and work requirements apply only to cash assistance funded by the federal block grant, Temporary Assistance to Needy Families (TANF). States can, however, devise programs without time limits or work requirements when they use their own money, spending state funds under TANF's "maintenance of effort" provision, which requires states to spend 75 percent of the state dollars they spent in 1994. States can even use federal TANF funds to provide benefits to low-income families without time limits if those benefits help pay the costs of working, such as child care or transportation. States can impose stricter work requirements or shorter time limits. They can change many other eligibility requirements for cash assistance, including asset and earnings disregards. They determine the services to be offered to low-income families and define who is eligible for such services. And they have wide discretion over which providers—public or private, secular or religious—carry out their programs.

This combination of work-focused policy mandates and increased state discretion raises several questions. Have states used their flexibility—and, if so, how? Have they advanced the philosophy of the federal legislation, or have they introduced different elements? Have states "raced to the bottom," competing with one another to make their policies more punitive and less attractive to low-income families? Or have they developed diverse approaches to welfare reform, responding to different economic conditions and political climates? And what do state choices suggest about changes that Congress may want to consider in reauthorizing TANF?

State Policy Choices

Initial evidence on the differences and similarities in state policies comes from an examination of choices states made under TANF. Table 1 summarizes several decisions and the number of states selecting them. The left column includes policy choices that use positive incentives to encourage the work, marriage, and childbearing objectives of the 1996 federal law. These policies tend to enhance access to services and income supports. The right column contains work, marriage, and childbearing policies that use negative incentives-typically, restrictions on benefits or supports-to meet the same objectives.

The policy choices listed in table 1 reflect the broad support that states have given to the employment goals of the federal legislation. Most states accepted the premise in TANF that assistance should be temporary. Six states have reduced the limits on payment of cash assistance below the 60 months in the federal law while fourteen states have introduced "intermittent" time limits (e.g., available for only 36 out of 60 months). Only a few states have chosen to eliminate the 60-month time limit, but several states have announced that they will apply time limits only to adults, apply broad exemptions, or otherwise limit the effects of time limits (not shown).

By 2000, forty-three states had strengthened the federal work requirements by demanding that caregivers engage in a work activity before the TANF-imposed deadline of twenty-four months; thirty-eight required adults to do so immediately. States also endorsed the federal law's emphasis on "work first" over education and training: the number of states counting full-time post-secondary education as an allowable work activity for two years dropped to twenty-six in 2000. The number of states extending the coverage of the work requirements to parents of children less than one year old rose from six states in 1996 to twenty-two states in 2000.

Other changes reduced assistance to people who failed to meet the new obligations. TANF did not require states to cut off all benefits to a noncompliant household, but seventeen states now levy 100 percent sanctions for first-time violations, and twenty-one states impose 100 percent sanctions for at least three months as an ultimate sanction. Twenty-two states also reduce or eliminate Medicaid and/or food stamp benefits if sanctions are imposed for violations of TANF work requirements. Twenty-three states have adopted family caps, which means that children born or conceived while a family receives welfare are not counted in determining cash benefits. Finally, thirty-four states have ended or reduced the "pass through" to families on welfare of $50 per month of child support collections that was required under the old Aid to Families with Dependent Children (AFDC) program.

Two other highly restrictive options are not now in effect in any state. By 1998, thirteen states had reduced or delayed assistance to new residents coming from other states. Such laws, however, were struck down by the U.S. Supreme Court as unconstitutional in 1999, so they no longer apply. And no state adopted a policy favored by the most conservative advocates of federal welfare reform in 1996—barring all cash benefits to teen parents. Overall, however, states accepted and often strengthened the restrictions on assistance found in the federal law. Few of these policies were adopted by a majority of the states, but most states adopted at least one such policy.

At the same time, several policies increasing access to services or supports became quite widespread. Earnings disregards were liberalized in forty-seven states compared to AFDC standards. Families with earnings were allowed to keep more assistance than before, thereby increasing the incentive to work. Sixteen states strengthened positive incentives by creating a state Earned Income Tax Credit for low-income families with earnings and children. However, these credits can be used only to lower tax liability rather than being received as a cash income supplement in five states.

Nearly all states increased their asset disregards-limits on what a family could save or own and remain eligible for assistance. All states increased their vehicle disregards, primarily because the $1,500 ceiling for an automobile under AFDC was viewed as a barrier to employment for people who needed a reliable car for work. A large majority of states also made it easier for two-parent families to get cash assistance. For example, AFDC restricted eligibility for two-parent families by limiting how many hours the parents could work in a month, but forty states had eliminated those restrictions by 2000.

Taken together, the changes in disregards and the elimination of restrictions on two- parent families have expanded the range of working families eligible for cash assistance. One indicator of this shift is a substantial increase in "break even" points for families on assistance—the income recipients may earn before losing eligibility.

By contrast, states have not made major changes in their maximum cash assistance levels; i.e., the money families receive if they have no other income. Indeed, the most common pattern is a continuation of the pre-1996 pattern of real benefit levels being eroded by inflation. Between 1994 and 2000, twenty-nine states made no change in the nominal value of the benefit a family with no earnings receives; benefits in these states lost about 14 percent of their real value. Fifteen states increased their nominal maximum benefits, though only three of these states increased their real value; seven states cut their nominal benefits.

The increasing disregards and the declining real value of maximum benefits for families with no other income shifted the distribution of cash benefits away from persons without income and toward those with earnings. However, there is substantial diversity across states. In 2000, thirty-nine states offered some benefits to persons working 35 hours a week at the minimum wage, at least initially. But in eighteen states, a three-person family with one minimum wage worker who worked 35 hours a week would get no TANF benefits in their fourth month; in another ten states they would get less than $100. In short, only in a minority of states does TANF provide major wage supplements for workers working full-time even at minimum wage. Wage supplementation is even more modest for workers earning $8 per hour or more. Because maximum benefits remain low in most states, even generous disregards whittle down assistance to small sums as parents increase their earnings.

In short, states generally accepted the "sticks" elements in TANF, those provisions that punish noncompliance with work requirements. Many states used their discretion to stiffen work requirements or penalties for non-work over those in federal law. A majority of states adopted stiffer initial work requirements, and a large minority of states strengthened the federal sanction policies and cut the time limits. Yet the vast majority of states also adopted "carrot" policies-those aimed at rewarding work by enhancing access to certain benefits or supports, especially by eliminating provisions that discouraged work. As table 1 shows, however, most policy choices, especially those that restrict access to benefits, are in the two intermediate categories in terms of breadth of diffusion, having been adopted in more than ten but fewer than forty states.

States engaged in substantial innovation in both access-enhancing and access-restricting policies before 1998 and in some cases before 1996 (through AFDC waivers prior to passage of the federal legislation). A leveling off of innovation occurred thereafter. In some cases, the leveling off occurred because policies had been adopted by almost every state (eased auto asset limits, for example). In other cases, the apparent political limits of the policy had been reached (notably family caps). Instead of a "race to the bottom"—a continuing expansion of restrictive policies and little or no expansion in access-enhancing policies—many states adopted both types of policies. Yet states have differed dramatically both in their overall degrees of policy change and in their mix of "carrot" and "stick" policies. Rather than an emerging homogeneity, either around a "race to the bottom" or a consensus set of "best practices," there remains substantial heterogeneity in packages of state choices.

Factors Related to State Variations

Why do states differ in their policy choices? To explain variation across states in their policy choices under TANF, we used statistical techniques designed to find the relationship between characteristics of states and the policies they choose, while controlling for other attributes of those states. Table 2 summarizes our analyses of five policy choices: family caps, time limits shorter than those required under TANF, immediate work activity requirements, stronger sanctions than required under TANF, and the generosity of work supplements for working families. In the cells of table 2, a "+" means that the variable or factor is associated with a policy choice that is comparatively "liberal"; i.e., makes assistance more widely available or more generous. A "-" sign means that the variable is estimated to have a "conservative" impact on the dependent variable; i.e., constrains access to public assistance. Several points emerge from this analysis.

First, ideological factors are correlated with policies restricting cash assistance. Stronger sanction policies, shorter time limits, and immediate activity requirements are more common in conservative states than in liberal states (liberalism is measured here by the percent of the state's popular vote going to Bill Clinton in the 1996 presidential election, but other measures of state public opinion produce similar results).

Second, policies restricting cash assistance—such as shorter time limits, more severe sanctions, and family caps—are also more common among states that have a high percentage of African Americans on the caseload. Having a high percentage of Hispanics in a state's caseload is associated only with stiffer time limits.

Third, a state's resources under the TANF block grant are strongly related to policy choices regarding income supplements through earnings disregards and state earned income tax credits. Earned income disregards are more generous in states that were given relatively large grants per needy person—here, measured as the size of the TANF grant per child living in a low-income household. Because the formula for distributing federal TANF funds was based on state and federal spending in 1994, states that spent a lot on a per-case basis then got a comparatively large block grant under TANF and now have greater resources to spend on each of their families.

Fourth, policy decisions among the states were generally not statistically related to the severity of social problems in the states once other factors are controlled for. Out-of-wedlock birth rates, welfare dependency (measured by the percentage of the population on welfare at its highest point in the early 1990s), and unemployment showed weak marginal effects on state policy choices.

Policies that restrict assistance are thus most responsive to factors likely to affect a state's politics, particularly in the area of social policy, such as its electoral tendencies and the racial and ethnic composition of the caseload. Policies offering positive incentives to work, by contrast, are most strongly affected by a state's resources, especially the resources per needy family member provided through the TANF block grants.

Implications for TANF Reauthorization

Most states responded to the federal TANF program by endorsing both the employment goal and the means to achieve it, including time limits and work requirements. Perhaps the most surprising finding is the large expansion of eligibility for cash assistance among working families. States increased the rewards of work and lowered barriers to employment by increasing earnings and asset disregards, by eliminating anti-work regulations aimed at two-parent families, and by increasing their funding for child care and other services that directly support employment.

Expanded access to assistance for working families was in no way mandated by TANF. It emerged out of the new flexibility accorded to the states. Some aspects of TANF may have encouraged this tendency, including the block grant funding formula, the performance requirements, and the political popularity of the law's employment goals. The strong economy may also have been a factor. Although employment levels were not significant in accounting for differences among the states in their earnings disregards, it is still possible that the general prosperity of the late 1990s made policymakers willing to spread benefits to a wider range of working families.

However, there were important differences among state responses. States that were politically conservative and those that had large numbers of African Americans on their welfare rolls tended to adopt policies-such as stricter time limits, work requirements, and sanctions—that made assistance less attractive and less widely available. Contrary to the hopes of some welfare reform proponents, the new welfare law does not seem to have dissipated the image of the program as disproportionately aiding minorities, or the negative impact that this image has on support for the program in many states.

Several implications flow from this analysis. First, the absence of evidence that a "race to the bottom" in state policy choices is under way weakens the case for tightening federal limits on the range of state choice. But it should be noted that the good economic conditions that have existed until recently are those least likely to produce a "race to the bottom."

Another issue for reauthorization is whether differences in policy choices across states are problematic and, if so, what can be done about them. If one finds the divide between states that rely heavily on "sticks" and those that put greater emphasis on "carrots" to be troubling, it may be necessary to increase the funding levels per poor family in the states that had smaller relative grants in the first years of TANF. Giving more states the resources to pay for income supplements and child care might push TANF to become a stronger work support program in a larger number of states, not just in the traditional high-benefit states.

Encouraging work could also be addressed by maintaining or increasing the required work participation rates while revising the caseload reduction credit in calculating state performance levels. One possible revision might be to transform the caseload reduction credit into an employment credit for former TANF recipients who are in the work force.

Increasing hours of work required for individuals as well as state work participation rates is another option, with its own distinct challenges. Income supplements for families with full-time workers remain small or non-existent in most states-even when they earn only the minimum wage. Since work participation rates are based on the number of families on assistance who work the required hours, basing those rates only on full-time workers would make it difficult for most states to increase or even maintain their work participation rates.

It is still unclear, moreover, how states will respond to new challenges. What policies will they develop in dealing with timed-out families? How will they react when and if they have to meet 50 or 70 percent work participation rates year after year, especially if they face higher caseloads in a weakened economy? Evidence from the first five years of the TANF program suggests that there could be wide variation in state responses.

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Authors

R. Kent Weaver
Thomas Gais

Note to Congress: Compromise; There are only two options: cutting benefits or committing resources.

