Next year, the federal government will institute electronic benefit payments. While the electronic funds transfer (EFT) program will reduce costs, it has a far broader potential to bring poor Americans into the banking mainstream.
To realize this potential, EFT should be implemented along with a grassroots economic literacy campaign and a national savings initiative. The overall package would encourage and enable the working and non-working poor alike to become more savings-conscious and financially self-sufficient.
POLICY BRIEF #32
Thanks to recent advances in banking technology and a 1996 amendment of an obscure law, millions of low-income, bankless Americans may soon become part of the financial mainstream. Beginning in 1999, federal payment recipients will join tens of millions of other Americans who currently receive their salaries or government benefits through electronic funds transfer (EFT)—what most of us call direct deposit. Cost-cutting is the driving force behind the move to a virtually all-electronic federal payment system, but it is not economy and efficiency that give this electronic initiative its vast human and community development potential. What the Department has come to call EFT’99 should not only encourage financial inclusion, but also foster the economic literacy of low-income consumers. The tens of billions of dollars in new, low-cost federal deposits that will start flowing through the banking system can be leveraged into affordable account services for the poor by mainstream financial institutions. This will indirectly help the poor to save.
The Administration and Congress can maximize the impact of EFT’99 by funding a grassroots economic literacy campaign directed toward the unbanked, and by creating a national savings initiative for the working poor, including those making the transition from welfare. The latter would strengthen and expand local asset-building programs—especially individual development account (IDA) initiatives—that a growing number of community-based organizations are creating in partnership with local financial institutions to help the working poor become more economically self-sufficient.
IDAs are dedicated savings accounts that can only be used for purchasing a first home, for education or job training expenses, or for capitalizing a small business. Deposits from salary or wages by lower income individuals into their IDAs are matched on a dollar-for-dollar basis using both public and private sources. Funding a major savings incentive initiative—such as an IDA program—in conjunction with EFT’99 is an excellent way for the Administration to share EFT’99 savings with the recipients themselves. An IDA initiative in support of EFT’99 would also complement welfare reform by helping those making the transition from welfare to work to begin saving and planning for the future. As Washington University in St. Louis Social Work Professor Michael Sherraden has said, “Income may feed people’s stomachs, but assets change their heads.” A credible national IDA program could be put in place for as little as $100 million a year, less than the annual savings that EFT makes possible, and only a tiny fraction of the $17 billion, ten-year cost of the enhanced IRAs the Congress made available to higher income American workers as part of last year’s balanced budget deal.
Cost-cutting is the driving force behind the move to a virtually all-electronic payment system that will affect the delivery of about $260 billion a year in federal benefits that are still being delivered by paper. When states complete their mandated transition to electronic delivery of food stamps and welfare benefits, which they must do by 2002, EFT is expected to save the government an estimated $195 million a year in postage, check production and replacement costs, and administrative overhead. While virtually all of the $95 billion a year in state-delivered welfare and food stamps is still being distributed in paper form, at least 40 states have begun the transition to electronic delivery.
But neither economy nor efficiency are the keys to the transformational power of this unheralded electronic banking measure. Treasury Secretary Robert E. Rubin understood from the beginning that EFT’99 presents “. . . a real opportunity to have an effect on a very large number of people in the inner city . . . [who] use expensive check cashing services to get hold of cash. If we can figure out a way to get them into the banking system for the first time, not only will it give them a more efficient way to cash checks and access to other financial services, but it may also encourage people to save, to plan financially, and therefore, to improve their economic life over time.”
Part of EFT’99’s significance is that it requires the Treasury Department to create electronic bank accounts for the unbanked, which include an estimated 20 percent of American families including 10 million federal benefit payment recipients. The unbanked include a third of all minority households; one of four renters; one of six under 35 years of age; and 15 percent of the working poor (families earning between $10,000 and $25,000). While the poor who receive no federal benefits don’t directly gain from EFT’99, the new account options the effort spurs in the banking sector will help them indirectly, and might dramatically alter the way they handle their financial affairs.
