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Expanding the Winners’ Circle: A Guide for Increasing Upward Mobility

Joel Slemrod and Robert E. Litan

Economic policy, it is often said, is about expanding the size of the pie and ensuring that its slices are not handed out too unevenly. By this criterion, the American economy was highly successful in its “golden age” from after World War II until 1973. Incomes for Americans in all parts of the income distribution increased faster than 2 percent a year – the pie was growing smartly while the ever larger slices were handed out fairly evenly. Since then, the economic pie has grown far more slowly, at little more than 1 percent annually, while the slices have grown far more unequal, bigger for those at the top income levels and actually smaller for those at the bottom.

But the pie metaphor doesn’t distinguish who gets the slices of the pie—the young or the old, for example—but instead simply measures how slices are divided among those who happen to be in different parts of the income distribution at any given time. In the real world, however, the economy is constantly in flux, with people moving in and out of the workforce and up and down the income scale.

The dynamic nature of the economy suggests that an escalator is a more useful metaphor. The distance between the various steps measures how unequal society may be. But a defining ethic of America has long been that, no matter which step you first land on or how great the distance to the higher steps, you have a good shot at moving up if, as President Clinton has frequently said, “you work hard and play by the rules.”

The ethic, of course, is part myth. Children of privileged parents get on the escalator at much higher places than do those from broken homes and rough neighborhoods. But Americans see enough success stories—the immigrants who come to this country with literally nothing and whose kids soon are excelling at school and getting good jobs—to remain committed to the ethic, as they should be.

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As we enter the 21st century, policymakers’ central challenge will be to keep the opportunities that undergird the ethic strong. The stable workplace of the golden age, when many could count on a job with one company throughout their working lives, has long since vanished. Americans know that they must rely on their own wits and drive to constantly upgrade their skills so that they can survive and prosper in today’s high-tech, global economy. Otherwise, they may well fall down the economic escalator—taking a lower-paying job after months of traumatic unemployment—if they become victims of the next downsizing, re-engineering, or merger. America must find a way to help more people avoid this fate. If it does not, the gap in Americans’ lifetime incomes will grow ever wider in the years ahead, as Daniel McMurrer and Isabel Sawhill warn in their excellent new book, Getting Ahead. McMurrer and Sawhill point to the growing inequality in wages over the past 25 years (with the modest interruption since 1993 discussed shortly).

In the long run, equal opportunity on the economic escalator is best assured by improving K-12 education for all American children, a subject to be tackled in a future issue of Blueprint. In this article, I outline four ways to broaden opportunities for all those already in the workforce:

  • run a “high pressure” economy;
  • make on-the-job training more widely available;
  • create the Leap Loan program for lifetime learning;
  • create a system of wage insurance.

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Run a “High Pressure” Economy

In the early 1970’s the late Arthur Okun, who was chief economist during the latter years of the Johnson Administration and is widely regarded as one of the great economists of the post-war era, demonstrated the virtues of keeping the economy operating at or near “full employment” as a way of sustaining faith in the American ideal of equal opportunity. Okun found that a “high pressure” economy not only keeps the escalator moving at its “potential” rate of speed, but it also improves upward mobility—not just for new entrants who often come in on the bottom steps (in terms of pay level) and learn what it means to hold a job, but for many currently employed workers who find it easier to advance within their own companies.

What was true nearly 30 years ago is true today. According to the 1998 Economic Report of the President, after falling for over a decade, real earnings for households in the bottom quintile of the income distribution actually rose faster between 1993 and 1996 than in all other households (reversing a trend of the 1980’s). Similarly, after remaining virtually flat from 1973 to 1993, median family earnings increased by 5 percent over the same period. A major reason for this welcome turnabout is that workers throughout the economy have been finding it easier to move up—thanks to prudent fiscal policy that has brought down interest rates to their lowest levels in a generation and to extraordinary monetary policy that has allowed the current expansion to eat away at the nation’s unemployment rate without igniting inflation.

A clear lesson is that the nation reaps great benefits when the economy is allowed to run flat-out. A fast-moving escalator not only takes millions of Americans along for the ride, but makes it easier for workers in the bottom of the income distribution to climb to higher steps on their own.

But policymakers should not rely solely on sound macroeconomic policy management to assure continued upward mobility. Society has an obligation to explore all reasonable microeconomic policies for making it easier for people to climb up the escalator, however rapidly it may be moving, or to climb back on with minimum wage erosion if they lose their jobs. One of the fundamental differences between the old economy and the New Economy is that fast-paced changes in technology require most workers in the New Economy to continually upgrade their skills. And yet, until very recently, the government has provided relatively little help once people leave the cocoon of their formal education.

At the Administration’s suggestion, Congress recently enacted tax legislation that provides modest incentives for many Americans already in the workforce to upgrade their skills. Americans with earnings under $100,000 can take a 20 percent tax credit on the first $5,000—and, after 2002, on the first $10,000—of expenses for post-high school education undertaken at any point in their lives. While this is a major step forward, the tax credit can only be taken if the individual is in school at least half-time and thus may be of limited use to many workers, who may not have the time to take that heavy a courseload given their current jobs. Moreover, the tax credit does not address a key problem facing many individuals in the workforce who want to attend school: providing financing to cover the tuition (which the availability of the tax credits may cause to increase somewhat).