R. Kent Weaver — Sun, 17 Mar 2002 00:00:00 -0500

After 15 years of being largely off the national policy agenda, Social Security came back with a vengeance in 2001. President Bush established the Commission to Strengthen Social Security, giving it a clear mandate to propose a way of incorporating optional individual accounts into the system. Critics denounced the commission as a stacked body and individual accounts as the first step in a long-term plot to do away with the program. The stage was set for some difficult but important negotiations.

Then came a series of events that changed the equation. Budget surpluses that might have helped lubricate an agreement on Social Security between conservatives and liberals vanished in the aftermath of Sept. 11. The president's commission issued a report that, instead of recommending a specific plan, outlined several options for reform, thereby earning denunciations from both proponents and opponents of privatization. And the Enron scandal—or, more particularly, the retirement-savings losses of Enron employees—dimmed some of the enthusiasm for privatization. It all has made the prospects for an agreement on major substantive reform of Social Security, not especially bright before Sept. 11, seem very dim indeed in 2002. This is a shame. If we want to avoid truly draconian policy changes in the long run, Social Security's very real long-term funding problem must be addressed quickly.

Finding a long-term solution will require both liberals and conservatives to make compromises they find unpalatable. Both sides must start by abandoning their most extreme positions. Liberals will not accept reforms that appear likely to undermine the current system of guaranteed benefits as the core of retirement-income policy by undermining its fiscal base of support over time. In particular, they will not accept the redirection of current Social Security payroll taxes to fund individual accounts. Conservatives will not accept putting any more payroll tax resources into the current Social Security program. Nor will they accept injecting significant general revenues into the current Social Security program, except perhaps for very narrow, carefully defined purposes.

Both sides also need to alter their rhetoric. Conservatives need to drop the shrill cries that we're in the midst of a severe crisis, while liberals must acknowledge there is a real long-term financing problem that must be solved. Both sides need to admit that investing in equities—either through individual accounts or collective investment of current trust fund surpluses—is not a free lunch that will solve Social Security's financing problem, but at best a healthy snack that will make it more manageable. In the long term, there are only two options: cutting benefits for retirees or devoting more resources to retirement income security.

Liberals and conservatives must accept this simple fact: The concerns raised by the other side about some of their favorite proposals are probably legitimate and need to be addressed. Specifically, liberals must agree to strong safeguards to protect against political interference in investment decisions if Social Security trust-fund money is invested in corporate equities and bond markets. Conservatives must accept limitations on administrative costs so that savings in mandatory individual accounts, especially the accounts of low-wage workers, are not eroded by high fees charged by fund managers. Eligible funds would have to be diverse in their holdings across firms and sectors of the economy to prevent a repeat, on a much larger scale, of the Enron retirement-savings debacle.

And one other thing: While we are fixing Social Security's fiscal situation, we must guard against making existing social problems worse. Despite major progress over the past 40 years, the United States still has many seniors in poverty, especially elderly widows. Many privatization proposals could make this vulnerable group even worse off.

Assuming that the two sides of the ideological divide are willing to attempt an agreement rather than trying to bash each other for fun and political profit, here are some specific ideas for bridging the Social Security divide:

* Increase the Social Security payroll tax by 2% of total earnings, split equally between employers and employees. All the new contributions would go into mandatory individual accounts. Workers would have a wide choice of privately managed funds, but all funds would have to have diverse holdings. Caps would be placed on the fees of account managers to hold down administrative costs. Funding mandatory savings accounts through payroll taxes, rather than general revenues, provides a stable income stream that is essential if mandatory savings accounts are to be a major part of seniors' retirement incomes, given that partial privatization will increase their risk in depending on market investments.

* Gradually reduce initial benefits for future cohorts of Social Security recipients as new individual accounts are phased in. Replacement rates would be set so that the combined "old" Social Security benefits and new mandatory savings accounts would roughly equal current benefits, given conservative estimates on rate of return for the mandatory savings component. Benefits would continue to be fully adjusted for inflation after retirement.

* Begin investing part of current Social Security trust-fund surpluses in equity and corporate bond markets through multiple funds. The size of individual funds would be limited to prevent any disruption of capital markets. These funds would have a strict legislative mandate to maximize return for retirees, rather than to serve social ends, and they would be privately managed. A major advantage of such an approach is the potential for increasing returns on Social Security contributions. Even more important, it would ease the cash-flow transition expected to occur around 2016 as Social Security shifts from serving as a source of financing for the federal government to being a drain on government revenues.

* Create a more generous minimum benefit for retirees, paid for out of general revenues. The current Supplemental Security Income (SSI) safety-net program for the elderly serves few people because its benefit levels are minimal and its assets tests are absurdly low. International experience suggests that it is almost impossible to eliminate poverty among the aged without increased reliance on some form of means-tested program. A new income guarantee within Social Security should have higher benefits and less stringent assets tests than the current SSI program, but not carry with it automatic eligibility for Medicaid, which would raise program costs substantially. Seniors who could meet SSI asset tests could still get Medicaid. To assuage concerns about high benefits luring immigrants, benefit guarantees should be prorated based on the years that a recipient spent in the United States as an adult—one-fortieth of the full monthly pension for every year of residency. Recertification for eligibility should occur automatically through filing an income tax return, as is done in Canada.

None of these proposals, individually or collectively, is a panacea for Social Security's problems. But they do form a balanced package that has elements appealing to both sides of the ideological divide. Seeking a middle-of-the-road solution on Social Security is not easy. But failure to reach an agreement now will pose an unacceptable burden on future generations of retirees and their children.

Authors

R. Kent Weaver

Publication: Los Angeles Times

Neediest Families in Texas Deserve a Fairer Deal

Debra Hevenstone and R. Kent Weaver — Thu, 21 Feb 2002 00:00:00 -0500

When Congress enacted welfare reform legislation in 1996, its goal was to move low-income families from long-term dependence on welfare benefits toward self-sufficiency. States were encouraged to spend less money on cash benefits and more on child care, transportation and job search assistance, as well as transitional Medicaid benefits for families moving into the low-wage labor force.

States have generally done a good job of taking up this challenge. But some states have faced a bigger challenge than others. Because funding allocations to states under the new Temporary Assistance to Needy Families, or TANF, block grant were based on what states spent under the old Aid to Families with Dependent Children, or AFDC, program, wealthier states generally received far more dollars for each low-income family they are trying to serve.

In 2002, for example, Texas will receive only a little more than $300 per child in a low-income (less than 125 percent of the federal poverty line) family to provide work supports and cash assistance for those who still need it—barely one-third the $885 received in the median state. Six other states (Alabama, Arkansas, Idaho, Louisiana, Mississippi and Nevada) will also receive less than $500 for each low-income child. But five states will receive more than $2,000 per low-income child, and 13 states more than $1,500.

Funding differences clearly matter: The generosity of state policies for both income supplements to low-income families and state funding for child-care assistance are closely tied to the availability of federal funding. States like Texas simply can't afford to be as generous in these policies as states like Connecticut. Thus it is not surprising that the 10 states with the lowest level of block grant funding per low-income child spent an average of only $79 in TANF funds on child care in 2000, while the 10 states with the most generous funding spent an average of $367.

There is no moral justification for the current TANF formula for allocating funds to the states, which gives vastly more resources per low-income family to wealthy states than to poor ones. Defenders of the status quo instead offer two justifications. First, they argue that any tinkering with the current allocation of funds could set off a huge formula fight, imperiling the overall funding level for TANF. Second, they argue that large grants should be given only to states that showed a political and financial commitment to support low-income families under AFDC—states that did not make that commitment in the past would probably not be willing to help poor families now.

We believe these concerns are misplaced, for two reasons. First, most legislators understand that TANF is no longer primarily a system of cash assistance for the non-working poor, but rather an important tool for aiding transitions to self-sufficiency for working families. This latter mission has been politically popular among many states, including states that spent relatively little under AFDC. Second, formula fights are commonly resolved by adding resources to placate aggrieved states, not by subtracting from the size of the total pot. And in the case of TANF, the grievances could not be more legitimate.

It is, nevertheless, important to find a fund allocation mechanism that will widely be seen as fair and that will not be seen as harming better-off states. In today's tight budgetary environment, chances for immediately eliminating the unfairness of the current funding formula are slim. Just bringing every state with a low grant per low-income child up to that of the median state would cost the federal government $2.3 billion in fiscal year 2002. But it is important to make a start in this year's TANF reauthorization bill, with a goal of bring all states up to the current median within five years. For states that do want to do more but have been handicapped by lack of resources—and for the low-income families in those states—adjusting the TANF allocation formula would be a critical step toward moving those families into the economic mainstream.

Authors

Debra Hevenstone
R. Kent Weaver

Publication: The Houston Chronicle

Whether Social Security Funds Should be Invested Collectively or Through a System of Individual Accounts

R. Kent Weaver — Thu, 06 Sep 2001 00:00:00 -0400

Thank you for the opportunity to testify before the Commission to Strengthen Social Security on the critical issue of whether Social Security funds should be invested collectively or through a system of individual accounts. This question is of course related to the larger question of the extent to which Social Security should retain its character as a program paying a "defined benefit" that is protected from risks of market fluctuations and inflation, or whether individuals should be exposed to increased risk from financial market fluctuations.

Almost everyone accepts the need for a multi-tiered retirement income system, including a minimum floor, an income-related defined benefit, some form of tax-advantaged and/or mandatory retirement savings, and voluntary savings for retirement. And most of the advanced industrial countries have adopted a multi-tiered approach. The questions we must all weigh are: what mix of these tiers is appropriate? What is affordable? How much leeway do we have for change given past policy choices? And if we do decide on policy change, over what time frame should it be imposed?

I will focus my testimony on four issues. What are the relative advantages of collective and individual investment? How can we minimize the political risks associated with collective investment? What mechanisms could mitigate problems associated with individual accounts? Are the serious problems associated with a partial opt-out from Social Security into individual accounts solvable?

I believe that there is a stronger case for some form of collective investment of trust fund surpluses than for a move to individual accounts as a way of addressing Social Security's financing problems. But I also believe that the Commission must move beyond the ideological debate for or against privatization to consider the details of particular proposals. There are better and worse ways of organizing and implementing both collective investment and individual accounts. Whatever you decide to recommend, the details count.

1. Collective investment of Social Security surpluses has important advantages over individual account plans.

Collective investment of Social Security funds in a broader range of instruments than government-guaranteed securities has several important advantages over the status quo. The most important is that it would allow a greater return on the trust funds over the long term through the higher returns (with higher risks) associated with equity investment.

Just as important as its advantages over the status quo, collective investment of Social Security trust funds has three important advantages over a system of individual accounts, with lower risks and costs. First, by pooling investments and keeping transaction, marketing, and reporting costs to a minimum, collective investments can lower the costs of investing funds dramatically and produce higher net returns than individual retirement savings accounts. How much administrative costs reduce the ultimate return on individual accounts depends heavily on the particulars of how that system is structured as well as the mix of assets that they invest in, as will be discussed further below. But an individual account system is inherently costly to administer, especially for small employers and firms with large labor turnover. A recent study by Estelle James, James Smalhout and Dimitri Vittas estimates that administrative and marketing costs in decentralized individual account systems where pension funds are "retailed" to individual consumers are likely to lower eventual pensions by fifteen to thirty percent. Those where there are more constraints on individual choice (e.g., a limited number of funds are offered) or where administrative functions are centralized (as in Sweden) lower pension accumulations by ten percent or less. Because many of the costs associated with maintaining individual accounts are fixed costs—notably record-keeping and communication with shareholders those charges are likely to hit small accounts held by persons working at low wages particularly hard unless fees are regulated in a way that protects small accounts (for example, capping fees at a total percentage of annual account balances while barring front-loaded fees, as in the new U.K. stakeholder pension).

A second advantage that collective trust fund investment has over individual accounts is that it lowers information costs for consumers, as the costs of evaluating alternative investments are spread over huge groups. There are also distributive issues here as well: low-wage workers are likely to bear the highest information costs in seeking information about investment options, because they are less likely to be targeted in the marketing efforts of fund managers who believe that they can make higher profits concentrating their marketing efforts on those with higher incomes and higher fund balances. Moreover, those with lower incomes will face a lower return on any information-gathering efforts because their fund balances are lower.

