Over
the next six years, the actions of Washington policymakers in
reforming education, the income tax system, and Social Security
will affect every American, but particularly those who struggle
most to achieve prosperity. Congress and the President have arrived
reluctantly at the moment of decision: Now, after years of talking
about these issues, the problems of current programs are so great
that immediate action is required. Either policymakers will enact
changes that positively influence the economic direction of the
country and the ability of families to care for themselves and
transfer wealth to the next generation to build significantly
better lives, or they will squander an opportunity to enact serious
reforms by choosing inaction or making only ineffective change.
To
illustrate how specific policy changes can promote economic
prosperity, Heritage Foundation analysts have conducted a series of
economic and statistical analyses over the past few months to
determine how these changes would affect various socioeconomic
groups. Although such reforms as making vouchers or scholarships
available to parents for their children's education, enacting a
flat tax, and privatizing portions of Social Security would benefit
all Americans, understanding how they would benefit a vibrant and
growing population like Hispanic-Americans offers Congress a clear
example of the promise they hold for workers and families in
general.
Education Reform
Great room exists for improving and expanding educational
opportunity for American children, but particularly for Hispanic
students. In 1993, only about 53 percent of Hispanic-American
25-year-olds had graduated from high school, and fewer than 10
percent had earned a bachelor's degree. Coupling tight economic
times with the normal challenges that face immigrants to the United
States is not a recipe for educational success, and the education
dollars they need to prevent their children from dropping out of
school to earn an income are scarce.
Reforms that put parents, teachers, and
principals in charge of the education of children would benefit
underachieving Hispanic-American students especially. Congress
should devolve decision-making authority and education dollars from
the federal bureaucracy back to the states, sending at least 95
percent of the funding directly into the classroom and programs
like vouchers that empower parents to find the best school setting
for their children.
Tax Reform
The current income and payroll tax systems offer low- and
moderate-income families little opportunity to achieve significant
economic improvement. The tax code's bias against savings and
investment (by taxing income when it is saved and again when it is
invested) prevents many people from saving or investing for the
future. This in turn slows the economy, reduces job growth, and
retards wage increases. In addition, current tax law is so complex
that small and emerging businesses pay as much to accountants and
lawyers to keep them in compliance with the code as they pay in
taxes.
The
tax code is regressive: Adding the payroll tax to the income taxes
paid by an average-income family consumes a higher percentage of
that family's income than do taxes paid by higher-income
families.
This regressivity harms Hispanic-American workers particularly.
Their median annual income of $24,900 is barely high enough to
create an income tax liability, yet 15 percent of every wage dollar
they earn is taxed to support Social Security and Medicare. A 15
percent payroll tax means that most Hispanic-American workers pay
more in social insurance taxes than in income taxes, and payroll
taxes have no deductions or credits that would balance out the
otherwise regressive nature of a single-rate tax.
A
simple and fair tax system, such as a flat tax, would go far toward
correcting some of the regressive aspects of current federal tax
policy. Many of the proposed flat tax plans before Congress call
for family allowances that would give a family of four a deduction
of between $30,000 and $36,000. Family allowances at these levels
would facilitate moving 2.3 million low-income Hispanic-Americans
off the tax rolls.
Social Security Reform
High taxes that reduce the growth of family income also,
in part, support a retirement program that reduces family wealth.
Social Security is the main (and often only) retirement program for
low- and moderate-income workers. The high payroll taxes these
workers incur for future retirement benefits might be justified if
those taxes yielded rates of return that were at least equal to the
most modest returns they could achieve from supplemental retirement
savings. However, returns from Social Security for young and
middle-aged workers are slipping below 2 percent. Each passing year
sees further erosion in their Social Security "investment," which
also widens the wealth gap in this country. Moreover, unlike
regular savings and investment, the publicly funded retirement
system provides nothing for the heirs of Social Security retirees
except a $255 death benefit.
On
top of this, Hispanic communities face a relative absence of local
capital that they can use to start businesses, purchase quality
education for their children, access adequate health care in their
communities, and save for retirement. Although Hispanics and other
minorities in America today have overcome many civil rights
obstacles, this economic "sticky floor" remains. Creating local
capital by privatizing a significant portion of the current Old-Age
and Survivors Insurance program not only would permit low- and
moderate-income Americans of all ethnic backgrounds to build
capital in their own communities, but also would save Social
Security from bankruptcy. And it would go far in lifting
Hispanic-Americans and other minorities off that sticky floor.