The EFT’99 Time Line and the Danger of Waivers
We are about halfway through the EFT’99 implementation process. On September 16th of last year, Treasury issued a proposed rule for public comment which, among other issues, addressed how current and new recipients of federal benefits will have their payments delivered electronically, and how those without bank accounts will receive their payments. The proposed rule deals with the unbanked in three ways:
- Through a massive public education campaign, Treasury hopes to encourage unbanked recipients to open bank accounts on their own, and to authorize their banks to receive benefit payments through direct deposit.
- Treasury hopes to stimulate new low-cost account options for unbanked recipients by urging financial institutions to offer alternatives to traditional checking accounts. Called Direct Deposit Too by Treasury, these accounts would feature debit card access to federal benefits, provide no depository or third party bill-payment privileges, and carry no minimum balance requirement. While it is too early to assess the success of the Direct Deposit Too marketing campaign, more than 300 Missouri banks agreed to offer no-cost/low-cost accounts to welfare recipients in response to a similar campaign mounted by that state’s Department of Social Services as part of its initiative to convert public assistance and food stamps to electronic delivery.
- Finally, Treasury will soon invite interested federally-insured depository institutions to compete to provide electronic accounts for unbanked recipients who don’t designate a recipient bank. The proposed rule describes these accounts in terms similar to a Direct Deposit Too account—recipients should be able to withdraw their funds through automated teller machines (ATMs) or point-of-sale (POS) terminals with an access card. But Treasury leaves open the possibility that these accounts might also provide other features, such as savings, check writing, and electronic payment options.
Some consumer advocates are concerned by the fact that the character and cost of these accounts will be largely determined through competitive bidding. Consumer advocates like the National Consumer Law Center believe that EFT’99 concerns not just bridge-building to the financial mainstream, but also cost-shifting. They feel that if all payments are made electronically, the government or the banks will be making money at the expense of indigent benefit recipients.
Perhaps these reservations were inevitable. These groups have long been opposed to high bank service charges, which have been increasing at twice the rate of inflation. The groups are indignant that Treasury is not requiring banks, as part of EFT’99, to provide low-cost lifeline accounts for the poor. And they are upset that Treasury does not require the new electronic accounts to include no-cost or low-cost checking or third-party payment services.
But these community advocates are up against the inevitable. Banks in the twenty-first century will rely increasingly on fees for specific services, less from interest margins, to meet their profit targets. EFT’99 will be no exception. In fact, the trend toward fee-based banking is already discernible. Today, about 35 percent of American banks’ total revenue comes from fees, almost double the proportion in 1980. The challenge for mainstream institutions, then, is to figure out how to use EFT’99 to forge a profitable new business line at the lowest possible fees while beating the competition, including the competition from check cashing outlets and currency exchanges.
This grassroots opposition has been highly vocal, and Treasury’s EFT’99 proposed rule slows down the implementation process by delaying for up to one year the deadline by which unbanked recipients must receive their benefits through electronic means. The rule also liberalizes the waiver process, which may prove to be more problematic in the long run if, indeed, EFT’99 is to lay the foundation for an asset-building initiative. Treasury Under Secretary John Hawke, Jr., recognized the importance of limiting waivers in a February, 1997 discussion of EFT’99 when he noted that the “waiver authority will have to be used selectively or the benefits of the electronic program could be undermined.” Perhaps, startled by stronger than anticipated consumer opposition, Treasury’s proposed rule opens the waiver door too widely.
Understandably, the rule would grant unbanked recipients a waiver if the switch to EFT would cause them financial hardship. It would also grant waivers to unbanked recipients who have physical disabilities or are confronted with a geographical barrier. However, the proposed rule also allows similar waivers to recipients with bank accounts who started receiving benefits before the EFT law was passed (July 26, 1996.) And because neither Treasury nor other agencies have the resources to evaluate each request, the waiver rule is customer driven—it simply lets benefit recipients take themselves out of the system. This undermines Secretary Rubin’s vision of EFT’99 as the centerpiece of a powerful individual empowerment strategy.
IDAs, Savings Incentives, and Asset Building
An IDA initiative would help the poor—working and non-working alike. Of the 7.5 million working poor in 1995, 3.1 million experienced at least one spell of unemployment, and nearly a quarter cited involuntary part-time work status at some time during the year. The combined impact of EFT’99 and an IDA program could encourage these workers to join the mainstream banking system and help them accumulate savings for future investment in their own education or training, or for a down payment on their first home. An IDA could also help keep the working poor, who are disproportionately in families maintained by single parents, from returning to the welfare rolls.
