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Cutting Is So Hard to Do

Mises Daily: Monday, August 09, 2010 by

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In recent months, fiscal austerity among governments on all levels has come to the political fore, albeit for different reasons.

In some cases, such as Greece, belt-tightening measures were essential to avert a sovereign-debt crisis. The Greek government enacted significant deficit-reduction solutions in order to receive monetary aid from the International Monetary Fund and European Union. In so doing, it continued the de facto monetization of Greek debt by the European Central Bank.

Other governments are finding fiscal consolidation necessary to bridge the gap between paltry tax takes and ballooning expenditures — like those of G8 nations Britain, Japan, and Germany, and most US states, which (unlike the federal government) must at least nominally "balance" their budgets on an annual basis.[1]

In Washington, the backlash against further deficit spending is ephemeral; it has only become fashionable, conveniently, just prior to a midterm election. Members of Congress recently balked at the price of a "Tax Extenders" bill that would continue certain tax-and-spend provisions from the 2009 stimulus legislation, as though doing so would exonerate them from their damning $1.4 trillion deficit.

Ongoing deficit-reduction solutions inherently entail two policy options: (1) permanent spending reductions or (2) permanent increases in taxes. The former reduces the state's claim on the material results of private economic activity — the wellspring of production, consumption, and an increasing standard of living. The latter confiscates private property for forced consumption spending, distorts economic decisions, and retards capital accumulation. Consequently, the former method of deficit reduction is by far economically preferable to the latter.

Nevertheless, cutting government spending is a daunting undertaking. Public reaction to proposed spending reductions is typically negative, emotional, and severe. One can expect a backlash that at a minimum includes media commentary and reports bemoaning the supposed dire economic consequences and job losses arising from reductions in government spending.[2] It might also include attempts by special-interest groups (SIGs) imperiled by potential cuts to sway public opinion in their favor. The backlash could even include protests on the streets and at the capitol. In some cases protests turn violent, prompting the destruction of private property or the tragic loss of life, as was the case of the three bank employees killed in Athens.

The purpose of this article is to identify the principal factors that make it so difficult to effectuate reductions in the state's seizure and consumption of the fruits of private enterprise. Combining the perceptive writings and analytical tools of the Austrian School and my experience as a fiscal- and economic-policy staffer on the legislative level, I have arrived at several conclusions. While the conclusions are by no means exhaustive, they are as applicable on the local level as they are on the federal level — the only difference is in the scope of each government or policymaker's reach.

Voting and Special Interests

Every dime of government spending pleases some in-built constituency. Once legislators give money away (that is, spend tax monies), it is much harder subsequently to take the spending back.

Whether it is public employees, government agencies, trade unions (teachers, fire, police, etc.), pensioners, or particular businesses and industries benefitting from government largesse, each constituency or special interest has its sacred cows of government spending. In times of plenty — such as cheap-money-induced economic booms — when the government's tax take is bountiful, each constituency fights for additional appropriations to be directed to their favored cause, whether it is new spending programs, special tax credits for social-welfare causes, or pseudo-economic purposes. In times of dire fiscal conditions, each constituency fights vehemently to oppose a loss of their share of seized private property.

This difficulty of reducing government spending is aggravated by the boom-and-bust cycle itself. In times of plenty, it is easy for politicians (who are spending someone else's money anyway) to budget new, ongoing spending programs lauded by the special interests — on top of what are clearly extraordinary and one-time boosts in tax take.[3] When the bust occurs and taxes dry up, not only do legislators have to bring ongoing spending into alignment with ongoing tax revenue, but they must also undo the extraordinary additions to spending that were approved during the boom — with the attendant fiscal pain and inevitable public backlash.

The inherent significance of in-built constituencies is the creation of what economists call a "collective action problem."[4] On the one hand are constituencies that are small relative to the overall population but disproportionately impacted by increases or reductions to government spending. On the other hand is the general public, which is large, disparate, and individually loses or gains relatively little when government spending is provided for or taken away from those constituencies.[5] Consequently, recipients of government spending will organize and fight vigorously to protect their special interests, while it makes little difference to any individual member of the general public to oppose government spending (e.g., writing to his or her representative to complain) because the individual cost is little relative to that which is accrued by the in-built constituencies.