HOW HISPANIC FAMILIES WOULD BENEFIT
FROM EDUCATION REFORM
Unquestionably, opportunities for economic
prosperity increase with one's level of educational attainment. As
Table
1 demonstrates, in 1993 fewer Hispanic-American students
received a high school diploma or a degree from a post-secondary
school than did either white or black students, or students in the
general population. Data from the Census Bureau's Current
Population Survey demonstrate that Hispanic students, in fact, have
the lowest levels of educational attainment of any major segment of
the American population. Specifically, only 53.1 percent of
Hispanic-American students over the age of 25 in 1993 had completed
high school, and only about 9 percent hold a bachelor's
degree.
Especially troubling is that 46.9 percent
of Hispanic students do not even graduate from high school. Lack of
a high school degree significantly influences an individual's
overall lifetime earnings potential. Average annual earnings in
1996 were nearly 40 percent higher for Hispanic students who had
received a high school diploma than for those who had dropped out
of high school ($18,528 versus $13,287, respectively, in nominal
dollars).
Even
worse, according to the National Center for Education Statistics,
47 percent of Hispanic high school graduates--the vast majority of
whom graduated from public schools--were either "marginally
qualified" or "unqualified" for admittance to a four-year
collegiate institution between 1992 and 1994. And nearly 21
percent of Hispanic high school graduates were only "minimally
qualified" for college. In short, two-thirds of all Hispanic high
school graduates are minimally, marginally, or not qualified to
begin college, compared with just over half of total high school
graduates in the overall population.
Although the Hispanic population endures
other barriers to education, such as high poverty levels and
limited proficiency in English, the public education establishment
continually shortchanges them in learning basic skills. As a
result, according to the 1996 results of the National Assessment of
Educational Progress (NAEP) exam, Hispanic students scored, on
average, 8.4 percent lower than average students in math and 12.3
percent lower than their white non-Hispanic counterparts.
Yet Hispanic students perform markedly better, on
average, in private and Catholic schools than they do in public
schools. Table 2 shows average scores on
the NAEP reading and math exams for 8th grade Hispanic students
(age 13) by the type of school attended. Not only do Hispanic
students perform better in private and parochial schools, but they
also stay in school longer once they are there. In Catholic
schools, for example, the Hispanic dropout rate falls to about 9.3
percent.
Derek Neal, an associate professor in
economics at the University of Chicago, recently found that
African-American and Hispanic students attending urban Catholic
schools were more than twice as likely to graduate from college as
their public school counterparts. He found that 27 percent of black
and Hispanic Catholic school graduates who started college went on
to graduate, compared with 11 percent of urban public school
graduates. According to Neal's study, the probability that
inner-city students would graduate from high school increases from
62 percent to at least 88 percent when those students are placed in
a Catholic secondary school. Furthermore, compared with their
public school counterparts, minority students in urban Catholic
schools can expect to earn roughly 8 percent higher wages in the
future.
The
successes of a renowned math teacher at Garfield High School in Los
Angeles demonstrate that low-income Hispanic students can excel if
challenged to meet high standards. By demanding that all his
students enroll in college-level Advanced Placement (AP) programs,
in just a few years Jaime Escalante had more calculus exam takers
than all but four other U.S. high schools in 1987. One of his
protégé's, teacher Angelo Villavicencio at Ayala High
in Chino Hills, California, was able to pass 80 percent of his
calculus low-income minority students in 1995 using Escalante's
methods.
The
public school establishment should have been quick to replicate
Escalante's success; yet AP classes are still confined to the
select few, the best and the brightest in most American schools.
This is symptomatic of the fact that, over the last half century,
the public school establishment has effectively eliminated
competition and thereby diminished the quality of public education
in this country. However, it remains the only generally
"affordable" alternative for the American population.
What Can Be Done?
The
private sector is leading the way in demonstrating how innovative
educational programs can help minorities and low-income students
excel. For example, the National Council of La Raza, the premiere
Hispanic-American advocacy group, developed a series of
supplemental after-school academic programs called Projects EXCEL
and EXCEL-MAS. The success of these programs illustrates that
community-based education programs help students learn potentially
better than programs developed in the public school
bureaucracy.
