Morningstar - Q2 2021 - 14

Dispatches

Would Baby Bonds Close the Racial Wealth Gap?

In a recent paper,1 we examined whether
the income-based baby-bond program proposed
in the American Opportunity Accounts Act
can address the racial wealth gap, given that the
academic literature suggests that income
and wealth may not be that closely correlated.
The answer is a resounding, overwhelming
yes. The exhibit shows the difference in the racial
wealth gap before and after we simulated the
effect of introducing baby bonds, assuming a 1%
real return. Baby bonds would cut the racial
wealth gap in half in terms of resources available
per child at age 18. To arrive at this impact, we
divided a family's wealth by the number of
children in it, including the child who just turned
18. We excluded the other children's baby
bonds from the household's wealth because these
funds are not accessible until they reach 18.
Without baby bonds, we calculate that the median
Black family has 96% less wealth per minor
child than white families. With baby bonds, the

median Black family would have 56% less wealth
per minor child. Similarly, without baby bonds,
we calculate that the median Hispanic
family would have 92% less wealth per minor
child than white families. With baby bonds, they
would have 55% less wealth per minor child.
We tested the program by using different
return assumptions, program designs, and
measures of wealth (fully reported in the paper). In
all cases, baby bonds would reduce the racial
wealth gap. They do not fully close the gap due
to differences in home equity between Blacks
and whites in America, which would still need to
be addressed through other avenues.
What Are the Potential Challenges and Trade-Offs
of Baby Bonds?

To be clear, baby bonds would not be a panacea
to solve wealth inequality, but they hold
promise for addressing the racial wealth gap.
We believe policymakers should explore ways to
make them a reality. Before they do, several
implementation challenges need to be addressed.

EXHIBIT 1

Closing the Wealth Gap How the baby-bonds program would give a boost to the
wealth of people of color.
Median Wealth Per Minor Child, Including Home Equity, for Families With Children Who Just
Reached Their 18th Birthday. Assumes 1% Real Return.

Black

White

Hispanic

Other

Not Reported
$100K
82,857

72,814

96%
Gap

3,011

56%
Gap

36,524
5,893

9,030

Wealth Without Baby Bonds

36,947

38,003

44,093

50
25

18,570

Wealth With Baby Bonds

One challenge is ensuring that, as recipients
gain access to the bonds at 18, they use the
money to increase their long-term wage potential
through education or their wealth through
investments. Policymakers need to build guardrails
with flexibility so the assets at age 18 can
be invested in education, housing, or traditional
investments. We feel strongly that policymakers
need to explore ways to make it easy to invest
in traditional retail investments, such as
mutual funds and exchange-traded funds, and to
ensure that 18-year-olds get good advice for
making such investments.
Another issue policymakers must wrestle
with is whether to allow accountholders to bear
more risk to potentially earn larger returns
by allowing them to invest in stocks rather than
just safe government debt. This is particularly
important given the current low interest
rates. Adding stock investment options would
mean that balances would vary based on
the sequence of returns-some accountholders
from identical economic backgrounds would
end up with better returns than others, depending
on the timing of their investments. Those who
happen to start investing at the beginning of
an up market may have far larger balances when
they turn 18 than those hit with a down market
early on. Policymakers need to decide whether this
inequity is acceptable in exchange for the
possibility of creating greater wealth among the
poorest kids in society.
At Morningstar, we plan to continue analyzing
further iterations of the baby-bond design,
particularly by using our stochastic wealthforecasting models to illustrate the trade-offs of
designing baby bonds to take more investment
risk than the current legislation anticipates.
We will also continue to analyze other ideas to
narrow the racial wealth gap. K
Aron Szapiro is director of policy research with Morningstar.
Lia Mitchell is a senior analyst, policy research,
with Morningstar.

Source: Morningstar Analysis.

1 Mitchell, L. & Szapiro, A. 2020. " Baby Bonds: Income-Based Program Designs Show Promise for Closing the Racial Wealth Gap. " Morningstar, Inc., September.

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