Are Americans obsessed with their credit score? They have good reason to be worried, as there is much that ails the credit reporting industry.
Information at risk. As the Equifax breach in 2017 highlighted, the industry is vulnerable to cyberattacks that give hackers access to personal data and financial information.[1]
Reporting errors. According to a study by the Federal Trade Commission (FTC), one in five Americans had an error on their credit report.[2]
Credit reports are discriminatory. A study by the Consumer Financial Protection Board (CFPB) found that 45 million Americans have no (or an un-scorable) credit history — with the largest cohort of individuals residing in communities of color or low-income areas.[3]
Consumers have too little control over their credit reports. Historically, Americans have lacked any real control over their credit reports and credit reporting agencies have put in place barriers that make it very difficult to challenge errors in those reports.
Unfortunately, the leading legislative fix — creating a public credit reporting agency — would fail to remedy these serious problems.
The government has not proven to be a better guardian against cyberattacks any more than the private sector. Over 22 million Americans had their information stolen in the course of two separate attacks launched on the U.S. Office of Personnel Management between 2012 and 2015.
Error rates are common in government data, and trying to get them fixed is hardly simple. Anyone who has ever dealt with their local Department of Motor Vehicles (DMV) can attest to that. Furthermore, a public entity would be relying on the same data inputs as the private sector credit reporting agencies. So any errors in the data will still spoil the results.
Ensuring the algorithms used in credit scoring don’t have discriminatory impacts is long overdue. But the government doesn’t need to replace private credit agencies to ensure non‐traditional sources of data like rental history and utility bills are used to determine a fair credit report. Congress could just require it and give the FTC and CFPB the resource and staff to enforce the rules.
While well-intentioned, the proposal to create a public credit reporting agency is an example of a classic problem in policymaking, the misalignment between the policy problem and the policy solution. That’s a shame, because anyone who has ever dealt with the credit reporting agencies (basically everyone over the age of 18) knows the present system is rife with problems. But there are some ideas that could improve the credit reporting.
To safeguard private information, the credit reporting agencies should be required to adopt the latest and most effective anti-cyberattack protections — and be subject to fines and other penalties if they fail to do so. And if someone’s information is stolen, credit agencies should provide a free and seamless way to freeze and un-freeze their credit reports — as often as they want.
To help consumers keep tab on their credit report, Congress should enact legislation that requires the credit reporting agencies to continue the practice started during the Covid-19 pandemic — to provide free credit reports on a weekly basis.
Finally, to help reduce the discriminatory impacts of the credit ratings, Congress should enact a Community Reinvestment Act (CRA) type law for the credit reporting industry. Such a law would give the FTC and the CFPB the ability to limit the credit reporting agencies from using discriminatory data and to add non-traditional sources of information. The law would also would require the FTC and the CFPB to issue an annual report tracking the efforts of credit reporting agencies to reduce the discriminatory impacts.
America’s credit reporting system needs fixing. But success means we need to put in place the right policies. If we don’t, we will have missed a historic opportunity to protect consumer information, reduce errors, and eliminate discrimination in credit reporting.
Paul Weinstein Jr. is a PPI Senior Fellow and Director of the MA in Public Management at Johns Hopkins University.
[1] “Equifax Data Breach Settlement,” Federal Trade Commission, January, 2020.
[2] Michelle Black, “Millions of Americans have errors on their credit reports — do you?” bankrate.com, May 13, 2019
[3] Kelly Holland, “45 million Americans are living without a credit score,” CNBC, May 5, 2015
Authors: Caleb Watney, Lindsay Milliken, and Doug Rand
Entrepreneurship is the engine of long-term economic growth and dynamism. For the United States in particular, foreign-born entrepreneurs have made up an extraordinary share of our most successful companies and technological achievements. To encourage the vitally important flow of immigrant entrepreneurs, and to accommodate the growing need for an entrepreneur-specific pathway into the country, the Department of Homeland Security (DHS) adopted the International Entrepreneur Rule (IER) in early 2017.
The rule was quickly put on hold by the incoming Trump Administration, but was never removed from the Code of Federal Regulations. With support from the new Biden Administration, the IER could quickly become an essential pathway to attract and retain foreign-born entrepreneurs who seek to build their businesses within the United States.
Using the DHS estimate that 2,940 entrepreneurs per year would come to the country through the IER, after adjusting for expected business failure rates, we project these entrepreneurs would produce approximately 100,000 jobs over ten years if they produce only the minimum number required for parole extension. If they mirror the average job growth of firms their age, we project more than 160,000 jobs over ten years. If 50 percent of them are high-growth STEM firms, we project more than 300,000 jobs over ten years.
If the number of yearly entrepreneurs is larger than DHS projected, job growth could be considerably higher:
This paper proposes the following recommendations for the new administration, both immediate and longer-term:
Publicize the International Entrepreneur Rule and credibly signal to stakeholders that the IER will receive agency attention and resources
Issue new guidance documents to agency adjudicators to clarify evidentiary standards and make it reasonably straightforward for investors to prove they meet qualifying criteria
Issue new guidance directing U.S. Citizenship and Immigration Services (USCIS) and U.S. Customs and Border Protection (CBP) to grant beneficiaries the full initial 30 months of parole, absent extraordinary circumstances
Issue future rulemaking to improve the IER based on feedback from stakeholder groups
Pursue a long-term legislative solution to stabilize immigration pathways for entrepreneurs
Introduction
More than half of America’s billion-dollar startups were founded by immigrants, and 80 percent have immigrants in a core product design or management role. Though immigrants make up only 18 percent of our workforce, they have won 39 percent of our Nobel Prizes in science, comprise 31 percent of our Ph.D. population, and produce 28 percent of our high-quality patents. To be clear, this is not because immigrants are inherently smarter than the average native-born worker, but instead because of strong selection effects wherein many of the talented and entrepreneurial people from many countries are the individuals most likely to emigrate in search of new opportunities.
Importantly, global competition for this population of international entrepreneurs is heating up rapidly. Countries like Canada, Australia, and the U.K. have adopted versions of a startup visa to create a dedicated pathway for international entrepreneurs, while other countries like China have elaborate talent recruitment programs to try and bring back talented students and workers who are living internationally.
In contrast to this global trend, the United States does not have a statutory startup visa category, and trying to use traditional pathways such as the H-1B visa can be very difficult for an entrepreneur, if not impossible. Other pathways for highly skilled immigrants, including the O-1, EB-1, and EB-2 visas, rely on a strong record of prior accomplishments and are not a good fit for entrepreneurs whose potential accomplishments lie in the future. Entrepreneurs like Steve Jobs or Bill Gates had little track record of success before founding Apple and Microsoft; if they had been born in another country, it is unlikely that traditional employment-based U.S. immigration pathways would have let them start their respective firms here. This inability to recognize prospective success is one of the core deficiencies in our immigration system that the IER was designed to address.
Unfortunately, much damage has been done to the United States’ reputation as the prime destination for the world’s inventors and technical practitioners over the last four years. It is vitally important that under the new administration, we begin attracting this valuable global talent again and opening pathways for their legal residence. The IER has the advantage of already existing⸺quite literally⸺in the federal rulebook, and so it can be revived immediately. For policymakers looking to quickly re-establish the United States as the top stop for international entrepreneurs, strengthening the IER should be an appealing first step.
The Biden administration has made it clear that immigration makes the U.S. a stronger, more dynamic country. Nowhere is this more obvious than with international entrepreneurs who very directly grow the pie of economic opportunity for native-born Americans. The political moment is ripe for action on immigration with public support for increasing immigration at record highs⸺ high-skill immigration is especially popular receiving support from 78 percent of the U.S. population.
Importantly, this proposal is complementary with the wide array of immigration proposals already being pursued by this administration. The IER operates through parole authority that does not impact existing visa caps for other programs, and not needing legislation or immediate regulatory action to operate means the IER is low-hanging fruit from an administrative perspective.
A Brief Primer on the International Entrepreneur Rule
The IER was finalized at the end of the Obama Administration as a way for the federal government to attract entrepreneurs to launch innovative startups in the United States. It is a federal regulation that was developed by DHS, rooted in the DHS Secretary’s statutory authority to grant parole on a case-by-case basis for “urgent humanitarian reasons or significant public benefit.” (In the context of immigration law, “parole” simply means temporary permission to be in the United States; it has nothing to do with “parole” in the context of criminal law.)
The Secretary’s discretionary parole power has historically been used for those with serious medical conditions who must seek treatment in the United States, individuals who are required to testify in court, individuals cooperating with law enforcement agencies, and volunteers who are assisting U.S. communities after natural or other disasters. Recipients of this temporary parole, however, do not have an official immigration status. They are merely permitted to stay in the United States for an amount of time determined by DHS, after which they must leave the country.
With the International Entrepreneur Rule, DHS first articulated its use of parole for individuals who could provide a “significant public benefit” by starting innovating businesses with high potential for growth in the United States. In the rule, DHS outlined the requirements for the types of entrepreneurs and startups that would be considered eligible for entry into the United States with parole. To be considered for parole, entrepreneurs must:
Have “recently formed a new entity in the United States that has lawfully done business since its creation and has substantial potential for rapid growth and job creation”;
Possess at least 10 percent ownership in the entity at the time of adjudication;
Have “an active and central role in the operations and future growth of the entity, such that his or her knowledge, skills, or experience would substantially assist the entity in conducting and growing its business in the United States”; and
Meet one of these thresholds:
Raise at least $250,000 from qualified U.S. investors with established track records;
Win at least $100,000 in grants or awards from federal, state, or local government agencies; or
Provide other “reliable and compelling” evidence that the startup will deliver a “significant public benefit.”
Up to three entrepreneurs per startup can qualify for IER parole. If an entrepreneur (or entrepreneurs) and their startup meet these requirements, DHS may grant them parole for up to 30 months. After this period, the entrepreneur can apply for a single extension of parole for at most another 30 months, if the startup continues to provide a “significant public benefit” as proven by increases in capital investment, job creation, or revenue.
It is important to note that U.S. Citizenship and Immigration Services (USCIS) processes IER applications and U.S. Customs and Border Protection (CBP) officially grants IER parole at a port of entry. When an IER petition is approved, USCIS recommends that CBP grant the beneficiary entry into the United States for a certain amount of time up to 30 months. Then CBP can decide whether to follow that recommendation, or grant entry for a shorter period.
While the IER is not a typical immigration pathway, it fills a gap for entrepreneurs that more common immigration statuses cannot satisfy. Other statuses have lengthy processing times or backlogs which are incompatible with launching a startup (H-1B and EB-2), require a significant amount of personal wealth (EB-5), necessitate establishing the business in another country first (L-1, E-1, and E-2), or require the entrepreneur to already be at the top of their field (O-1 and EB-1), which is uncommon for most startup founders.