There are two basic types of market-based
approaches to improving education in low-income communities:
charter schools and school choice programs.
- Charter Schools. Public
charter schools are run and managed independent of state and
federal rules and regulations. Principals are given a greater
amount of fiscal and legal autonomy to run these schools in return
for demonstrable academic outcomes. The first charter school law
was passed in 1990 in Minnesota. Today, 33 states and the District
of Columbia have passed charter school legislation, resulting in
1,100 charter schools that serve over 235,000 students around the
country.
Recent studies of charter schools by the
Hudson Institute and the U.S. Department of Education reveal their
popularity with Hispanics and other at-risk students. In fact, 25
percent of charter school students are Hispanic, and 40 percent of
the existing charter schools serve dropout or at-risk youth.
Charter schools attract the type of student that public schools
fail to serve. Although it is too early to evaluate their academic
outcomes, anecdotal evidence suggests that charter school students
may even outperform their public school counterparts.
- School Choice Programs.
School choice programs provide parents with funding to send their
children to the private, public, or religious school of their
choice. Such programs currently exist in the form of vouchers for
low-income students in Milwaukee, Wisconsin, and Cleveland, Ohio,
and education tax deductions and/or credits in Minnesota and Maine.
Private organizations, such as the Children's Educational
Opportunity Foundation (CEO America) and the Children's Scholarship
Fund (CSF), provide partial assistance to low-income children to
attend the school of their parents' choosing. Today, close to 88
privately funded programs serve a growing number of poor minority
children, with many more still on waiting lists. For instance, the
CEO America program in San Antonio, Texas--where about 80 percent
of school-age children are Hispanic--already has placed 1,600
students (or 10 percent of the eligible student population) in
schools of their choice.
To spur improvement in the public schools,
and to provide better opportunities for children, two things are
needed: (1) Individual public schools must be given greater
autonomy from central office bureaucracy and the freedom to
innovate, and (2) financial control must be put directly in the
hands of parents, through vouchers and credits, so that public
schools come under the financial market pressure to improve and
parents possess the means to choose other schools when they do not.
Improving the educational attainment of all students, but
especially a group like Hispanic-Americans, will lay the groundwork
for their economic prosperity in the future.
HOW HISPANIC-AMERICAN TAXPAYERS WOULD
BENEFIT FROM FUNDAMENTAL TAX REFORM
According to a survey of Hispanic-American
entrepreneurial activity published in The Economist in March, the
fastest growing segment of small business in America is
Hispanic-owned, and prospects for the continued growth of Hispanic
businesses appear good. However, the economic status of
average Hispanic-Americans relative to the general U.S. population
falls short on virtually every count. Specifically, in 1996,
-
The median income of Hispanic
households, at $24,906, was 67 percent that of white
households;
-
20.9 percent of Hispanic families were
"working poor," compared with 6.6 percent of white families;
-
Personal savings of the average-income
Hispanic family amounted to about one-third that of the
average-income family in the general population; and
-
Hispanic males earn 81 percent of the
average national lifetime wage earnings, while Hispanic females
earn 58.5 percent of the national average.
-
High taxes that discourage savings and
reduce economic growth raise additional obstacles for
Hispanic-Americans who struggle to achieve at least statistical
parity in the American economy. An important way to help those who
seek to improve their prosperity would be to make the tax code fair
and simple.
Who would benefit from a flat
tax? To answer this question, Heritage Foundation analysts
used income tax data extracted from the U.S. Bureau of the Census
Current Population Survey for March 1997 and the Heritage
Individual Income Tax Simulation Model in order to simulate tax
payments under a flat tax. The Current Population Survey
provided income, demographics, and tax data for 10,149,000 Hispanic
taxpayers. Income variables from the Survey were employed to create
a tax base for the flat tax similar to that described in H.R.1040,
the flat tax legislation recently proposed by Representative
Richard Armey (R-TX). This tax base consists of wages and salaries,
unemployment compensation, employer-provided health care benefits,
and income from previously untaxed pensions and other retirement
income streams. Each adult taxpayer was given a $10,000 allowance,
and each child of a taxpaying family received a $6,000 allowance.
Thus, a married couple with two children making $50,000 in income
would deduct $32,000 from that amount to determine their taxable
income. The Heritage model then taxed this income at a flat 17
percent rate.
