Tag Archives: David Primo

Why a shutdown threat won’t work

There are many people who think that the Affordable Care Act (ACA) is bad policy. I am among them. There are also many who think that the current trajectory of government spending is unsustainable and economically harmful. I am also among them.

Then there are people who think it would be wise to shut down the federal government if they can’t get language passed that threatens to defund the ACA. (Notice that I didn’t say language that “defunds the ACA”; I said language that “threatens to defund the ACA.” Much of the ACA is actually funded through mandatory spending so Congress would need to pass a full repeal of the bill to defund it. What these folks want is language in the budget resolution saying that the ACA ought to be defunded. The bill might strip out some discretionary funding but most of the ACA would go forward.)

I am not among them.

To help us think through the options, let’s borrow from game theory and employ a decision tree. The House (H) can either choose to pass a continuing resolution (CR) that funds the ACA or a CR that calls for de-funding the ACA. The Senate (S) can choose to pass whatever the House sends them or to reject it. If they reject it, and no CR is passed by October 1, the federal government will shut down. In this case, as the CRS puts it, “substantial ACA implementation might continue during a lapse in annual appropriations that resulted in a temporary government shutdown.” If the Senate passes whatever the House sends them, then it will go to the President (P) who can either sign it or veto it.

At the end you can see the outcomes and the way that each group feels about them.

Options are happy, sad, neutral, and outwardly sad but secretly happy. (click on the images to enlarge):

decision tree

 To figure out the most likely outcome (the “equilibrium”) you do a fancy thing called “backwards induction.” It is actually quite simple: think about how each player would act at each stage, starting at the end of the game, and cross off implausible actions. This will help you eliminate unlikely outcomes. This is what I’ve done below, with dashed lines indicating an action that a particular player is unlikely to take.  

We can with confidence cross off the possibility that the President will veto a CR that keeps the government open and fully funds his signature initiative or that the Senate would reject such a bill.

We can also cross off the possibility that the President would sign or that the Senate would send him something that calls for defunding his signature initiative.

That leaves us with two plausible scenarios: the House doesn’t use the CR as a means to attack the ACA, the CR passes the Senate, and the President signs it. This is the top branch of the game tree. House Republicans will be neutral about this outcome since they will have escaped blame for a shutdown but will have done nothing to stop the ACA. Senate Democrats and the White House will be pleased.

The other somewhat plausible scenario is that the House passes a CR calling to defund the ACA, and the Senate rejects it. The government would shut down and the ACA would mostly be untouched. I’m guessing Republicans would get most of the blame for shutting down the government since they lack a bully pulpit, aren’t as gifted as the president at communicating, and the ideological stereotype is that Republicans would like to see the government shut down any way. The White House and Senate Democrats will be outraged—simply outraged—that Republicans would do this but they will secretly be happy to have one more reason to say Republicans should never be trusted with power.

If Republicans see all of this, they will likely flinch, hold their noses, and pass a CR that doesn’t touch the ACA and hopefully come up with more constructive ways to challenge the policy. But, it is a close call for some House Republicans so for this reason, I’ve only partially crossed off the first bottom fork of the decision tree. decision tree 2

What the tree doesn’t indicate is the long run consequences of a government shutdown. Two and a half years ago, when Washington was staring down a different government shutdown, I drew from the experience of U.S. states to conclude that a shutdown is not in the interest of those who advocate for limited government:

As is often the case, we can look to the American states for some guidance. It turns out that in 23 U.S. states, the government will automatically shut down in the event that the governor and the legislature fail to agree on a budget. In his work on budget rulesDavid Primo examined the theoretical impact of these provisions from a game theoretic perspective. He noted that in states with an automatic shutdown provision, “the legislature will be able to achieve its ideal budget, so long as the governor prefers it to no spending.” (p. 102)

He therefore predicted that states with such a provision will spend more than states without such a rule. He then tested the hypothesis, controlling for a number of other factors known to impact state spending and found that states with an automatic shutdown provision actually spend about $64 more per capita than other states. As he notes, “This effect is remarkably large, given that shutdowns occur rarely.” (p. 103)

This suggests that the federal government’s automatic shutdown provision—by making Congress’s desired spending level a take-it-or-leave-it offer—tends to bias the government toward more spending. By extension, it also suggests that a government shutdown will shift negotiating power toward those who favor more spending. So, paradoxically, fiscally conservative tea partiers stand to lose the most if the federal government shuts down.