The IER is currently the only path to work in the United States that was designed specifically for attracting talented startup entrepreneurs, and should be reimplemented swiftly so it can achieve its full potential. In addition, the IER gives U.S. investors a strong interest in ensuring that the entrepreneurs are successful and that they integrate well while in the United States. Qualified investor organizations are highly motivated to put their money into strong teams with a high capability to execute.
A Rocky Start: Key Takeaways from the Last Four Years
Unfortunately, implementation of the IER has had a host of issues. On January 17, 2017, the final rule for the IER was published in the Federal Register, just days before President Trump was inaugurated. It was supposed to come into effect on July 17 of that year. On July 11, however, DHS delayed the effective date with the stated intention of rescinding the IER completely, thus dissuading potential applicants from taking advantage of it. The Trump Administration was against any expansion of parole authority and directed its energy to reducing immigration levels to an unprecedented extent.
In December 2017, however, the U.S. District Court for Washington, DC ordered DHS to stop delaying and to begin accepting IER applications. It did so, grudgingly, warning applicants that the administration still sought to eliminate the program.
Then, in May 2018, DHS issued a proposed rule in the Federal Register to formally rescind the IER, creating even more confusion and casting another cloud over the program. Even though this rescission rule was never finalized and therefore never took effect, the contentious early history of the IER stunted its potential and convinced an untold number of entrepreneurs to look elsewhere to start their businesses.
For those few who nevertheless chose to pursue entrepreneurship in the United States via the IER, the application process was grueling. Attorney Elizabeth Goss, one of the few immigration lawyers in the country who had a client approved for IER parole thus far, notes that many of the difficulties she faced during the application process were likely related to the unfamiliarity DHS had with implementing the rule. The two biggest pain points were the difficulty of obtaining investment history information from her client’s investors and the discretionary nature of IER parole length.
First, in order to be approved, the applicant must provide proof that their investors are “qualified” as defined in the IER. This includes having the investor organization prove that it has invested in startup entities worth no less than $600,000 over a five-year period and that at least two of these startups created at least five full-time jobs and generated at least $500,000 in revenue with an average annualized revenue growth of at least 20 percent—all information that is not commonly shared with outside parties.
Next, after compiling all of the necessary evidence and fielding requests for additional information from the agency, Goss’ client was only granted a year-long parole by CBP instead of the full 30 months. The entire application process itself took one year.
Former USCIS Deputy Chief of the Adjudications Law Division Sharvari Dalal-Dheini, who observed the initial implementation of the IER within the agency, echoed some of Goss’ points about the difficulty of obtaining IER parole. She agreed that the standards in the IER regulations are very high and have likely dissuaded potential entrepreneurs from applying. In particular, the requirements to be considered a qualifying investor are restrictive, as the investor organization must be majority-owned by U.S. citizens or permanent residents. It is not uncommon, however, for high-profile investor organizations to have foreign investors.
That said, many groups have strongly advocated for the IER, noting that there is no other adequate pathway for startup entrepreneurs. Greg Siskind, another leading immigration lawyer, explained in a public comment that IER parole is no less risky than holding a nonimmigrant work visa, at least as long as USCIS has rescinded its policy of deference for prior determinations for status renewals. He also outlined how other immigration pathways are inadequate for startup entrepreneurs, a summary of which can be found in the table below.
Table 1: A comparison of alternative pathways for startup entrepreneurs and their drawbacks
Potential pathway for entrepreneurs
Requirements
Reasons pathways are not adequate for startup entrepreneurs
L-1 – Intracompany transferee (temporary status)
The business must be operating both inside and outside the U.S. for a year.
The executive, manager, or specialized knowledge employee must be employed abroad full-time for one year prior to transfer to the U.S.
The startup must be founded in another country and expand to the U.S., negating the benefits of starting a business in the U.S.
The entrepreneur must already have significant funding and a founder already in the U.S.
H-1B – Specialty occupation worker (temporary status)
Employers must be able to pay the candidate the prevailing wage according to the geographic area in which the business is located.
The number of H-1Bs is capped at 85,000 per year.
H-1B holders must legally be an “employee” who does not have sole decision-making authority, which can be difficult to structure as a startup founder.
Startup founders regularly underpay themselves to ensure more money goes to the business.
Startups often lose money in the first few years, making it difficult to prove that the business would be able to pay an employee the prevailing wage.
O-1 – Extraordinary ability or achievement (temporary status)
This status is reserved for those with extraordinary abilities “sustained by national or international acclaim.”
Current standards used to judge “extraordinary ability” are very high and create a bias towards those with very documentable awards/accomplishments, typically not recognizing investor funding.
This may help a small number of accomplished entrepreneurs, but renders many young professionals with innovative ideas ineligible.
E-1 and E-2 – Treaty traders and investors (temporary status),
These visas are only available for the countries which have signed certain treaties with the U.S.
To be eligible, investments must be made by those from the same country in which the business started.
The founder must have at least 50 percent ownership of the business.
This excludes entrepreneurs from many countries that do not have treaties with the U.S., including India, China, and Russia, among others.
It is common for startups to have founders from more than one country, or also have an American founder, rendering them ineligible.
It is necessary to give small portions of ownership to investors in each funding round, quickly making it very difficult for a startup founder to maintain at least 50 percent ownership.
EB-1 – First preference, employment-based (permanent residency)
One type of EB-1has requirements that are similar to O-1s in that beneficiaries must “demonstrate extraordinary ability.”
EB-1s for “multinational managers or executives” are for those who have been employed outside the U.S. for at least one year with a business that has been active in the U.S. for at least one year.
Many early-career entrepreneurs will not meet the extraordinary ability requirements.
The executive/manager pathway for EB-1s is inadequate as well, because the startup would have to be founded in a different country, negating the economic benefits of its launch in the U.S.
EB-2 – Second preference, employment-based (permanent residency)
Beneficiaries must have an advanced degree or 10 years of work experience
National Interest Waivers (NIWs)—which remove the requirement for a lengthy labor-market test—are only granted to those with exceptional ability and whose employment would “greatly benefit the nation.”
This high level of work experience may work for some founders but does not allow those earlier in their careers or without advanced degrees to benefit.
NIW adjudications also take up to a year, which is too long for an entrepreneur looking to launch a startup.
EB-3 – Third preference, employment-based (permanent residency)
Approval requires an individual labor certification from the Department of Labor.
Founders cannot obtain an individual labor certification because they have ownership or control over the business and cannot conduct a typical market test for the position.
EB-5 – Immigrant investor program (permanent residency)
To be eligible, the beneficiary must invest at least $900,000 or $1.8 million (depending on the location) and create or preserve at least 10 full-time jobs for U.S. workers.
Only entrepreneurs who are independently wealthy would qualify for an EB-5, which is rare.
Processing times can also extend to over two years, with consular processing taking another six months, which is too long to wait to found a startup.
The Road Ahead: Getting the Most Out of the International Entrepreneur Rule
The IER, if allowed to work properly, fills an important gap in the immigration system. The Biden Administration has an opportunity not only to revive the IER but to address some of the implementation difficulties of the last several years and make the program more effective. There are three levels of changes that can be made to strengthen the IER:
Improve marketing and outreach to make it clear to practitioners and stakeholders that the IER is available and workable.
Implement non-regulatory changes such as improving program operations and issuing updated policy guidance to make evidentiary standards clearer.
Solidify the program through new regulations, such as adding a more durable qualified investor status.
Program marketing and outreach improvements
At the broadest level, for the IER to live up to its full potential, it needs the credible backing of the administration, publicly committing to the rule and its improvement based on feedback from the broader community. Immigration lawyers play a vital role in guiding their clients through the labyrinthine process of navigating various immigration channels and they are unlikely to recommend their clients pursue the IER unless they believe that it is a “real” program with well-articulated standards and a reasonable processing timeline.
This can be achieved in a number of ways. First, vocal support and recognition of the program by the White House and high-ranking administration officials will raise the profile of the IER and indicate that the program will be actively administered and improved over time.
Second, DHS can make a concerted effort to market the program, highlight the IER specifically as an option for qualified candidates, compare the different pathways for legal residence for talented international students, and be sure to circulate such information with U.S. colleges and universities where many potential entrepreneurs will be studying.
With the IER being a relatively new program, it is likely to face additional implementation barriers that are difficult to anticipate beforehand. Accordingly, it will be important to create and maintain real-time feedback mechanisms that allow external stakeholders to flag unnecessary bureaucratic hurdles or improperly targeted eligibility criteria. One option for facilitating feedback would be to use an existing DHS council under the Federal Advisory Committee Act (FACA) to get real-time implementation suggestions from such stakeholders as immigration lawyers, venture capital firms, and international student groups—for example, the Homeland Security Academic Advisory Council (HSAAC). Questions regarding the optimal investment size minimum, the structure of qualified investment groups, and the process for U.S. border entry will be better addressed with the buy-in and input of the communities that are most impacted by them.
Guidance documents and operational improvements
Given the fairly wide scope for agency discretion in the administration of the IER, there are many ways of improving implementation simply by issuing new guidance documents and streamlining operations, among other subregulatory actions that do not require altering existing regulations.
As described above, past applicants to the IER program were approved by USCIS but granted entry by CBP for a shorter period of time than the full 30 months. This increases uncertainty for future applicants and makes it much more difficult for an entrepreneur to launch a startup and cultivate its success prior to the parole period ending. In addition, to obtain a renewal IER status, the startup must meet stringent requirements, and shortening the amount of time the entrepreneur has to satisfy those requirements adds a significant burden—dissuading future applicants and forcing entrepreneurs with innovative ideas out of the country prematurely. This could be mitigated by issuing internal guidance that directs USCIS and CBP to grant beneficiaries the full 30 months of parole, absent extraordinary circumstances.
In addition, one of the biggest pain points during the application process is proving that an entrepreneur’s investors are qualified. Often the information that is required is not publicly available or is proprietary. For Goss’ client, it took an entire year to gather the right information to satisfy the investor requirements. USCIS could simplify the process, making it clearer what documentation is necessary, and making it easier for investing organizations to provide information without compromising sensitive financial data in certain cases. In addition, once an investing organization has proven to USCIS that it is qualified, it should be allowed to refer back to its previous documentation for future IER approvals for a period of time (e.g. three years). This would encourage more U.S. investors to become willing participants in the IER program, since the bureaucratic hurdles would be viewed as more a one-time cost rather than a recurring issue.
An alternative approach to streamline the process of verifying qualified investor status would be to look to the “accredited investor” process adopted by the Securities and Exchange Commission (SEC) for private placements. Rather than have investors submit sensitive financial data to the SEC, the agency allows investors to submit a sworn affidavit that indicates the investor meets the standards for accreditation under penalty of perjury. This process is much simpler for investors and the SEC alike, and would surely save DHS both time and resources.