Constituencies that stand to gain and lose acutely from increases and reductions in government spending mobilize politically to wield significant influence over the political process.

Again, whether they are government employees, unions, subsidized industries, or government contractors, the in-built constituencies establish political organizations and associations to influence the appropriations process. These special-interest groups typically perform or fund some or all of the following functions: direct government lobbying, politically motivated policy research, media-and-public-relations activities, and campaign financing of like-minded candidates to protect their special interests.

"Constituencies that stand to gain and lose acutely from increases and reductions in government spending mobilize politically to wield significant influence over the political process."

SIGs diligently work to identify, vet, financially support, help elect, and ultimately work with and lobby like-minded politicians once they are in office. Prior to elections, SIGs often distribute comprehensive questionnaires, conduct lengthy interviews, and perform intense evaluations of both aspiring office holders and incumbents to find politicians willing to support their preferred policy positions.

Candidates meeting SIG "purity tests" enjoy political endorsements and accompanying campaign monies.[6] Throughout the legislative cycle, SIGs monitor office-holders' voting records, public comments, and policy stances to determine whether reelection support is merited or not.

Once elected, politicians find they have a number of differing "constituencies." They are accountable to their party, the legislative district they represent, their base voters who actually supported them at the polls, and the SIGs that endorsed and funded their campaigns. Now in office, the candidates are dealing with the competing priorities of all of those constituencies; however, the constituents they will be dealing with most on a day-to-day basis are those very SIGs that helped get them to office.

SIGs in turn ask elected officials to sponsor or support special interest legislation developed and drafted by the SIGs and oppose legislation threatening SIG-supported appropriations and public policies.

The legislative system is inherently a labyrinth of trade-offs, compromises, and deals, resulting in opaque and contradictory outcomes in public policy.

In a bicameral legislative system, the passage of bills requires majority support in both legislative bodies and an executive signature. For example, in a bicameral body consisting of 60 representatives, 30 senators, and one executive, the passage of a bill requires a sponsoring legislator to collect 31, 16, and one vote, respectively. Unless the bill is as innocuous as a resolution recognizing January as the first month of the calendar year, legislators face a labyrinth of challenges to get their proposals through the entire process.

Generally in the United States both legislative houses are divided between two principal parties separated in numbers by slim majorities. Politicians hailing from a wide variety of backgrounds, who possess diverse personalities and interests, establish, adopt, amend, and repeal laws in policy areas as distinctive and complex as education, health, environment, taxation, appropriations, economic development, industry regulation, and public safety. When one takes into account the difficulty of securing majority votes, heavy SIG involvement, bills spanning several different spheres of public policy, it is easy to see how the system engenders an environment rife for trade-offs, compromises, and oftentimes curious outcomes from a policy perspective.

Any bill — for example, one that originates in the House of Representatives — must make it through assigned committees, house-floor debates and votes, go to the senate for the same vetting, and ultimately be considered by the executive. Each step in the process entails public scrutiny, serious opposition, negotiations, and trade-offs, as there will be winning and losing constituencies with any piece of legislation.

Constituencies (particularly the SIGs), legislators, and the executive will actively work to try to kill bills, freeze them at a certain stage of the legislative process, or muster the votes necessary to amend bills beyond recognition. At each stage of the process, constituencies and legislators will demand compensation from one another — for example, votes on each other's favorite bills, or an agreement to kill someone else's bill — a phenomenon commonly known as "log rolling." Taking bills hostage — that is, holding bills in committee, or keeping them off the calendar for a floor vote, a privilege of legislative leadership and committee chairmanships — is common to extract concessions elsewhere.

