PPI | Briefing | August 22, 2000
Individual Development Accounts
How Are They Working?
By DeWayne Davis and Jeff Lemieux
In September, Congress and the President will face off on the merits of several huge tax cut proposals. The estate tax repeal, for example, would cost about $20 billion to 25 billion a year if it were fully phased-in today, and, according to IRS statistics, fully half of the benefit of the estate tax repeal would flow to the 2,000 or 3,000 wealthiest families in America -- those with the most assets to pass on and inherit.
The Progressive Policy Institute (PPI) believes that for a tiny fraction of that cost, the government, working with private and charitable institutions, could give millions of lower-income people a decent chance to accumulate assets of their own in new individual development accounts, or IDAs. Whatever the merits of repealing the estate tax, helping poor families get started on the path to savings and prosperity should be a much higher priority. IDAs give poor families a way to build wealth, just like the rich.
In the early 1990s, PPI published a paper by Professor Michael Sherraden that emphasized asset building as a new method for combating poverty.1 The need for assets was obvious: Old welfare laws provided income to the poor, but systematically failed to lift families out of poverty. The old laws discouraged poor people from saving money, but without savings, the poor were totally dependent on welfare. Without savings, they could not invest in a better education, a business, or a permanent home.
With IDAs, low-income individuals with little previous experience with financial institutions can accumulate savings and wealth, and finance their own educations, homes, or business ventures. IDA participants open up savings accounts in which their deposits are matched at a rate determined by the sponsoring organization. Using state and private funds, sponsors -- usually local not-for-profit community organizations, credit unions, or community banks -- design and administer IDAs. Each state and sponsoring organization can determine the eligibility requirements and target population for its participants. For instance, IDA programs in Oregon and Texas are run by not-for-profit housing organizations that target low-income rental property residents as participants.2
IDAs are more than just matching funds, however. They provide a local support system for a new culture of savings. They help bring people into the economic and financial mainstream. Assets allow families mobility and job flexibility, so that they can take advantage of business or job opportunities that people without any financial cushion cannot risk. Ultimately, families that grow up talking about things like investment returns and compound interest pass that financial knowledge down to their children.
While Congress has not authorized a universally available federal IDA program, lawmakers have recognized and helped promote IDAs as an innovative tool to help low-income families accumulate savings. Candidate Bill Clinton touted IDAs as a crucial component of his welfare reform plans in the 1992 election. In the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, Congress granted states the authority to use funds from the federal welfare-to-work program --Temporary Assistance for Needy Families (TANF) -- to establish IDA programs. As an incentive for people to maintain their savings, the act also required that IDA funds be disregarded as assets when determining the eligibility for all means-tested government programs. Under the authority established in the 1996 law, twenty-five states have included IDAs in their welfare reform plans, and twenty-seven states have passed IDA legislation for TANF recipients and other low-income individuals.3
Congress went further in 1998 when it passed the Assets for Independence Act, which authorized the U.S. Department of Health and Human Services to conduct a 5-year, $10 million per year nationwide demonstration of IDAs. The Assets for Independence Act moved beyond TANF IDAs by allowing those families qualifying for the Earned Income Tax Credit and meeting the $10,000 net worth ceiling to become eligible for IDAs.4 It further authorized emergency withdrawals for medical expenses, preventing evictions, and meeting expenses for those who lose their jobs.5
Recent reports from the states indicate that IDA participants can and do save, and that the savings are used for the intended purposes. An evaluation of the American Dream Demonstration, a trial of 14 IDA programs, finds that IDA participants save an average of $33 per month. Also, while most participants had intended to use their savings to purchase homes, most of them used their savings for small business ventures. As a result of the promising news about IDAs, Congress should pass the Savings for Working Families Act of 2000, introduced by Senators Joseph Lieberman (D-CT) and Rick Santorum (R-PA) and Representatives Joseph Pitts (R-PA) and Charles Stenholm (D-TX), which would:
expand the use of IDAs beyond the demonstration phase;
provide tax incentives to induce increased participation by private financial institutions; and
require more training in saving, banking, and investing for participants in IDA programs.
