Discussion Paper
No. 2007-12 | March 23, 2007
Philip E. Graves
A Simple Coase-Like Mechanism that Transfers Control of Government Spending Levels from Politicians to Voters

Abstract

Elected representatives have little incentive to pursue the interests of those electing them once they are elected. This well-known principle-agent problem leads, in a variety of theories of government, to non-optimally large levels of government expenditure. An implication is that budgetary rules are seen as necessary to constrain politicians’ tax and spending behavior. Popular among such constraints are various Balanced Budget Amendment proposals. These approaches, however, are shown here to have serious limitations, including failure to address the central concern of spending level. An alternative approach is advanced here that relies on a Coase-like mechanism that transfers control of government spending to the voter. Prisoner's dilemma incentives and political competition are seen to be critical to the superiority of the present mechanism to approaches requiring budget balance.

JEL Classification:

H11, H61, H62, H72

Cite As

Philip E. Graves (2007). A Simple Coase-Like Mechanism that Transfers Control of Government Spending Levels from Politicians to Voters. Economics Discussion Papers, No 2007-12, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2007-12


Comments and Questions



Signe Krogstrup - Referee Report
May 09, 2007 - 10:22
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Philip Graves - rejoinder
July 19, 2007 - 21:42 | Author's Homepage
Mr. Krogstrup well-characterizes the aim of the paper. His first objection (that countercyclical spending and spending on valuable projects) can be countered by the mechanism's ability 1) to have alterations in spending level with some voting majority--which would be noticed by the electorate; and 2) by pointing out while seeking office the meritorious nature of large, but important spending (e.g. interstate highway system under Eisenhower). In any event, vis-a-vis the pro-cyclicality issue, the mechanism performs better than existing alternatives, such as the balanced budget rules often advocated. His second objection is, again, a potentially important issue, but the mechanism has no greater accounting problems than competing balanced budget mechanisms--indeed, because revenue need not be considered, tricky accounting practices would only be limited to the expenditure side. The third objection (the common pool problem, and incentives to over-spend on the part of any elected official, potentially bankrupting their party) is a bit more problematical, but there would certainly be strong party incentives to attempt to control this phenomenon, to internalize the externality via sanctions, etc. (e.g. the threat of not supporting politicians in future elections who get too greedy for their constituents). I actually view this "problem" as a potential benefit of the proposed mechanism, since it will force parties to consider the efficiency and fairness of the regional sub-allocations of the overall spending limit. Similar comments apply to the coalition government case raised in the next bullet of the review. The Casella (2002) paper sounds interesting as a concrete mechanism to internalize the overall spending limit, addressing specifically some of the concerns raised by the referee. I suspect that the "time inconsistency" problem is reduced by the proposed mechanism. That is, even those favoring reduced spending realize they need to spend to get re-elected under the current regime--the mechanism would make force fiscal conservatives be true to their goals.

VICTORIA ELIZABETH VILLAGOMEZ MORALES - Participatory budgeting
May 31, 2007 - 09:54
The author might like to look at work on democratization of budgets an also some real life examples of participatory budgeting (www.internationalbudget.org). On a first reading it seems to me that M is not viable, certainly not in developing countries and would perhaps be overlooking other purely political objectives of government budgets. The recent case of Germany breaking the stability pact rule within the EU is a case in point. Maybe in the US system the M rule woudl be possible, but the author does not address how exactly the fund will work. Will party voters or members pay this debt? Dr. Elizabeth Villagomez

Philip Graves - rejoinder
July 19, 2007 - 21:46 | Author's Homepage
The nature of the mechanism is such that there would actually never be any money in the "fund." If parties over-spent (according to accounting rules to be agreed on), they would both a) go bankrupt immediately, and b) lose reputational credibility. It is true that general accounting rules may be too vague in many developing countries to get to a general agreement--and of course one-party dictatorships have no incentive to submit to the mechanism!

anonymous - Referee Report
June 12, 2007 - 09:33
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Philip Graves - rejoinder
July 19, 2007 - 21:57 | Author's Homepage
The referee provides an excellent, succinct summary of the paper in his/her opening two paragraphs. The referee takes issue with certain informational assumptions that underlie the simplicity and power of the mechanism to provide fiscal restraint. The negative consequences (physical externalities, e.g. in the airport case) of a spending policy had not really occurred to me--this is because the emphasis of the paper is on reducing excessive spending independent of such issues. However, to the extent that negative externalities are positively correlated with higher spending levels, the proposed mechanism is likely to reduce them as an additional side-benefit. The issue of substituting regulatory activity for direct spending is pertinent. I believe, however, that if spending can be capped--unlike under existing conditions--that voters might turn their attention to regulatory issues. At any rate, while of considerable interest in its own right, the level of regulatory intervention should not be expected to be any more of a problem than under the present governmental institutions.

Anonymous - Associate Editor´s Report
September 20, 2007 - 10:14
I have had a chance to have a look at the replies by Phil Graves. I have really appreciated dealing with this paper. The proposed mechanism is quite simple and nevertheless striking as also the referees have acknowledged. However, as we know from many studies in political economics, the common pool problem is central for over-spending in most countries. The author has not clarified how his mechanism could actually cope with that problem. I am not convinced that party control will do the trick as parties face a common pool problem of their own. Unfortunately, the paper can thus not be accepted for publication in economics.

Phil Graves - Response to the Associate Editor´s Report
September 20, 2007 - 10:30
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