A third important advantage that allowing Social Security trust fund equity investments has over individual accounts is that it is doing so would not undermine or erode the defined benefit structure of Social Security, which provides a predictable retirement income that spreads the risks of fluctuating asset values and annuity prices across the population and over generations. The leading work on this topic has been done by my Brookings colleague Gary Burtless, who has estimated the initial replacement rates for successive cohorts of hypothetical workers over most of the past century who invested a constant six percent of their salaries in a broad stock market index and then converted the fund value to a level-rate annuity upon retirement at age 62. Burtless found that the initial replacement rates for workers ranged between 20 and 110 percent, with an average rate of 53 percent. This difference of more than 5 to 1 in replacement rates is a fatal flaw for a program designed to ensure a basic income level. These variations can also be seen in very recent history: individuals under an individual account system who retire today rather than eighteen months ago would be hit by the double whammy of a falling stock market and higher annuity prices resulting from lower interest rates.

Workers in an individual account system would also be exposed to substantially varying degrees of inflation risk after retirement. Participation in an inflation protected-defined benefit plan eliminates the risk that whole cohorts of individuals who have played by the rules and done the right thing by saving may be left with an inadequate retirement income because of market conditions over which they have no control.

2. The risks of political interference with collective investment can be minimized through proper insulation mechanisms.

Critics of broadening the investment options for the Social Security trust funds fear that such funds would inevitably be subject to political interference, and that they would be so big that they would disrupt private capital markets. However, both of these concerns can be addressed in designing a set of safeguards for Social Security investment funds drawing on both domestic and foreign experience. I will focus here on what I believe are the most appropriate models for the United States relating to three issues: insulation mechanisms, fund size, and corporate governance.

Insulation Mechanisms: Many state pension plans in the United States, as well as the Federal Thrift Savings Plan and the Canada Pension Plan, have managed to achieve excellent financial returns, while keeping costs low and avoiding political interference in investment decisions. Although the governance structure of these plans varies substantially, their experience suggests several "best design practices" that are likely to minimize political interference, notably:

Give the investment funds explicit organizational mandates to maximize return on contributors' investment consistent with a prudent approach to risk rather than including social considerations in investment.

Have independent boards of trustees for the funds, serving long terms. Expertise in financial services should be an explicit requirement for appointment to the boards. Appointment of politicians on a partisan or regional basis should be avoided.

Have the investment fund trustees contract out portfolio management to professional fund managers on a competitive basis. Contracting out allows the Canada Pension Plan Investment Board to manage more than $C8 billion (with growth to $C130 billion planned by 2011) with a staff that currently totals about 15 persons.

Invest funds primarily in broad, indexed investments. This need not preclude more active investment policies entirely, however. The Canada Pension Plan Investment Board, for example, has recently begun to implement a policy to actively invest up to half of its Canadian equity assets. It has also begun working in partnership with merchant banks and other pension funds to take advantage of venture capital opportunities while spreading risks.

The four mechanisms outlined above are not particularly difficult to design and maintain. With tens of millions of current and future Social Security beneficiaries looking on to make sure that Congress does not meddle with "their" retirement futures, it is almost certain that Congress would maintain a hands-off policy.

Fund Size: Once concerns about political interference have been addressed, worries about the size of public investment funds can be addressed in two ways. One is simply to limit the size of any single Social Security fund, creating new funds that are separately (and also privately) managed once a public fund reaches a certain size. Multiple funds are already used in Sweden, which has six separate funds to manage accumulated surpluses in Sweden's pay-as-you-go public pension system, and a seventh to manage the funds of workers who do not designate a fund choice in the new individual accounts tier of the pension system. The government has put explicit limits on how much individual funds, and all the funds collectively, can own of a single firm and of the total market.

But how big a fund is too big? One simple standard would be to limit the size of any one Social Security investment fund to roughly the size of the largest private investment funds—a position currently held by Fidelity with 3.3 percent of domestic equities, followed by Barclay's Global Investors with 2.1 percent, and State Street Global Advisors with 1.6 percent. Once a Social Security investment fund reached this size, it would not receive any new investment funds from Social Security surpluses, and a new investment fund or funds, again privately-managed, would be set up to receive new funds.

A second and somewhat more convoluted mechanism for limiting Social Security investment fund size would involve tracking employee contributions into tax-favored 401(k) plans. Social Security trust fund surpluses would be distributed among fund managers in proportion to 401(k) contributions—or at least to those fund managers who agreed to provide a hefty discount to the Social Security system in recognition of the vastly lower costs of administering one large account than tens of thousands of individual 401(k) accounts. The logistical difficulties and financial costs of setting up and administering such a system are not inconsiderable, but they are minute in comparison to the costs of setting up roughly one hundred million individual accounts, many of which would receive very small and irregular contributions from low-earners. The size-limited Social Security investment funds and "401(k) mirror" options outlined above could also be combined, each receiving half of Social Security surpluses.

Corporate Governance: Another concern that has been raised about collective investment of Social Security trust fund surpluses is that they will be the object of repeated initiatives aimed at affecting corporate governance and the investment practices of corporations. For example, liberal members of Congress might try to require fund managers to support shareholder resolutions forbidding a company from investing in Myanmar or in tobacco stocks, while social conservatives might try to get publicly-owned biotechnology companies to refrain from engaging in stem cell research. The record of some state public employee retirement funds in the 1980s has increased concern in the corporate sector about such risks. However, a recent study of state retirement funds by Alicia Munnell and Annika Sunden suggests both that there has been a move away from such practices in recent years by state retirement systems and that such funds have earned returns that compare well to those of private retirement funds. To prevent such initiatives from occurring, the simplest solution is probably to establish in legislation that shares held by Social Security investment funds will not be voted by fund managers.

Is there a guarantee that the steps suggested above will completely eliminate all risk of political interference in how those funds are invested? Of course not. But neither can proponents of individual accounts guarantee that all interference (for example, domestic investment requirements) would be avoided with private accounts that provide compulsory or tax-advantaged retirement savings. However, the steps suggested above should keep the risks of political interference very low—certainly low enough that the overall return on such funds is likely to be higher than for any plausible system of individual accounts, once the administrative and marketing costs of the latter are taken into account.

3. Individual accounts pose a more complex set of design issues than collective investment of Social Security trust funds, but once again there are better and worse options.

While collective investment funds present important and complicated issues of program design, designing an effective individual account system is far more complex. I assume that later speakers will focus on the many difficult issues related to the benefit structure in an individual account system. These issues include:

the extent to which individuals are required to convert their account balances into some form of income stream at retirement, and the conditions under which that conversion takes place;

the problems that a system of individual accounts creates for spouse's benefits, and for survivors and disability insurance; and

(3) the higher annuity prices charged to women given their longer life expectancy. Equally important is the issue of how to finance a transition from the current largely pay-as-you-go system to a system that includes fully-funded individual accounts, the so-called "double payment problem."

All of these issues deserve the Commission's full attention.

Even leaving these aside, individual account plans pose a formidable list of design choices. In addition to the question of whether to have individual accounts as an opt-out from the defined benefit plan or as a mandatory component, which will be the focus of the next section of my testimony, there are important issues of administering accounts and investment practices. I will focus briefly on each in turn, again seeking to draw out potential "best practices."

Account Administration: Administration of individual account systems differs on several dimensions. One is whether they are administered by employers, by government, or by some combination of the two (as in the U.K.). A second is whether government regulates entry and/or fees charged by pension providers. These governing choices have important implications both for the number of pension options available (in the aggregate and to subsets of the population) and for the costs of pension provision.

Many options are possible. Sweden's new individual account tier, for example, features a highly centralized system of account administration. Funds flow into the Treasury and out through a specialized state agency that moves resources into and out of investment funds, with the individual fund managers knowing only the amount of the funds to be moved rather than the identity of their owners. The advantages and disadvantages of this approach are clear. It facilitates maximum fund choice (regarding entry and switching of funds as well as distribution of assets among multiple funds) at minimum cost. When the program debuted in the fall of 2000, Swedes could choose from approximately 450 funds. The Swedish system also minimizes the additional paperwork burden for employers, who can follow existing procedures for submitting payroll taxes and do not need to get involved in administering fund choices and payments to multiple funds by their employees. Thus it almost certainly weakens opposition from employers (and especially small employers) to participation in such a system. Central administration of funds also makes it easier to negotiate reductions in management fees by fund providers, but it contributes to a very long lag time in crediting of individual pension accounts.

Other countries have made very different choices. Bolivia, for example, created a duopoly of pension providers when it created its privatized pension system, minimizing choice but also lowering administrative costs. Australia, with a decentralized individual account system run by individual employers or on an industry basis (fund management functions are generally contracted out), has a high cost system where the number of options available to employees differs greatly—but is usually quite limited.

Which set of options might be most appropriate for the United States if there is a move toward individual accounts in this country? Given the large size of the U.S. economy, limiting entry to a small number of competitors in an individual account system does not seem either politically sustainable or desirable. The five fund options offered by the Thrifty Savings Plan, for example, would be enormous if expanded to cover all persons currently paying Social Security taxes. On the other hand, the evidence presented by James et al and others suggests that the cost savings from centralized administration can be substantial. Overall, the best option is probably a variant of the Swedish approach, in which record-keeping and administrative functions are centralized—thus lowering the cost of fund administration—and a large number of fund options are permitted. This method would also lower costs to (and probably political opposition from) employers, although it does have the disadvantage of delaying the movement of funds into individual accounts.

Investment Practices: A key issue in the design of individual account systems is whether those accounts should be required to limit risk by holding several different assets. Issues relating to diversification requirements are complex, and have been politically contentious in several countries. Should small business people be allowed to invest most or all of their individual retirement savings accounts in their businesses, for example, which may boost their long-term income if the business succeeds but leave them with nothing if the business fails? What about investing in the house that they occupy, which might allow them to pay off a mortgage faster and thus enter retirement with a lower drain on their income? Or concentrating most of their individual retirement savings in the stocks or bonds of their employers, if they work for a relatively large firm? Or putting all of their savings into a low-yielding bank account, which is insured against loss of principal by government but provides very limited opportunities for growth? All of these issues have surfaced in other countries. Note that Congress has successively broadened the conditions under which individuals are allowed to borrow against tax-advantaged retirement savings in the United States. Clearly such pressures would also be felt in an individual account system that was part of Social Security, as individuals asked why they could borrow against one form of retirement savings but not another.

There are no simple answers to these questions, but there is a principle that can help: the more that income from an individual investment account is expected to supply a "basic" level of income to a future retiree rather than supplemental income above a basic minimum or replacement rate, the stronger the case for investment diversification requirements and for prohibitions against borrowing. Certainly any type of account that is expected to supplant or offset current levels of Social Security income fits within the category of accounts where diversification requirements and borrowing prohibitions are essential.

4. Partial opt-outs from Social Security into individual accounts are not a compromise between the status quo and privatization but rather the worst of both worlds.

The mandate that President Bush gave to this commission was to develop a proposal that would permitworkers to shift some of their payroll taxes to individual retirement investment accounts but not require anyone to do so. Permitting rather than requiring sounds great. What could be more American? No one would be forced to do anything, but everyone would enjoy increased choice. But experience from abroad suggests that Social Security opt-outs pose some very serious problems.

Several advanced industrialized countries have adopted or, at least considered, mandatory savings programs for all workers. However, only the United Kingdom and (to a very limited degree) Japan use an opt-out approach for privatized pensions. In the U.K., an opt-out system emerged not as a planned outcome but as a by-product of the fact that earnings-related pensions were not adopted until the 1970s, after a private system of occupational pensions was already highly developed.

The British experience with opt-out public pensions offers a number of cautionary lessons about the perils of this approach. Social Security opt-outs have all of the disadvantages associated with mandatory saving through individual accounts—notably high administrative costs and increased risk across individuals and cohorts. But opt-outs also pose an additional set of problems not found in mandatory individual accounts. One problem with an opt-out reflects the fact that the present system offers higher returns on contributions of low-wage workers to help provide them with a decent retirement income. If an opt-out were available, higher-income workers would be more likely to opt-out, seriously undermining the current Social Security system's financing. Conversely, opting out of Social Security wouldn't make sense for many low-wage workers. But they're likely to be the least sophisticated investors, so they might opt out when they would be better off staying in the current system.