Lastly, DHS could issue further clarification on what would satisfy the “alternative evidence” standard for IER eligibility. If an entrepreneur does not have $250,000 in investor funds or $100,000 in government grants or awards, they can still qualify for IER parole if they can prove that their startup has “significant potential for rapid growth and job creation.” USCIS guidance in a Policy Memorandum could encourage adjudicators to place particular weight on evidence that the startup will:
Be headquartered and creating jobs in a rural area or region with high unemployment;
Commercialize new technologies in high-priority industries for the nation, such as cybersecurity, biotechnology, and artificial intelligence;
Tackle societal issues such as racial or economic disparities; or
Create not just a sufficient number of jobs to satisfy the minimum requirements of the IER, but also jobs that are sufficiently high-paying or high-quality as measured by salary or necessary skills.
Regulatory improvements
While guidance documents can be a useful near-term tool to improve the functioning of the IER and allow flexibility for the agency, ultimately the program will have more stability if long-term changes are established in regulation.
First, new rulemaking should be used to formalize guidance once the agency has worked out more definitive and objective standards around a more durable definition of “qualified investor” and evidentiary standards for “rapid growth and job creation.” Increasing stakeholder certainty in the long-term viability of the rule will be key to its uptake and success.
Second, new rulemaking should be used to help bridge the gap between the IER and existing immigration pathways for permanent residence. It would be a perverse outcome if successful entrepreneurs were forced out of the country after their parole term concluded. Policymakers should identify natural “bridge” statuses for individuals on the IER to graduate into, and make the operation of a growing U.S. business an explicit criterion for eligibility. For instance, the EB-2 green card overlaps well with the skill sets and purpose of the IER, as it is meant for a “foreign national who has exceptional ability.” Almost by definition, the successful launch of a growing U.S. business should demonstrate exceptional ability. Modifying the EB-2 and National Interest Waiver rules, as described in Table 1, to explicitly include entrepreneurship as a qualifying criterion will provide a natural on-ramp to permanent residence and the continued long-term operation of the entrepreneur’s business.
The role of Congress
Finally, it is important to note that while the IER is a promising tool for making the United States a welcoming home to international entrepreneurs in the immediate term, even with all the proposed changes above, it may not be sufficient. The uncertainty around long-term permanent resident status in the United States, which cannot be granted through parole alone, and uncertainty around future political changes to (or suspension of) the program could prevent the IER from being maximally effective. Over the longer term, Congress should pass more enduring startup visa legislation, expand the number of green cards available, and reform existing immigration pathways such that they would be more suitable for an international entrepreneur seeking to start a firm in the United States.
In fact, not one but two statutory pathways for entrepreneurs were already passed by the Senate in its bipartisan 2013 comprehensive immigration bill. Congress should consider reintroducing these pathways, updating them with the best parts of the IER while maintaining DHS’ flexibility. Such changes include:
Removing the 2013 bill’s requirement for applicants to submit a business plan, which DHS adjudicators are unlikely to have adequate time and expertise to review—unlike professional investors with “skin in the game”;
Allowing a simplified process to evaluate the qualifications of the startup’s investors, with deference to previous approvals;
Providing a more explicit way for adjudicators to account for the value of a startup being accepted into an exclusive accelerator program as evidence of its potential for rapid growth; and
Granting DHS the flexibility to adjust investment and revenue thresholds to account for changing industry standards.
In addition to these changes, Congress should make a point to gather stakeholder feedback on the details, particularly on the definition of a qualified investor, to ensure that no legitimate investors are barred from participating.
What is the potential impact of a fully implemented IER?
Baseline job creation estimate
We have developed a few baseline estimates as to the number of jobs that could be created through the IER by using a similar methodology as the one used by the Kauffman Foundation in their earlier paper estimating the job impacts of a statutory Startup Visa.
To begin with, we use the DHS estimate that the IER will attract 2,940 entrepreneurs per year with one founder for each firm. However, starting a business is difficult, and some percentage of firms will fail each year. Using the Business Employment Dynamics (BED) dataset from the U.S. Bureau of Labor Statistics, we can see the percentage of firms starting in 2010 that survived from year to year among the “Professional, scientific, and technical services,” category which we believe to be the closest analogue for the types of firms likely created under the IER.
Then, we can create an estimate for the total number of surviving entrepreneurs that remain in the country that entered through the IER and add the addition of a new entrepreneur class that joins each year.
Finally, we can apply a simple job creation rate under a number of scenarios. Under the most conservative scenario, we estimate the number of jobs created if surviving firms create only the required 5 jobs over a 30 month period to satisfy the terms of the program and be eligible for parole renewal. We then assume no further job growth while the firm survives.
In the second scenario, we estimate job growth under the assumption that each of these firms mirrors the average job creation rate of a U.S. firm its age so long as it survives. To estimate this we used the BED dataset and the average employment of firms at age 1, age 2, age 3, and so on starting in 2010.
Finally, we consider the scenario in which 50 percent of these firms are in STEM fields and have a corresponding higher rate of job growth. We use the estimate of Vivek Wadhwa from a prior Kauffman study, which found that the average immigrant technology or engineering startup in their sample from 2006 – 2012 had 21.37 employees. The other 50 percent of firms are assumed to mirror the average U.S. job creation rate for a firm that age. Fundamentally, this third scenario is trying to capture the idea that while the average US firm begins to slow down the rate of job creation after the first several years, the types of entrepreneurs and investors likely to make use of the IER are those disproportionately in the” high-growth young firm” category that will sustain fast rates of job growth overtime.
The table below shows these three scenarios applied to the projected entrepreneur population:
After 10 years, the IER could bring in more than 13,000 new businesses and create more than 300,000 jobs in the United States. While this projection is already promising, the IER has the potential to contribute even more to the economy.
Reasons for optimism
The above job creation projections are all based on the assumption by DHS that a fully implemented IER will attract 2,940 entrepreneurs per year—but there is good reason to expect a much higher level of uptake. Entrepreneurs, investors, and local communities are all responsive to potential opportunities, and if they perceive that the IER program is workable and stable for the immediate future, they are likely to adapt their own practices to better utilize this pathway.
➤ Venture capitalists
For instance, firms and individuals that have a proven track record of investing in international entrepreneurs through the IER may begin to specialize in such cases and seek out promising potential entrepreneurs from around the world and encourage them to apply for IER status in the first place. Today a few groups like Unshackled Ventures specialize in finding, investing in, and bringing international entrepreneurs to the United States through the limited immigration pathways that already exist. With a dedicated path to entry for international entrepreneurs, many more such firms would likely come to exist. Similarly, major venture capital groups with significant foreign investment may reorganize their structure to ensure that their U.S. investment arms are majority-owned and controlled by U.S. citizens and permanent residents, thereby satisfying the eligibility requirements for qualified investors under the IER.
➤ State and local governments
States and local governments frequently award competitive research grants on a wide range of R&D and business development topics, and would likely expand these efforts if they also entailed a legal path to residence for international entrepreneurs. Legislative proposals like the Economic Innovation Group’s “Heartland Visa”—largely endorsed by the Biden presidential campaign—would have Congress create a new immigration pathway to promote regional economic development through state- and city-sponsored visas. Essentially, a pilot version of this proposal could be pursued immediately through the IER as states and localities that award at least $100,000 to promising international entrepreneurs could thereby ensure the creation of a new startup in their region.
➤ International students
In addition, international students studying here would know ahead of time that a path exists for those starting a successful business, and could organize their studies and plans accordingly. This could end up having a very large impact, given the startling finding that foreign-born STEM PhDs are not currently founding or working for U.S. startups at the rate we would expect given their stated career interests.
Economists Michael Roacha and John Skrentny found that immigration barriers are a significant deterrent in these PhD graduates’ ability to realize their startup career interests, compelling them to either leave the country or work at larger U.S. firms where visa pathways are more well-established.
“Foreign PhDs are as likely as U.S. PhDs to apply to and receive offers for startup jobs, but conditional on receiving an offer, they are 56 percent less likely to work in a startup. This disparity is partially explained by differences in visa sponsorship between startups and established firms and not by foreign PhDs’ preferences for established firm jobs, risk tolerance, or preference for higher pay. Foreign PhDs who first work in an established firm and subsequently receive a green card are more likely to move to a startup than another established firm, suggesting that permanent residency facilitates startup employment. These findings suggest that U.S. visa policies may deter foreign PhDs from working in startups, thereby restricting startups’ access to a large segment of the STEM PhD workforce and impairing startups’ ability to contribute to innovation and economic growth.”
This is further evidence that America has a latent population of foreign-born entrepreneurial talent that could be effectively unlocked by creating better pathways for them to stay in the United States while launching or working for a startup.
In short, the prior estimate of IER leading to 100,000 – 300,000 jobs over 10 years, generated by fewer than 3,000 startups per year, is likely a lower bound. Consider that angel investors in the United States fund about 63,000 startups per year, most of them in STEM fields. Roughly one quarter of tech startups have at least one foreign-born founder, who was able to stay in the United States, thanks to an immigration pathway not designed for entrepreneurs.
With a permanent, predictable pathway for international entrepreneurs, it is reasonable to expect far more than 3,000 additional founders to choose the United States over other alternatives, leading to significant job creation in the aggregate. If we instead adjust the number of incoming immigrant entrepreneurs to 5,000, more than 500,000 jobs could be created over 10 years. And if 10,000 immigrant entrepreneurs came each year, more than a million jobs could be created over 10 years.
It is also worth remembering that today’s startup can become tomorrow’s industry-shaping giant. Among America’s first four trillion-dollar companies, one was co-founded by an immigrant (Google), two were founded by the children of immigrants (Amazon and Apple), and one is run by an immigrant (Microsoft). These four companies alone employ over 676,000 people in the United States.
The bigger picture
In addition to the direct job gains, adding more international entrepreneurs could help reverse the decades long decline in American economic dynamism. Fewer American firms are being started, fewer firms are exiting, and the resulting slowdown has coincided with a slowdown in productivity growth.
Stimulating the U.S. economy with more international entrepreneurs would very directly increase the number of firms started in the country, but increased competition could also force U.S. incumbents to become more nimble and adopt new technologies and products to survive and thrive.
As concern continues to build on both the right and the left that the United States may be losing its status as the world’s leader in science and technology, one of the easiest ways to solidify this lead would be to allow international entrepreneurs to build their companies in the United States rather than in competitor nations. For emerging technologies like artificial intelligence, drones, quantum computing, and biotechnology, this is especially important.
