Subsidy Reform Challenges

Structural Challenges to Cutting Government Waste

Doug Koplow www.earthtrack.net
Revised January 2009/ Incentive Pay for Congress Article from Feb. 1996

Comments or corrections to comments (AT) earthtrack.net

Subsidy reform is a topic often discussed, but far more rarely implemented. About five years ago, I did an information survey of people around the world involved with subsidy transparency and reform. There were virtually no examples where they felt they had achieved systematic and lasting reform. Many had blocked bad policies for awhile; others were thankful they had prevented even worse policies from being implemented.

Having spent nearly 20 years examining government subsidies, I have a few thoughts on this debate. Most of the efforts to reduce pork use an "expose and embarrass" approach to pressure members of Congress cut wasteful spending. This approach alone is unlikely to achieve broad success for two reasons. First, direct spending programs are the primary focus of most organizations working for change in this arena, but unfortunately comprise but one of many ways that governments transfer public resources to well-connected organizations. Second, the current expose and embarrass approaches leave unaddressed the core structural problem in pork-barrel spending: that individual members of Congress have large incentives to boost spending in their electoral district, but the body as a whole has no incentive to act in a fiscally prudent manner.

This article provides an introduction to why the indirect forms of spending are also important in curbing pork, and presents an idea for realigning incentives to achieve more effective public spending programs. This idea, developed in a paper I wrote in early 1996, proposes establishing incentive pay for Congress and the President to force them to work together to ensure our national wealth is used well. The names and topics of the paper are somewhat dated, but the core challenge remains exactly the same today.

Whether or not people agree with this specific approach, I hope they will think beyond a mere listing of pork towards solutions that address the missing incentives for Congress to work as a group in a fiscally responsible manner. In my view, this is a critical element in any return to fiscal solvency. Comments and critiques are welcome at the e-mail address shown above.

Current efforts focus rely on "expose and embarrass" for pork reduction

There are many groups focused on trying to reign in government spending. With apologies to those I'll inevitably miss, a few of the ones I've found useful include Citizens Against Government Waste, the Green Scissors campaign, the Environmental Working Group (EWG), and Taxpayers for Common Sense (TCS). EWG has been extremely successful in ferreting out the ultimate individual beneficiaries of mammoth US farm subsidies, an innovation that has made their database widely used and cited. Related efforts, such as the Center for Responsive Politics Open Secrets campaign database attack pork by exposing the largest funders for specific legislators, thereby increasing the political costs of buying influence. TCS has worked to develop quite powerful resources on earmarks.

Blogs have been quite successful in challenging opinions and errors propagated by many sectors of society of the past few years. The widely-read ones can pull together a dizzying array of information sources and arcane technical expertise in short order to rebut (and sometimes demolish) claims propagated by public officials or the mainstream media. These successes are often focused on a single incident or event, which, once past, recedes to blog archives.

Porkbusters is the first example I've seen where the power of blogs to organize and focus audiences has been used to concentrate the information possessed by their many readers into an organized and structured database that can support policy changes on an ongoing basis. Like the many non-profit organizations operating in this area, however, it has also struggled to stay on top of the dizzying array of Congressional activity on a limited fiscal and time budget. The Pew Charitable Trusts (to which I am an advisor) is a recent entry into this field, hoping to pilot increased subsidy transparency across multiple sectors. Its size and leverage will hopefully be able to open informational and legislative doors that are closed to smaller groups.

Fiscal reform needs to go beyond direct spending

Governments give favors in far more ways than just budget appropriations. In contrast, line item databases such as Porkbusters or even Citizens Against Government Waste's Pig Book, tend to focus on direct spending as measured by government cash flows. Missing are the more arcane programs such as special tax breaks, access to subsidized credit or insurance, or special rules that charge below-market rates for goods or services produced by government-owned enterprises.

