Deinonychus antirrhopus

Fiscal Mismanagement

In an article over at the von Mises Institute the case is made that the main reason we have fiscal mismanagement is due to a lack of defined objective for the government.

For a firm, the typical objective is to maximize profits. For a firm that is producing the profit maximizing level of output, it is also minimizing costs. The argument continues that firms respond to price signals. If the price for a good drops then the firm will allocate fewer resources towards the production of that good. If the situation turns out that the price drops below avarge cost then the firm may even shut down. Furhter it doesn't stop there, if the price of one of the resources increase then the firm will respond to that price signal as well and will reduce demand for that input and when possible substitute into other inputs.

With government there is not this kind of responsivness to price signals. If the price of one of the inputs increases, it does not necessarily follow that less of that input will be used or that there will be substitution effect. Also, if there is no price for whatever good or service the bureaucracy is providing. This latter fact means that there is not going to be any response by the bureaucracy when people's preferences for the good or service change, at least not right away.

So why is it that there should always be a tendency towards over-spedning instead of underspending? Well on possible explanation is the Niskanen theory of bureaucracy. This theory holds that the objective of government bureaucracies is to actually maximize the size of its budgets. This in turn will allow the bureaucracy to maximize its power, the income of its members, and even improve the prestige of the top bureaucrats. Further, the bureaucracies know what their cost functions are (or at least know them better than the legislators) and the legislators don't so the bureaucrats can increase the size of their budget by lying about their budgets and what can be produced with a given budget.

Another problem is rent seeking. In this case various corporations, business groups, consumer groups, labor groups, and so on, will want special favors, benefits, and deals from the government. Perhaps a subsidy, or a target tax cut, or some such. This to can have an effect where the government runs a deficit. Senator A wants some sort of pork, but Senator B can block it. So Senator A agrees to help out Senator B with another issue. In end, two nice yummy bills with pork pass.

We can also bring in Mancur Olson's logic on collective action. Groups that want to obtain a benefit from the government are going to be more motivated than the vast number of tax payers. For example, suppose there is a piece of legislation that will pay a group of say 100, $10,000. This will be funded by increasing the taxes on the 1,000,000 tax payers (by $1). Now if you are already paying taxes, you might not be all that motivated to figure out why our taxes went up $1. So the recipients are going to much more motivated to secure the benefit than those funding the benefit are to learn about it, let alone fight against it.

So in the end, there is going to be tremendous pressure to spend more and more money. The way in which this is controlled is clumsy and infrequent at best. So you find that budget deficits are far more common than surpluses.