Perhaps it is time for them to rethink their support of a shutdown.

 

A Better Balanced Budget Amendment

A few weeks ago, I wrote about the state-level evidence on strict balanced budget requirements:

I believe the evidence supports this claim. David Primo (2003) and Mark Crain (2003) find that states with a strict balanced budget requirement tend to spend less than other states. Shanna Rose (2006) finds that states with strict balanced budget requirements tend not to experience a political business cycle in which government spending rises just prior to an election and falls shortly thereafter. Bohn and Inman (1996) find that states with strict balanced budget requirements tend to have larger General Fund surpluses and larger rainy day funds.

Since then, the recently-inked debt deal has obliged Congress to take up and vote on a balanced budget amendment. I think the most-compelling argument against such an amendment is the concern that it would exacerbate the ups and downs of the business cycle by forcing spending cuts when the economy is contracting and permitting increases when the economy is expanding.

This is a concern, but there are ways around it.

One answer is a rainy day fund. Forty-seven states have such funds; states contribute to them during good years and then draw on them when the budget is strained due to a downturn or some other event like a natural disaster. Gary Wagner and Erick Elder find that states whose rainy day finds have strict rules governing the amounts they must deposit and the reasons for which they may withdraw from them tend to experience less spending volatility.

Alex Taborrok makes the case for essentially the same scheme at the federal level.  He calls it an “unbalanced Budget Amendment.”

Glenn Hubbard and Tim Kane weigh in with a similar proposal, arguing that “the annual constraint on expenditure should be defined by the median federal revenues of the last five years, not the current year.”  They have a number of other proposals worth considering as well:

  • The “balance” should count accrued liabilities in entitlements.
  • It should use “escalating supermajorities for exemptions,” meaning that “a 3/5 vote in both houses is required the first year of exemption, 4/6 the second year, 5/7 next, and so on.”
  • It should provide a glide path to a lower debt-to-GDP ratio.

David Primo highlights a current proposal in Congress that incorporates many of these features.

Balanced Budget Rules and Unintended Consequences

In my view this is one reason of many why a balanced budget amendment is not a workable path toward fiscal conservatism.

That is Tyler Cowen’s take on my paper with Noel Johnson and Steven Yamarik. I can certainly see why he might come to this conclusion.  We find that when Democratically-controlled states face a binding constraint on their ability to carry a deficit over from one year to the next, they may regulate more instead. A friend of mine calls this the “muffin-top” problem: belt-tightening can sometimes lead to unsightly bulging…elsewhere.  In spite of the muffin-top problem, I am actually still an advocate of a balanced budget amendment at the federal level.

Though I often marvel at the fiscal irresponsibility of state governments, I can’t help but feel that if the states and the federal government were in some sort of fiscal beauty contest, the states would easily come in 1st through 50th while the federal government would come in 51st.  Consider:

  • Collectively, state and local governments are in debt to the tune of about 2.6 trillion dollars, while the federal government has racked up nearly 4 times that amount.
  • The states have accumulated $9.9 trillion in unfunded obligations that will come due over the next several decades.  The Feds, meanwhile have accumulated 5 to 10 times this amount (depending on whether you agree with Medicare’s chief actuary that the current political path is highly unlikely).
  • Most states manage to balance their operating expenses (some gimmickry aside) on an annual or biannual basis. In contrast,
    for the last 80 years, the federal government’s norm has been to run an annual operating deficit (with deficits about 85 percent of the time).
  • When states do borrow, it is typically for long-term capital projects (again, some gimmickry aside).  So future generations are on the hook for bridges and buildings that they, too, will use. In contrast, the Feds don’t even pretend to borrow for future projects; much of what my daughter’s generation will pay for is my generation’s consumption.
  • When states encounter budgetary problems, they tend to deal with them by cutting spending rather than raising taxes.

