Bohanon: A Swedish Reform for a Hoosier Scholarship

January 5, 2015

by Cecil Bohanon, Ph.D.

Some of my favorite college students have been 21st Century Scholars. The popular state-financed college access program for low-income households enrolls students in junior high school. If the student maintains a decent high school grade-point average, stays out of trouble and participates in college-prep activities, he or she becomes eligible for a significant scholarship to Indiana universities. This makes an otherwise unaffordable college education a reality for many students from low-income households.

A facilitator of the program gave a presentation a few years back about the program. I recall asking how the program was financed. We were told it was an unfunded liability of the General Assembly. “Uh-oh” I recall thinking; “Here is a time-bomb waiting to go off.” Now we read that the program is short some $90 million that will have to come from somewhere in the upcoming legislative session.

We have heard this story before at the local, state and federal level: Our elected representatives are good at starting visible popular programs without a plan for their long-term fiscal sustainability. This is an endemic and predictable component of democratic politics: Enjoy goodies today and worry about paying for them somewhere down the road. Even fiscally prudent Indiana cannot resist the lure.

My academic mentor, the late Nobel-Prize winning Professor James Buchanan, was a great admirer of the Swedish school of public finance. This may seem strange because he was not at all enthralled with the big-government welfare state often associated with that country. However, what the Swedish economists Knut Wicksell and Erik Lindahl insisted on was that each state-expenditure program be accompanied by a clearly specified way to pay for the program. Or in Wicksell’s own words: “. . . no public expenditure (should) ever be voted upon without simultaneous determination of the means of covering their costs.”

Sweden never adopted Wicksell’s procedure. Its spirit, however, is embedded in the country’s reform of its old-age pension scheme. Like most wealthy countries, Sweden’s equivalent to Social Security was at risk of becoming insolvent. The Swedish reform entailed changing from a system with defined benefits for retirees in a pay-as-you go, state-funded pension system to one in which retiree benefits are contingent on the revenue from the 16 percent Swedish payroll tax and the life expectancy of retirees.

For example, Knut retires and receives a $2,000 a month pension. When his brother Erik, 10 years younger with the same earnings profile, retires a decade later he may receive more or less than $2,000 a month. It all depends on what has happened to the growth of the Swedish economy and the life expectancy of retirees. These reforms ensure there will be no Social Security crisis in Sweden.

Had the 20th-century scholarship program been established under similar principles, its funding would be tied to a particular tax base. Just as important, the magnitude of its benefits would be contingent on the revenues from that base. For example, had 3 percent of the proceeds of the state income tax been allotted to the 21st Century scholars, the program would be projected to receive about $155 million in 2016. This compares with its estimated cost of $174 million in 2016. The deficit would either be made up from accumulated surpluses from previous years or by an 11 percent reduction in recipient benefits.

Wicksell’s system is no panacea, but it does offer a sound principle of public finance that is worthy of consideration. Its appeal and problems are independent of political affiliation or ideology. Stockholm may provide a useful lesson for Indianapolis.

Cecil Bohanon, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a professor of economics at Ball State University.

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