Using the Survey data, the Heritage
analysis applied this formula to Hispanic-Americans. Table
3 compares tax payments under current law to those under a flat
tax for all Hispanic-American taxpayers. Under a flat tax:
-
About 2,390,000 Hispanic-American
taxpayers (24 percent) would fall off the tax rolls;
-
The average tax payment for
Hispanic-Americans would drop by nearly $400 or 16 percent; and
-
Middle-class Hispanic-Americans would
see their tax payments drop by an average of 9.5 percent.
Nearly 44 percent of all Hispanic
taxpayers file joint or married returns. Due to the presence of
children in these households, the flat tax would produce even more
significant changes in tax payments (see Table
4):
-
Nearly 1,400,000 Hispanic married
taxpayers would see their tax payments reduced to zero; and
-
Average tax payments would drop by
$930, or by 25 percent.
HOW HISPANIC AMERICANS WOULD BENEFIT
FROM
SOCIAL SECURITY REFORM
Social Security's low rate of return means
that Americans see fewer potential retirement savings. If Americans
were allowed to direct some of their payroll taxes into safe
investment accounts similar to 401(k) plans, or even into U.S.
Treasury bonds, they would accumulate far more money in savings for
their retirement years than they are likely to receive from Social
Security.
For
example, a single Hispanic-American male born in 1975 who earned
the average income for that age group--about $17,900 in wage,
salary, and self-employment income in 1996--can expect to receive
an annualized real rate of return from Social Security of just 1.44
percent. By contrast, he could expect to receive a long-run real
rate of return of at least 2.8 percent from long-term U.S. Treasury
bonds. This seemingly small difference in the rate of return
translates into thousands of dollars more in funds for retirement
than Social Security will pay.
Social Security also has a very low rate
of return for two-income Hispanic-American households with
children. A double-income Hispanic couple with two children, if
they were born in 1965 and earned the average wage received by
Hispanic-Americans, can expect a rate of return of
2.17 percent from Social Security over their lifetime. This rate
contrasts with a return of 3.17 percent over the same period on an
ultra-conservative portfolio composed of 100 percent U.S. Treasury
bonds, or a return of 4.67 percent on a prudent portfolio of 50
percent broad market equities and 50 percent U.S. Treasury bonds.
In terms of 1997 dollars, this couple could expect to receive
$347,000 more in lifetime after-tax income from a portfolio
composed equally of government bonds and broad market equities than
it could from Social Security.
The
low rate of return also has a damaging impact on communities. To
understand how, consider a hypothetical city populated by 50,000
young, married, double-earner Hispanic couples in their thirties,
in which each person earned the average wage for Hispanics and each
couple had two children. The cumulative amount these couples could
save by retirement by investing in private pension plans, with the
same dollars they currently pay in Social Security taxes, is more
than $12.8 billion greater in 1997 dollars than what they will
receive from Social Security. This amount is roughly equal to half
of what the federal government currently spends on food stamps each
year and half as much as direct federal spending on
education.
Crowding Out Savings
Social Security's poor rate of return
should be important to anyone interested in planning for an
adequate retirement income in old age. If the rate nearly equals
what one could achieve from stocks and bonds, then it makes sense
to devote current savings to things other than retirement savings.
But retirement rates of return from Social Security are
significantly poorer than returns from bonds or stocks, even after
adjusting for inflation and risk; therefore, additional current
savings need to be allocated to future retirement needs.
Defenders of Social Security argue that
rates of return are irrelevant to the Old-Age and Survivors
Insurance (OASI) portions of the program. Social Security, they
suggest, was intended to provide a basic, but decent, retirement
income to beneficiaries and stopgap incomes for surviving spouses.
Future Social Security beneficiaries, they argue, should be saving
now for additional retirement income to supplement benefits from
OASI. Thus, they contend, comparing rates of return on private
pension investments with those from a public program intended to
pay out during retirement at least 35 percent of the wages an
average worker earned prior to retirement is like comparing apples
to oranges.
Such
reasoning, however, has a fundamental flaw: If Social Security
taxes were low enough to allow workers to save these additional
dollars for their retirement, then conceivably Social Security
would be the pension program of last resort; but Social Security
taxes are not low, and they in fact crowd out the ability of most
low- and middle-income Americans to save for retirement. Thus, the
rate of return on these taxes is very important, especially for
those Americans for whom Social Security is the primary source of
retirement savings.
