Power of the purse

A classic economic thought experiment imagines two bank robbers. For argument’s sake, let’s call them Bonnie and Clyde. The local police catch them a few days later and place them into separate interrogation rooms. The police have a problem: The evidence is circumstantial and at best they could possibly get a conviction on a lesser gun charge. So, they devise a plan.

Officers go to each defendant separately and offer them the same deal. If Bonnie will rat out Clyde, they will release her with a slap on the wrist (one year in prison), but if she chooses not to confess then she will take the fall if Clyde pleads guilty (resulting in a longer prison sentence). If both don’t confess, they face only the gun charge (two years). However, if both defendants confess, they will both receive eight years in prison.

The goal of each prisoner as a team should be to minimize the total amount of prison time that both collectively serve. It would be in the best interest of their partnership to have them both refuse to confess and take the gun charge. Working together would produce the best social outcome.

However, human nature never works that way. If one person chooses not to confess, then they open themselves up to a weaker position. The other party will take advantage of their goodwill and rat their partner out. This strategy is in the prisoner’s best interest privately but fractures the public good. Since both criminals know that there is no honor among thieves, they will anticipate their partner will cheat on them and preempt the other’s infidelity by confessing. Both parties go to prison for eight years each; an outcome that collectively is the worst possible outcome in the aggregate, but makes perfect sense for the individual.

This thought experiment, pioneered by John Nash of “A Beautiful Mind” fame, turned economic thought on its head. Adam Smith proposed that the economy would reach its social optimum via each of its individual pieces working in tandem while pursuing their own separate interests. However, the prisoners’ dilemma found that individual incentives could cause stakeholders to deviate from the public good and end up in situations (called Nash equilibria) where they themselves are also not happy with the outcome.

Clayton Christensen, a former Harvard Business School professor, taught that theories are like a set of eyeglasses that help us understand the world. Once one sees the prisoners’ dilemma, it is hard not to observe it everywhere: climate change, mutually assured destruction via nuclear armament and family disintegration are all stark examples of where trust breaks down when individuals follow private incentives at the cost of their own and others’ welfare.

Political polarization is no different, especially regarding fiscal policy, budget deficits and the national debt. Some deficit spending is helpful in times of recession, national emergency, war, or infrastructure investment. During times of economic boom, government needs to tighten its belt and, if necessary, increase taxes to pay off the accumulated debt. However, the last two administrations have done the opposite: overstimulating the economy with inflationary effects. Given the dramatic spike in interest rates coupled with a booming economy, we need to get our fiscal house in order. Otherwise, we will be saddled with incredibly high interest payments with no remedy when a recession strikes. Congress knows this but political incentives steer lawmakers away from meaningful action and toward the embarrassing situation that played out after Congress passed its most recent temporary plan to fund the government.

American style conservatism was a unique offshoot from its European predecessor. Nurtured in the small-L liberal tradition of the Enlightenment, conservatives embraced that idea of natural rights endowed by nature or a creator. Citizens yielded some liberty through consent of elections and constitutional authority to governments to solve vexing public problems. However, conservatives understood that human nature is fixed and while the government could influence behavior via incentives, it could not alter the tendency for power to accumulate and be abused.

To prevent the abuse of power, conservatives wanted to diffuse political power across three branches of government that would be equally balanced and can check one another. The legislative branch would be first among equals and the framers of our Constitution chose to divide powers among the Senate and House. The Senate received the power to advise and consent on presidential appointees and the House received the “power of the purse.” The people’s representatives would determine how much revenue to raise and where to spend public funds.

Conservatives should strive to maintain this balance and constitutional order.  Sadly, there are many that claim this mantle but have failed to actually live by these principles. Instead of regular budgetary order, chaos has ensued. This dysfunction is apparent in the repeated debt limit crisis, deficit spending and looming government shutdowns.