All of this is somewhat surprising given the fact that, constitutionally, the states were given a blank check whereas the feds were not. As Madison put it in Federalist 45:

The powers delegated by the proposed Constitution to the federal government, are few and defined. Those which are to remain in the State governments are numerous and indefinite.

So why, given so much more (constitutional) power than the feds, do the states seem to manage their affairs more-responsibly? Tiebout competition and the lack of a central bank likely play a role. But I believe the fact that every state but Vermont has to balance its books each year must account for a large share of this relative fiscal probity.  As James Buchanan and Richard Wagner argued over 30 years ago, the ability to buy items for today’s generation while putting the tab on tomorrow’s generation creates a systematic bias in favor of irresponsible spending. In contrast, they argue:

The restoration of the balanced-budget rule will serve only to allow for a somewhat more conscious and careful weighting of benefits and costs. The rule will have the effect of bringing the real costs of public outlays to the awareness of decision makers; it will tend to dispel the illusory “something for nothing” aspects of fiscal choice.

I believe the evidence supports this claim.  David Primo (2003) and Mark Crain (2003) find that states with a strict balanced budget requirement tend to spend less than other states.  Shanna Rose (2006) finds that states with strict balanced budget requirements tend not to experience a political business cycle in which government spending rises just prior to an election and falls shortly thereafter. Bohn and Inman (1996) find that states with strict balanced budget requirements tend to have larger General Fund surpluses and larger rainy day funds.

In our paper we find that stricter balanced budget rules tend to constrain partisan fiscal outcomes.  The fact that they may lead to bulges in the regulatory state is, indeed, unfortunate.  But in my view, that suggests that we should also examine biases in the political economy of regulation and consider institutional reform to address those as well.  Perhaps there is need for a more-conscious weighing of the benefits and costs of regulation?  If belt-tightening leads to muffin-tops, maybe we need more than a balanced budget amendment?  Perhaps spanxs?

Should the Tea Party Hope for a Government Shutdown?

Last week, yet again, Congress passed a short-term continuing resolution, funding the federal government for another few weeks while Republicans and Democrats attempt to work out some sort of compromise to get an actual bona fide budget passed. This pushed off the prospect of a government shutdown a few more weeks.

Also last week, CNN released a poll finding that 73 percent of Americans believe a government shutdown that lasted a few weeks would be a bad thing. This general opinion seems to cross ethnicity, age, income, geographic region, and political party affiliation (though a little more than half of Republicans would be okay with a shutdown if it lasted only a few days). There was, however, one exception to the near-universal opposition to a shutdown: Tea Partiers. Fifty two percent of those who self-describe as Tea Party supporters thought a government shutdown that lasted a few weeks would actually be a good thing. I should note that 46 percent of Tea Partiers opposed such a shutdown and that the margin of error was plus/minus 5.5 percentage points. Still, this suggests that those who support the Tea Party are far more sanguine about the possibility of a shutdown than other Americans.

As advocates of limited government, are the beliefs of Tea Partiers justified?

As is often the case, we can look to the American states for some guidance. It turns out that in 23 U.S. states, the government will automatically shut down in the event that the governor and the legislature fail to agree on a budget. In his work on budget rules, David Primo examined the theoretical impact of these provisions from a game theoretic perspective. He noted that in states with an automatic shutdown provision, “the legislature will be able to achieve its ideal budget, so long as the governor prefers it to no spending.” (p. 102)

He therefore predicted that states with such a provision will spend more than states without such a rule. He then tested the hypothesis, controlling for a number of other factors known to impact state spending and found that states with an automatic shutdown provision actually spend about $64 more per capita than other states. As he notes, “This effect is remarkably large, given that shutdowns occur rarely.” (p. 103)

This suggests that the federal government’s automatic shutdown provision—by making Congress’s desired spending level a take-it-or-leave-it offer—tends to bias the government toward more spending. By extension, it also suggests that a government shutdown will shift negotiating power toward those who favor more spending. So, paradoxically, fiscally-conservative Tea Partiers stand to lose the most if the federal government shuts down.