Over
the past 25 years, Congress and the President have increased
Old-Age and Survivors benefits so often and so much that the high
payroll taxes needed today to pay those current benefits crowd out
private retirement investments. In 1972, the average worker
(with his or her employer) paid 8.1 percent in Old-Age and
Survivors payroll taxes on the first $9,000 of wages and salary
(equivalent to about $21,500 in 1997 dollars). In 1997, that
worker paid 10.7 percent on the first $65,400 of "earned" income
(or the first $27,340 in 1972 dollars). Moreover, between 2020 and 2046,
the Old-Age and Survivors tax rate will have to rise to 14.4
percent from today's 10.7 percent if benefit costs are not
cut.
Because of rising payroll taxes for Social
Security, increasing numbers of poor and middle-income workers do
not have after-tax funds to create private supplemental pension
investments. In fact, today, Social Security
taxes consume as much of the average family's budget as do outlays
for housing, and nearly three times more than annual health care
expenses.
Further, because of the long-term
financial problems of the Social Security trust fund, today's
calculations of the rate of return for Social Security are likely
to prove optimistic for future generations. The fact is that Social
Security will not be able to pay out old-age benefits to the "baby
boom" generation without additional tax increases on workers or
cuts in benefits. These tax increases or benefit cuts will further
reduce the Social Security rates of return for those workers
currently in their twenties (members of the so-called Generation X)
and their children. As Social Security's rates of return fall, the
relevance of rates of return on private pensions rises. That is,
members of Generation X simply will not be able to ignore the
prospect of inadequate income during their retirement years.
Comparing rates of return for private and public pensions will
become even more important to subsequent generations.
Few
aspects of Social Security are as unintended or as damaging to low-
and middle-income workers as the squeeze that high payroll taxes
put on the formation of intergenerational transfers of wealth. The
inability of low-income workers to accumulate enough savings to
leave a sufficient nest egg to their children may mean that their
children will be as dependent on a monthly Social Security check as
their parents are. It means that poor communities will not have as
much "home-grown" capital available with which to create new jobs
and sources of income. Without these jobs and income, members of
the next generation will be less able to save for retirement. Thus,
by taxing away one generation's opportunity to help the next
generation earn income at a higher level, the Social Security
system acts as a drag on the prosperity of future generations.
Social Security's Rates of Return for
Hispanic Families
The
ability of individuals to make the important decision to invest in
bonds or stocks depends on how clearly they can see their
prospective retirement rate of return from Social Security. The
declining rates of return and mounting tax burdens implied by the
current system disproportionately affect the comparatively youthful
Hispanic population. Social Security tax rates would have to
increase by about 40 percent between now and 2050 just to keep the
system solvent. The U.S. Bureau of the Census estimates that
Hispanics will comprise almost 25 percent of those in the
economically active 18- to 66-year-old population in 2050 (compared
with 11 percent in 1997), but only 17 percent of those aged 67 and
over. In other words, the burden of paying Social Security
retirement benefits will be borne increasingly by Hispanic
workers.
To
demonstrate actual Social Security benefits for Hispanic-Americans,
Heritage Foundation estimates of rates of return refer only to that
portion of Social Security that provides retirement income.
Heritage analysts removed the non-retirement components of Social
Security by subtracting pre-retirement survivors' benefits and
taxes that support this separate insurance program from the
rate-of-return calculations. Similarly, Heritage analysts did not
include disability insurance taxes or benefits in its retirement
rate of return estimates. Heritage also assumes that both the
survivors' and disability programs will continue unaffected by the
privatization of the retirement portion of payroll taxes.
Heritage Foundation analysts calculated
Social Security's inflation-adjusted (or "real") rates of return
for various segments of the Hispanic population, and then compared
these returns with the rates of return workers could receive if
they were allowed to invest their Social Security taxes in safe,
private retirement investments. These calculations show that
Hispanic families of many types receive relatively low returns for
the lifetime taxes they pay.
