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Diverted Funds

December 6, 2001

September 11 has triggered overwhelming generosity by Americans. The American Red Cross was even able to suspend donation requests for its Liberty Fund, because more than half a billion dollars of pledges will cover its expenses in aiding the WTC victims.

But that tidal wave of response also triggered controversy, when the Red Cross announced that some of the money raised would not go to those victims, but to future disaster victims and to community outreach and ongoing programs. They were accused of shifting funds away from what donors intended in contributing, and the furor which that generated has now led them to retreat from that position. 

This diversion issue is an important one. But ignored in this controversy is the fact that there are many, many government programs that exhibit the same failing--dollars spent for one purpose end up having a far different effect than intended or than advertised to the American public.  The reason is that money can be spent on anything one chooses. 

These sorts of diversions occur in municipal bond issues, lottery funds for education, humanitarian foreign aid, food stamps and other in-kind transfer programs, etc.  And in each case, the reason is the same: earmarked expenditures replace dollars that would have otherwise been spent in the same areas, freeing up those dollars to be spent however their recipients decide.

Consider municipal bond measures to fund particular local government expenditures.  Diversions of such  funds to uses different than those advertised (as in a just-released study of San Francisco school bond revenues) are such common news items that citizen oversight boards are being created, not only to reduce the abuses (with limited success), but increasingly to demonstrate public agency trustworthiness in order to get voters to approve bond issues in the first place.

State lotteries were promoted to supplement education funds. But what actually happens is that politicians, taking into account those additional funds, reduce their budgetary support (or its growth rate) for education. The dollars released are then available to be spent however the state government decides, just as if the lottery proceeds went directly into its general fund. 

As professors Patrick Pierce and Don Miller conclude in a study of education funding in all fifty states, "Regardless of the state, the educational spending rate declined once a state lottery went into operation." 

The same sort of diversion has also often converted humanitarian foreign aid--for food, medical supplies, and development projects--into both wasteful spending and weapons in many poor nations.  The humanitarian aid frees up the resources that would otherwise have been required to buy such supplies, allowing those resources to be spent wherever the receiving government chooses. 

All too frequently, that humanitarian aid has not just been lost to corruption, it has been converted to other uses, including military spending, often used by recipient governments to terrorize those the aid was intended to help and threaten neighboring countries, leading them to spend more on arms as well. 

The food stamp program, as well as many other in-kind transfer programs, suffers the same fate. The subsidy is equivalent to a cash transfer for almost all recipients, because the vast majority of recipients would have purchased more food than their food stamp allotments, even if they were given cash. The food stamps simply replace money that recipients would have spent on food anyway, freeing up that cash to use however they choose. 

The same thing is true for many other in-kind programs as well, such as housing and energy subsidies. In every one of these government programs, money's ability to be redirected in any way decision makers wish results in earmarked funds being diverted to whatever uses their recipients desire. Even for those who assume that they address what are legitimate concerns for government involvement--a far from defensible assumption for someone committed to liberty--this undermines the purpose in earmarking the funds in the first place, not to mention the only rationale for the massive bureaucracies necessary to administer them. 

Watchdog groups are correct to monitor the disbursement of the Red Cross's September 11 donations.  And the issue of appropriate uses of charitable funds promoted for a particular purpose must be addressed. But the same issue should be raised about innumerable government initiatives whose claimed goals are also undermined by the same diversion of resources.

Ignoring this effect only adds to Americans' delusions that government programs accomplish far more than they actually do, which many then claim as a bogus justification for taking others' property to fund such "do-gooder" attempts. As Frederic Bastiat said over 150 years ago, "Our own ignorance is the primary, the raw material of every act of extortion to which we are subjected."


Gary M. Galles is Professor of Economics at Pepperdine University. Send him MAIL, and see his Mises.org Articles Archive


Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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