The Corporation for Enterprise Development initiated the first nationwide demonstration of IDAs, The American Dream Demonstration, in 1997. The demonstration involved 14 IDA programs run by private, not-for-profit organizations in low-income communities across the country. The sponsoring organizations in the demonstration were chosen through a competitive process to design, implement, and administer IDA programs in their local communities. Targeted participants set up savings accounts at local banks or credit unions, and the sponsoring organizations set up separate accounts to deposit the matching funds. (The funds were held separately until the time of withdrawal, when the participant contribution and the match were combined for a specific use.) The match rates were set by each sponsoring organization and ranged from a dollar-for-dollar match to a 7:1 match, depending on the participants' economic status.6 Eligibility was determined by the sponsoring organizations and included such people as TANF recipients, low-income rental property residents, poor youth, and self-employed women.
The Center for Social Development has done the most comprehensive evaluation to date of the actual impact of IDAs on the savings and deposit patterns of participants.7 The most significant conclusion is that IDA participants do save and use their accounts for the intended purposes. The results provide encouraging news for those who seek to expand the use of IDAs to help low-income families start building wealth:
Participants: As of June 30, 1999, there were 1,326 participants in the American Dream Demonstration. More than 90 percent of the participants had incomes below 200 percent of the federal poverty level. The participants were overwhelmingly female (78 percent) and urban (84 percent). More than half of the participants (60 percent) were full-time workers, and about 65 percent either had a high school degree or attended some college (see attached table for complete participant characteristics).
IDA Accumulation: The total accumulation of savings in the IDA programs from start-up until June 30, 1999 was $1,120,317. The total amount of participant savings was $378,708, and the total matching amount was twice the savings, $741,609.
Participant Savings: American Dream Demonstration participants saved about 71 cents for every dollar they were allowed to deposit in their savings account for a match. The average amount saved by the participants since the inception of the program was $286. The largest amount saved was $2,253.
Deposit: The typical participant made a deposit seven out of every 10 months. The average monthly deposit was $33.
Withdrawals: Of the 92 matched withdrawals, 33 percent used them for microenterprise; 27 percent used them for home purchase; 20 percent used their withdrawals for home repair; and 20 percent used them for education.
Given the initial success of the program, IDAs should be extended to all families on the lowest rung of the economic ladder. The Savings for Working Families Act of 2000 would provide favorable tax treatment for banks, community groups, and credit unions that make a dollar-for-dollar match of up to $500 per year per person for savings in an IDA. It opens the way for federally insured banks to create IDAs for all U.S. citizens age 18 and over whose household income is less than 80 percent of the area median income and whose assets (excluding home equity and the value of a single car) do not exceed $10,000. To encourage financial institutions to participate, the act proposes giving financial institutions a 90 percent federal tax credit for every dollar they contribute to an individual's IDA account up to $500 per account. Nonprofits and credit unions with IDA programs would be eligible for a 50 percent federal tax credit. Another attractive feature of the proposal is that families can use tax refunds from the Earned Income Tax Credit to deposit into their IDAs. Finally, to make sure that IDA participants are fully informed about their options for use of their savings, the bill requires that participants complete an economic literacy course on saving, banking, and investing before they are allowed to withdraw their funds. The Treasury Department would be given oversight and monitoring responsibility and would report to Congress on progress and further recommendations.
Financial institutions would be induced to participate not only for altruistic purposes, but also because their participation in an IDA program is good business. IDA programs across the nation have the potential to create for banks a new long-term customer base of millions of previously "unbanked" Americans whose deposits and other banking transactions can only make financial institutions more profitable. More important, those savings accounts are likely to serve as seeds to a wider array of additional banking services including home mortgage and small business loans which are subject to additional favorable tax treatment by federal and state governments.
The Savings for Working Families Act does not mandate the development of IDAs; however, it creates an incentive-based system that encourages both private institutions and individuals to participate. Therefore, an expanded IDA program would be very different from a traditional entitlement program for the poor.8 Importantly, the success stories of demonstrations from across the nation indicate that the IDA program functions best as an incentive-based program rather than a government transfer program.
