The problem is, by now, well known. Amid all the hoopla over welfare reform, mindless rules still actually penalize savings. Take Grace Capitello, a 36-year-old single mom who scraped together $3,000 toward her daughter’s college expenses, only to be charged with fraud by the Milwaukee County Department of Social Services for exceeding strict asset limitations.
The good news is that such rules are changing, thanks in part to the emergence of an anti-poverty strategy known as Individual Development Accounts. IDAs, as they are known, have been credited with near-miraculous results (“It enabled me to say farewell to welfare,” an IDA participant recently told the Chronicle of Philanthropy). They have received tens of millions of dollars in foundation grants, from funders such as the Ford, Joyce, MacArthur, Levi Strauss, and Charles Stewart Mott foundations. They may be the future of local, state—and perhaps even federal—public assistance.
But what are they—and do they work?
Perhaps the cardinal failure of the traditional approach to fighting poverty has been its myopic focus on income. Poverty is often described as a cycle. But by ignoring other variables (such as culture, assets, or access to credit) income-oriented responses to poverty have proven to be—when not outright counterproductive—mitigating rather than cycle-breaking, more triage than cure. Locking the focus on short-term cash band-aids may help smooth out the sharpest valleys of economic insecurity, but it does little to address the underlying condition of poverty.
And nothing keeps a family in poverty like a dearth of savings. The gap between the poor and the middle class is far more pronounced in assets than it is in income. On average, the median family makes three times as much as a family in poverty, but is worth more than twelve times as much. With no appreciable financial foundation, the poor are far more vulnerable to even minor economic disruptions: a setback that would be a “tough patch” for a middle class family quickly becomes a way of life for someone with no savings.
Scrambling the Incentives
Now, due in large part to the emergence of IDAs, most states allow welfare recipients to save a certain amount of money in special restricted accounts. As Washington University professor Michael Sherraden, a leading proponent, observes, “I was talking to a group of welfare mothers and one of the things that kept coming up was that welfare was a trap and that they could never get anywhere. It was impossible to accumulate anything so that they could save for education or a home or a small business.”
In his 1991 book Assets and the Poor: A New American Welfare Policy, Sherraden wondered what would happen if the incentives were reversed. If poor people were properly rewarded and incentivized, would they save? And if they did manage to build up some savings, would they blow the money, or use it to escape from poverty?
A number of foundations (most prominently Ford) were willing to pay to find out, and a constellation of demonstration projects sprouted up around the country. The idea also appealed to Jack Kemp, then Secretary of Housing and Urban Development in the Bush Administration, spurring governmental attention to IDAs and establishing a (thus-far) surprisingly bipartisan interest in exploring their possibilities.
Though they vary in details and implementation, IDA programs essentially offer to set up savings accounts for participants at a bank or local savings institution, and to match the participant’s contributions to the account. The match is typically between one and three dollars from the program for every dollar that the participant contributes, though some of the programs offer ratios as high as nine-to-one. The programs have a cap (typically, $1,000 per year) and a vesting period (between six months and a year), before which the participants can withdraw their own funds, but lose the matching money. Participants can only withdraw the matching money for a program-specified purpose, such as to put a down payment on a home or small business. Some of the programs allow money to be withdrawn for educational or work-related expenses, such as uniforms or tools.
A thousand dollars a year may not sound like very much, particularly in a program where the participant has to scrape together $500 over the course of a year to get the matching $500. But this interpretation would be mistaken on two grounds. First, a thousand dollars is a lot of money to a family in poverty—and that’s exactly the point. Those who stick with a program over time (and that is the goal) will, over the course of a few years, build up the several thousand dollars needed for a home or small business downpayment. Second, and perhaps more importantly, it may be the discipline of the saving itself, particularly over time, that turns out to be the most valuable return on the individual’s investment.
Most of the programs require that participants attend and complete a series of financial education classes. This is an essential component, not just window dressing. In fact, it might be argued that the real utility of a successful IDA is the inverse of their popular impression—that the financial education classes are the medicine and the cash is the sugar. The Ford Foundation admits as much, noting that the IDA participant showcased in their report Down Payments on a Dream, “benefited even more from the financial counseling she received. . .. The classes changed the way she thought about money—and her life.” Preliminary results from other IDA programs seem to be bearing this out as well. One program compared a group of IDA participants with a control group; they found that the credit card balances of those in the control group rose, while those of IDA participants declined. That is, the debts of the IDA group went down even though they were putting money into their IDA, and thus had less marginal cash than the control group. Presumably they learned the virtue of saving as they discovered what a trap consumer debt can be. That’s a potent anti-poverty combination—and one traditional welfare approaches don’t teach.