A second major opt-out problem is the differing returns offered by contributions to an individual retirement investment account during a worker's life. The earlier in one's career these contributions are made, the likelier they are to generate higher pension value. Conversely, contributions to Social Security are indexed for wage growth. Contributions of equal real value will provide relatively equal returns regardless of when they are made. As a result, many opted-out workers will find it advantageous to opt back into a state-defined benefit plan at some point. However, British experience suggests that it is unclear where that point is, given uncertainties about future returns on investments and prices for annuities. Given the complex and confusing choices faced by British workers, it is no wonder that when the U.K.'s Financial Services Authority recently prepared a decision tree to help individuals make pension choices, almost all paths led to the same end point: consider getting professional financial advice.

In the U.K., incentives to opt back into the state pension have been addressed through age-related rebates for National Insurance contributions: older workers get higher rebates as an incentive to continue to opt out of state pensions. These age-related rebates make the British system complicated and expensive to administer. Age-related rebates make even less sense in the U.S. system, where there is a closer linkage between contributions and benefits. The absence of general revenue financing in Social Security means that more generous Social Security contribution rebates for older workers would undermine the financing of Social Security as a whole. An alternative solution would be to require young workers to make a one-time, irrevocable choice to opt-out or opt-in from Social Security. But this option is almost certainly not appropriate given unforeseen changes in earning potential, and it is even less likely to be politically sustainable.

Problems concerning who should opt out and when to opt back in raise a third critical problem with opt-outs: To whom could workers turn for impartial advice on whether opt-outs were an appropriate choice for them? Pension fund providers and many financial advisers have a vested interest in selling their products. And the Social Security Administration would likely resist such a role under intense pressure from the administration, Wall Street and the pension industry not to weaken the message that privatization is a good thing.

Unfortunately, the outcome in the United States could mirror the British experience: workers may respond to high pressure sales practices by pension providers who "mis-sell" pension products. In the U.K., mis-selling in the late 1980s is estimated to have cost more than 15 billion dollars. Were this to happen in the U.S., litigation would surely follow. A U.S. pension mis-selling scandal could be the biggest boon to trial lawyers since the Ford Pinto.

In short, opt-out plans for Social Security impose too much additional complexity in an already very complex pension system. Potential implementation problems could undermine the legitimacy of both Social Security and the private pension industry. While universal mandatory savings plans have merit, they should be considered as a supplement to rather than an opt-out from Social Security.

Conclusions

In closing, I would like to leave you with five thoughts, most of which reflect my political scientist's orientation to issues of pension program design, implementation and political viability.

First, investment of Social Security funds in a broader range of financial instruments, whether done collectively or through individual accounts, is not a panacea that will solve all of Social Security's long range funding problems, which flow from the demographic bulge of the Baby Boom's retirement and more fundamentally from longer life expectancies. To use a nutritional metaphor, collective or individual investments in equities are not a free lunch that will cause this financial problem to disappear, but more like a healthy snack that can help to make it more manageable.

Second, any proposal that the Commission recommends should have as a central objective strengthening the long term financial viability of the current defined benefit system. Social Security is by far the most popular federal program, and the most successful in reducing poverty. Defined benefit replacement rates are very low in comparison to most other advanced industrial countries. Any plan that is perceived by the public as weakening the ability of Social Security to pay currently promised defined benefits—and almost all opt-out plans fit in this category—will be political non-starters, moving the debate on Social Security reform backward rather than forward. Any plan that does not reduce the projected long-term deficit is no plan at all. The Bush administration's Social Security proposals suffer from a widespread perception that it is a mechanism to send billions of taxpayers' money to Wall Street for the administration of individual accounts. Unless this perception is credibly addressed, policy stalemate and heightened political division are the likely outcomes. Strengthening Social Security is likely to require going beyond the Commission's mandate to design a viable opt-out system: as talented as this group is, being given a mandate to make two plus two equal five doesn't mean that it can be done.

Third, getting program design right is as important as the choice between individual accounts and collective investment. For collective investment, it is imperative that a strong set of protections be put in place to prevent political interference in investment decisions. As noted above, I believe that both foreign experience and experience with state retirement systems and the Federal Employee Retirement System suggest that these risks are manageable. Individual accounts pose a far more complex set of design issues, including how to prevent the erosion of accounts by administrative expenses, minimizing risks posed by market fluctuations in asset values and annuity prices, whether and how to require conversion of account balances into income streams, and whether or not to allow inheritability of fund balances if a worker dies before retirement or shortly thereafter. Again, there are better and worse solutions to these issues. I believe that any move to individual accounts should focus on lowering administrative and marketing costs and should be integrated as much as possible with the current program in terms of conversion of fund balances into retirement income streams.

Fourth, even if the commission does recommend a system of individual accounts, some element of collective investment is still desirable, and probably necessary. It will still be desirable to increase the returns on the surpluses in the Social Security trust funds, and it will probably be necessary to have collective funds to deal with individuals who do not make a choice among funds and to deal with transitional periods between when funds are collected and when they can be attributed to individual accounts.

Finally, although it is important to preserve the current, relatively modest level of Social Security defined benefits, that benefit is clearly insufficient to provide a retirement income that most Americans will find adequate. The federal government should do more to encourage individual savings for retirement by its citizens. This can be done in a number of ways. A broader public education campaign modeled after the "Choose to Save" campaign by the American Savings Education Council and Employee Benefit Research Institute could be useful in increasing public awareness of the importance of retirement savings. More direct steps to encourage retirement savings among all income groups should also be undertaken. The 2001 tax bill makes important strides in this direction for upper-income workers, but more needs to be done to help low-income workers who cannot save enough on their own by providing tax subsidies or direct subsidies to these workers. Strengthening Social Security should be the keystone of a broader effort to improve the retirement income system in the United States.

Authors

R. Kent Weaver

Publication: President's Commission to Strengthen Social Security

For Social Security, Opt-outs Don't Add Up

R. Kent Weaver — Fri, 24 Aug 2001 00:00:00 -0400

As President Bush enjoys his month-long vacation, the process he set up to reform Social Security is seriously off track. Critics have derided the commission he appointed to brainstorm reform proposals as stacked, charging its preliminary report was biased.

There is a more fundamental problem with Mr. Bush's Social Security strategy. The mandate he gave the commission—to develop a proposal that would permit, but not require, workers to opt out and shift some of their payroll taxes to individual retirement investment accounts—is unworkable. Permitting, not requiring, sounds great. What could be more American? No one is forced to do anything, but everyone would enjoy increased choice.

But experience from Britain, the only other advanced industrial country that uses the opt-out in a major way, suggests that Social Security opt-outs have all of the problems associated with universal mandatory saving—notably high administrative costs and increased risk. In short, they're a financial and administrative nightmare. One problem with an opt-out reflects the fact that the present system offers higher returns on contributions of low-wage workers to help provide them with a decent retirement income. If an opt-out were available, higher-income workers would be more likely to opt-out, seriously undermining the current Social Security system's financing.

Conversely, opting out of Social Security wouldn't make sense for many low-wage workers. But they're likely to be the least sophisticated investors, so they might opt out when they would be better off staying in the current system.

Contributions to Social Security of equal real value will provide relatively equal returns regardless of when they're made.

As a result, many opted-out workers will find it advantageous to opt back into Social Security at some point. It's unclear where that point is, however, given uncertainties about future returns on investments and prices for annuities.

In Britain, incentives to opt back into the state pension have been addressed through age-related rebates for National Insurance contributions. Older workers get higher rebates as an incentive to continue to opt out of state pensions. These age-related rebates make the British system complicated and expensive to administer.

Age-related rebates make even less sense in the U.S. system, in which there is a closer linkage between contributions and benefits. The absence of general revenue financing in Social Security means that more generous Social Security contribution rebates for older workers would further undermine the financing of Social Security.

An alternative solution would be to require young workers to make a one-time, irrevocable choice to opt-out of Social Security. But this option is almost certainly not appropriate and even less likely to be politically sustainable.

Problems concerning who should opt out and when to opt back in raise a third critical problem with opt-outs: To whom could workers turn for impartial advice on these issues? Not to pension fund providers or financial advisers; they have a vested interest in selling their products. And not to the Social Security Administration, which would be under intense pressure from the Bush administration, Wall Street and the pension industry not to weaken the message that privatization is a good thing.

Unfortunately, the result is likely to mirror the British outcome: Workers will respond to high-pressure sales practices by pension-providers who "mis-sell" pension products. In Britain, mis-selling in the late 1980s is estimated to have cost more than $15 billion.

Were this to happen in the United States, litigation surely would follow.

If the United States is to adopt a mandatory individual savings pension tier—and that's a big if—it should be required for all workers.

Potential implementation problems with opt-outs could undermine the legitimacy of both Social Security and the private pension industry. Mr. Bush would be well advised to use some of his vacation to rethink both his objectives for Social Security reform and his strategy for getting reform enacted.

If he doesn't, the problems with opt-outs mean that stalemate will surely follow.

R. Kent Weaver is a senior fellow in the Governmental Studies Program at the Brookings Institution and author of the forthcoming book Reforming Social Security: Lessons From Abroad.

Authors

R. Kent Weaver

Publication: The Baltimore Sun

Social Security's False Alarm

Alicia H. Munnell and R. Kent Weaver — Thu, 19 Jul 2001 00:00:00 -0400

When making their case to the American public, the forces committed to privatizing the Social Security system face a major challenge: the popularity of the current system. In order to sell their case for reform successfully, advocates for privatization must paint a picture of Social Security as teetering on the brink of crisis.

Unfortunately, the buoyant economy continues to push the date when the Social Security retirement and disability trust funds will be depleted further and further into the future. Currently, the trust funds are not expected to run out until 2038.

However, in the past few weeks, proponents of privatization, including members of the President's Commission on Social Security reform, have moved this "drop dead" date up. The real crisis date, they now say, is not 2038, but 2016 - the first year when the outflow of Social Security benefits would exceed the inflow of Social Security contributions.

This argument is incorrect. It implies that the taxes in excess of benefit payments that working people have paid to prefund the system since 1983 are worthless. It implies that the federal government is not going to honor its claims when the trust funds seek to redeem the bonds it has acquired with the excess payroll taxes. Neither is true.

The excess payroll taxes that have been used to build up reserves in the trust funds have increased national saving and in recent years have helped pay down the debt. In this way, the very real sacrifice of today's workers has boosted investment and enhanced our capacity to pay future benefits.

Once Social Security benefits exceed contributions in 2016, the system can continue to pay benefits by redeeming the bonds held in the trust funds. Neither Social Security nor private pension funds hold "real assets'' in their portfolio; they both hold IOUs or the paper promises of some public or private entity to pay interest or dividends. In both cases, the value of the assets depends on the willingness of someone to redeem them. Private sector portfolios rely on US bonds as their bedrock security, because government obligations are more certain to be redeemed than those issued by the private sector.

The government not only has the means to pay, but it is inconceivable that lawmakers would allow the government to default on its obligations.

The argument that the federal government will have to raise taxes or cut spending to redeem Social Security in 2016 does not make the system's assets any less "real." If General Motors or IBM redeemed the government bonds in their pension funds, the Treasury would also have to raise new funds to pay them off. The bonds in the Social Security trust funds are just as valuable as the bonds in private pension funds. And the date to worry about is 2038, when the trust funds are exhausted, not 2016.

Social Security is facing a long-term financing shortfall that needs to be fixed. Many options exist to solve the problem. Raising a false alarm just confuses the issue.

Alicia Munnell is Peter F. Drucker professor of Management Sciences and director of the Center for Retirement Research at Boston College. R. Kent Weaver is a senior fellow in governmental studies at the Brookings Institution.

Authors

Alicia H. Munnell
R. Kent Weaver

Publication: The The Christian Science Monitor

How to Privatize Social Security

Alicia H. Munnell and R. Kent Weaver — Mon, 09 Jul 2001 00:00:00 -0400

In the past few weeks, proponents of Social Security privatization, including members of the president's commission on Social Security reform, have introduced a new argument for dramatically restructuring the system. They claim that the assets contained in the Social Security trust fund are not "real" but merely IOUs from the government. This assertion is wrong—and would be obviously so if Social Security were able to acquire corporate equities and bonds in the same way that private pension funds, public employee pension funds and the Canada Pension Plan (the Canadian equivalent of Social Security) do.