The federal and state governments have paid more attention to the plight of displaced workers, providing them with unemployment insurance payments for 26 weeks or longer and offering a variety of training programs. Nonetheless, while unemployment insurance is important, it is too much “safety net” and not enough “trampoline.” Neither the regular unemployment insurance program nor the extended version for workers displaced by trade (under the Trade Adjustment Assistance program) encourages workers to return quickly to work because workers continue to collect as long as they stay home (although they may be in a training program). Moreover, neither unemployment insurance nor trade adjustment assistance directly helps many workers who are forced to take a cut in pay when returning to work. This is perhaps the most severe long-term impact of unemployment: having to re-enter the economic escalator on a much lower step.

The hodgepodge of federal government training programs also has had its flaws. Some improvements are likely now that Congress has enacted the Workforce Investment Act (WIA) of 1998, after several years of prodding by the Administration. Among other things, the WIA consolidates multiple training programs, devolves responsibility and money for training to the states in “one-stop” offices for delivering counseling and training services to unemployed workers of all types, and encourages the states to give workers vouchers so that they can choose the training they believe best suits them. Still, the WIA will take time to have an effect, and even under the best of circumstances it should be viewed only as a good first step toward helping temporarily displaced workers.

While the government’s current efforts deserve applause, the conditions of the New Economy require that we expand the winner’s circle—or watch the gap between the well-to-do and the working class grow to unacceptable levels. Three ideas for expanding the circle follow.


Make On-The-Job Training More Widely Available

Most private sector companies have incentives to train their employees because that training will help workers be more productive and deliver better products. According to the American Society for Training and Development, American business spent $55 billion on training in 1995.

But company-provided training primarily benefits a relatively small portion of the American workforce. For one thing, larger companies spend relatively more on training employees than do small and medium-size companies, which often do not have the resources or time to train their workers. Moreover, workers for these smaller companies tend to earn less and receive less generous benefits packages than do their counter-parts at major corporations. Even within large companies, training is disproportionately provided to professionals and higher-salaried employees. And understandably, companies do not usually train workers for new careers, the option that for many people offers the best chance of moving up the escalator.

Robert Shapiro, former vice president of the Progressive Policy Institute and current Under Secretary of Commerce, has suggested an innovative way to encourage firms to spread around the training wealth more evenly. He notes that currently firms may count any training expenditures as a tax deduction—even those for junkets by top managers who attend a few courses in the morning at some resort but then frolic at the beach or on the links for the rest of each day. Accordingly, Shapiro suggests that much as the tax law now permits companies to deduct health care and pension costs only if they meet a “non-discrimination” test, firms should be able to deduct expenses for training only if it has been offered to a broad spectrum of the workforce.

Admittedly, writing workable, easy-to-apply non-discrimination rules is not simple. Current pension rules are a lawyers’ and accountants’ relief act. In addition, training expenses—some of which may consist of on-the-job instruction by full-time supervisors—are inherently more difficult to verify than health care and pension costs, which are almost always paid out to third parties. Nonetheless, the perfect should not be the enemy of the good. It should be possible to write a workable “safe harbor” such that firms could be deemed to satisfy the training non-discrimination test if, for example, they demonstrated that their training expenses constituted some portion (say 1 percent) of the salaries paid to the employees in the bottom 25 percent or half of their pay scale.

The non-discrimination test will not solve all problems with employer-provided training. Because training is like any other investment that firms consider making—it pays only if workers stay around long enough to apply the lessons they learn to help the firm make more money—companies may still be reluctant to help upgrade their workers’ skills. Nonetheless, because many workers do stay with their companies and so investing in their skills promises payoffs for firms, a non-discrimination test for tax deductibility of training expenses should at least help ensure that those at the bottom of the pay scale will not be left behind as companies design their training programs.

Create the LEAP Loan Program for Lifetime Learning

Changing the tax law to ensure that training is made more widely available within companies, however, is not likely to help most Americans who work for smaller companies or workers who want to develop skills for new careers. Nor, for reasons already given, will the new lifetime tax credit help many of these workers. Instead, these workers need financing, especially those in the bottom half of the income distribution who generally have very little liquid savings (outside of retirement accounts) to pay for further education.

The obvious solution to this problem is to provide LEAP (Lifelong Education Advancement Pursuit) loans, modeled on the program that has helped finance the educations of tens of millions of American college students, most of whom are still in the workplace. Through LEAP loans, people with household incomes below a certain threshold (such as the $100,000 limit for the education tax credits) would be eligible for a certain amount of financing (such as $40,000) over their lifetime. The loans would be provided at subsidized interest rates, carry long maturities, and defer repayment for a fixed period (say four years). Such a program need not be that expensive. If, say, two million workers borrowed an average of $5,000 a year with an annual interest subsidy (counting the delayed payment benefit) of 10 percent, the government’s total cost would be $1 billion, or 1/6 of the annual cost of the recently enacted education tax credits. An added twist would be to base repayments on the borrower’s income so that workers would not find themselves overburdened with loan payments if their incomes do not rise initially.