Debt and deficit spending has been part of our nation’s history since the founding. The colonies individually racked up huge amounts of debt to finance the Revolutionary War. The biggest question facing the new republic was whether the federal government would assume the new debt or should all 13 states have to settle individually with their European creditors. Washington delegated this question to his young Treasury Secretary Alexander Hamilton. Hamilton wanted to create a national bank that would hold this debt and regulate currency. Thomas Jefferson, then secretary of state, despised this idea. The two cabinet members negotiated the Compromise of 1790 in “the room where it happened.” Jefferson got his financial plan and Jefferson and Madison moved the national capital from New York City to the Potomac; closer to home for the Virginians.

The national debt ebbed and grew throughout history. Each new project required Congress to issue a new type of bond to finance the debt. During WWI, Congress decided to issue only one type of savings bond to the public and set a limit on itself that it would have to raise from time to time. This compromise made each year’s deficit easier to manage for financial markets, but created poor incentives for would-be appropriators. Congress could authorize deficit spending in one year, and then hit the debt limit during the next cycle. This action is like eating a three-course meal and then refusing to pay for it when the bill is due.

Given the incentives at play, Congress could now avoid making tough trade-offs during the normal budgeting process and then force drastic measures at the last moment before the debt ceiling expires. This type of pseudo-hostage taking is neither conservative (refusing to act in a constitutionally mandated way) nor good governance. Investors consider U.S. Treasury bonds as the most trustworthy, risk-free asset because the United States of America promises to pay its interest on time. However, each time that certain members of Congress use tactics outside the normal appropriations process, it threatens this premier creditworthiness.

It may seem counterintuitive that abolishing the debt ceiling may help get spending under control, but it will remove the incentive to threaten fiscal health by a slim minority to get concessions that will only have a minuscule effect on the national deficit. This change would put more emphasis on the appropriations process in the House, where the Constitution intended. No party wants to be the one to raise the debt ceiling, so they return to the prisoner’s dilemma. Collectively, it would be best for the nation to not default, but the party that votes to lift the debt ceiling opens themselves up to political consequences when the next election rolls around.

Eliminating the debt ceiling means that members would have to focus their energies on the budgeting process, as opposed to threatening to “burn it all down” if they don’t get meaningless cable news interviews or social media clicks for their fans. Removing venom from the extremes would give cover for the majorities in both parties to work within the productive middle.

Another counterintuitive way to get the parties to work together again on better fiscal health is the recent move to bring back earmarks — or an allowance for members of Congress to allocate funds for projects specifically in their districts.

Earmarks (or sometimes called pork barrel spending) received a bad reputation in the late 2000s with images of bridges to nowhere or obscure research grants. It made logical sense to get budgets under control to eliminate this wasteful spending. James Madison reminds us in Federalist Papers No. 51 that we are not governed by angels, but human beings who respond to incentives. Earmarks allowed members to trade off various projects to give an incentive to work together. In the prisoner’s dilemma, if the district attorney reduced the punishment for confession, then both players would work together to reach a better solution.

Earmarks were a very small part of the federal budget, but without skin in the game, policymakers have little interest in their main constitutional duty: budget appropriations. In many cases, the members yield the budget process to either House leadership or the executive branch and agencies. Since federal agencies do not have to face voters directly and aim to maximize program size, they have no incentive to rein in spending. Thus, not only are constitutional duties transferred from the legislative to the executive branch, but we, as citizens, no longer have a seat at the table.

Government can be a source of innovation in the public sphere, but everyone’s ideas sound great at the time. Never underestimate the ability for the good idea fairy to strike, especially in committee hearings. The best way to counteract this tendency is to focus on outcomes as opposed to inputs. It is easy for policymakers to get caught up in the cost of programs, but rarely do they ask if programs are obtaining their required goals.