Holding private-sector assets would produce higher returns for Social Security trust funds. It also would smooth the transition of Social Security from a vehicle that finances government debt to an entity that receives payment from the government.

Those in the privatization lobby oppose broadening investment options for Social Security. They claim that such funds would be subject to political interference and that they would be so big as to disrupt private capital markets. But little evidence supports the first concern, and the latter "problem" easily can be prevented.

State and local pension plan funds, the Federal Thrift Savings Plan for federal employees and the Canada Pension Plan all have achieved excellent financial returns while keeping costs low and avoiding political interference in investment decisions.

How? First, they have explicit organizational mandates to maximize return on contributors' investment. Second, they have independent boards of trustees, whose members generally serve long terms. Third, they contract out portfolio management on a competitive basis. Finally, they emphasize investment in broad indexed investments.

This is not financial rocket science. With tens of millions of current and future Social Security beneficiaries watching, Congress certainly would maintain a hands-off policy. Once concerns about political interference have been addressed, worries about the size of public investment funds can be resolved in a number of ways.

One answer is to limit the size of a fund, creating new funds that are separately (and privately) managed once the public fund reaches a certain size. This practice is already used in Sweden, which has six funds to manage accumulated surpluses in its partially funded public pension system. The government has put limits on how much of a single firm—and of the total market—can be owned by individual funds and by all the funds collectively.

But how big is too big? One standard would be to limit the size of any one Social Security investment fund to roughly the size of the largest private investment firm. In 1999 Fidelity was the largest, with 3.3 percent of domestic equities, followed by Barclay's Global Investors with 2.1 percent and State Street Global Advisors with 1.6 percent. Once a Social Security investment fund reached, say, 3 percent of the market, it would not receive any new investment funds from Social Security surpluses. Instead, the government would establish a new investment fund, again privately managed, to receive new funds. A somewhat more convoluted mechanism for limiting size would involve distributing Social Security funds among fund managers in proportion to 401(k) contributions.

While the logistics and costs of establishing and administering a system for Social Security investments are not inconsiderable, they are minute compared with the costs of setting up roughly 100 million individual accounts, many of which would receive small and irregular contributions from low-earners. A system of investing the trust fund reserves in equities would pay out far less in fees than an individual account system—which is why most fund managers favor the latter.

Building up Social Security reserves and investing them in private-sector securities offers the advantages of individual accounts without the risks and costs. It has the potential to increase national saving and offers participants the higher risk-higher returns associated with equity investment.

By pooling investments and keeping transaction and reporting costs to a minimum, collective investment would produce higher net returns than personal saving accounts. But unlike personal saving accounts, a partially funded Social Security program with equity investments ensures predictable retirement incomes by maintaining a defined benefit structure that enables the system to spread risks across the population and over generations.

Authors

Alicia H. Munnell
R. Kent Weaver

Publication: The Washington Post

The Politics of TANF Reauthorization: Panel II

Thu, 25 Jan 2001 00:00:00 -0500

Event Information

Falk Auditorium
The Brookings Institution
1775 Massachusetts Ave., NW
Washington, DC

Participants

Moderator

Panelists

Alan Weil

Director, Assessing the New Federalism project, The Urban Institute

Jeffrey M. Johnson

President & CEO, National Center for Strategic Nonprofit Planning & Community Leadership

Judith Gueron

President, Manpower Demonstration Research Corporation

Robert Greenstein

Executive Director, Center on Budget and Policy Priorities

Robert Rector

Senior Research Fellow, The Heritage Foundation

Susan Golonka

Program Director for Welfare Reform, National Governors' Association

Welfare Reform Reauthorization: An Overview of Problems and Issues

Isabel V. Sawhill, R. Kent Weaver and Ron Haskins — Wed, 03 Jan 2001 00:00:00 -0500

Executive Summary

Although the 1996 welfare reform legislation has produced a number of positive outcomes, there are serious issues facing the 107th Congress as it prepares to reauthorize the legislation by October 1, 2002. This policy brief discusses 13 important issues associated with the legislation and the controversy surrounding each of them. The issues include: funding of the Temporary Assistance for Needy Families (TANF) program and whether states will retain the level of funding and flexibility in program design and operation they currently enjoy; the growing concern that some families are worse off as a result of sanctions or time limits, or because they failed to find or retain jobs after leaving welfare; and the concern that too many children are being reared by single mothers. Also at issue for the new Congress is whether there is enough money for child care, if more assistance should be provided to working poor families, and whether more should be done to help mothers qualify for better jobs.

On August 22, 1996, President Clinton signed legislation that substantially transformed the American welfare system. Many of the new law's provisions, including the TANF program, which replaced the Aid to Families with Dependent Children (AFDC) program, were authorized for six years.

Timing of the Reauthorization Debate

Given the magnitude of the 1996 legislation, there is little question that reauthorization will be a major issue for the new Congress and the new administration, beginning with congressional hearings in 2001 and concluding with reauthorizing legislation that will probably move through the House and Senate during the summer and fall of 2002. It can be expected that there will be extensive hearings by the eight or more committees of jurisdiction in the House and Senate, that the leadership of the House and Senate committees will introduce their own reauthorization bills, that the governors will want a seat at the table during the debate, and that many of the lobbying organizations that played such an important role in passage of the initial 1996 legislation will seek to be actively involved.

In addition to congressional hearings, the Congressional Research Service and the General Accounting Office will publish a score or more reports on various aspects of welfare reform, many of them based on research findings. But the congressional committees with jurisdiction over TANF and related programs will in all likelihood not introduce legislation until late 2001 or early 2002. The Committee on Ways and Means and the Committee on Education and the Workforce in the House will likely act first, bringing a joint bill to the House floor sometime in the late spring or early summer of 2002. The Senate, if it has not acted earlier, will then probably enact its own version of the House bill in late summer. A House-Senate conference committee will fashion the final bill in the fall of 2002.

Purposes of the 1996 Reforms

A question that will pervade the reauthorization debate is what the real purpose of the TANF program is. The 1996 legislation stated that the purposes of the program were to assist needy families, fight welfare dependency by promoting work and marriage, reduce nonmarital births, and encourage the formation and maintenance of two-parent families. Conservatives wanted to emphasize the work and family formation issues while many liberals, although appreciating the emphasis on work, were equally concerned with ensuring benefits and adequate income for needy families.

In the reauthorization debate, the tension between these various goals will continue. Although the restoration of the pre-TANF entitlement to cash benefits seems unlikely, there is bound to be extensive discussion of the provisions that limit benefits for needy families, notably the five-year time limit and sanctions. And given the number of low-income mothers who are now employed, new attention may be paid to the goal of assisting the working poor.

Structure of the TANF Block Grant

The TANF block grant was established as an essentially fixed sum of $16.5 billion per year through fiscal year 2002. A first area of potential conflict during reauthorization is the overall size of the block grant. Fiscal conservatives note that TANF block grant funding levels were set when welfare caseloads were much higher than they are now. Moreover, some states are not using their full TANF block grant allocations.

States argue that Congress initially urged them to build TANF surpluses during prosperous times (because the annual grant level is declining in real terms, and will no longer adjust automatically when the economy goes downhill and caseloads rise), yet now complains when the states do exactly that. If states did spend all their TANF funds now, there is little doubt that when the economy turns sour, federal legislators would change their tune and criticize the states for profligate spending during boom times. Congress is likely to consider several options for the overall structure of the TANF block grant during reauthorization, including smaller annual funding and/or building some counter-cyclical element into the block grant.

A second potential area of conflict is the formula for allocating the TANF block grant among states. The share apportioned to individual states is based on states' historical allocation of federal AFDC funds. Largely because of state choices in benefit levels under the old AFDC program, poorer states generally receive far fewer federal TANF dollars per poor child than wealthier states. While this may have been justified in the AFDC program, because it was based on a matching formula designed to encourage state spending, it makes little sense with a fixed block grant. Defenders of the status quo argue that whatever the shortcomings of the current allocation formula, reopening the issue is likely to fragment support for TANF and may result in lower overall funding levels.

A third issue is reauthorization of the TANF provision that allocates additional funds to states that have high levels of poverty and high growth rates. Unlike TANF itself, this provision expires in 2001. A total of 17 states now receive money from this supplemental fund which they will lose if the provision is not reauthorized. The debate will be further complicated by the fact that money for this provision is not assumed in the CBO baseline. Thus, Congress must find a funding offset of about $3 billion over five years if the fund is to be reauthorized.

Floundering Families

Another important problem is that a subset of families has not responded well to the new welfare requirements. Before 1996, adults with problems could stay on welfare year after year without having to meet any work or training requirements. But now, most families are being subjected to such requirements and some families appear to be unable to meet them. Studies of mothers leaving welfare show that around 20 percent of them go through long periods without work and many more are without jobs from time to time. Census Bureau data suggest that many of these mothers are likely to live with others—either relatives or boyfriends—who have income, but the stability of these arrangements is unclear. In addition, Census Bureau data show that in 1995 and 1996, mothers with total incomes below about $11,000 actually experienced declines in their total income. Finally, while the overall poverty rate has dropped consistently since 1995, the rate of families in deep poverty (below half the federal poverty level) has actually increased.

Research conducted at the University of Michigan and at the Urban Institute shows that these floundering families often have multiple barriers to employment. These barriers include addictions, disabled children, emotional illnesses, domestic violence, lack of work experience, and poor education. Several states are now developing programs to help these families, but a major question that looms is whether cash welfare will be needed for more than 5 years for such mothers.

These mothers used to simply stay on welfare where they were more or less invisible. Now that mothers are expected to leave welfare by finding a job, the problems of this seriously disadvantaged group are coming more clearly into view—as is the fact that not much is known about how to help them.

Congress will devote substantial attention to this problem and is likely to consider directing research funds at interventions designed to learn how adults with multiple barriers can be helped to hold jobs and become less dependent on welfare. Congress may also consider some loosening of the five-year time limit for families with multiple barriers to employment.

Family Formation

There are several reasons why so many children are growing up in poor, single parent families. The first is the continuing high rates of nonmarital births, including teen births. A concern for this problem animated Republicans during the debate on the 1996 legislation and many provisions to address the problem were included in the 1996 law. Although all the measures of nonmarital births have leveled off for the first time in half a century, and the rate of birth among teens has dropped every year for nearly a decade, the levels are still among the highest in the industrial world. Moreover, few states have made a concerted effort to develop policies to reduce nonmarital births. In fact, several researchers have reported that there is a reluctance among welfare caseworkers to broach issues of sex or marriage with clients.

A related reason for the growth of poor single-parent families is that marriage has declined precipitously, especially in poor communities. In the past, both the federal government and the states have been reluctant to become deeply involved in promoting marriage, in part because of the fear of stigmatizing single parents. However, recent years have seen some movement on this front. Oklahoma has established the promotion of marriage as a major goal of its TANF program and has formed a panel of researchers, practitioners, and advocates to advise the state about policies that can be adopted to promote marriage. In 2000, both Houses of Congress passed legislation that would have reduced the marriage penalty on low-income families receiving the Earned Income Tax Credit (EITC), a program that now provides cash assistance to over 19 million working families. The 107th Congress will almost certainly return to legislation designed to promote marriage among poor families, and to reduce the marriage penalty in the EITC.

Another reason for the growth of poor single parent families is deteriorating economic prospects among low-income fathers. As welfare reform and the strong economy lured millions of poor mothers into the workforce, many of the fathers of their children remained jobless. Indeed, Census Bureau data show that between 1992 and 1999, as the economy boomed and the labor force participation of 20- to 24-year old black females increased from less than 65 percent to nearly 80 percent, the labor force participation of comparable black males actually declined from almost 85 percent to less than 80 percent. By 1999, young black females had a higher employment rate than young black males. Congress has already signaled its interest in this issue by nearly passing legislation in the last session that would have funded a national network of programs designed to promote marriage, better parenting, and employment among poor fathers. Congress will undoubtedly return to this issue as part of the reauthorization debate.

Five-Year Time Limit and Sanctions

Two of the more controversial features of the 1996 law were the imposition of the five-year time limit on use of federal dollars to provide assistance to any adult and the mandatory use of financial sanctions against families that do not comply with program requirements. Given the raucous debate surrounding both of these issues, it would be a surprise if Congress failed to revisit these issues during reauthorization and if Democrats did not introduce legislation to soften the five-year time limit and the use of financial sanctions against recipients.

