Tag Archives: Steven Yamarik

To Regulate or to Tax

It has now been a week since the Supreme Court handed down its long-awaited ruling on the ACA. From an individual liberty perspective, it was either a dark cloud with a silver lining or a dark cloud with a dark lining.

I am not a constitutional scholar (though like many Americans, I have spent the last week playing one on Facebook), so I’ll spare you my legal interpretation. But what can we say about the political economy of the decision?

For one thing, the decision highlights the fact that fiscal and regulatory policies can be substitutes for one another. As George Mason University economist Richard Wagner put it some 20 years ago, “a central principle of public finance is that any statute or regulation can be translated into a budgetary equivalent.”

For example, Congress might have passed the individual procreation mandate. It might have fined every childless couple $3,000, every couple with one child $2,000, every couple with two kids $1,000 and every couple with three or more kids $0. Congress, of course, didn’t do this. Instead, they went the fiscal route and created the per-child tax credit, the marginal incentives of which are identical to what I have just described (up to the first three kids).

Alternatively, Congress might have imposed a tax on employers equal to $12,100 for each employee not paid $7.25 an hour. Instead, they went the regulatory route and created the federal minimum wage, the marginal incentives of which are identical to such a tax.

In my paper with Noel Johnson and Steven Yamarik, we explore the inherent substitutability of fiscal and regulatory instruments. Specifically, we look at state behavior in the presence of fiscal limits. We are interested in whether politicians substitute into regulatory policy when fiscal rules bind their decisions (we find evidence that they do). The ACA ruling essentially gets at the opposite phenomenon: the Court has ensured that Congress’s regulatory hands are relatively more constrained. Does this mean that Congress will substitute into fiscal policy, using taxes, tax credits, and spending to address questions that they might have addressed with regulatory instruments? My guess would be: yes.


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?

Do Politicians Regulate When They Can’t Spend?

That is the question Noel Johnson, Steven Yamarik, and I examine in our latest Mercatus Working Paper: Pick Your Poison.

Relying on data from 48 states covering the years 1970 through 2009, we look at the relationship between fiscal rules, fiscal outcomes, and regulatory outcomes.  The specific fiscal rule that we examine is a so-called “no-carry” rule, present in about half of the states.  It forbids legislatures from carrying a deficit over from one year to the next.  A number of previous studies have examined the impact of these rules (some of which I have blogged on in the past) and generally find that they restrain spending and taxation. We ask whether politicians constrained by these rules attempt to attract votes by engaging in active regulatory policy instead.  We tackle this question in three stages:

1.      First, we quantify the different spending and taxing outcomes that obtain when one or the other party gains control of both the executive and the legislative branches of state government.  After controlling for a number of other factors that have been shown to impact fiscal outcomes, we find that Democrats tend to raise individual income taxes by about $66 per capita when they are in control, while Republicans tend to lower overall taxes by $265 per capita and income taxes by $99 per capita.  Republicans also reduce total spending by about $353 per capita, education spending by about $135 per capita, and welfare spending by about $113 per capita (all figures are in 2009 dollars).

2.      Next, we show that when states have rules that restrict the legislature’s ability to carry a deficit into the next year, most of these partisan differences in fiscal policy disappear.  (There are exceptions, however; Democrats continue to increase individual income taxes and Republicans continue to reduce total taxation).

3.      Lastly, we look at the impact of these fiscal rules on regulatory behavior and find that they actually seem to be associated with more partisan regulatory outcomes.  In particular, Democrats appear to be more-likely to raise the minimum wage when no-carry rules restrict their ability to spend and tax more.  They are also less-likely to adopt right-to-work statutes (i.e., they are more-likely to favor a closed union shop than they otherwise would be).  Among Republicans, fiscal no-carry provisions tend to enhance their likelihood of adopting right-to-work statutes outlawing closed union shops.  We corroborate these results using Jason Sorens’s and William Ruger’s measure of paternalistic regulations.  These are regulations that are not easily justified on economic grounds.  They include things such as home schooling regulations, alcohol regulations, marriage and civil union laws, gun laws, and marijuana laws.  We find that, here too, the no-carry provisions seem to make Democrats more-likely to regulate and Republicans less-likely to regulate.

As we write in the paper:

Our results suggest political actors will use whatever policy instruments are available to them to achieve their ends.  If they are constrained along one dimension, they will substitute into more-partisan activities along the other dimension.

The implication for those who are trying to restrain spending is this: Institutions such as strict balanced budget requirements can be useful tools to restrain the fiscal size of government, but they may lead to an expansion in the regulatory state.

Thanks to my excellent coauthors, I learned a lot in researching and writing this piece.  It is still a working paper, so we would be grateful for any comments readers might have.