Conclusion
Countries all over the world are competing to attract the best talent to their shores. These efforts include developing an environment that supports the establishment and growth of promising startups. The United States, however, has no statutory immigration pathway designed for entrepreneurs. To address this unnecessary handicap, DHS established the International Entrepreneur Rule in 2017 to welcome foreign-born entrepreneurs with innovative ideas with high growth potential. Unfortunately, the IER was never fully implemented by an administration determined to eliminate it.
IER has survived, however, and now is the time to strengthen it. This paper provides a suite of recommended improvements to bolster the IER and ensure that the United States is better positioned to attract international entrepreneurs. Tens of thousands of entrepreneurs and subsequent economic growth are at stake. The IER is a valuable tool in the economic toolbox—not only for the federal government but for states and localities as well—which can attract entrepreneurs to settle throughout the United States. It should be fully implemented and reinforced. The United States has a renewed opportunity to solidify its reputation as the best place on Earth to start and grow a new company.
Colin Mortimer, the Director of the Center for New Liberalism, is joined by two special guests. First is Adam Hartke, the co-owner of a music venue in Wichita, Kansas, and the co-chair of the advocacy committee at the National Independent Venues Association. We talk about what it has been like to be a music venue owner during this pandemic, suffering the brunt of the economic fallout. Second, PPI’s Chief Economic Strategist Michael Mandel comes on to talk about how an obscure tax cut that expires in December might make the recovery for music venues, bars, restaurants, brewers, and others even more difficult than it was already expected to be.
The federal government is on track to run a record-shattering $4 trillion budget deficit in 2020, in large part due to its aggressive fiscal response to the pandemic-induced recession. Some on the right have raised alarm about this borrowing, despite their support for budget-busting tax cut and border-control policies over the last three years. The hypocritical chorus will likely only grow louder if Democrat Joe Biden is elected president in November.
But temporary deficits are an invaluable tool for mitigating the damage caused by economic downturns, as government spending replaces a drop in demand from the private sector. The long-term fiscal costs of failing to support an economy with a double-digit unemployment rate would far exceed those of even the most overzealous stimulus measures. Necessary fiscal support should therefore continue as long as the economy remains hobbled by the coronavirus, no matter the cost.
However, Washington also faces structural deficits that will persist long after the pandemic has been contained. Thanks to the Trump administration’s reckless borrowing binge at a time when the unemployment rate was below 5 percent, the federal government was already projected to spend over $1 trillion more than it raised in revenue even before the pandemic hit. This structural deficit will only grow worse in the coming years because our nation’s aging population is causing federal spending on health-care and retirement programs to grow significantly faster than the revenues needed to finance them. The Trump administration did not create these problems, but it did make them significantly worse with its pre-pandemic fiscal policy and its disastrous handling of the public health crisis.
In the two years following the 2008 financial crisis, the national debt grew from less than 40 percent of gross domestic product to more than 60 percent of GDP. In 2020 alone, the debt will likely surpass the all-time high it reached following the end of World War 2 (106 percent of GDP). The rising cost of servicing this growing debt threatens to crowd out critical public investments that lay the foundation for long-term growth after the recession ends.
The federal government spent more money servicing the national debt last year than it spent on critical public investments in education, infrastructure, and scientific research combined. Although interest rates are low now, they eventually will rise as the economy recovers. Allowing interest payments on our debt to further crowd out these investments – which have already fallen by nearly 40 percent in real terms since the 1980s – would have disastrous consequences, including lower incomes, fewer high-quality jobs, and reduced economic mobility.
It is therefore essential to pay down the debt during expansions to create fiscal space for the necessary surge in short-term borrowing during recessions. Unfortunately, Washington has often waited too long to enact sufficient stimulus in response to recessions, and then failed to summon the will to narrow the structural gap between taxes and spending when the economy rebounds.
To make our economy more resilient against downturns, PPI proposes the federal government adopt a “fiscal switch” that automatically balances out the business cycle by increasing spending during recessions and recouping the cost during subsequent periods of economic growth. This switch would trigger based on economic variables such as the unemployment rate and operate through three mechanisms: a rebalanced relationship between federal and state governments, a more dynamic and progressive tax code, and phased-in reforms to mandatory spending programs driving our structural deficits. Implementing these automatic mechanisms, as recommended here and in PPI’s Emergency Economics report earlier this year, takes politics out of these decisions and ensures stimulus or deficit reduction will be implemented as warranted by economic conditions.
The first step is to better leverage the federal government’s unique borrowing capacity, which is unavailable to the vast majority of state and local governments required by law to balance their budget each year. Many government programs, including Medicaid, infrastructure, and education spending, are partnerships in which the federal government provides matching grants for state and local spending.
Some of these partnerships could be improved by allowing matching rates to adjust up or down automatically based on a state’s unemployment rate. This would prevent state and local governments from having to cut essential services during a downturn while asking them to shoulder a greater share of program costs when their budgets are healthy.
Other programs that currently function as a federal-state partnership but whose costs fluctuate significantly with the business cycle would benefit from becoming more nationalized. For example, when Congress tried to ensure that unemployment insurance replaced a minimum percentage of lost wages for everyone who was laid off in the early days of the coronavirus recession, lawmakers found they were unable to do so because of outdated operational infrastructure in a messy patchwork of 50 different state programs. As a result, policymakers were forced to settle for a controversial across-the-board benefit increase of $600 per week that gave some laid-off workers even more income from unemployment benefits than they lost in missed wages, while failing to make others whole. Even worse, Congressional squabbling over how long to maintain this benefit increase allowed them to lapse temporarily in the midst of an economic crisis.
Moving the operations of unemployment insurance and similarly-situated safety-net programs off state balance sheets and onto the federal government’s, in addition to automatically making benefits more generous during downturns and phasing them out in recoveries, would leverage Washington’s fiscal firepower in recessions when it’s needed most.
The second step is to make the income tax code more progressive, which serves as a strong automatic fiscal stabilizer by boosting average tax rates when incomes rise in expansions and lowering them when incomes fall in recessions. This objective could be accomplished by closing tax preferences for the wealthy, such as lower tax rates on inherited income and income from capital gains, while expanding the Earned Income Tax Credit and other pro-worker tax incentives. PPI also favors replacing the antiquated payroll tax with a dynamic value-added tax – which has a rate that automatically falls during recessions and rises during expansions – to encourage hiring and consumption when the economy needs it most and reclaim substantial revenues during economic expansions.
Finally, lawmakers must take additional measures to rein in the drivers of underlying structural deficits automatically when the fiscal switch calls for a pivot away from stimulus. Social Security and Medicare – the two largest programs in the federal budget – both face the prospect of becoming insolvent within the next decade, potentially leading to sudden and across-the-board benefit cuts for millions of seniors if lawmakers take no action to close the growing gap between dedicated revenue and scheduled benefits. Significant deficit reduction that takes effect in the middle of a recession could be catastrophic, but lawmakers should put in place a process now to develop and phase in a balanced package of revenue increases and benefit changes as the economy recovers. PPI’s Progressive Budget for Equitable Growth offers policymakers a model for how they can modernize these programs to strengthen work incentives, retirement security and financial sustainability in a way that is fair to both younger workers and older beneficiaries.
The right fiscal policy in a recession is not the right fiscal policy for an expansion, and vice versa. Washington politicians are often too slow or ideologically beholden to react sufficiently swiftly to changing economic circumstances. Taking these steps and creating a two-sided fiscal switch will give our government the tools it needs to manage the economy through both the ups and the downs of the business cycle.
Millions of America’s smallest businesses have been severely affected by the COVID-19 crisis. They’ve seen revenue evaporate and have been forced to lay off millions of workers. Over two million small businesses had simply disappeared by June 2020. The U.S. economy now finds itself in a deep hole, with millions of small businesses gone for good—and a dried-up pipeline of new business creation.
By the end of June, the American economy also was without tens of thousands of new “employer” businesses (those with employees) that normally would have been started. The pandemic and economic crisis have wreaked havoc on existing small businesses and the new start-ups that the economy depends on for job creation and innovation.
Meanwhile, the Trump administration’s implementation of the Paycheck Protection Program (PPP), authorized by Congress to provide billions in loan guarantees through the Small Business Administration (SBA), has been flawed. The Treasury department has provided insufficient, and constantly changing, guidance to lenders and businesses. The SBA’s own Inspector General found that the administration did not adhere to Congressional intent in deploying PPP funds.
Even before COVID-19, the Trump administration had proven itself incapable of inspiring entrepreneurial confidence. Business formation had trended steadily downward over the previous two years. According to a PPI analysis of Census Bureau data earlier this year, new business applications fell steadily from the middle of 2018, after rising more or less interrupted since 2012. Business applications that have a “high propensity” of turning into employer businesses had also fallen since the middle of 2018.
The picture gets worse the deeper you dig. The pandemic recession has disproportionately affected female, Black, and Latinx business owners. By April, the number of female-owned businesses had fallen by 25 percent (compared to 20 percent for male-owned businesses). The number of Black- and Latinx-owned businesses had shrunk by, respectively, 41 and 32 percent (compared to 17 percent for white-owned businesses).
These are astonishingly high losses and they come on top of a small business landscape already tilted against minorities and women. According to Census data, going into the crisis, Blacks owned just two percent of employer businesses in this country, despite comprising 13 percent of the population. Latinos and Latinas, making up 18 percent of the population, owned six percent of businesses. Male-owned businesses were larger and with higher revenues than female-owned businesses.
What’s needed now is a major national push to reinvigorate business creation and address underlying demographic disparities in business ownership. For women and minorities, when it comes to entrepreneurship, returning to the pre-crisis status quo is simply not an option. It shouldn’t be an option for the country, either. Greater business creation and ownership among women, Blacks, Latinx, and others will accelerate recovery and strengthen resilience.
Over the last 40 years, new businesses have, on average, created about six jobs per year, per company. If one million new Black and Latinx businesses opened (replacing the ones that have closed permanently) and were joined by half a million additional new businesses, we could see about nine million new jobs created. Not all these companies would survive—in the “normal” course of economic activity—but a significant subset of them would not only survive but also thrive. Young companies that survive and grow drive the lion’s share of net new job creation each year.
Public policy should seek to help stimulate new business creation and support the survival and growth of young businesses. The focus of this effort should be on women- and minority-owned businesses. Vice-President Joe Biden has proposed renewing the State Small Business Credit Initiative (SSBCI), an Obama-era program, to focus on these businesses. Evaluations of the SSBCI found positive effects in terms of investment and job creation, but a much larger effort is likely needed. The federal government has many tools at its disposal to be leveraged in support of new business formation and to aid specific types of entrepreneurs.