There are good studies on both of these issues. Briefly, the research on time limits shows that most recipients leave the rolls before the time limit hits, even in cases in which the time limit is much less than 5 years. Not surprisingly, one reviewer concluded that time limits have produced neither the strong positive effects expected by conservatives nor the strong negative effects predicted by liberals. Even so, it is clear that a substantial number of families will hit the five-year time limit in 2001 and every year thereafter.

States now have the flexibility to provide federally financed benefits beyond the five-year limit for up to 20 percent of their caseload and can use their own funds for families that have passed the time limit. But whether this will be enough flexibility to help all the families that hit the time limit—assuming states want to continue providing these families with some benefits or services—is an open question.

One policy reform that is bound to receive attention in the reauthorization debate is whether states should be allowed to stop the time-limit clock for recipients who are working some minimum number of hours per week—perhaps 25.

Research on sanctions shows that many states routinely use them. In some states, as many as a third of the cases are under sanction or have received a sanction, and 35 states use full family sanctions, meaning they can end the entire cash welfare benefit of families that fail to meet requirements. Some research suggests that states use sanctions against families that do not understand why they are being sanctioned and that sanctions are sometimes applied inequitably.

Congress will certainly want to examine these issues and some lawmakers are likely to support legislation that restricts the circumstances under which full family sanctions can be applied and that addresses issues such as adequate notice and due process rights.

Food Stamps and Medicaid

One of the most widely studied and agreed upon problems associated with welfare reform is that a large number of families who are eligible for food stamps and Medicaid are not receiving these benefits. Based on careful research in 12 states, for example, the Urban Institute found that many families leaving welfare are eligible for food stamps but are not receiving the benefit. Similarly, many investigators have shown that families and children are also not receiving the Medicaid coverage to which they are entitled.

The problem in both cases is not that changes in federal statutes during welfare reform rendered families and children ineligible for food stamp or Medicaid benefits. Rather, the problem appears to be that for some reason, families that are eligible under federal statutes do not participate. Under the old AFDC program, families that applied for welfare were automatically given food stamps and Medicaid. But under the TANF program, some applicants are diverted from the welfare program into work and never appear on the rolls, thereby missing out on food stamps and Medicaid. There is also much more turnover in the caseload. Studies show that once a family leaves AFDC or TANF, participation in food stamps and Medicaid declines, perhaps because families have not been informed that they retain eligibility. In addition, working families may find it too difficult and time consuming to report to welfare offices to confirm their eligibility, especially in states where families must actually visit the welfare office, and families with frequent changes of income may be put off by the continuous reporting requirements.

Impacts on Children

As noted earlier, there is little information on whether welfare reform is having an impact on children. On the positive side, the evidence we have suggests either small positive or no effects. However, there are still fears that, especially in the case of floundering families, children could go hungry, be left alone at an early age while their mothers work, or suffer more abuse and neglect as a result of increased stress on their mothers.

Child advocates and others will raise the concern that when the first recession hits or the first wave of families lose benefits as a result of the five-year time limit in 2001, the picture for children could take a sudden turn for the worse. There is little question that Congress will devote considerable attention to these issues during the reauthorization debate.

Child Care

Two child care issues will receive extensive attention during reauthorization: whether states have enough money to pay for care and whether available care is of sufficient quality.

The 1996 reforms created a child care block grant with about $4.5 billion more available for child care over the 1997 to 2002 period than under previous law. In addition, states were allowed to use money from their TANF block grant for child care. Regulating the quality of care was left to states and localities.

Although less than half the families leaving TANF for employment use child care funds, states nonetheless have used all the federal and state dollars in the Child Care and Development Block Grant (CCDBG) and have now used about $3 billion of their TANF funds for child care. Thus, states are purchasing much more care than ever.

Despite this increased funding, critics believe that even more federal spending is necessary, especially since families leaving welfare are provided with child care subsidies while similar low-income families that did not go on welfare but are eligible for subsidies often do not receive them. A widely-cited estimate from the Department of Health and Human Services suggests that existing child care block grant funding provides enough money to serve only 12 percent of all eligible low-income children. There is also continued concern about the quality of care and the federal role in promoting better care through federal or state regulation or by providing federal funds that states must use to improve quality.

Supports for Working Families

Assistance for the working poor has increased dramatically since the early 1980s, with expansions of the Earned Income Tax Credit being the most prominent example. But reauthorization will almost inevitably catalyze a debate about whether a mother who has moved into the low-wage job market has enough income to adequately support her family. Those who believe she does will point to the numerous benefits already available to such families, including the EITC, child care, food stamps, Medicaid, and enhanced child support. Further expansions are likely to be expensive and could lead to permanent dependence on government support. Others will press for more assistance, whether in the form of a higher minimum wage, an expanded EITC, greater subsidization of child care and health care, more money for education and training, or other work supports. They will argue that in the absence of such assistance, high rates of poverty and living at the margins of society are likely to continue.

Work Programs

The vision of those who supported work requirements in the 1996 reforms was that every state would have an increasing percentage of its caseload actively involved in work programs for 25 or 30 hours per week. However, because all states have reduced their caseloads and caseload reductions can be used to meet the work requirement, states have been able to meet the work requirements without starting programs in which welfare recipients work in exchange for their benefits.

Advocates of work programs may propose a requirement, separate from the current work participation standard, that states place some fixed percentage of their caseload, perhaps 20 percent or more, in work programs. Supporters of this proposal will argue that adults on welfare should work, that properly designed work programs provide valuable work experience to mothers with barriers to employment, and that having work experience positions available will be especially important as the rolls expand during recessions. States can be expected to vigorously oppose additional work participation mandates.

Child Support Enforcement

The child support program appears to be improving steadily. However, two problems seem nearly certain to receive attention during the reauthorization debate. First, as demonstrated by a 405 to 18 vote in the House during the 106th Congress, many members of Congress, and both conservative and liberal advocacy groups, believe more child support collections should be paid to families. Under current law, the state and federal governments can retain all payments by fathers while mothers are on welfare and around half the payments on overdue child support after mothers leave welfare. There seems to be nearly universal agreement that all payments on overdue child support should go to mothers, not the government, once mothers leave welfare, and somewhat less, but still considerable, agreement that mothers should receive at least part of the fathers' payment while they are still on welfare. Powerful members of Congress from both parties will make this issue part of welfare reauthorization.

Second, states can be expected to have increasing difficulty financing their child support enforcement programs. The average state now receives around 30 percent of the money it uses to finance its child support program from retained collections in welfare cases. Because the welfare caseload has been in such precipitous decline since 1994, these collections have shrunk. Some states are already experiencing this problem. As a result, states can be expected to come to Congress and ask for additional child support funding. The strong backing for distributing more collections to mothers on welfare will aggravate this problem, thereby making the issue even more important during the reauthorization debate.

Education, Job Retention, Job Advancement

There are three issues in this area that are likely to receive attention during the reauthorization debate. First, during the original debate on welfare reform, Democrats expressed great concern that the law did not place greater emphasis on education and training. At a minimum, there will almost surely be amendments to expand the number of hours of education that can count toward fulfilling the work requirement. Republicans may oppose these amendments on grounds that welfare mothers can combine work and education now, and that states already have enough flexibility to increase education even if it does not count toward the work requirement. Moreover, because of the rapid decline in the welfare rolls, states have much more money available for education than they had before welfare reform.

A second issue is that research shows clearly that mothers who leave welfare for work often lose their jobs in a few weeks or months. Some of the job terminations are voluntary and even those that are not may be caused by factors over which mothers have some control, such as missed work, lateness, or conflicts with peers or supervisors. Program operators and researchers believe that programs are needed that help mothers retain their jobs longer or find new ones quickly. A number of studies of model programs that attempt to help mothers adjust to the workplace and retain their jobs are now underway. Again, Congress is likely to search for ways to require or encourage states to launch such job retention programs.

Beyond helping mothers simply keep their jobs, a third important issue involves steps that states can take to help mothers achieve career advancement. Previous programs aimed at helping low-income adults train for and then obtain jobs that involve moderate to high levels of skill have not been very successful. But now that two million or so additional low-income mothers are working, the debate is likely to intensify about how to help them get the education and training they need for better jobs. A related issue is how to improve cooperation at the local level between TANF and the other federal and state programs designed to promote work. Congress may also debate measures allowing states to experiment with granting former TANF recipients who lose jobs greater access to unemployment insurance.

Policy for Recessions

As in 1996, there is bound to be extensive discussion of what will happen to mothers who leave welfare for jobs when the next recession hits. Many advocates fear that layoffs will disproportionately affect former welfare mothers because of their limited skills and experience. Moreover, most of the mothers who lose jobs do not qualify for unemployment insurance because they have not worked enough hours to qualify or because they left their job voluntarily.

During the 1996 welfare reform debate, most members of Congress wanted to ensure that states would have enough money so that unemployed mothers could return to welfare. Thus, the 1996 legislation contained a fund from which states could borrow money and a contingency fund that provided modest sums of money to states that suffered high unemployment or similar signs of economic distress.

These two measures, both modest, are widely perceived as inadequate to ensure that states will have enough money to pay benefits during recessions. Critics also point out that the old AFDC program automatically adjusted during recessions because increased federal funding flowed to states as they added new cases to the welfare rolls. This issue will be especially intense if the nation faces an economic slowdown during the reauthorization debate.

The Political Environment for TANF Reauthorization

Congress must act on TANF and related programs before October 2002. But several factors make changes as dramatic as those that were enacted in 1996 unlikely. The political impetus for dramatic reform has been tempered both by the 1996 law, which abolished the extremely unpopular AFDC program, and by dramatic declines in caseloads since the early 1990s. The absence of a strong commitment by President Bush to substantial reform (unlike 1992, when President Clinton promised to "end welfare as we know it") narrows the likely scope of reform and means that Congress may take the lead during reauthorization. And the very tight margins of control in Congress mean that neither conservatives nor liberals will have strong leverage for enacting their preferred reforms. The general satisfaction of the states with the status quo also weakens the impetus for reform.

Substantial uncertainties remain, however. The biggest unknown is the state of the economy during 2002, when Congress is most likely to be considering reauthorization legislation in detail. If the U.S. economy is in recession at that point, Congress is likely to give increased attention to problems confronted by floundering families—especially if there is evidence that mothers who have left TANF are having greater difficulty in obtaining and keeping jobs. A recession is also likely to lower legislators' concerns about states "hoarding" money, and increase the probability that provisions making the TANF block grant sensitive to economic conditions are added.

The other significant unknown is the content of the flood of research findings that will emerge over the next year. Findings that states are supplanting their funds with federal money, for example, would increase legislators' determination to put tighter controls on use of federal money. Research that shows deterioration in the welfare of children in the poorest families would certainly increase attention to problems of those families. What is critical over the next eighteen months is that policymakers have access to high quality, reputable and user-friendly interpretations of emerging research. Making that research available is the objective of this series of policy briefs.

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Welfare Reform: An Overview of Effects to Date

Isabel V. Sawhill, R. Kent Weaver and Ron Haskins — Mon, 01 Jan 2001 00:00:00 -0500

Executive Summary

The 1996 welfare law produced numerous, wide-ranging changes in state policies and practices. Greater emphasis is now being given to job placement in welfare offices in most states. Employment by single mothers, a group which in the past has been the least likely to work and most likely to be on welfare, is on the rise. Increased employment has led to higher earnings and declining welfare payments to poor and low-income families. Similarly, starting in 1994, there have been substantial declines in overall child poverty and the largest declines ever in black child poverty. In addition, after increasing for decades, nonmarital births have leveled off; and teen births have declined significantly since the early 1990s. Although the evidence of the law’s impact on children is sparse, most researchers conclude that for young children, the results are either neutral or slightly positive in areas such as school behavior and school performance. Some of the good news must be attributed to a strong economy. Moreover, the research also shows there are problems associated with welfare reform. For example, some unemployed families are financially worse off and some families eligible for Medicaid and food stamps are losing those benefits when they leave the welfare rolls. These and other problems merit careful attention and, possibly, action by the 107th Congress during the upcoming reauthorization debate.

On August 22, 1996, President Clinton signed legislation that substantially transformed the American welfare system. Many of the new law's provisions, including the Temporary Assistance for Needy Families (TANF) program, which replaced the Aid to Families with Dependent Children's (AFDC) program, were authorized for six years. Thus, with a deadline of October 1, 2002, the 107th Congress must reauthorize the welfare reform legislation (see Appendix Table 1 for summary).