Thus, it is little wonder there are earmarks and log rolling in the political process. No legislator is going to get something for nothing. SIGs will call in political favors, make trouble for legislators and the executive in the media, or find other leverage points (like campaign donations) to influence the fate of certain bills. What one gets in the legislative system is accomplished through negotiations, trade-offs, and backroom deals, resulting in a bevy of legislation that is often contradictory, convoluted, or illogical.[7]

Budget votes endure this entire process. Legislators buy votes, hold each other's bills hostage, and trade off policies to get a budget passed. Budget cuts can only elevate the difficulty and attendant rancor. Likening legislative politics to making sausage does not do the process justice and no mainstream textbook or politically sanitized public school classroom adequately describes this process.

Voters are generally overburdened, under- or misinformed (by political spin and the media), and apathetic.

As Thomas Di Lorenzo points out,

Modern government is much too large for any citizen to possess knowledge about anything other than a miniscule percentage of its activities. The average citizen is "rationally ignorant": he has little incentive to become informed about the activities of government, for he spends most of his time earning a living, educating himself, raising his family, etc. To make matters worse, the state, its media lapdogs, and its court intellectuals comprise a vast propaganda apparatus designed to confuse the voters about what the state is really up to.

This problem is compounded by the fact that government has grown so large that it is involved in every aspect of life. It is sometimes unfathomable to realize modern governments possess a claim on one's wages (Social Security, Medicare, and payroll and withholding taxes, income (progressive income taxes), property (property taxes), spending (sales taxes and VATs) — and this is not to mention the destruction of savings and distortion of prices through inflation. With no prospect of relieving any of these profound burdens, it is little wonder the average citizen is largely apathetic and alienated by modern government.

Taking the notion of "rational ignorance" and the "collective action problem" described earlier in this article further, one understands why elections (democracy's supposed proof that government outcomes are the will of the people) typically have low levels of participation, particularly in local and nonpresidential-year elections. It is the base of voters with the greatest amount of time, interest, or direct personal and financial stake (unions, pensioners, government employees, government contractors) who wield the greatest amount of voting clout in the political system.

"With no prospect of relieving any of these profound tax burdens, it is little wonder the average citizen is largely apathetic and alienated by modern government."

In general, citizens, particularly those voters who tend to actively participate in the political process, want government spending directed toward their favorite programs, but are reluctant to pay for it. Typically they conveniently advocate policies to force someone else — be it "greedy corporations," small businesses, the wealthy, or future generations — to pay for what they want. Accordingly, every voter has his or her own opinions on what spending constitutes the highest priority, as well as how and by whom it should be paid for.

The bottom line is that people like to get goods and services but hate to pay for them.

Cuts and Calculation

The economic value of government services cannot be calculated on a profit-and-loss basis. Government-spending cuts, like the spending itself, are arbitrary and irrational. This uniquely Austrian insight is the most critical facet of understanding why it is so difficult to reduce government spending. Government cannot calculate: it does not operate on the same basis as private enterprise.[8]

Businesses exist to serve customers. By bidding for factors of production (labor, land, and capital) entrepreneurs incur costs in making a final product for sale to customers, with the expectation of earning a surplus of yield over cost: profit.

In the free-enterprise system, customers are sovereign. Their ever-shifting tastes and demands determine what goods and services should be produced, in what quality, and whether each and every business earns or does not earn a profit. Consumers are integral in constantly shaping the quality, quantity, and types of goods and services produced in the market economy and the attendant utilization and remuneration of the various factors of production.

At the heart of the capitalist system is the reality that all business planning and decision making must be based on market prices. Prices are used to determine whether various configurations of the factors of production are available at prices low enough to yield a profit based on the expected prices customers are willing and able to pay for businesses' products.

It follows then that valuation of business performance can be made through the method of accounting. By accounting for the market prices paid for the business inputs (factors of production employed) and the market prices received for business outputs (products sold to customers), business managers may ascertain whether a profit or loss is being made. In particular, business managers can use this accounting information to identify which aspects of the business are yielding profits and which ones are not.

"At the heart of the capitalist system is the reality that all business planning and decision making must be based on market prices."