Create a Wage Insurance Program

The other component of any upward mobility program must be a better trampoline for those who temporarily fall off the escalator because of involuntary unemployment. The new idea here is to provide wage or earnings insurance to supplement—and, as a practical matter, partially supplant—unemployment insurance.

For many workers, the most significant loss they suffer when getting laid off is not the temporary loss of income while they look for a new job, but instead the immediate and often long-lasting erosion in their earnings when they do land new employment. Workers develop what economists call “firm-specific” capital in the jobs they currently hold: a set of skills and relationships that often makes them more valuable to their existing employers than to their new ones, especially ones in a different industry. That loss of firm-specific capital is the reason many displaced workers have to return to the escalator on a lower step.

Wage or earnings insurance would help compensate workers for this painful adjustment, while providing strong incentives to returning to the escalator as quickly as possible. For example, under the version of the idea outlined in Globaphobia (a recent Brookings-PPI-Twentieth Century book I co-authored with Gary Burtless, Robert Lawrence and Robert Shapiro), displaced workers would be provided—for some period of time—a portion, say 50%, of their wage loss suffered in taking a new job. The total compensation would be capped at $10,000 to ensure that upper income individuals were not disproportionately compensated. Payments would be made through the states, as with current unemployment insurance. To provide a concrete example: A worker who made $40,000 at her old job who takes a new job paying $30,000 would collect the equivalent of $5,000 a year (50 percent of the $10,000 income loss) until the eligibility period expired.

Of key importance: Workers would not begin collecting wage insurance payments until they found a new job, and would collect only for a set time period that would be counted from the time they were laid off (say, two years). This feature would provide a very strong incentive for workers to find new employment, even if it meant taking a pay cut, which can be viewed as either the loss of firm-specific capital or the amount the firm must reinvest in training the new employee—or both. Indeed, wage insurance can be seen as a subsidy for the kind of training that has proved to work the best: on-the-job rather than in a classroom, where job placement prospects always will be uncertain.

As a government program, wage insurance could take various forms. In its most limited version, it could be viewed as a supplement or even replacement for Trade Adjustment Assistance, aimed at workers displaced either by trade generally or by new trade agreements. In that event, it is unlikely that the program would cost more than $1 billion annually, and conceivably could cost much less.

The logic of wage insurance, however, argues for a more expansive application to the workforce. Trade, after all, is only one—and indeed a relatively minor—source of displacement. But a general program could be considerably more expensive. A variation of an economy-wide program would be to provide a refundable income tax credit to workers who suffer a loss in income exceeding some threshold percentage.

It might even be unnecessary to run wage insurance as a government program. Instead, government could work with private sector insurers to develop a product that these insurers could provide either directly to workers or through employers as a fringe benefit. Indeed, an increasing number of firms already are offering severance benefits as a fringe benefit to entice new workers, who understandably are worried that they could one day become the next victims of downsizings or mergers.

Private insurers can be expected to figure out how to structure insurance so as to minimize the familiar problems of “moral hazard” (insureds taking greater risks because of the insurance) and “adverse selection” (only the riskiest insureds signing up for the program). One possibility is to offer the insurance only for workers who have been with a firm for some minimum period of time (say, one year), to avoid churning.

There is one impediment that insurers would need some government help overcoming, however. Insurers now do not offer unemployment insurance primarily because of the risk that a large increase in the state-wide or national unemployment rate could require them to compensate many of their insureds at one time. For similar reasons, insurers are reluctant to write insurance against large natural disasters, which can cause widespread damage to many insureds simultaneously.

The government can address this risk, however, by selling reinsurance to private insurers to cover their costs when the statewide or national unemployment rates exceeds a certain threshold. Indeed, Congress has been considering during the past year a similar system for reinsuring property-casualty insurers against large disaster-related risks.


Where Will The Money Come From?

An effective program for expanding the winners’ circle in the New Economy need not be prohibitively expensive. Adding training non-discrimination provisions to the tax code probably wouldn’t cost anything and, indeed, might gain the Treasury some revenues if it increased productivity. As already noted, a lifetime skills upgrading loan program could be structured to cost in the $1 billion range. A carefully targeted wage insurance program might have a cost that is at least similar and, arguably, much less if run as a reinsurance program for private insurers (which, if properly priced, need not cost the government anything).

Whatever the modest costs, they should be kept in perspective. With new education tax incentives in place, the federal government now spends directly and through the tax system over $13 billion annually assisting college students with their education. Counting the lifetime learning credit, the government spends only about $8 billion on training all the rest of the workforce combined. A modest increment for those already working is a small price to pay to assist Americans to climb higher on the economic escalator.

It should be a matter of principle and pragmatism that all Americans get a chance to share in the opportunities presented by the changes that are shaping our world. If America is to succeed in the New Economy, then Americans must succeed – and the circle of opportunity must be expanded so that no one is left out.

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