The 1996 legislation provoked extensive research on many facets of the law and its implementation, making it one of the most closely-examined pieces of social legislation in recent decades. The law itself contained numerous provisions funding research and evaluation studies, and many non-profit foundations have also funded studies of the law's major provisions. Moreover, a great deal of research on issues addressed by the legislation was already underway at the time of its passage in 1996. Finally, many states have conducted their own research, especially on what happens to families that leave welfare. The available research has the potential to play a vital role in the reauthorization debate, but it must be synthesized, organized, and interpreted so that members of Congress, their staffs, and the policymaking community can use what has been learned about the effects of the 1996 legislation as a basis for considering changes in old policies or the initiation of new policies. This series of policy briefs from the Brookings Institution will attempt to do just that.

The appendix to this policy brief describes the welfare reform law in some detail. Six major programs were reformed by the 1996 legislation. The programs include AFDC, the Supplemental Security Income (SSI) program for children, child support enforcement, child care, food stamps, and child nutrition. In addition, the new law put considerable emphasis on reducing nonmarital births and welfare benefits for aliens. These changes are also described in the Appendix.

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Ending Welfare as We Know It

R. Kent Weaver — Thu, 10 Aug 2000 00:00:00 -0400

Brookings Institution Press 2000 352pp.

Bill Clinton's first presidential term was a period of extraordinary change in policy toward low-income families. In 1993 Congress enacted a major expansion of the Earned Income Tax Credit for low-income working families. In 1996 Congress passed and the president signed the Personal Responsibility and Work Opportunity Reconciliation Act. This legislation abolished the sixty-year-old Aid to Families with Dependent Children (AFDC) program and replaced it with a block grant program, Temporary Assistance for Needy Families. It contained stiff new work requirements and limits on the length of time people could receive welfare benefits. Dramatic change in AFDC was also occurring piecemeal in the states during these years. States used waivers granted by the federal Department of Health and Human Services to experiment with a variety of welfare strategies, including denial of additional benefits for children born or conceived while a mother received AFDC, work requirements, and time limits on receipt of cash benefits. The pace of change at the state level accelerated after the 1996 federal welfare reform legislation gave states increased leeway to design their programs. Ending Welfare as We Know It analyzes how these changes in the AFDC program came about. In fourteen chapters, R. Kent Weaver addresses three sets of questions about the politics of welfare reform: the dismal history of comprehensive AFDC reform initiatives; the dramatic changes in the welfare reform agenda over the past thirty years; and the reasons why comprehensive welfare reform at the national level succeeded in 1996 after failing in 1995, in 1993-94, and on many previous occasions. Welfare reform raises issues of race, class, and sex that are as difficult and divisive as any in American politics. While broad social and political trends helped to create a historic opening for welfare reform in the late 1990s, dramatic legislation was not inevitable. The interaction of contextual factors with short-term political and policy calculations by President Clinton and congressional Republicans-along with the cascade of repositioning by other policymakers-turned "ending welfare as we know it" from political possibility into policy reality.

ABOUT THE AUTHOR

R. Kent Weaver

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Time to Stop the Perennial Bidding Wars Over Super

R. Kent Weaver — Wed, 03 May 2000 00:00:00 -0400

The recent Dialogue page exchange between Simon Upton and Michael Cullen on superannuation policy was a depressing variation on old themes in superannuation politics.

The major party in Government claims that only its policies can produce a sustainable superannuation programme, while the parties out of power criticise these proposals as unnecessary or counterproductive. Government and Opposition point fingers at the other for past transgressions against the elderly or fiscal good sense.

New Zealand needs to escape from the cycle of excessive promises at election time followed by cuts imposed under urgency that have so poisoned superannuation politics.

This 25-year period should teach us that both bidding wars for the electoral support of senior citizens, and Treasury efforts to use superannuation cuts for short-term budget-balancing purposes, are disruptive and counter-productive.

Several modest steps should be taken to provide a new direction.

The first is restoring a multi-party accord. In disestablishing the Super 2000 Task Force, the Government argued that it was not needed because it had a superannuation policy. It is not, however, a policy that enjoys support on the other side of Parliament.

The experience of the 1990-92 Todd Task Force suggests that an independent body can help to build a multi-party agreement. And experience since then suggests that building consensus is not something that politicians are capable of doing on their own.

To rebuild consensus, the Government should move up the next scheduled report of the Periodic Reporting Group on the (semi-defunct) retirement incomes accord, scheduled for 2003, to next year. To build confidence in this body, the Government should gain the agreement of National and the Alliance—and preferably other parties—on the group's membership.

Secondly, governments must stop using urgency to pass superannuation law. It has been used repeatedly over the past two decades to avoid criticism and obstruction by opposition parties. This is not only undemocratic but has caused governments to make judgments of monumental stupidity. Policies that proved to be politically unsustainable, most notably in Ruth Richardson's 1991 budget, were pushed through.

To restrain such policy changes, Labour has floated the idea of entrenching superannuation legislation, making it amendable only through special parliamentary super-majorities or a referendum.

If, however, the present arrangements for changing superannuation policies are too flexible, Labour's proposal would make them too rigid. There is a sensible middle-ground: going into urgency on superannuation legislation should require the support of 60 per cent of MPs.

The Government could still enact superannuation legislation through normal channels. It could even repeal the new rule if it wished - but there would be an added moral and political sanction against doing so. This change would result in more deliberation before action was taken, better legislation and less voter cynicism about broken promises.

Thirdly, a modest, phased-in superannuation surcharge should be reimposed. No element of superannuation politics has been more controversial than the surcharge. Many people were justifiably outraged about the instability of their pension incomes as governments repeatedly altered the structure of the surcharge. And a small number of better-off seniors, after a lifetime of paying taxes, received no superannuation benefit at all as their benefits were clawed back.

Again, a middle ground is possible. New Zealand should consider reimposing a modest surcharge on the incomes of better-off seniors, but with three important limitations.

It should be modest in scale, no more than 20 per cent above normal income tax rates, and with a substantial income disregard before it takes effect. It should be capped: instead of taxing back all superannuation benefits, well-off recipients should retain a minimum of one-third of their benefit.

And a surcharge should be phased in gradually, applying only to future retirees. Today's retirees should not be subjected to a cut in their incomes for which they would not plan.

In short, a surcharge should be part of a broader effort to build a univeral, sustainable and equitable New Zealand Superannuation—not as part of an effort to balance governments' books in the short run.

Modest retirement savings incentives should also be established. New Zealanders receive three very inconsistent sets of signals about the importance of savings for retirement.

The Office of the Retirement Commissioner runs a campaign telling them that such savings are extremely important. The Treasury says that while saving in general is important, retirement savings are not more important than any other form of savings (such as paying off a mortgage) and, therefore, should not receive any special incentives.

And the tax system discourages retirement savings by taxing all employer contributions to registered superannuation schemes at 33 per cent, even for employees in lower tax brackets.

Is it any wonder that employers increasingly have decided simply to give employees cash rather than making contributions to superannuation schemes?

New Zealanders need to receive more consistent signals about the importance of saving for retirement. A modest step in that direction would be to tax the first $5000 in employer contributions a year to a super scheme for each employee at the lowest income tax bracket, rather than at the highest rate. This would not provide an adequate supplemental income to retirees, but it would be a start, and it would get them in the habit of saving.

None of these steps, individually or collectively, is a panacea for superannuation policy. The country still faces a very serious funding crisis as the baby boom generation retires after 2015.

But panaceas are not what New Zealand needs now. It requires small, solid steps to restore confidence and to dampen the poisonous atmosphere surrounding superannuation that the country's politicians have created.

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R. Kent Weaver

Publication: The New Zealand Herald

It Ought to Be Easier to Change Presidents

R. Kent Weaver — Wed, 28 Jan 1998 00:00:00 -0500

If the U.S. had a parliamentary system, the Clinton presidency would already have been consigned, in Augustine Birrell's felicitous phrase, to the great ash heap called history. In parliamentary systems, the head of government and head of state are different offices. The head of state is usually a powerless figurehead, like Britain's (and Canada's and Australia's) Queen Elizabeth; sometimes an excruciating embarrassment, like Austria's Kurt Waldheim; occasionally a symbol of national pride, like the Czech Republic's Vaclav Havel.

In parliamentary systems, heads of government must maintain the confidence of their legislature, and of their party. Usually they're elected for fixed terms or, in constitutional monarchies, until they die or abdicate. And when they do go, the impact on policymaking is usually minimal.

Heads of government are a different story. They must maintain the confidence of their legislature, and of their own party. If they don't, they're out. New Zealand Prime Minister Jim Bolger was recently deposed in a Cabinet coup for the horrific sin of being unpopular with the electorate. Others, like Canada's Brian Mulroney and Britain's Margaret Thatcher, met the same fate, although sometimes with the face-saving facade of voluntary resignation.

Scandal, too,—financial, sexual, or otherwise—can do in prime ministers. Think of poor Willy Brandt, who had the misfortune of having an East German spy as a top adviser. And in countries where coalition governments are the norm, one or more parties in the coalition may withdraw their support, causing the prime minister and his or her government to resign. In Italy, it's as common as eating pasta.

Not in the US. In this country, we elect presidents for fixed terms. And the president is viewed as a symbol of national unity—even when elected with a plurality of the vote. Thus residents stay in office even when they are incapacitated, like Woodrow Wilson, or discredited, like Herbert Hoover.

Absent a smoking gun that makes impeachment politically viable, a wounded president can stay in office until the end of his term. Proponents of a shift to parliamentary institutions, like Lloyd Cutler, have long viewed the difficulty of getting rid of presidents who have outlived their usefulness to the country as one of the central weaknesses of our current institutions.

It doesn't need to be that way.

And it's time for a change.

No, not a change in our institutions. The hurdles to changing our Constitution make even considering such a move a waste of time. It's time for a change in our beliefs about the presidency, and in the behavior of our presidents. We should stop believing that an election every four years gives the presidential incumbent a divine right to rule unless he dies or commits an impeachable offense. And presidents should start considering whether, when their administration seems mired in scandal or simply spinning its wheels, it might not be better to give the country a fresh start, with a new face at the top—a face they had enough confidence in to choose as their running mate. Not because there is no alternative, but because it would be better for the country.

It's not a change without potential costs. If the political barrier to getting rid of a president is lowered from an impeachable offense to merely an embarrassment and a political cost to the governing party, then the opposition party may declare open season on the president, hoping to drive him out of office on the slightest pretext.

That's possible, but doesn't seem very likely. Appearing to have a vendetta against the president can generate a backlash, as it has against independent counsel Kenneth Starr. And if it results in a more popular replacement entering the presidency, campaigning to get the president out of office can have even higher costs. It's likely that even if completing a four-year term was no longer viewed as a sure thing, it would remain the norm. Only presidents like the current one who, whatever their other abilities, seem to have extraordinarily poor judgment in one or more areas of their personal or political lives, are likely to be threatened by such a change.

If we citizens changed our beliefs, and presidents changed their behavior, a presidential resignation would not necessarily be seen as a sign that the incumbent was one step from the paddy wagon, but rather that the president was willing to put the interests of his country and party above personal considerations of pride and comfort in office. Such a president might be viewed more kindly by history than one who overstayed his or her welcome.

Changed public expectations and changed presidential behavior won't come easily or quickly. But change can and should come. And now seems like a pretty good time to start.

Authors

R. Kent Weaver

Publication: The The Christian Science Monitor

Reinventing Welfare... Again: The latest version of reform needs a tune-up

Gary Burtless and R. Kent Weaver — Mon, 01 Dec 1997 00:00:00 -0500

Welfare reform was the focus of fierce partisan debate in the last Congress. President Clinton promised to "end welfare as we know it" in his 1992 campaign, but failed to submit reform legislation in time for congressional Democrats to act on it before they lost their majority in the 1994 election. Last winter, Clinton vetoed the Republican Congress's budget reconciliation bill and a stand-alone welfare reform bill. Both would have fundamentally restructured the safety net on GOP terms. Last August Congress passed a modified version of the Republican plan—the Personal Responsibility and Work Opportunity Act—and the president signed it over the objections of many Democrats in Congress and senior officials in his own administration.