Social science has made dramatic developments in the field of causal inference. Causal inference is moving policy evaluation beyond correlation and using methods that allow researchers to tease out causal estimates on the effectiveness of policies ranging from Pell Grants to Medicaid expansion to defense spending. However, elected officials can be apprehensive of testing their ideas for fear of failure. We need to cultivate an atmosphere of innovation on all levels of government. University of Chicago economist John List (a pioneer in this field) recently wrote, “When resources are limited, if you’re not getting the most out of every last dollar spent, the opportunity cost includes the additional impact your dollars could have had if allocated more effectively.”

While the Congressional Budget Office scores new government initiatives for cost, Congress should also require that any new idea or program be piloted first using robust methods. While not all ideas scale from a local to federal level, researchers can quickly partner to help tease out good intentions with null results. Researchers are hesitant to publish a zero result because academic journals favor splashy, positive magnitudes. However, Congress should fund and encourage finding out what does and does not work. Conservatives win by eliminating programs shown to have little or no effect for the cost, while liberals can invest in programs that are effective. Fiscal conservatives should shift their mantra from the party of “NO” to the party of “ROI” — return on investment. A culture of innovation combined with rigorous evidence-based testing removes stigma and shame, rebuilds trust, and allows warring factions to work together again. Conservatives can once again tout states as literally the “laboratories of democracy” where state and local officials can try out new ideas.

Finally, all these recommendations simply work around the edges of solving our big budget issues. Congress has a funny way of labeling problems it does not want to solve. It separates discretionary spending (earmarks, foreign aid, agency appropriations) from nondiscretionary spending (Social Security and Medicare). This misnomer gives the illusion that Congress has no ability to change spending levels on the largest sections of the federal budget. Neither side wants to be the one who cuts grandma’s Social Security check or reforms Medicare, but with an aging society, those programs are exactly the areas where Congress needs to explore reforms.

Modern medicine has dramatically extended life expectancy beyond what one could dream of in the 1930s when President Franklin Delano Roosevelt and Congress created Social Security. With an aging population and a declining birth rate, we are rapidly approaching a scenario where Social Security will have to support two simultaneously retired generations with a shrinking labor force. Immigration could solve this problem, but neither party seems interested in smartly handling that issue.

In the medium term, interest on the national debt should keep every American up at night. Federal treasury bonds are fixed rate, meaning that for 10 years the interest reflects the market conditions of the issuance data. However, since the pandemic, the Federal Reserve has rapidly increased interest rates to combat inflation. Any new federal spending bonds will carry that higher fixed rate. Also, without an excess of spending, bonds that did offer a lower interest rate will be “rolled over” to pay off the holder as they mature. Thus, the Treasury will have to refinance parts of the debt at the new higher rates as well.

In the 1987 film, “The Princess Bride,” friends of an injured and unconscious hero rush his body to a doubtful and snarky Miracle Max. He declares the patient to be mostly dead and exclaims, “There’s a big difference between all dead and mostly dead. Mostly dead is slightly alive. All dead, well there’s only one thing you can do. ... Go through his clothes and look for loose change!”

I don’t think our fiscal situation is even mostly dead, but it doesn’t seem quite alive, either. As the social psychologist Jonathan Haidt recently wrote, “democracy had an Achilles’ heel because it depended on the collective judgment of the people, and democratic communities are subject to ‘the turbulency and weakness of unruly passions.’” We are seeing what happens when we drain trust from our democratic systems. To overcome our own prisoners’ dilemma, we need to shift incentives for both sides to work together, otherwise, as William Butler Yeats wrote, our democracy will see that “the best lack all conviction, while the worst are full of passionate intensity.”

Deficits and debt are dollars and cents, but they are also an expression of values and judgment. We will be facing real world consequences if we do not shift course. We need to realign incentives (even when counterintuitive), empower evidence-based policymaking, and allow trade-offs on big issues. All these things are still in our power because … we are still “slightly alive!”

Michael Kofoed is an assistant professor of economics at the University of Tennessee at Knoxville and a research fellow at the Institute of Labor Economics.

This story appears in the November issue of Deseret Magazine. Learn more about how to subscribe.