This relationship between the move to an all-electronic benefit delivery system and welfare reform needs to be better appreciated by the policy and advocacy communities. It is hard to imagine a mother moving from welfare to work, and staying off welfare, without a bank account and without building up some cash reserves for emergencies. This is why the widespread adoption of measures to encourage personal savings and asset-building by the dependent poor is so important.
Twenty-five states had already received waivers to increase their asset and personal savings limits—some to as high as $5,000—even before the president signed the August ’96 welfare reform bill. However, while liberalized asset rules protect the eligibility of persons with assets, they do nothing to help the poor grow assets. That’s why the welfare reform bill also authorized states to create community-based IDA programs with welfare block grant funds and to disregard all money saved by the poor in IDAs in determining eligibility for means-tested government assistance. By June 30th of last year, 18 states had already included IDAs in their welfare reform plans.
Despite its seemingly broad appeal, however, the grassroots IDA movement has yet to gain much currency in Congress. IDA supporters point to the bipartisan sponsorship of national IDA legislation in the 104th Congress as a sign of its growing strength, but the bill died in committee. Last October, the Assets for Independence Act, which would authorize $25 million a year to provide matching funds for 50,000 IDAs over four years, was once again introduced in Congress—again, with bipartisan support, and again it will stay buried in committee unless it is resuscitated as part of a comprehensive EFT’99/asset-building initiative.
For two years, the Administration has failed to take an official position on the Asset for Independence Act despite the fact that IDAs were part of the president’s own 1994 welfare reform plan. Maybe the addition of an IDA component to EFT’99 would guarantee greater grassroots enthusiasm. Regardless, the Administration should recognize that using EFT’99 savings to fund community-based economic literacy campaigns and IDA matches is the correct policy direction. It is far wiser than using that savings to provide long-term subsidies to banks that agree to create electronic accounts for unbanked benefit recipients, an idea some community advocates have endorsed. In the long run, banks should be able to offer benefit recipients electronic accounts with limited service options without subsidies. And the economics of these accounts should improve over time.
As they become more familiar with using the banking system, the newly banked recipients will tend to withdraw cash as needed, rather than in a lump sum upon receipt. Bank earnings will correspondingly increase on the investment of the idle account balances. A national IDA initiative that matched deposits from wages dollar-for-dollar would improve the banks’ picture even more. Presumably, the federal match would encourage benefit recipients to save more, thus increasing average account balances. And if the withdrawal of matching funds from these accounts were restricted to the uses discussed earlier, then a high percentage of these cheap deposits would remain in the account for substantially longer periods, thus lowering the fees that banks have to charge for additional account services.
Another argument for why Congress should mount a major asset-building campaign for those without financial assets is equity. Analysis of the balanced budget legislation shows that initiatives which primarily assist low- and moderate-income children and families, legal immigrants, and elderly people are modest in size and dissipate over time. By contrast, the tax cuts for high-income individuals get much bigger over time. Together, the capital gains, estate tax, corporate alternative minimum tax, and IRA provisions of the balanced budget deal reach a cost of nearly $24 billion in 2007, the tenth year. This is more than six times the $3.8 billion annual average cost of these provisions from 1998 through 2002. Back-loading is particularly egregious in the provisions for IRAs, the benefits of which will be garnered mostly by taxpayers who have incomes between $50,000 and $160,000, and who are already covered under an employer-sponsored retirement plan. Treasury estimates the costs of expanding current deductible IRAs and providing new back-loaded, so-called Roth IRAs, to be just $1.4 billion for FY 1998-2002, ballooning to $16.4 billion over the succeeding five years, FY 2003-2007.
A way to democratize IRAs is through a national initiative that would provide federal matching funds to encourage the working poor to invest in their own future. While IDAs might not have much of a statistical impact on the national savings rate because of the small amounts of income that the poor can afford to invest, we can be pretty sure that whatever low-income families do save in their IDA accounts would result in a net increase in aggregate personal savings. That’s more than we can say for IRAs and other tax-advantaged savings incentives for middle- and upper-income Americans. According to William Gale of the Brookings Institution, “wide variation in effective tax rates on saving merely create opportunities for investors to shift funds into the most tax-preferred accounts.”
