Wreckonomics: America’s Fiscal Policy in Action

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“The Moment of Truth” is upon us or so proclaims the title of the report issued by the bi-partisan National Commission on Fiscal Responsibility and Reform. The report correctly identifies the fiscal mess we now find ourselves: deficit spending that is unsustainable and entitlement programs that can’t possibly keep their promises without massive tax increases. To the Commission’s credit, its proposals likely would find broad support from economists. But for political reasons, little or nothing is likely to be done, at least until a crisis develops. The same factors that put us into this mess are the ones blocking reform: politicians prefer policies that provide benefits now and costs later. The Commission’s proposals would do just the reverse.

The behavior of politicians reminds me of a personal experience with a troublesome bear in Minnesota. The big bear appeared at my cabin porch one day drawn by aromas of some steaks cooked the night before. The bear tried to enter the cabin by rearing on its hind legs and trying to push in windows and doors. Finally I resorted to banging pots and pans to drive the beast off, but not before he knocked over a few things in the yard. I called the Department of Natural Resources to report the bear. I had hope of getting someone to come out to move the bear further into the wilderness. The DNR officer asked me to explain what had happened. After doing so, the officer said: “So he was just doing bear things?” It was obvious the DNR was not riding to the rescue.

Politicians are a lot like bears in that they just do “politician things.” It is just the nature of the beast. To get elected, successful politicians know that they must provide benefits to constituents who can provide votes and/or money. These constituents are usually members of special-interest groups who receive substantial individual benefits while costs get dispersed over a large numbers of taxpayers. Some years back, a study on the milk-price support program showed the program raised milk prices about a penny per quart. Benefits to the milk producers were in the hundreds of millions of dollars. Few government programs can stand up to a rigorous benefit-cost study. Far too frequently, the benefits of the programs are less than the costs to taxpayers.

The “cash for clunkers” program in 2009 provides a nice illustration. Billed as a program to help save the environment and put autoworkers back to work, the government gave people with “clunkers” up to $4500 to trade in their old vehicles for new more fuel efficient vehicles. The “clunkers” that were traded in had to have their engines and transmissions destroyed. I and a fellow economist, George Parsons, put the clunker program under a cost-benefit analysis and concluded that for every $4000 spent by taxpayers there was a $1,000 net loss in value, even after including environmental benefits. Imagine a private business that took $4000 worth of inputs to produce a product worth $3,000. How long would this business survive? But politicians seem to flourish.

On a much larger scale, the Medicare, Medicaid and Social Security systems already have provided or promised benefits far in excess of any reasonable ability for us to pay for them. Economists have estimated that, if these programs were actuarially sound, they would have amassed an additional $60 trillion or so in financial assets. One prominent economist and past President of the St. Louis Fed has said that the future tax rates needed to finance these programs with their current promises would “produce tax rates inconsistent with a market economy.” Obviously promised benefits are going to be cut, but which politician is going to step up to the plate? It likely will require a monumental crisis before a solution is seriously sought.

Is there any way to improve government governance? This is a key question, but one with no easy or obvious answers. Improving government governance is arguably even more difficult than improving corporate governance. I’m working with a colleague on a book and we plan to explore some possibilities. But don’t expect any magic solutions.

Transcript of Research Presentation given on February 24, 2011 at the New York Historical Society

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