New Jersey’s ‘Baby Bonds’ Plan Doesn’t Add Up

(Bloomberg Opinion) -- Is it worth taking baby steps toward baby bonds?.That, in a nutshell, is what Governor Phil Murphy of New jersey is about to find out. As part of his 2021 fiscal year budget, he proposed a statewide “baby bonds” initiative in the same mold as federal legislation introduced by Senator Cory Booker, a fellow New Jersey Democrat. Under the plan, the state would provide a $1,000 deposit for each newborn as long as family income was less than $131,000 a year, or 500% of the federal poverty level. “When these residents turn 18, they can withdraw these funds to help them pursue higher education, buy a home, start a business, or pursue other wealth-generating activities,” according to the state’s budget presentation..As a concept, using baby bonds as a way to help narrow the yawning wealth gap in America is appealing. For one thing, as an article in the Atlantic pointed out, it’s a relatively cheap solution. A study from Naomi Zewde at the City University of New York, which proposed allotments as high as $50,000 for babies of the poorest families, pegged the cost to the federal government for such a sweeping program at $80 billion a year. As a frame of reference, the Federal Reserve buys that amount of U.S. Treasuries each month. Booker’s legislation, which starts with $1,000 in savings followed by additional payments of up to $2,000 a year based on family income, would be “fully paid for by making common sense reforms to federal estate and inheritance taxes.”.On its face, New Jersey’s plan would be even more modest, costing about $72 million next year. But there’s one catch, and it’s a big one for a bond program: the interest rates don’t add up..According to Booker’s plan from July 2019, “funds would sit in a federally insured account managed by the Treasury Department, achieving roughly 3% interest.” That figure is probably based on the 30-year Treasury bond, which yielded 3% in April 2019 and about 2.6% when he reintroduced the legislation. What’s more, if U.S. yields increased, so would interest payments for the baby bond accounts, and vice versa..New Jersey can’t offer that same equilibrium. As the second-lowest rated U.S. state, its 30-year bonds yield 2.5%, compared with 1.4% for comparable Treasuries. And there’s reason to expect that New Jersey’s credit standing will only worsen. Last month, the legislature authorized up to $9.9 billion in borrowing in response to the coronavirus pandemic. The revised budget calls for $4 billion in bond sales, with the option to tap the Fed’s Municipal Liquidity Facility if it can’t get more favorable interest rates from investors. New Jersey’s credit grades indicate it would almost certainly pay more to borrow from the central bank than even the strapped Metropolitan Transportation Authority, though current market pricing suggests the state could avoid this last resort..This mismatch in interest costs is why baby bonds were envisioned as a federal initiative. Unlike the U.S. government, which issues dollars and can run persistent deficits, states must balance their budgets one way or another. Asking a president or senator “how will you pay for it?” is often disingenuous at best; it’s a very real question for governors..In Murphy’s case, that means a variety of tax increases, like boosting the marginal rate on every dollar earned over $1 million to 10.75% from 8.97% (that higher rate applies to those earning more than $5 million as of now), and raising the cigarette tax to the highest level nationwide. He’s also proposing $1.25 billion in spending cuts. Then, of course, there’s the $4 billion of state borrowing. It all adds up to a likely drag on New Jersey’s economic growth coming out of the pandemic, to say nothing of its relative competitiveness with other states..According to the New York Times, Murphy insisted baby bonds were worth the cost, even with the state in dire financial straits. “This is one of those moments,” he said, “where we’ve got to see beyond what’s in front of us.” He said it’s possible that more money could be added to each child’s state account in future years..The urgency to do something to address the U.S. wealth divide is commendable, particularly as Covid-19 draws a stark divide between the country’s haves and have-nots and federal lawmakers squabble over much-needed aid to states and cities. “The inequities are too wide, too raw, to ignore,” Murphy said..But unless he has inside knowledge that a torrent of federal funds is headed his way, it’s unclear how baby bonds move the needle for New Jersey. Think of it this way: If it’s risky for states to issue pension-obligation bonds and hope that investment proceeds exceed interest payments, what about borrowing and using the money to purchase lower-yielding Treasury debt?.At current Treasury yields, a $1,000 deposit would increase to about $1,280 in 18 years. It’s hardly a guarantee that kind of growth will outpace inflation. On top of that, the funds can be used only for certain expenses, and New Jersey isn’t in a position to promise additional payments. It’s doubtful that $1,280 could cover a down payment for a house or a semester of college in 2039. For all the long-term benefits of starting the program now, residents will see and feel elevated tax rates and reduced public services immediately. Any outmigration or productivity decline will only imperil the state’s economy and ability to finance each child’s account in future budgets..If Murphy and Booker want baby bonds to meaningfully reduce financial disparities, they would be better off channeling their energy into making a federal program like the American Opportunity Accounts Act a reality. Of course, they’ll likely need Democrats to hold the White House and each chamber of Congress for it to have a chance of becoming law. Even still, that’s a better bet than this kind of state-level baby step..This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners..Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder..©2020 Bloomberg L.P.

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New Jersey’s ‘Baby Bonds’ Plan Doesn’t Add Up

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