In some cases cuts in certain parts of the business may be justified; in other cases a redeployment of factors of production from one line of the business to another may be necessary to improve profitability. Calibrating business operations to minimize costs and maximize profit is the task of business managers and entrepreneurs.[9] The accounting ledger displaying profits and losses, based on market prices, allows business managers to make rational decisions about whether to cut spending, redeploy resources, or invest more capital in certain lines of production altogether.

Conversely, government does not operate by the rules of the marketplace. As the only organization in society — save criminal gangs — that parasitically thrives on plundering the fruits of others, its existence, purpose, and method of evaluation are distinctly different from business.

Government agencies do not operate on the basis of profit and loss; this method of calculation is inapplicable because government does not incur costs and receive revenues the same way a business does. Government operations are not funded through the sale of goods and services to customers; rather, monies are acquired through coercion — principally taxation — and then allocated to each agency through the Byzantine legislative process described earlier.

Regarding costs, government agencies' operations are confined to the lump-sum and dedicated line-item appropriations, regulations, and statutes meted out by legislators. The costs incurred to operate are based what is available on the market — e.g., the price of concrete for road construction — as well as approximations or imitations of market prices for inputs, such as wage rates for bureaucrats.[10]

Because there is no link between the "revenue" acquired by government agencies and the costs these entities incur to perform public functions, there is no way of utilizing the yardstick of profitability to evaluate whether agencies are performing a useful function.

As Ludwig von Mises succinctly puts it, "bureaucratic management is management of affairs which cannot be checked by economic calculation."[11]

Unlike the business manager of a private enterprise, bureaucrats and elected representatives have no means of rationally evaluating the value of any public service. This means that any cuts to that spending are intrinsically irrational — one simply lacks a reliable means of making a decision. Given this vacuum of objective assessment criteria, legislators, voters, SIGs — and really, anyone — may manufacture their own methods of justifying an increase or decrease to any dime of government spending, whether through persuasion, political pressure, or any other means available. Constituencies necessarily drive the appropriations process.

Economic calculation does not apply to government services; that is fundamentally why cutting spending is so hard to do.

What Does It All Mean?

Taken together, each of the factors above do much to explain why it is so difficult to reduce the scope of government through budget cuts. They also demonstrate the impossibility of calculating whether some government functions add economic value to the public, given government's inherent inability to operate according to profits and losses.

From the constituencies created by every dime of spending to the voters who tend to like government spending but hate to pay for it themselves, cutting budgets is extremely difficult, frustrating, and incremental. Given this reality, what do these impediments to fiscal austerity say about legislative politics and democracy itself?

"Because there is no link between the 'revenue' acquired by government agencies and the costs they incur, there is no way of utilizing the yardstick of profitability to evaluate whether agencies are performing a useful function."

As Hans Hermann-Hoppe adeptly describes in Democracy: The God That Failed, the democratic state is inherently a "public" monopoly. Unlike privately owned monopolies — for example, monarchies where the sovereign generally has an incentive to moderate expropriations of property to preserve the realm's present value for heirs — state officials in a democracy are mere caretakers who cannot privately enrich themselves from ownership or sale of government property.

Rather, a moral hazard and tragedy of the commons ensues as bureaucrats, politicians, and special interests may merely exercise use of government property while being a member of the government apparatus, precipitating a strong inducement to maximize current use of government property, irrespective of whether such activities entail dire consequences for taxpayers and the economy at large.

As concerns government finance, officials conduct the borrowing, spending, and taxation, and enjoy the resultant political plaudits from the constituencies that benefit from state largesse, while other private citizens defray the expenditures and debts through taxation or government-stoked money creation.

Hoppe also points out that democracy abolishes the distinction between rulers and ruled. And it assumes that any member of the political system may ascend to the upper echelons of governance. Given the state's indispensable need to steal for its subsistence and the nearly unfettered entry into the ranks of the ruling class, democracy renders it that much easier for politicians and their connected special interests to accelerate exactions from the public, as the gates remain open for any individual or faction to gain access to governmental powers and impose the same taxes, regulations, and direct spending themselves. As democracy has taken root in the United States and elsewhere, jostling between rival political factions has not been about how flaccid or robust the state should be, but rather about what direction the state should take as its scope expands.