There are additional provisions that Congress could implement to more fully integrate the use of IDAs into the world of banking and finance and allow low-income individuals to save more. First, lawmakers should consider allowing workers to chose automatic payroll deductions so that funds can be directly deposited into their IDAs. Such automatic deductions make it less likely that workers in poor neighborhoods would visit check cashing shops or pay-day loan centers that encourage immediate consumption rather than savings. In addition, some studies have shown that for former welfare recipients and the unemployed, transportation is a leading barrier to getting and keeping a job since job creation has been strongest in the more prosperous suburbs.9 In response to the suburbanization of employment and the relative isolation of the working poor from those areas, policymakers should allow funds from IDAs to be used for the purchase and operating costs of cars for low-income workers.10
Also, given that Congress is already proposing to mandate economic literacy training for IDA participants, the next step would be to give economically savvy participants the flexibility to participate in a wider variety of financial instruments. Lawmakers should eventually allow IDA participants to invest their savings in one of three possible wealth-creating vehicles: a money market interest-bearing fund, a bond fund, or an indexed common stock fund.11
Finally, wealthy Americans have always bequeathed to their heirs some measure of wealth upon their deaths, and this same principle should be extended to IDA participants whose only wealth may be their IDAs. Individuals should be allowed to bequeath the balances in their IDAs to the IDAs of their spouses or children.
Asset-building can be the most effective way of eliminating poverty without reliance on the inefficient income transfers and entitlements. Now that we know IDAs work, we should expand their potential to help low-income working families become independent participants in the vibrant U.S. economy.
1. See Michael Sherraden, "Stakeholding: A New Direction in Social Policy," Policy Report No. 2, Washington, DC: Progressive Policy Institute, January 1990. IDAs were more fully examined and studied in Michael Sherraden, Assets for the Poor: A New American Welfare Policy, Armonk, NY: M.E. Sharpe, Inc., 1991; and Will Marshall and Elaine Ciulla Kamarck, "Replacing Welfare with Work," in Will Marshall and Martin Schram, editors, Mandate for Change, New York: Berkley Books, 1993:217-236.
2. Michael Sherraden, et al., Saving Patterns in IDA Programs. Downpayment on the American Dream Policy Demonstration: A National Demonstration of Individual Development Accounts, St. Louis, MO: Center for Social Development, Washington University in St. Louis, January 2000.
3. Karen Edwards, State IDA Policy Profiles, St. Louis, MO: Center for Social Development, Washington University in St. Louis.
4. Ray Boshara, Overview of the Assets for Independence Act, Washington, DC: Corporation for Enterprise Development.
5. Ibid.
6. The Capital Areas Asset Building Corporation (CAAB) of Washington, DC is the only sponsoring organization that offers the most generous match, 7:1 in some cases. CAAB is able to offer some of its participants such a generous match because it is a large collaborative of 8 community organizations working to improve District neighborhoods.
7. Michael Sherraden et al., Saving Patterns in IDA Programs. Downpayment on the American Dream Policy Demonstration: A National Demonstration of Individual Development Accounts.
8. See statement of Senator Joe Lieberman, Introducing the Savings for Working Families Act of 2000, February 3, 2000.
9. Welfare Reform: Transportation's Role in Moving from Welfare to Work, Washington, DC: U.S. General Accounting Office, GAO/RCED-98-161, May 1998.
10. See Margy Waller and Mark Alan Hughes, Working Far From Home: Transportation and Welfare Reform in the Ten Big States, Washington DC and Philadelphia, PA: Progressive Policy Institute and Public/Private Ventures, August 1999.
11. See Center for Social Development, Policy Considerations for IDAs, St. Louis, MO: Washington University in St. Louis.
| Gender: |
Female |
78% |
| Male |
22 |
| Race: |
Caucasian |
41% |
| African-American |
40 |
| Latino |
12 |
| Asian or Pacific-Islander |
2 |
| Native American |
2 |
| Marital Status: |
Single, never married |
46% |
| Married |
24 |
| Widowed, divorced, separated |
30 |
| Education: |
Did not complete high school |
15% |
| High School Diploma or GED |
27 |
| Attended College |
38 |
| Graduate College |
20 |
| Employment: |
Full-time |
59% |
| Part-time |
25 |
| Involuntarily Unemployed |
11 |
| Voluntarily Not Employed |
5 |
| Source: Michael Sherraden et al., Saving Patterns in IDA Programs. Downpayment on the American Dream Policy Demonstration: A National Demonstration of Individual Development Accounts, St. Louis, MO: Center for Social Development, Washington University in St. Louis, January 2000.
|
DeWayne Davis is a health and budget policy analyst. Jeff Lemieux is senior economist at Progessive Policy Institute.
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