PPI believes the federal government should launch a National Start-Up Initiative that aims to spur creation of at least two million new businesses as our country recovers from the pandemic recession. It would include the following key actions:
Create a startup visa for founders of new companies. These would include foreign students graduating from a U.S. university, those transitioning out of Optional Practical Training, or any H1B visa-holder after three years. The foreign-born start companies at disproportionately high rates; encouraging them to do so would give a significant boost to overall business creation. This could be accompanied by incentives for business creation in specific geographic areas or neighborhoods.
Leverage federal research funding to reform technology commercialization processes at universities. America’s research universities are the best in the world at knowledge creation, yet their ability to turn knowledge into innovation and new companies has been declining. Many promising entrepreneurial ventures get stuck in bureaucratic processes. The federal government, which provides billions of dollars to support university research, should create new incentives for those institutions that devise more effective commercialization practices and generate new businesses for their communities.
Create a new “Start-Up Tax Credit” to encourage new businesses to grow into large businesses. Modeled on the Earned Income Tax Credit, the Startup Credit is designed to help these businesses avoid the scale-up trap unintentionally posed by tax breaks and regulatory exemptions for new enterprises. For example, businesses with fewer than 50 employees are exempt from the employer shared responsibility payment of the Affordable Care Act and providing unpaid leave. While these “carveouts” certainly help small businesses get off the ground, they impose an implicit tax when those companies grow past a certain threshold. The Startup Tax Credit would mitigate that tax.
As proposed by PPI economist Elliott Long, the Startup Tax Credit would be tied to the number of employees and payroll at a small business. Firms that have been operating for fewer than five years would be eligible for a credit equal to half the employer-side payroll tax they pay on their first 100 employees, up to a maximum credit of $1,200 per employee in 2020 (indexed to inflation). The proportion of payroll taxes offset by the credit and the maximum credit per employee would then gradually phase down as businesses grow until phasing out entirely once the business reaches 500 employees. PPI estimates this proposal would cost roughly $150 billion over 10 years.
PPI has also supported the New Business Preservation Act, introduced by Sen. Amy Klobuchar (D-MN). This would allocate $2 billion in federal funding to match private investments in areas of the country bereft of startup equity investments.
These steps would help seed the ground for new business creation, just as our country needs to create millions of them to provide jobs to U.S. workers whose previous jobs vanished in the pandemic shutdown. They would also create conditions that would make America’s entrepreneurial culture more vibrant and resilient against future public emergencies of all kinds.
As Covid-19 wreaks havoc in Southern and Sunbelt states, America’s battered economy faces a new round of shutdowns, bankruptcies and layoffs. Yet one sector seems strangely buoyant – the financial markets. From its all-time high in mid-February, the S&P 500 plummeted 34%, only to recoup all its losses by mid-June.
What explains Wall Street’s remarkable resilience while Main Street endures a punishing pandemic recession?
Although the three economic relief packages Congress has passed since the crises began no doubt have played a supportive role, the answer mainly lies in bold intervention by the Federal Reserve. The Fed played a similar role in staving off a financial collapse following the 2007-08 housing crisis. With a robust toolkit at its disposal, from slashing interest rates, purchasing securities, lending money directly and backstopping unstable markets, the Fed allayed investor fears about the impact of the Covid-19 lockdown on corporate profits and debts.
While Fed action to keep capital markets afloat is essential to prevent a wider economic implosion, it does have the unfortunate consequence of aggravating economic inequality. Only about 55% of Americans own stocks, and the top 1% percent own 50% of all equities. Pushing up stock prices, in other words, helps the rich get richer.
The progressive response to this distributional dilemma is not to let financial markets crash, but to democratize capital ownership in America.
U.S. policymakers therefore should emerge from the Covid-19 crisis resolved to tackle a growing “wealth gap” that is largely defined by race and ethnicity. According to the Urban Institute, the median wealth of white families in 1963 was $45,000 higher than the median wealth of nonwhite families. By 2016, the median wealth of white families had climbed to $171,000, or $132,600 more than the median wealth of black families ($17,400) and of Hispanic families ($21,000).
The strategy for narrowing the nation’s wealth gap has three key parts: Reduce racial and ethnic wage disparities, expand home ownership, and create new opportunities for Americans now locked out of capital markets to build financial assets that allow them to take advantage of the power of compound interest.
Focusing here on the third element, PPI endorses a radically pragmatic idea for democratizing capital ownership: Create lifetime savings accounts for all newborns, tied to voluntary national service. Here’s how these new “America Serves” investment accounts would work:
At birth, the federal government would stake every U.S. child to a $5,000 investment account similar to a government Thrift Savings Plan or a 401k. The money would be invested in a market index or target date fund to ensure the high average returns of investing in equities rather than low-return T-bills. With one stroke, this action would put America on the road toward universal capital ownership.
Families could also contribute post-tax earnings to their children’s accounts. No one could touch the funds in the account until the children turned 18. An “asset waiver” would also protect the account, preventing the income from being counted toward means testing for financial aid, food stamps, Supplemental Security Income (SSI), Social Security Disability Insurance (SSDI) or Medicaid.
Upon turning 18, account owners would face a choice. If they agree to perform a year of national service before they turn 25, they would be deemed 100% vested and could tap their funds after serving for specified purposes at tax advantaged rates. These include: post-secondary tuition, down payment on a first home, or starting a business.
Our goal is to start by engaging one million young adults in qualified domestic and international service programs (including active military), out of the roughly four million who turn 18 every year. Those who choose not to serve would be entitled to only the returns (and principal) on half the original stake — $2,500. The other half of their accounts would revert back to the taxpayers via the U.S. Treasury.
Although the governments’ upfront investment is considerable, over the long-term costs of America Serves accounts will likely decline. We estimate that the first 10 years would cost $230 billion, and a 25-year timeline sees total outlays of just under $700 billion.
It’s even possible that after 25 years, the program could become self-financed, depending on how many people choose to serve. Our projections are based on the assumption that one in four newborns will receive the full government contribution via service.
We use a historic average return rate on the S&P 500 of 8% for our assumptions. That means the $5,000 initial taxpayer contribution invested in the market grows to $34,250 after 25 years (See tables below). Assuming that one in four account holders choose to serve, the rest will be required to return to the U.S. Treasury half their savings – $17,125 (half the original government contribution plus market earnings.) That would be enough to stake three newborns with $5,000 contributions.
By creating a strong incentive to serve, this proposal – in the spirit of the World War II G.I. Bill — would link the opportunity to start building significant financial assets to civic responsibility. It would help to scale up voluntary national service and make it a more potent tool for public problem solving. Volunteers, for example, could assist in contact tracing during future pandemics, provide services to the swelling population of older Americans, help tutor low-income children, clean up public spaces, and much more.
A large national service program would also help our divided society bridge its class, racial and cultural divisions by bringing together youths from all backgrounds to engage in a common civic enterprise.
The organizing framework already exists: AmeriCorps and Peace Corps and other volunteer programs that operate under the aegis of the Corporation for National and Community Service (CNCS). The 75,000 yearly volunteers in these civilian service programs are in addition to the approximately 180,000 Americans who join the active duty military each year, and who would also qualify for full “America Serves” investment accounts.
The idea of expanding national service already enjoys bipartisan support in Congress. Senators Chris Coons, (D-DE), Roger Wicker (R-MS) and Cincy Hyde Smith (R-MS) recently introduced the CORPS ACT, which would increase from 75,000 to 150,000 in year 1, and up to 300,000 in years 2 and 3, the number of civilian national service slots.
“As we work to recover from the dual challenge of a public health crisis and an economic crisis, national service presents a unique opportunity for Americans to be part of our response and recovery while earning a stipend and education award and gaining marketable skills,”
Sen. Coons has said. “Expanding these programs to all Americans who wish to serve should be a key part of our recovery effort.” Another sponsor of the bill, Sen. Tammy Duckworth (D-IL), a Purple Heart military veteran gravely wounded in action, notes that “Just as picking up a rifle to defend our country is ‘American Service,’ so is helping out a food pantry for those at risk of hunger, assisting students with remote education and helping patients make critical health care decisions.”
WHY INVEST FUNDS IN THE MARKET?
Simply put, stock markets have been the most reliable generator of long-term wealth accumulation in history, and financial capital grows traditionally faster than wages. There have also been a series of innovations that have helped underpin the ability to efficiently and safely invest for the long term.
These include Index based, passive investing in target date ETF’s (Exchange Traded Funds), which essentially invest in a diverse basket of stocks or other assets such as commodities or bonds, and manages risk according to a future “target date” – usually when someone plans to retire. This passive investment approach diversifies the risk of any single stock plunging in value, and uses the ETF structure with minimal fees as opposed to active management models that assess much higher fees. Small investors get access to higher returns with less risk and keep more of their money as it grows.
To illustrate how “America Serves” investment accounts could grow, consider these projections of possible returns over 18, 25, and 65 years from an initial $5,000 contribution:
Let’s look at the standard market benchmark of the S&P 500, which since adopting 500 stocks to the index in 1957 has produced an annual return of 8% (through 2018). Yet, since stocks and bonds fall as well as rise in value, it is worth looking at the largest “drawdown” (market pullback) since that time. According to S&P Dow Jones Indices:
“the most significant market downturn occurred in the early 1970s, coinciding with the U.S. economy reeling from double-digit inflation courtesy of a quadrupling in oil prices. During this period, the S&P 500 declined by 45% over a 21-month period and took three and a half years to return to its previous local peak.”
This means that should the market be down in any given year, history shows us the largest pullback only took about 5 years to regain all its lost value. What that means is that by ensuring that every American has an opportunity to build a significant financial asset, this proposal would enhance their economic security and resilience in economic downturns from whatever sources.
CONCLUSION
The pandemic has thrown a harsh light on America’s economic and racial inequities. The government’s otherwise commendable efforts to keep the comatose U.S. economy from flatlining have had the unintended effect of making these disparities worse. By giving every newborn child a capital stake in America’s future, we will put our economy on a higher growth trajectory while also making it fairer. And by linking the accounts to service, we will create a powerful new incentive for young Americans to give back to their communities and their country.
(Note: The author would like to thank Alan Khazei, a longtime PPI friend and co-founder of Boston’s City Year voluntary service program, who with the late Harris Wofford and other leading national service advocates originally envisioned the link between “service bonds” and service.)
Consumers are getting turned down for all sorts of financial products, from personal and auto loans to credit cards. The Wall Street Journal, using Equifax data, reports that credit card approvals totaled 483,000 in the week ending May 10, down from 856,000 in the week ending March 22. To compare to the year prior, weekly card approvals in 2019 “rarely fell below 1.2 million,” according to The Wall Street Journal.
But as banks are tightening their lending requirements, a new tool is trying to prevent lenders from cutting off consumers’ access to credit.