If we believe that surviving, let alone thriving, in today’s world requires full access to the mainstream banking system, then it is incumbent upon government to do all it can to assure the success of the ongoing transitions to electronic delivery of federal- and state-delivered benefits. I recommend the following three actions:
Increase economic literacy.
Congress should ensure that Treasury has sufficient funds—those close to this issue believe $17 million over two years is required—to support a national grassroots economic literacy campaign in poor urban and rural communities throughout the country. Swarthmore economist John Caskey suggests that economic literacy courses should include money management skills, cost comparisons for fringe banking services, the economics of rent-to-own contracts, and credit planning. There is an army of community-based partners, already routinely dealing with economic literacy issues, that stands ready to work with lending institutions and others to make EFT’99 effective for their constituents.
Leverage federal community development bank resources.
The president ran on a campaign to create a national network of community development banks to help close the affordable credit deficit in poor communities. While it remains a relatively small program under Treasury auspices, the Administration should align the agenda of its community development financial institutions program with the move to an all-electronic federal benefit delivery system. This means funding more community-based partnerships committed to helping EFT’99 succeed, and rewarding mainstream financial institutions that create, agree to manage, and/or invest in IDA programs. There are 346 existing federally chartered community development credit unions that were created exclusively to meet the financial service needs of low-income persons in under-served communities. Treasury should help these credit unions acquire the technology to receive federal benefit payments electronically, and to enable their customers to access benefits by ATM.
Create a national IDA program for the working poor.
EFT’99 is more likely to succeed over the long term if it is linked to a major effort to stimulate savings and wealth creation by the poor. Funding of a national IDA initiative could take several forms, including, for example, democratizing IRAs through a federal refundable tax credit that would match low income individuals’ deposits on a dollar-for-dollar basis up to, say, $300 a year for five years. Another alternative is to modify the Assets for Independence Act discussed earlier by funding it on the mandatory side of the budget through the vehicle of the earned income tax credit (EITC), for which all IDA-eligible individuals automatically qualify. Through her annual federal tax return, a low-income worker would instruct the IRS to electronically deposit into her IDA account a specified portion of her EITC, along with a one-to-one federal match, up to a maximum of, perhaps, $300 a year. A final, preferable option that could achieve the envisioned scale of 400,000 new accounts a year for five years while minimizing compliance problems would be administered by financial institutions in partnership with community-based organizations to provide required economic literacy services. Federal tax credits would offset the bank’s costs of funding and administering their local asset-building programs, while the availability of CRA (Community Reinvestment Act) credit would be a further inducement to encourage widespread participation.
Regardless of how a national IDA program might be funded, the IDAs would all have the same basic look. The Corporation for Enterprise Development, the non-profit national champion of IDAs, says there are common elements each IDA should include:
- Participants would open ordinary interest bearing savings accounts maintaining control over their account balances, including the right to withdraw savings at any time and for any use. But they could only access federal matches for eligible withdrawals, and only with prior approval by the community-based sponsor.
- The federal government would deliver match funds to a pool account, separate from individual participant accounts, in each participating financial institution. To minimize fraud and maximize compliance with use restrictions, match money would never be transferred into participants’ accounts. Community sponsors would maintain control over matches, approving financial institution payment directly to designated vendors—a real estate agent for a house closing, a college for tuition, and so on. No savings would be permitted to go into the participant’s IDA account that were not eligible for matching money, and accounts would be matched only at the time of authorized withdrawal. However, earned matches would be reported to account holders on a regular basis so that they can keep apprised of their matches and watch their account balances grow.
It is clear that EFT’99 concerns not only the technology of electronic banking, but also financial inclusion, strengthening welfare reform, and making compound interest work for low-income Americans. Within the framework outlined here, all these aspects of the EFT initiative can be addressed quickly, fairly, and effectively. With careful planning, a relatively small investment can have a major payoff in real assets and improved prospects for those who have been, for far too long, on the fringes of the country’s mainstream financial banking system.