Indeed, the psychological and cultural power of IDAs may ultimately be more significant than their economic impact. As Sherraden says, “Income may feed people’s stomachs, but assets change their heads.” Home and small business ownership are critical steps on the path from dependency to self-sufficiency. They don’t just provide healthier financial wherewithal, they mark a positive change in an individual’s perception of their own stake in society. Moreover, they inevitably color an individual’s interaction with government, gradually transmuting them from handout seeker to taxpayer, from client to citizen. The personal effect can be equally transformative: an “investor” views the economic and political landscape with a different eye than a hand-to-mouther. Savings represent hope, and the future. Those words are too often absent from the literature of poverty.
One thing that surprised the initial IDA designers was people’s reluctance to join the programs. Critics point to this as a possible flaw. In fact, far from being an argument against IDAs, this reticence may underscore precisely what’s most right about them. And herein lies the aspect of IDAs that is most vexatious to advocates of traditional welfare. By requiring participants to make a very real (if short-term) sacrifice, and by insisting upon the financial education component, IDAs can, by design, sort out the people that they can help from those that they can’t.
While savings and asset accumulation are good ideas for everyone, the truth is that some people simply aren’t ready—or aren’t willing—to accept the discipline required by IDAs. The funds are usable only for certain targeted savings goals. They don’t help people save for cars, health expenses, new televisions, satellite dishes, or beanie babies—though, ostensibly, the discipline, habits, and education gained through IDA participation will prepare people to save for such things.
Saving for a Pet Snake
So IDAs, if properly designed, are a showcase example of a program that helps people help themselves. How to craft them, then, is the key—and we are now in the midst of the experimental phase, with the “laboratories of the states” cooking up different recipes. Some early conclusions are already discernible:
Longer time periods are better. People who drop out of the programs tend to drop out early on; those who stay in reap more significant benefits (personally and financially) with longer investment; while no “magic number” has been found for the matching ratio, some of the early attempts set the number too high. A nine-to-one return for every dollar you save doesn’t really teach anything about savings—it’s more of a handout than an incentive.
Financial education programs are critical. Mismanagement of personal finances, high levels of credit card debt, and falling for get-rich-quick scams are staples of a life of poverty. Many program participants had never balanced a checkbook—indeed, many had never had a bank account—before learning basic personal finance through an IDA program.
Successful IDAs must have tight rules about what constitutes a permissible withdrawal. Loose rules, which many IDA supporters favor, invite trouble. In one of the early IDA programs, the first graduating participant used his savings to buy a large pet snake.
And finally, the question that is both the least important (in that it applies only to the extent that the programs succeed) but potentially the most problematic (again—ironically—in the event that the programs are a success): Where does it end?
The substantial funding from Joyce, Ford, Mott, et al went specifically to “demonstration” projects. They were never intended to serve as ends in themselves; they were meant to demonstrate the viability and worth of IDAs. So the question remains—demonstrate to whom? Other foundations and grantmakers, certainly. But these projects were explicitly designed to garner the attention of the biggest grantmaker of all—the federal government.
And they have succeeded. The IDA train has, with little public notice, already left the station. This year, the federal government has allocated $125 million to further IDA demonstration projects.
Should private philanthropy be worried about the federal government muscling in and fundamentally changing what works about these programs? IDA advocates like Sherraden don’t think so. They see IDAs as a helpful leg up for the poor, a savings plan for the poor analogous to the popular IRA and 401(k) plans available to the middle class. Supporters invoke the GI Bill and the Homestead Act as intellectual and cultural predecessors of IDAs; those programs also offered rewards to those with initiative, and produced general societal benefits.
Tempting imagery, but there are problems with the analogies. Unlike a 401(k) plan, which involves employer contributions, IDA contributions would come from the federal government—a significant difference. And both the GI Bill and the Homestead Act required beneficiaries to do quite a bit more than merely put some money into a savings account for a year. “Microcredit” is often elided with IDAs, though they, too, are fundamentally different: IDAs are not a loan, they are a payout, made with no expectation of financial return.
But the danger of government overreach shouldn’t obscure the promise of the idea, especially for grantmakers. Nor should the fact that the details are still being hammered out through experiments in dozens of locations around the country be seen as a negative. On the contrary, IDAs are still very much a work in progress—even supporters are still trying to figure out what works. As Lisa Mensah, deputy director of the Economic Development Unit at the Ford Foundation, points out, the two core components of a successful IDA are the matched accounts and the financial education. The details of specific programs are to a large extent left to the nonprofits that are administering them.
The question that the IDA demonstration projects seek to answer is: “if properly incentivized and given structure—can and will the poor save?” After decades of failed welfare policies that refused to treat the poor as rational economic actors, it may be time to find out whether they will, like everyone else, take advantage of economic incentives. And while even the most cleverly crafted IDAs can’t on their own bring people in from the economic periphery, the early evidence suggests that they can help people who want to help themselves.
Tom Riley is director of research for the Philanthropy Roundtable.