Fair Isaac Corp., the data analytics company behind the FICO credit score, has just launched the FICO Resilience Index, a new scoring model designed to help lenders better assess consumers’ sensitivity to financial stress by looking at their capacity to survive financially though a downturn.
“The FICO Resilience Index, used in conjunction with a FICO Score, allows card issuers to limit access less than they otherwise would have because they can now identify borrowers who are more resilient to the economic downturn,” Sally Taylor, VP of FICO Scores, tells CNBC Select.
FICO defines resilient borrowers as “consumers that are more likely to pay as agreed in the event of a recession.”
The new scoring model ranks consumers’ resiliency on a scale of 1 to 99. The higher your score, the higher the risk you will default on your payments; the lower your score, the more likely you are to make on-time payments even when the economy experiences a downturn.
Two bills introduced in Congress, H.R. 6370 and S. 3508, ‘‘Disaster Protection for Workers’ Credit Act of 2020’’ would impose a moratorium on credit reporting of “adverse information” for the duration of the coronavirus crisis. Credit scores are an integral part of the consumer credit underwriting process as their power to predict the likelihood of borrower default is well-established empirically. Consequently, lenders have come to heavily rely on the integrity and information content of credit scores as a critical measure of a borrower’s creditworthiness.
Economic theory suggests that in the absence of viable mechanisms to effectively distinguish between high and low risk borrowers, lenders will ration credit. Under a credit reporting moratorium, the reliability of credit scores to distinguish between borrower risks would come into question. Lenders would respond to the proposed credit reporting moratorium by raising minimum credit score requirements and/or raising borrowing rates as a credit uncertainty premium to offset the risk they face from the moratorium. During the 2008 financial crisis, lenders raised credit score minimums on FHA loans, for example, beyond those set by the agency as a response to uncertainty over indemnification provisions that posed significant costs to lenders. And today, during the coronavirus, a number of Ginnie Mae originators have raised credit scores to blunt some of the risk they face due to requirements to pass-through mortgage payments to investors, including those in default or subject to forbearance.
Join Paul Weinstein, Jr., Senior Fellow at the Progressive Policy Institute in Washington, D.C., and Joanne Gaskin, Vice President of Scores and Analytics at FICO, for a discussion on the changes FICO has made to its models, and how they may impact credit scores, particularly for millennials and GenZ.
Or listen to the full audio here without a Spotify account:
Join Paul Weinstein, Jr., Senior Fellow at the Progressive Policy Institute in Washington, D.C., and Joanne Gaskin, Vice President of Scores and Analytics at FICO, for a discussion on the changes FICO has made to its models, and how they may impact credit scores, particularly for millennials and GenZ.
Or listen to the full audio here without a Spotify account:
Some are concerned that subprime auto loans – which offer higher interest loans to riskier borrowers – pose a threat to the stability of the global economy in much the same way that the subprime mortgage market contributed to the Great Recession. Democratic presidential candidate Elizabeth Warren, in particular, has raised the warning flags as part of her campaign. But these worries are ill-founded and based on misleading data and faulty analogies.
In particular:
Auto loans account for a relatively small percentage of the increase in nonfinancial debt over the past five years;
Americans are spending less of their budgets on car purchases today, including finance charges, than they were before the recession;
Low-income households saw motor vehicle purchases and finance charges fall from 8.5 percent of household budgets in 2000 to 4.9 percent in 2018;
Over the past five years, the share of new auto loans going to low-credit borrowers has remained relatively constant. There are no signs that low-credit borrowers are either being frozen out of the market or becoming too large a share of loans;
Newly delinquent auto loans, as a percentage of current balances, have been falling over the past two years; and
Subprime auto loans differ significantly from subprime mortgages in key respects that make them less likely to pose a serious threat to financial stability
Risk-based pricing of auto loans appears to be working so far, keeping low-income borrowers in the market without driving up delinquencies or to low-income consumers, while not posing the same risk that the subprime mortgage market.
Introduction
To purchase a vehicle, Americans with low or non-existent credit scores often use auto loans with higher interest rates than loans to prime borrowers. Some market watchers have indicated concern about “subprime” auto-loan trends and the potential for a crisis similar to the subprime mortgage crisis that heralded the last recession.
The subprime mortgages and the related mortgage-backed bonds remain the classic case of a poorly executed financial innovation. The initial impetus behind the idea was a good one. Housing is a key element of middle-class wealth, so expanding the system of mortgage finance to help lower-income households buy homes seemed like a positive. However, the subprime mortgages and bonds were designed in such a way that they assumed rising housing prices. When housing prices started to fall, the subprime mortgage system collapsed and contributed to the financial crisis.
Will subprime auto loans create the same problems? In a recent essay, Democratic presidential candidate Senator Elizabeth Warren raised the warning flag:
Auto loan debt is the highest it has ever been since we started tracking it nearly 20 years ago, and a record 7 million Americans are behind on their auto loans — many of which have similar abusive characteristics as pre-crash subprime mortgages1 .
Warren is not alone in her worries. In late 2016, for example, the Office of the Comptroller of the Currency warned that auto-lending risk was increasing and that banks (and other investors in securitized assets) did not have sufficient risk-management policies in place. Fed Governor Lael Brainard pointed to subprime auto lending as an area of concern in a May 2017 speech, while analysts worried about “deep subprime” auto loans2. Some groups used the term “predatory” auto lending.3
But these concerns are misplaced. As we will show later in this paper, the statistic cited by Senator Warren does not reflect the current state of the auto loan market, as it includes old loans from much weaker economic times. Perhaps most fundamental to understanding the problem with drawing a parallel between the mortgage crisis and today is the fact that subprime mortgages and subprime auto loans are very different products.
Naturally, lower-income households with low credit scores or limited credit history may have fewer financial resources and be inherently riskier borrowers. Moreover, the fact that motor vehicles depreciate over time means that the collateral for the loan becomes less valuable.
Nevertheless, the ability to own a car and, therefore, access credit is crucial for this population. Risk-based pricing charges low- rated borrowers higher interest rates, but in return, offers them the opportunity to borrow money to buy a vehicle that might otherwise be financially inaccessible.
For many lower-income households, their vehicle is the single biggest asset they own.
While vehicles do not appreciate in value as homes do, vehicles are income-producing assets in the sense that they are often essential for commuting to work, especially in non-urban areas. As one report noted, “Owning a car is the price of admission to the economy and society in much of America.”4
In this paper, we analyze the auto loan market, paying particular attention to auto loans made to low-income Americans and to people with bad credit. We find that:
Auto loans account for a relatively small percentage of the increase in nonfinancial debt over the past five years;
Americans are spending less of their budgets on car purchases today, including finance charges, than they were before the recession;
Low-income households saw motor vehicle purchases and finance charges fall from 8.5 percent of household budgets in 2000 to 4.9 percent in 2018;
Over the past five years, the share of new auto loans going to low-credit borrowers has remained relatively constant. There are no signs that low-credit borrowers are either being frozen out of the market or becoming too large a share of loans;
Newly delinquent auto loans, as a percentage of current balances, have been falling over the past two years; and
Subprime auto loans differ significantly from subprime mortgages in key respects that make them less likely to pose a serious threat to financial stability.
Risk-based pricing of auto loans appears to be working so far, keeping low-income borrowers in the market without driving up delinquencies or threatening the financial system. We conclude that the subprime auto loan market is beneficial to low-income consumers, while not posing the same risk that the subprime mortgage market did before the financial crisis. While it will be instructive to observe subprime auto loan trends going forward, current trends do not indicate significant instability concerns in this market.
Recent Patterns in Debt Accumulation
Recent patterns in debt accumulation are very different from those that preceded the financial crisis and Great Recession. Non-mortgage consumer credit – including auto loans, credit cards, and student debt – has risen by $900 billion over the past five years, according to Federal Reserve data. While that figure sounds substantial, that increase amounts to less than 9 percent of the total increase in domestic nonfinancial debt – that is, all debt except borrowing by financial institutions. The rise in consumer borrowing is dwarfed by the increase in business debt ($4.1 trillion) and federal debt ($4.2 trillion) over the same period. Those two categories together account for 82 percent of the increase in domestic nonfinancial debt (Table 1). The leading contributors to business debt growth are mortgages and corporate bonds.
Indeed, businesses have taken the greatest advantage of low-interest rates. Nonfinancial corporations have almost doubled their outstanding corporate bonds since the end of 2007 when the last recession started. Meanwhile, household debt has risen by only 10 percent.
Taking home mortgages into account, households have only accounted for 19 percent of the increase in domestic nonfinancial debt since 2014. By contrast, in the five years leading up to the Great Recession, households accounted for 48 percent of the debt increase. In other words, the financial boom in the pre-recession years was heavily driven by household borrowing, while households have only contributed a small portion to the current debt increase.
A skeptic could argue that, given derivatives and financial engineering, it’s possible for a relatively small portion of the debt market to drive an outsize increase in risk for the whole system. Indeed, that’s what happened ahead of the 2008 financial crisis. In May 2007, then-Chairman of the Federal Reserve Ben Bernanke famously said, “We believe the effect of the troubles in the subprime sector on the broader housing market will be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”5 At the time, the value of subprime mortgages was about $1.3 trillion, which was only 10 percent of the mortgage market and an even smaller share of total borrowing. Bernanke and other policymakers figured that the problems in subprime mortgages could be easily contained.
What Bernanke and others failed to reckon with, however, was how the subprime mortgages had been designed to make sense only in a rising real estate market. Subprime mortgages were constructed effectively to subsidize interest rates with the possibility of appreciation. These financial instruments would offer low upfront rates that enabled lower-income borrowers to qualify. When the teaser rates eventually reset to much higher levels, the assumption was that the borrower could refinance into a new mortgage.
Moreover, the subprime mortgages were then securitized and used to build complicated financial derivative products. And when the subprime mortgages failed because of declining home prices, so did the derivatives. In other words, problems in a relatively small financial sector could be amplified and have a much larger effect on the rest of the economy.
