The Best Return on the Surplus

February 17, 1999

The emerging federal budget surpluses—now projected to exceed $4 trillion during the next 15 years—offer a unique opportunity for the nation to prepare for the retirement of the baby boomers. A strong future economy would reduce the need for painful Social Security and Medicare cutbacks or debilitating tax increases. To address this issue, the president has proposed paying down the government debt by bolstering the Social Security trust funds, while the Republicans have proposed large-scale tax cuts. Although we believe reducing the debt would be far more effective than tax cuts, both alternatives omit a crucial ingredient in the nation’s economic future: an educated work force.

The key question is what’s the best way to ensure that the next generation will be able to pay for their parents’ retirement? We do not deny the importance of reducing the debt by partially funding Social Security and freeing funds for private investment. But the most important “tool” for future workers will be their brainpower, and the most direct and effective way to raise their productivity is to ensure that a greater number of them have the skills to operate in tomorrow’s high-tech economy.

We must invest a sizable chunk of projected surpluses in educating the next generation. The rate of return on education has risen sharply over the past two decades and is easily competitive with returns on financial assets. Making today’s children more productive, more self-sufficient and better able to use emerging technologies could create a much stronger economy than if we devote all of these resources to increased financial saving. Equally important, investments in children are more likely to produce dividends that are broadly shared. And investments in children are more likely to remain in the country, to the benefit of us all, while financial saving might migrate to other countries.

If we want to make America a more attractive place to invest, we need to focus more attention on the most important home-grown asset we have: our work force.

A cautionary note: It is easy to invest in financial assets and earn the market rate of return, simply by purchasing a broad-based index fund. Public investments in education are less certain to pan out. The funds may get squandered on bureaucracies. The teaching and learning may be ineffective. The funds may not influence people’s educational choices much. For example, the recent tax credits for college education seem most likely to go to parents who would have sent their children to college anyway.

Evidence suggests that the highest rates of return come from investing in early childhood education. Well-structured programs targeted toward preschool children have produced large improvements in their later educational and labor market success, with estimated rates of return that would make a venture capitalist envious. Yet we are spending a tiny fraction of total federal resources on children under the age of 5, a commitment that is likely to wane further given the tight budget caps on discretionary spending for the foreseeable future.

Unlike other countries such as France and Italy, we do not routinely subsidize the education and care of young children. Child-care debates in this country have focused on the benefits for working mothers but should be redirected to examine how more educationally oriented programs could help children and the nation’s future productivity. About half of all 3- and 4-year-olds, most of them from more affluent families, are already enrolled in preschool programs. The opportunity ought to be extended to less advantaged children as well. With welfare reform moving more mothers into the job market, we shouldn’t miss the opportunity to put more of their children on a path to success.

As always, the devil is in the details. But just as it is possible to imagine independent boards managing the Social Security trust fund or the nation’s money supply, so too can we imagine an independent intermediary that might evaluate and advise on how to invest a public trust fund for children. If such funds were provided as a block grant to the states but with a proviso that their effectiveness be rigorously evaluated, chances are that much good could be accomplished.

Other options could be considered, including tax credits or vouchers that could be used only in independently accredited preschool programs, or assistance to urban public schools tied to accountability for results. Our goal is not to resolve this debate here but to point to the need for increased educational investments as part of a balanced portfolio for the next century, one that would not only help today’s children but also help to pay for their parents’ retirement as well.