Social Security's formulae are designed
expressly to redistribute income toward retirees with average- and
low-income work histories. Yet single-earner, average-income
couples born before 1935, who have paid much lower lifetime payroll
taxes, fare better than do much younger workers. However, even the
"best case" rate of return (4.9 percent for a single-earner couple
with children in which the worker was born in 1932) lies below 7
percent, a conservative estimate of what economists consider is the
long-range real rate of return on equities. Every other average-income group
lies below this rate of return, or well below the rates of return
available to Americans who invest in stocks and bonds for the long
term.
Double-earner, average-income families, as
well as single, average-income males and females, fare poorly under
Social Security. Average-income, single Hispanic males are hit
particularly hard because of the lower life expectancy of males and
the absence of spousal and survivors' benefits. The expected real
rate of return from Social Security for average-income males falls
from a high of 3.4 percent for those born in 1935 to 1.4 percent
for those born in 1975, well below what could be realized from a
prudent private investment
portfolio.
What Do These Rates of Return Mean in
Dollar Terms?
Because of the power of compound interest,
even what appears to be a relatively small difference in the real
rate of return can have significant implications for a Hispanic
family's lifetime accumulated wealth. In order to analyze the
dollar implications of Social Security's lower rate of return,
Heritage analysts calculated the inflation-adjusted differences
between Social Security's benefits and what a fairly conservative
investor could accumulate by retirement from a portfolio split
equally between long-term U.S. Treasury bonds and broad market
equity funds.
An
average-income, two-earner couple (both aged 32 years in 1997) with
two children can expect to receive about $420,400 in Social
Security benefits in return for a lifetime of payroll taxes.
Investing these same tax dollars in a portfolio made up of 50
percent U.S. Treasury bonds and 50 percent blue-chip equities,
however, could command an estimated $767,100 of after-tax
retirement income for this couple in 1997 dollars. Even an
investment portfolio composed entirely of intermediate and
long-term U.S. Treasury bonds outperforms Social Security: By the
time of retirement, this couple would generate a lifetime
retirement post-tax income of $526,400.
Hence, staying in the Social Security
program costs an average-income, married Hispanic couple in this
age group between $106,000 and $346,700 in retirement savings that
they could have enjoyed if current law gave them the ability to
invest their payroll taxes in super-safe U.S. Treasury bonds or in
a prudent mix of Treasury bonds and high-grade equities. These
dollar differences translate into significant differences in rates
of return. Social Security "produces" a 2.17 percent
inflation-adjusted rate of return for this couple. If the couple
invested their payroll taxes entirely in Treasury bonds, however,
they would receive a return rate of 3.17 percent, while an even mix
of bonds and equities would produce an annualized return of 4.67
percent.
The
gains under a mixed portfolio are such that this average-income
Hispanic-American couple could create an annuity out of their
retirement savings that paid them as much each month as Social
Security would, and still have approximately $205,000 left in their
accumulated savings at age 67 to bequeath to their children. This amount
could be used to start a business, pay for education or health
care, or to seed the retirement security of the next
generation.
CONCLUSION
To
realize the economic potential inherent in American communities,
regardless of their ethnic composition, involves much more, of
course, than changing government programs. Parents and community
leaders know well the vital role that individual responsibility,
ethical behavior, and equal treatment before the law can play in
achieving economic prosperity. Too often throughout this century,
Americans have turned to the federal government as a way to ensure
their economic improvement.
Now,
at the end of the 20th century, the problems of that reliance on
government are evident. As the progeny of the Great Society parse
through its public policies, they are saving the valuable and
attempting to eliminate or reconstruct those that work against
their social and economic well-being in the long run. Congress and
the President are faced with making fundamental reforms in
education and tax policy as well as Social Security in light of
that effort.
Unleashing the economic potential of all
Americans, and especially Hispanic-Americans, will require many
things: changing current education policy, lifting the heavy and
growing tax burden from the shoulders of hardworking Americans, and
permitting workers to invest a portion of their payroll taxes in
bond and stock portfolios to build income for retirement and their
children's future. Such changes in key federal policies can enable
all Americans to use their individual talents to achieve greater
economic rewards and individual well-being in the coming
decades.
-- William W. Beach
is John M. Olin Senior Fellow in Economics and Director of The
Center for Data Analysis at The Heritage Foundation. Gareth G.
Davis and Kirk Johnson are Policy Analysts, and Rea S. Hederman is
a Research Analyst, in The Center for Data Analysis. Nina Shokraii
Rees is former Education Policy Analyst at The Heritage
Foundation.