Despite this concern, there is evidence to suggest that subprime auto lending is not a substantial risk to the broader economy. Auto loans are only 7.4% of household debt, which is the 40-year historical average.6 Moreover, the auto asset-backed securities (ABS) market is likewise dwarfed by the mortgage-backed securities (MBS) market. As of the second quarter of 2019, there was a mere $264 billion in auto-related securities, which included only $55 billion in subprime auto securities. By comparison, the amount of outstanding mortgage-related securities came to almost $10 trillion.7
Further, subprime auto loans don’t work the same way that subprime mortgage loans did in the pre-crisis era. Cars and trucks depreciate steadily over time, so the value of the collateral diminishes. That means lenders can’t afford to offer teaser rates, or excessive levels of negative equity, to buyers with low credit scores. They must charge higher rates, properly pricing risk. As one article put it, “the very nature of a real estate loan is very different from an auto loan. Real estate is an investment that typically appreciates over time. During the bubble years, consumers and lenders falsely believed appreciation would bail them out from poor judgment. Vehicles, on the other hand, depreciate. There is no false hope of higher values in the future to bail out a borrower or a lender.”8
The Auto Market
Despite the relatively small role that consumer debt is playing in the current debt expansion, some people can’t shake the idea that Americans are over-spending and over-borrowing to maintain a particular lifestyle. Consider this quote from an April 2019 piece from Business Insider:
The fact that America’s top-selling vehicle — a Ford truck with a price starting at nearly $30,000 – and many like it cost nearly half the median household income hasn’t stopped people from buying them and hasn’t stopped lenders from facilitating loans.9
Over the past five years, the price of new motor vehicles has risen by only 1.1 percent, according to estimates by the Bureau of Economic Analysis (BEA).10 By contrast, the overall price level of consumer goods and services have risen by 6.7 percent over the same stretch.11 In other words, the relative price of new motor vehicles has fallen over this period.
Not surprisingly, the share of consumer spending on new and used vehicles has fallen as well. In 2000, 5.4 percent of consumer spending went to purchases and leases of new and used vehicles. Today, that share is down to 3.6 percent (Figure 1).12
The BLS Consumer Expenditure Survey tells the same story. In 2000, motor vehicle purchases and finance charges amounted to 9.7 percent of household outlays. As of 2018, the last year for which full data is available, the share of vehicle purchases and finance charges fell to only 6.7 percent of household outlays.13 In part, this decline may represent a lengthening of the term of auto loans.14 (These figures would not be changed much by including automobile lease-related payments, which amount to about 10 percent of automobile purchase-related payments in 2018.)
The State of the Low-Income Auto Market
It’s not surprising that lower-rated borrowers pay more for their auto loans. Table 2 below shows interest rates for a 36-month new car loan at different credit rates for December 2015, which was close to the bottom of the credit cycle, and August 2019 (Table 2).
We can see that rates have risen for all credit-rating levels, but more so for the low-rated borrowers.
This risk-based pricing means that low-rated borrowers are not frozen out of the auto loan market. That’s good news, since, in many parts of the country, a car or truck is a necessity, even for low-income households. There is little or no public transit outside of densely populated urban areas, and ride-sharing services are not viable alternatives in many places. So, it is unsurprising that the share of low-income (the bottom quintile) households with a vehicle hold steady at 66 percent in both 2000 and 2018.
At the same time, low-income households saw motor-vehicle purchase and finance taking a smaller share of their budgets. In the bottom quintile of pre-tax income, motor vehicle purchases and finance charges fell from 8.5 percent of household budgets in 2000 to 4.9 percent in 2018 (Figure 2), a drop of almost four percentage points.15
Similar data from the New York Fed’s Household Debt and Credit Report confirm that low-income households are not being uniquely stressed financially by automobile borrowing. Figure 3 shows the share of all auto loan originations that are going to low-rated borrowers (with a Riskscore of less than 620). Before the financial crisis, about 30 percent of new auto loans were going to low-rate borrowers, a startlingly high percentage. That share fell to 20 percent after the crisis and shows no signs of rising (Figure 3).16
The biggest piece of negative news has come from the New York Federal Reserve’s well-publicized finding in February 2019:
…(T)here were over 7 million Americans with auto loans that were 90 or more days delinquent at the end of 2018. That is more than a million more troubled borrowers than there had been at the end of 2010 when the overall delinquency rates were at their worst since auto loans are now more prevalent.18
This startling number, while impressive, simply doesn’t mean what it seems to suggest. This figure includes anyone who still has an old, bad auto loan on their credit record, even if the loan was made and written off years earlier.19 In fact, even after the lender writes off the loan, the loan servicer could continue to report the account to the credit bureaus.
The recent economic history of the United States helps to explain this figure. The number of nonfarm jobs did not return to pre-recession levels until 2014, while the employment-population ratio for Americans with a high school diploma but no college did not bottom out until 2015. As a result, today’s subprime borrowers are carrying around bad loans from the days when the labor market for less-educated workers was still struggling.
Indeed, in an August 2019 blog item, New York Fed economists recommend that anyone interested in the current performance of debt should look at the transition into delinquency- that is, a chart such as Figure 4.20 And by that measure, auto loans are doing far better than in the pre-recession years.
Conclusion
In the event of a recession or a significant economic slowdown, auto loan delinquencies will predictably rise. Subprime auto borrowers, who are more likely to have fewer resources, will be likely to fall behind in their payments when times turn bad.
Nevertheless, a careful look at the data does not suggest that either the origination of subprime auto loans or the exposure of the broader macroeconomy to the auto loan market is a cause for concern. In particular, the subprime auto-loan market looks nothing like the mortgage market before the Great Recession.
Newly delinquent auto loans, as a percentage of current balances, have been falling over the past two years, and the fact that a record number of Americans have a bad auto loan on their credit record is a testimony to economic history more than current loan practices and economic conditions, particularly given the rapid rise in total car sales during this period.
Indeed, risk-based pricing in the auto loan market appears to be supplying a steady flow of credit to low-rated borrowers without imposing excess stress on the financial system.
About the Authors
Michael Mandel is Chief Economic Strategist of the Progressive Policy Institute.
Douglas Holtz-Eakin is President of the American Action Forum.
Thomas Wade is Director of Financial Services Policy of the American Action Forum.
In recent days, Sen. Bernie Sanders and his campaign surrogates have accused former Vice President Joe Biden of being dishonest about his views on Social Security. Although much has been written about Biden’s position, far less scrutiny has been applied to what Sanders proposes to do with the nation’s largest federal spending program. That’s a problem, because Sanders’ agenda isn’t honest about Social Security’s financial condition and would gravely harm the young voters powering his presidential campaign if enacted.
Here are the facts: both Biden and Sanders, as well as nearly every other Democrat running for president in 2020, have proposed to expand Social Security benefits during the campaign. Nobody is championing benefit cuts in this election. The only real difference among the candidates’ proposals is for whom benefits would be expanded. Biden has targeted his benefit expansions to low-wage workers and window(ers), two groups of older Americans that are statistically more likely to be left in poverty by our retirement system. These are the folks who need Social Security the most. Sanders, meanwhile, has proposed across-the-board benefit increases that would increase benefits for even the wealthiest retirees regardless of need.
Unfortunately, no one is talking about the elephant in the room: Social Security doesn’t even have the capacity to pay out the benefits already scheduled. Every year since 2010, the program has spent more money on benefits than it has raised in payroll taxes. The U.S. Treasury is currently covering that shortfall, because it borrowed from previous surpluses and is now paying that debt back. But once those funds are exhausted in 2035, Social Security would be legally required to cut benefits across the board by roughly 20 percent. Even Sanders has acknowledged the program has “been adjusted before, and adjustments will have to be made again.”
IRS Free File and VITA programs should be improved not discarded.
According to the Internal Revenue Service (IRS), 90 percent of taxpayers hire paid tax preparers or utilize tax preparation software to file their taxes.
For low-income families the cost of tax preparation can significantly reduce the value of their refunds. A 2016 study by the Progressive Policy Institute (PPI) found that low-income taxpayers in the Washington-Baltimore metropolitan areas can expect to spend between 13 and 22 percent of the average Earned Income Tax Credit (EITC) refund when using tax preparation services.
One way working families can give themselves a “tax break” is to take advantage of the IRS Free File program. This public private partnership between the IRS and the software industry makes free online tax preparation and electronic filing available to 70 percent of the taxpaying population, and together with the Volunteer Income Tax Assistance (VITA) program serve between 2.5 to 3 million needy taxpayers a year.
In recent years some have criticized these programs for low enrollment rates and encouraging deceptive business practices. But a recent third-party report commissioned by the IRS shows that the Free File program (while in need of improvement) has saved taxpayers $1.6 billion and is responsible for 53 million free returns since 2002.
One way working families can give themselves a “tax break” is to take advantage of the IRS Free File program or the Volunteer Income Tax Assistance program. The Free File program, public-private partnership between the IRS and the software industry, makes free online tax preparation and electronic filing available to 70 percent of the taxpaying population and currently serves 2.5 to 3 million taxpayers annually. The Volunteer Income Tax Assistance (VITA) program helps another 3 to 3.5 million taxpayers file every year.
If you think your credit report is accurate, there is a good chance you are wrong. According to the Federal Trade Commission (FTC), one in five Americans has a potentially material error in their credit file, and one of the biggest contributors is medical bills—with half of all medical bills containing an error.
In fact, mistakes on credit reports have become so pervasive that around a third of all complaints filed annually to the Consumer Financial Protection Bureau (CFPB) resulted from problems with consumer credit reports.
Credit report errors are a serious threat to the financial well-being of American families. As Senator Elizabeth Warren has noted, “credit reports regularly contain errors that can make it harder for families to access credit, find jobs, and get housing.” And as many consumers know all too well, it’s very difficult to get those errors corrected.” (1)
Under the Fair Credit Reporting Act, the company that furnished the information to the credit bureau must conduct an investigation to verify the information and correct a mistake, if they find one. Unfortunately, consumers who want to try to fix mistakes on their credit report face three daunting obstacles.
First, the system put into place by the credit reporting agencies heavily favors creditors and other data furnishers. Credit bureaus almost exclusively depend on lenders (such as banks, credit unions, credit card providers, and mortgage underwriters).
Consumers contacted the credit reporting agencies approximately eight million times in 2011 to initiate a credit dispute. But only a small fraction of those disputes was resolved internally by credit bureau staff. According to the CFPB, 85 percent of credit report disputes are passed on to data furnishers (the lenders) to investigate and resolve. (2) Unfortunately, in most cases the disputes are then shelved unless the consumer perseveres.
Second, the credit report agencies earn their profits by providing services such as credit checks to the very entities that provide the data used to create the credit reports – banks, mortgage lenders, credit card companies, retailers, and other businesses that provide credit. This creates a serious conflict of interest.
Third, despite several notable efforts to try to empower consumers, trying to correct errors on your credit report is still tedious, confusing, and time consuming.
CREDIT REPAIR ORGANIZATIONS AND COMPANIES
Because the system is rigged against them, many consumers turn to credit counseling agencies or credit repair companies. The dispute system designed to help consumers fix the problem favors the position of the debt collector over the consumer. Specifically, the credit bureau is only legally required to check with the creditor or debt collector and ask them whether they stand by their claim. As long as the creditor says you owe money, the dispute is resolved in their favor. As the National Consumer Law Center concludes: “Credit bureaus have little economic incentive to conduct proper disputes or improve their investigations.” (3)
Credit counseling agencies are typically a free resource from nonprofit financial education organizations that review your finances, debt and credit reports with the goal of teaching you to improve and manage your financial situation.