The ability of elected politicians and entrenched bureaucrats to institutionalize and enforce systematic predation and redistribution of private property is an outcome of the democratic ethos itself. Indeed, the grand bargain of democracy is this: every individual within the system — voluntarily or not — cedes the inviolable title to his or her property for the ability to elect, participate in, or marshal a political movement that competes for the privilege of seizing and spending everyone else's money. It follows that individual responsibility and private property ownership are seriously impaired and denigrated. Furthermore, the government-instituted "law of the jungle" fosters base, innate human characteristics such as envy, self-preservation, and keenness for gratification.

As Frédéric Bastiat explains in The Law, self-preservation and self-development are universal instincts among men, as is the preference to do so with the minimum amount of pain and the maximum level of ease. Plunder then is favored over production, so long as the risks and inputs of confiscation are not as agonizing or as indomitable as the painstaking act of production and exchange. When given an opportunity to seize private property or stipulate regulations on an owner's use thereof, as democratic rule is wont to do, participants in the political system vie for the chance to apply the state's coercive arm in service of their supporters' ends.

Bastiat argues that the onset of universal plunder undermines the purpose of law, which in his view is the collective organization of the individual right to defend life, liberty, and property. The moment law is perverted to engineer ends contrary to individual liberty — e.g., enshrining the notion that individuals are entitled to a portion of each other's property absent voluntary agreement — morality is pitted against the adulterated law. Thus, moral chaos is the outcome of democratization, as one must either relinquish respect for the law or compromise moral sense.

It's little wonder that cutting government spending is hard to do.

Notes

[1] "Balanced" budgets are evaluated on a cash basis. Inflows of monies, whatever their source (e.g., borrowing, deferring payments to the next fiscal year, or one-time windfalls) must equal outflows. A more honest standard would be a structurally balanced budget requirement, which would mean ongoing inflows (taxes) equal ongoing expenditures.

[2] Such contentions assume that government spending and jobs are not merely derived from diversion of the private sector resources.

[3] Capital gains taxes and corporate income taxes are among the most sensitive to the economic cycle, producing extraordinary tax receipts during the boom and disappear during the bust as mal-investments financed by cheap credit are liquidated.

[4] See Mancur Olson, Jr., The Logic of Collective Action: Public Goods and the Theory of Groups (Harvard University Press, 1971).

[5] The costs of any particular spending program or special tax credit can be spread across the entire populace, conveniently diluting its direct financial impact on citizens.

[6] This observation does not imply that officeholders do not leverage their positions to extract campaign donations from SIGs, too. Specters like "tax reform" often are convenient mechanisms for politicians and their political parties to keep campaign coffers full. It is best to think of politicians, political parties, and the SIGs as symbiotic entities — or other, more-appropriately incestuous partners in legalized plunder.

[7] For example, although all taxes are objectionable, there is very little reason why a sales tax is applied to auto parts, but not the labor performed on the car at an auto repair shop. In most states, there are hundreds of exemptions of goods and services from sales taxes, as well as individual and corporate income tax credits. A few of these may have legitimate economic or public policy rationales, but most have scant public benefit or purpose, and were instead the creature of some political trade-off to satiate particular SIGs, legislators, or executives at some point in time.

[8] Although there are several superb Austrian writings on this subject, this article liberally utilizes Mises's treatment of this issue in Ludwig von Mises, Bureaucracy (New Haven: Yale University Press, 1946).

[9] This delicate balancing act to achieve profits gives rise to the business schools, MBA and other business education programs, and the innumerable business periodicals and self-help books published annually.

[10] The wage rates for bureaucrats are not based on the marginal productivity of wage-earners, as they are in the private sector. As there is no way of calculating the value of the service provided by government agencies, it follows that there is no way of determining the marginal productivity of each bureaucrat within the agencies.

[11] Ludwig von Mises, Bureaucracy.