Perhaps it is time for them to rethink their support of a shutdown.

A Balanced Budget Amendment: Not so Far-Fetched

The Alexandria News reported last week that Virginia Governor McDonnell sent the General Assembly a resolution for their consideration. If passed, it would be one step toward enactment of a federal balanced budget amendment.

Remember, there are two ways to amend the Constitution. One option is for two-thirds of each federal chamber to pass it and then forward it to the states where three-fourths need to ratify it (by convention or by the legislature). This is the way all 27 amendments to the constitution have been passed. The second—so-far unused—option is for the states to get the ball rolling by calling a convention: If two-thirds of them petition Congress for a constitutional convention, then a convention must be called. It will then consider an amedment (or amendments) and if it can agree, forward these back to the states where, again, three-fourths must consent to passage.

The Virginia bill would take a stab at both methods. It calls on Congress to pass a balanced budget amendment. But, “in the event of congressional inaction,” it petitions Congress for a constitutional convention.  

The idea is not so far-fetched. After all, there have been 17 amendments to the Constitution since the Bill of Rights, which comes to around one amendment every 13 years. The most-recent took effect 19 years ago in 1992. Moreover, in 1995, the U.S. Congress came razor-close to passing a balanced-budget amendment, obtaining the requisite two-thirds of House votes and falling just one vote shy of two-thirds of all senators.

What is more, we are actually closer to the second means of amending the Constitution than you may think. David Primo writes (p. 130):

In the 1970s, thirty-one states called for a convention on the subject of a balanced budget, and Missouri did so in 1983. Since then, three states (Alabama, Florida, and Louisiana) have rescinded this request, though it is unclear whether they can do so. Depending on how the counting is done, then, only two to five more states are needed for a convention to be called.

The CAP Act: A Glass Half-Full?

Aaron Merrill is “very pessimistic” about the new “CAP Act” proposal. I’m mildly pessimistic.

First, a few things that I think are good signs:

  1. Unlike PAYGO, the law isn’t just about making sure spending is paid for. It is an attempt to actually limit spending. Also unlike PAYGO, the law targets existing, not just new programs.
  2. In the event that Congress can’t agree on where to cut, the act would trigger automatic, evenly distributed cuts across all categories of spending. This is good. Across-the-board cuts are sufficiently unpleasant to make legislators want to prioritize. But since the cuts will be evenly-distributed, Congress won’t have a strong incentive to scuttle the bill altogether. The last time something like this was tried (the Gramm-Rudman-Hollings (GRH) Act of 1985), a number of programs were exempted from the automatic cuts. These included: Social Security (which was actually in surplus at the time), veterans’ pensions, the earned income tax credit, the president’s compensation, the postal service, welfare payments, and (for the most part) Medicare. This meant that the cuts had to be concentrated on a relatively few programs. David Primo writes (p. 111) that: “At one point, GRH authorized the [office of management and budget (OMB)] to make cuts of over 30 percent to both defense and unprotected discretionary spending.” Faced with this option, Congress found it much more palatable to simply repeal GRH.
  3. It is smart to give OMB—an executive branch agency—the authority to execute the automatic cuts. The goal here is to tie legislators’ hands so that they don’t have to police themselves. GRH initially gave Congress’s Government Accountability Office the authority to execute the automatic cuts. But when a court struck that provision down, the fallback provision was for a joint committee of Congress to execute the cuts. As Primo explained (p. 111), this meant that Congress had “to pass legislation each time it wanted to trigger a sequester.” You can imagine how eager they were to do that. Ultimately, GRH was amended so that the OMB would make the cuts. And to me, that makes sense.   
  4. The CAP Act would permit legislators to avoid the cuts if they can muster a supermajority in both houses. This, too, is a step in the right direction, though I share Aaron’s concern that it is not enough. Normal legislation, of course, can always be repealed with 60 votes in the Senate and a simple majority in the House, plus the President’s signature. By requiring a supermajority in both chambers, this raises the hurdle a bit. But I would be much happier if it were a higher bar (90% of lawmakers?). Of course, even a 90% hurdle could be overcome by repealing the law. In the end, a Constitutional Amendment may be the only way to really bind.    
  5. The cuts are gradual which means that they are more likely to happen. As the GRH experience shows, spending reduction plans that call for cuts that are too dramatic often end up being repealed or ignored.