A credit repair company is a firm that offers to improve your credit in exchange for a fee. Unfortunately, the quality of these firms varies greatly. Some credit repair firms are highly reputable and follow best practices. Unfortunately, a significant cohort of credit repair firms are not good actors and, in some cases, have committed outright fraud. In 2016 the Consumer Financial Protection Bureau (CFPB) stated that “more than half of people who submitted complaints with the CFPB about credit repair chose the issue ‘fraud or scam’ to describe their complaints.”
There are some telltale signs for consumers trying to separate the bad actors from legitimate credit repair firms. Companies should be avoided that:
Demand an upfront payment.
Don’t provide a written agreement that includes cancellation rights for consumers.
Guarantee they’ll raise your credit score or fix an error.
Have multiple complaints against them with the Consumer Financial Protection Bureau or the attorney general’s office in the state where they operate.
Suggest they can remove legitimate negative information.
Offer to create a new credit profile based on a new employer identification number, rather than your Social Security number.
In contrast, responsible credit repair companies not only follow federal and state law but also:
Offer a free consultation
Have a track record and consistently solid reviews from past clients.
Have an attorney on staff.
Are licensed, bonded and insured.
WHAT NEEDS TO CHANGE?
To protect consumers, some policymakers have suggested new regulations to further police the credit repair industry. They note that credit repair firms don’t do anything someone with a bad credit report couldn’t do on their own. Anyone can dispute credit errors on their own behalf. But the Do-It-Yourself approach can be dauntingly complicated and time-consuming for harried families.
In essense, paying for credit repair assistance is really no different than paying an accountant or purchasing software to do your taxes – something 90 percent of Americans do according to the Internal Revenue Service.
It is important to note that there is already existing legislation to regulate the credit repair system. The Credit Repair Organizations Act (CROA) was signed into law in 1996 to protect consumers from the unscrupulous practices commonly used by several credit scammers.
Because of CROA, credit repair organizations are not permitted to misrepresent the services they provide, including guaranteeing the removal of negative credit listings. Credit repair organizations are also not permitted to attempt to create a “new” credit file or advise you to lie about your credit history. The Act also bars companies offering credit repair services from demanding advance payment, gives consumers certain contract cancellation rights as well as the right to sue a credit repair organization that violates CROA. (4)
CROA is a sensible law, and despite criticisms that it does not go far enough in regulating the credit repair industry, the law does provide consumers with protections against bad actors in the credit repair sector without eliminating legitimate credit repair firms. CROA needs strengthening, not in the form of new regulations but rather more effective enforcement.
Under CROA, the Federal Trade Commission (FTC) is the primary enforcement body at the federal level. The problem is the FTC is severely underfunded and understaffed. In a Senate hearing last year Commissioner Rebecca Slaughter said the FTC’s staff level is 50 percent below its level at the beginning of the Reagan administration in 1981. Senators Jerry Moran (R-Kan.) and Catherine Cortez Masto (D-Nev.) agreed the FTC needs more resources and is “understaffed.” (5)
As Table 1 confirms, FTC staffing levels dropped dramatically during the 1980s and have never really recovered. Yet, over the same time, the responsibilities of the agency have dramatically changed and expanded. Today the FTC has to address some 2.7 million complaints a year in areas from debt collection, to identify theft, to imposter scams. (6)
Better enforcement of CROA would obviate the need to pile on new rules. Unfortunately, in fact, Congress has added to the FTC’s workload even as its workforce has shrunk. The simplest solution is to provide the FTC with additional resources dedicated to enforcing CROA and protecting consumers from those credit repair companies that have acted fraudulently or in bad faith.
To pay for this increase in supervisors, a small annual fee could be placed on the credit reporting agencies (Equifax, TransUnion, and Experian). To create an incentive for these agencies to be more responsive to consumer complaints about credit reporting agencies, the fee could be lowered or raised in synchronization with the number of consumer complaints about their credit reports.
OTHER REMEDIES
Another approach to fixing the current system is to go to the source of the problem, eliminating some of the causes for the extraordinary amount of errors made by the credit reporting industry. As Aaron Klein of the Brookings Institution has noted, there are three major reasons why credit scores are so inaccurate: “size, speed, and economic incentives of the system.”
One way to change the incentive structure would be to create some consequences for credit rating companies that frequently give lenders inaccurate data about borrowers. Lawmakers could consider legislation that would penalize credit reporting agency error rates above a certain level. Klein’s approach would use a random sample method (5 to 10 percent of complaints) to review credit rating firms’ performance. Another approach would be to grade the credit bureaus on their error and response rates.
CONCLUSION
While it is tempting to lump all credit repair firms into the same basket, many of these firms act in good faith and follow CROA to the letter of the law. Yet there is no doubt that a significant number of these companies are misleading consumers and sometimes acting fraudulently. If lawmakers really want to crack down on these bad actors, however, the first step should be strengthening enforcement of existing law.
Otherwise, spawning new laws and regulations would likely enmesh all credit repair firms in new layers of regulatory complexity and compliance burdens, making it even harder for consumers to detect and correct errors on their credit reports. In CROA we have the consumer protection law we need, now it’s time to focus on oversight and enforcement.
PPI’s Ben Ritz joined an expert panel on Capitol Hill last week to discuss the recently published report by Social Security’s trustees. The annual report projected that the program’s trust funds face insolvency within the next 16 years, after which point beneficiaries face the prospect of an across-the-board cut of 23 percent. All panelists encouraged policymakers to close the gap between Social Security’s revenues and spending sooner rather than later, which Ben noted is critical for ensuring the changes are fair to younger and older Americans alike.
In the movie series “Nightmare on Elm Street” the words “He’s back” indicated that the antagonist – Freddy Krueger – was not dead after all. The tax reform equivalent to Freddy Krueger is the so-called “return-free tax system” that would make the IRS the nation’s tax preparer. As Tax Day came around, Freddy’s ‘Return-Free’ slashed its way back onto the airwaves once again.
When this proposal is described by academics and political figures, it all sounds too good to be true – and it is. Supporters point to examples in California and Great Britain as successful, and yet the truth is quite different.
In California, where millions of taxpayers were sent pre-populated government returns each year, an average of little better than 2-3% of the state’s taxpayers ever accepted it. Eventually, the experiment fell of its own weight and California quietly abandoned it.
Some proponents have also claimed the idea originated with the 1998 IRS Restructuring and Reform Commission, which I co-chaired, and to the subsequent statute enacted that year that implemented the commission reforms. This is simply not true. The 1998 act did instruct the Treasury Department to study the proposal. Their conclusion was that Congress would have to enact radical changes in our tax laws before it could conceivably be feasible. Question asked and answered.
The much-praised “simpler’ system in Great Britain was examined in a recent study by the British Parliament which reports that the efforts by government to implement an EITC-type tax credit in their return-free tax system were initially a disaster. The reason was because the blue collar taxpayer in the UK is not involved in determining their own taxation, and government did not have the information needed to accurately qualify taxpayer eligibility for the credit. After the initial failed effort at an EITC-like welfare-to-work credit, the British no-return tax system moved to Plan B.
Now British workers are required to prepare a pre-return tax submission, reporting extensive personal and family information to the government, in order to claim tax credit eligibility. This lengthy pre-return filing – which looks like an American 1040 tax return – then enables the government to determine the citizen’s tax liability, so the taxpayer doesn’t have to prepare and file a tax return. This circular logic, and layered complexity, is what passes for a “return-free” tax system in practice in the real world.
The UK Parliament’s post-mortem analysis summed up the true myth-buster reality:
“The Right Honourable Alan Milburn, a former Labour Chief Secretary to the Treasury during Prime Minister Blair’s Premiership, described the reason for the inaccurate and significant overpayments as a result of the state not having enough information about people’s lives to accurately determine tax credit eligibility….”
This is the return-free tax system that is most frequently held up as the one we should adopt to replace American voluntary compliance. And yet the conclusion of the UK study states the obvious:
“The only party that has all the relevant information about an individual’s economic and family circumstances pertinent to his taxation is the individual himself, not the government and not the individual’s employer….”
The alternative to taxpayers preparing and filing pre-returns would of course be for the IRS to just independently collect extensive additional personal information about the private, personal lives of our taxpayers and their families, in order to make the false assertion true that the Government has all the information it needs to prepare people’s tax returns for them. However, in American culture, such an expansion of the role of government in our society would trigger a host of civil liberty and individual privacy questions. Some might describe this as a chilling prospect.
The fact is the American system of income taxation has become, over many decades, a central instrument of national economic policy. A significant proportion of the complexity we all rail about in our income tax system emanates from the public policy objectives we have asked the tax system to carry, from Welfare-to-Work (EITC) to Retirement (IRA’s) to Energy Conservation to Education. The implementing regulations alone have added enormous complexity, and require voluminous information.
One more problem with Freddy Krueger’s return-free system: the implications for national security. I have not heard a single expert in cyber security say that we should not worry about the risk of replacing a highly decentralized, diversified tax system with one characterized instead by over-concentration and centralization of systems and data, and the associated risks of attack by cyber criminals and determined nation-state adversaries. We should shiver when Freddy tells us there’s nothing to worry about.
Another basic question would seem a rather straightforward one: What do the people want? The suggestion that the American public is clamoring for Congress to enlarge the role the tax collector plays in their personal lives is nonsensical. And that simple truth has been consistently and overwhelmingly demonstrated in national polling over many years. The idea that the American public would welcome the tax collector as their new best friend is seriously disconnected from reality. And that is compounded by another reality — that the IRS is already understaffed, technologically struggling, and under-funded for its core mission.
It is time for a reality check. True tax reform and simplification is very much needed, and it will be hard work. But it does not begin with getting the taxpayer out of the room where their tax liability is being determined. In fact, the direct involvement of our citizens in their own tax system is much too valuable to lose. Rather than curtailing the role of the taxpayer, we should leverage the annual engagement of our people by helping them develop basic financial literacy, including learning how to save, and the importance of doing so, for their own financial well-being.
The tax refund, for many families, is the largest paycheck they see all year. The reality is that the “tax time moment”, as many economists call it, is an invaluable national economic policy asset, far too valuable to kick to the curb, regardless of whether the theoretical objective is tax administration expediency, or a strategy to increase revenue collections to pay for public spending.
And so, my sincere advice for what to do as the Freddy Krueger return-free advocates try to slash their way back into our lives this Spring like clockwork: Just wake yourself up, look outside
at the real world, and apply common sense. There is no good reason for this nightmare to ever become a reality.
(To read the full text of Senator Kerrey’s tax policy analysis, click here.)