While the new law may appear to settle the issue of welfare reform, at least temporarily, political pressures and implementation problems could soon put it back on the congressional table. Even as he signed the welfare bill Clinton promised to try to soften some of its harshest provisions. Social conservatives, disappointed that most of their preferred remedies for illegitimacy were left out of the new law, may also press for change.

Welfare has been on the nation's agenda for more than two decades. It is deeply unpopular. Most voters believe that the old Aid to Families with Dependent Children program discouraged work and encouraged illegitimacy and family breakup. It provided too little help to keep families from falling into poverty, but too few incentives to push able-bodied adults into self-sufficiency. The 1996 reform addresses some of AFDC's worst problems, but it creates some big new problems for state and federal policymakers. And it imposes serious and unnecessary risks on the nation's poorest children. To improve their prospects, welfare should be fixed—again.

The New Welfare Law

The new welfare law changes the nature, organization, and financing of a vital part of the U.S. safety net. Under AFDC, Washington offered states open-ended grants for cash welfare benefits for needy children and their adult caretakers. States had to match the federal dollars to get the grants, but federal spending had no fixed limit. States were free to define need, establish benefits, and determine eligibility, leading to a great deal of interstate variation.

The new law replaces AFDC with a federal block grant called Temporary Assistance for Needy Families. Though small exceptions will be made for low-income states with fast-growing populations and states in recession, most states' TANF grants will be determined by their federal AFDC grants during the past few years. The new law ends the individual entitlement to benefits. Under new state programs, poor children may no longer be automatically entitled to cash benefits. The new law gives states more program flexibility in many areas, but it also imposes new federal requirements. For example, each state must ensure that a rising percentage of its adult aid recipients engages in approved work. The head of each family on welfare will now be required to work within two years after cash payments begin. Work hours requirements are stringent, and states will face increasingly harsh penalties for failing to meet them. The Congressional Budget Office estimates that states would have to invest about $14 billion of their own money over 1997-2002 to meet the new work requirements.

States cannot use the TANF grant to pay benefits to a family for more than 60 months; they can limit benefits to fewer than 60 months if they choose. They can use existing federal social service funds to provide noncash benefits to families after 60 months. Up to 20 percent of a state's caseload can be exempted from the 60-month limit for hardship reasons. Unlike earlier versions of the GOP welfare bill, the new law does not require (but does permit) states to deny benefits to unmarried teen mothers and to impose family caps. (A cap denies higher monthly payments to families into which children are conceived or born while the mother is receiving welfare.)

Predicting the impact of the new law is not easy. It is not clear, for example, how quickly or well states will implement the new work programs. No one knows how states or aid recipients will react to incentives in the new law. How many recipients, facing the five-year time limit, will find work in the private sector? How many states will use their own resources to pay for aid to recipients who exhaust their eligibility for federal benefits? Will competition among states lead to lower monthly payments or tighter time limits? How many states will impose a family cap or deny benefits to unwed teen mothers? Will such measures reduce illegitimacy and caseloads? How will recessions affect states' willingness to pay for family assistance?

Many specialists believe the new law will, in time, increase poverty and deepen distress among people who are already poor. Some of the hardship will result from cuts in food stamps, Medicaid, and Supplemental Security Income. The new law abolishes or sharply curtails most forms of public aid to noncitizen immigrants, trims food stamps, and restricts SSI and food stamp eligibility for some classes of recipients. To reduce the risks the new law poses to poor children, several features should be revised.

Revisiting the Issues: Entitlement

Converting AFDC into a block grant probably settled the entitlement issue with respect to family support payments for the foreseeable future. But ending the entitlement will cause problems. State disparities in eligibility for cash benefits will almost surely increase. Some states may even decide to vary eligibility within their borders, as they do in state-financed general assistance programs. In states that do not make aid a legal entitlement, low-income children may have no assurance of receiving benefits. Even in states that do, monthly benefits may fluctuate if the state decides to operate within a fixed welfare budget. The distribution of cash assistance within and across states could become quite capricious.

The first GOP reform package allowed states to convert federal food stamp funds into a federal nutrition block grantþeffectively ending the federal entitlement to food stamp benefits in states taking up this option. The new law dropped this provision. Future efforts to wring savings out of entitlement programs may revive the effort to allow states to turn food stamp funds into a block grant. That would be a serious mistake.

Food stamps are the only program guaranteeing a uniform level of aid throughout the nation to indigent families in all kinds of circumstances. Food stamp spending is also highly responsive to unpredictable needs arising from recessions, natural disasters, and demographic change.

Time Limits

The new law contains two kinds of time limits. States must require adults to work not later than 24 months after cash benefits begin. Federal funds cannot be used for cash aid to families whose adult head has received aid for more than 60 months. The limits send a clear signal to beneficiaries that they must become self-sufficient in the labor market and set an unambiguous timetable for achieving that goal. But the harsh reality is that many adult recipients will not become self-sufficient in the foreseeable future. Some lack skills, others have no work experience, still others face family circumstances or health problems that make steady work impossible. A number live in areas—rural counties and Indian reservations, for example—where jobs are few and far between. Given the inherent instability of many jobs in the low-wage labor market, many current and future aid recipients will suffer repeated spells of unemployment, some of them long. If no government-financed cash assistance is available, strict time limits could cause highly visible hardship and even homelessness among unskilled parents and their children.

To mitigate hardship under time limits, the law should be changed in several ways. States could provide cash assistance after five years to those willing to engage in workfare or subsidized jobs—a move consistent with the Clinton administration's original welfare proposal. If Congress is unwilling to offer this flexibility, it could authorize federal waivers permitting states to extend the five-year time limit under certain conditions.

Allowing states to set time limits shorter than five years, as the new law permits, is particularly risky. Some states may be tempted to export their welfare problem by adopting tighter time limits than their neighbors. To avoid a "race to the bottom" in time limits, states should be required to get federal approval to impose time limits of less than five years.

Work Requirements

Political competition between President Clinton and congressional Republicans ensured that the new welfare law would feature stiff work requirements. Work requirements enjoy overwhelming support among the public and surprisingly strong support among assistance recipients themselves. They are essential to maintaining public support for cash and nutrition assistance programs over the long run. But we must be realistic about what such requirements can accomplish and about the capacity of the low-skill labor market to absorb new workers. Research has shown that welfare-to-work programs can increase both earnings and work among welfare recipients, but not enough to allow most to become self-sufficient. Further, many recipients will endure long spells of joblessness after completing the programs. Without access to publicly provided jobs and supplemental aid, such as child care, some single mothers will find it impossible to support their children.

On the details of work requirementsþ how many hours of work, how much of the caseload to cover—it is tempting for federal policymakers to be overly prescriptive. They can earn easy political points that way, but they may also strip states of the flexibility needed to implement effective programs. Welfare-to-work experiments find that pushing recipients into jobs instead of training achieves the highest short-term earnings gains. But these findings may not be valid for mothers with very young children, who will increasingly become subject to stiff work requirements. States need greater flexibility than the new law provides to set the number of hours that welfare recipients must work and the mix of work and training that they will be offered.

Reducing Illegitimacy

The new law requires that teenage mothers live with a parent or responsible adult to receive cash benefits. As long as exceptions can be made in case of parental abuse or other hardship, the requirement is appropriate. The law also offers small incentives for states to reduce out-of-wedlock birth rates and, as noted, allows states to impose family caps. Flexibility on family caps is sensible because evidence on their impact, drawn mainly from recent experience in New Jersey, is slim. Reductions in births to welfare recipients appear modest, but the evidence is incomplete.

Many conservatives argue that states should deny cash assistance to teenage mothers who bear children outside of marriage. The new law does not require states to take this step, but it allows them to do so. It would be more prudent to permit strictly limited and carefully evaluated trials of the policy. While there is little doubt that out-of-wedlock teen pregnancies are costly, not only for society but for the children they produce, we have no evidence that denying benefits to unwed teen mothers will cause illegitimate births to fall. Such a ban has never been tested, and the potential harm to affected children could be large.

State Fiscal Effort

Under the new block grant formula, states can reduce their welfare spending significantly, thereby risking a race to the bottom in eligibility and benefits. To qualify for full federal block grant funds under the new law, states that meet the work participation targets need spend only 75 percent of what they spent in the past. The "maintenance-of-effort" requirement is even less stringent than it appears because states can spend part of the TANF block grants on services that may not go to low-income dependent children or their parents. In addition, inflation will erode the value of previous state efforts, making the requirement less onerous over time.

The shift to block grant funding for family assistance, combined with continued availability of federal food stamps, will present states with a powerful inducement to reduce cash benefits. By cutting cash benefits and spending some of its TANF grant on other services once funded by state tax dollars, a state can free up money for tax cuts or other nonwelfare spending. The amount of its block grant would remain unchanged, and the cut in assistance payments would be partially offset because food stamp payments, based on families' cash income, will grow. The temptation for states to reduce spending on cash assistance and shift the funds to other purposes or tax relief will be particularly strong in the next couple of years. Although AFDC caseloads in many states have dropped noticeably from their peak in the early 1990s, future state block grants are set equal to the federal AFDC payments states got when caseloads were at their peak. With more federal money than they need to maintain benefits for current caseloads, many states will be able to shift some welfare spending to other needs. But when welfare again becomes a pressing fiscal problem, they will find it politically difficult to recapture these monies.

A good case can be made for strengthening state maintenance-of-effort requirements. Effective programs that move recipients toward self-sufficiency are costly. So, too, are the new administrative arrangements needed to implement time limits and other features of the new system.

State Funding Allocations

The TANF block grant has three big shortcomings. It provides uneven levels of federal support to children in rich and poor states. It is not responsive to states' changing demographic needs. And it may not offer much help in serious recessions. The first two flaws grow out of the decision to allow states to base their grant allocations on the highest of their 1994, 1995, or average 1992-94 spending levels. The decision, based not on compelling policy arguments, but on the political need to avoid visible winners and losers, will lock into place a distribution of federal funds that favors wealthy states. Recently, for example, the federal government spent $1,800 per poor child on AFDC in Connecticut but only $300 in Mississippi. In time, the new allocation formula will help states that are losing low-income residents and hurt those with growing numbers of poor children. If the block grant is to be retained, Congress should make it more equitable. Over a 10-year period the allocation of federal funds could be revised so that spending is based on the number of poor children in a state, not on the amount of federal spending in the first half of the 1990s.

To address the problem of recessions, Congress should increase the contingency grant fund. Budgeted at $2 billion for fiscal 1997-2001, the fund will be available to states with high and increasing unemployment and states whose food stamp caseloads jump at least 10 percent. To compensate states for recession-related burdens, the fund should probably be doubled or tripled. States using the fund should be required to maintain pre-reform funding levels and to match federal dollars they draw from the fund.

Efforts to increase the contingency fund or the TANF block grants will face the same obstacle that blocked the Clinton administration's welfare reform plan in 1994. New appropriations for the fund must meet deficit neutrality requirements under the Budget Enforcement Act of 1990. Increasing taxes or cutting other programs to increase spending for family assistance is likely to be tough politically—just as it was when policymakers tried to reform AFDC.

Reinventing Reform

Few public programs arouse as much passionþor antipathy—as welfare. Broad dissatisfaction with welfare has led to many calls for reform over the past quarter-century. Some reform efforts have yielded modest adjustments in the structure of welfare, but until 1996 none produced fundamental change.

The Personal Responsibility and Work Opportunity Act is a decisive break with the past. It removes the guarantee of federal support for cash aid to indigent children and their parents, toppling a pillar of social protection that stood for more than six decades. While it is not certain how states will respond to the incentives in the new law, it seems safe to predict that most will offer aid with more strings attached. Cash assistance will be linked to recipients' efforts to find and keep a job. The emphasis on work is a significant and welcome change in the orientation of welfare. It conforms with Americans' deeply held belief that able-bodied adults should toil for their daily bread, at least eventually, if they are to earn the right to public support.

But the new law has serious shortcomings. By abolishing the entitlement of needy children to cash assistance, it places a large and extremely vulnerable population at risk. By allowing states to cut spending on welfare, it tempts them to divert resources to other uses, including tax reductions or benefits for more affluent citizens. And it offers scant fiscal relief to states falling into recession.

Sensible reform can correct these defects. If states fail conspicuously to protect the interests of poor children, the impetus for reform will be strong. Because states are most likely to fail when facing economic hard times, welfare should be reinvented one more time—before the next recession.