But it isn’t all sunlight and rainbows. I still have some concerns:

  1. As Aaron points out, the bill is enforced via a “budgetary point of order.” As my friend Jim Musser explained to me, the House Rules Committee can and often does waive all points of order when they consider certain pieces of legislation. In this case, this evidently means that a simple majority of a committee can basically suspend this rule whenever it so chooses.
  2. The reductions are not enough to solve the problem. They want to get spending down to its historical average, but I’d point out that the historical spending average is greater than the historical revenue average and this is a formula of unsustainable debt accumulation.
  3. The reduction in the growth of spending doesn’t start until 2013 and even then, the glide path is so shallow that after 10 years, the national debt will still be well above 100 percent of GDP (assuming revenue remains at its 10 year average).
  4. It is possible that the CAP Act could—perversely—act as an excuse to spend up to the limit. 20.6% may have been the norm for the last 40 years, but I don’t think it is the ideal by any stretch.

Tough Love

Last week, Michael Powell over at New York Times’s Economix blog characterized my position as one of “tough-love.” That is probably a fair way to put it. 

In an example of un-tough-love, yesterday’s Grey Lady featured an article by Christopher Edley Jr. (dean of the University of California, Berkeley, School of Law). In it, Dean Edley argues that states ought to be allowed to borrow directly from the Treasury:   

[S]tates are managing huge budget crises with the only tools they have, cutting spending and raising taxes — both of which undermine the federal stimulus.

That’s why the best booster shot for this recovery and the next would be to allow states to borrow from the Treasury during recessions. We did this for Wall Street and Detroit, fending off disaster. It’s even more important for states.

From my view, such a policy would permanently enshrine the notion that states are too big to fail. We know that states have a spending problem. According to data from the Bureau of Economic Analysis, for the last 9 years, the inflation-adjusted average annual growth rate of state and local government spending was 2.6%. At the same time, the private economy—on which state and local governments depend for their tax revenue—only grew at an average annual growth rate of 1.4%. In other words, states are already spending at a faster rate than the economy can create wealth. Furthermore, they are doing this without the power to deficit spend (for general operating expenses) or the power of the printing press. 

Allowing states the permanent ability to rely on the Federal Treasury would, of course, change all of that. How might we expect them to behave under those circumstances? Important research by the University of Rochester’s David Primo gives us some idea. It turns out that while all states save Vermont have balanced budget requirements, these requirements vary considerably from state to state. Some are allowed to carry deficits over from one year to the next while others are not. Furthermore, others are required to balance their planned spending, while others must balance their actual budgets at the end of the year. Lastly, some states are checked by independent courts, while others are not. In sum, some states face strict balanced budget requirements while others face weak balanced budget requirements. In his analysis, Professor Primo found that state and local spending in states with strict balanced budget requirements averaged $3,336 per citizen. In contrast, in states with weak requirements, the average was $3,756 per citizen.

The Federal Government’s balanced budget requirement isn’t weak; it is nonexistent (you might say they are on the honor system). So what might we expect spending to look like if every state in the union could borrow from the Federal Government whenever it was expedient?  I prefer tough love.