Other resources do pick up some of these gaps, but not comprehensively. The Joint Committee on Taxation (part of the federal government) estimatestax subsidies in many of the large bills Congress puts forth. However, these estimates can be fairly rough and are not open to public scrutiny with regards to methods and accuracy. In addition, they are not closely linked to legislative districts or beneficiary private parties, both necessary if the expose and embarrass model is to work. Citizens for Tax Justice (CTJ) periodically estimates the magnitude of tax breaks by corporation, but the link to the specific Congressional actions (and actors) generating the pork is not there. Available data also limits CTJ to publicly-traded firms only. Pew's Subsidyscope does plan to bring in tax expenditures and credit programs, which will be an important improvement if they can force the needed data out of the parties that hold it.

The indirect government supports may have little visible effect on short-term outgoing cash flows, but are no less important to track than budget outlays if one wants to control pork. The indirect supports can substantially reduce cash coming in to the Treasury, can bias private markets in inefficient ways, and can create multi-year risks to the government which may, and often do, require substantial public funding in future years.

Every dollar in tax exemption either adds to the deficit or must be made up via higher taxes on some other, less politically-favored, activity. As shown in the table below, these other categories are not small. Special tax breaks cost the Treasury more than $800 billion per year. Because the benefits are themselves often tax-exempt, the net subsidy to recipients approaches $1 trillion per year.

New extension of credit (direct loans and guarantees) is lower -- though still huge -- at roughly $500 billion per year. However, these commitments generally last multiple years, magnifying their impact. If they go wrong, the cost to taxpayers can be enormous -- as the Savings and Loan fiasco demonstrated. Aggregate data are sketchy, especially with regards to aggregate insured risks across the federal government. However, federal exposure on credit and insurance programs can reasonably be expected to exceed $6 trillion.

Unless pork removal efforts focus on all mechanisms of value transfer, spotlighting only budget outlays can have the perverse effect of driving big subsidies to less visible subsidy mechanisms. This creates long-term financial time bombs for the country. To learn more about the ways governments transfer value to constituents, see Common Forms of Government Interventions in Energy Markets and Intervention and Subsidy Basics. Though these links are tailored to the issue of energy subsidies, the categories apply generically to all spending areas.

Summary of Federal Value Transfer ($ billions)

     
           
    Cost to Gov't % Share Value to Recipients Data Yr.
           
Annual Activity        
  Direct outlays            2,158 60.6%   2003
  Tax expenditures               840 23.6%             954 2003
  New lending activity        
    Direct loans               108 3.0% Note 1 2004
    Loan guarantees               455 12.8% Note 1 2004
  New risks underwritten        
    No centralized estimates; implicit coverage (e.g., through liability caps) not tracked at all.
           
  Total annual activity, available categories            3,561      
           
Cumulative metrics of government activity      
  Federal debt            6,733 51.3%   2003
  PV tax expenditures in current law  Unknown      
  Lending portfolio        
    Direct loans outstanding               249 1.9%   2003
    Loan guarantees outstanding            1,184 9.0%   2003
  Insurance portfolio        
    Direct risks insured            4,967 37.8% Note 2 1995
    Implicit risks covered  Unknown   Note 3  
           
  Total cumulative exposure, available categories          13,133      
     

Compiled by www.earthtrack.net

Notes:
(1) Both direct loans and loan guarantees have a higher value to recipients than the direct cost to the government due to the intermediation value of the government as a borrowing agent. This is the difference between the interest rate a smaller borrower would have to pay a commercial lender to get a loan versus the rate the US Treasury can borrow funds at. The smaller the borrower and the riskier the endeavor, the greater the divergence between the cost of the credit and its actual value to the recipient.

(2) Data on the covered risks for each of the federal government's main insurance programs are not presented consistently or systematically in current budget documents. Data were assembled by the US General Accounting Office for fiscal year 1995, though this may or may not be an accurate representation of current exposure. Recent passage of terrorism risk insurance (with maximum outlays of $100 billion per year), as well as inflation, suggest the face value of these policies would be higher today.

(3) Implicit risks arise when the government is the de facto insurer of accident risks as a result of statutory caps on coverage that are insufficient to cover the expected damage of incidents that have a reasonable probability of occurring. In the energy area, such risks include nuclear accidents, large oil spills, and catastrophic failures of large hydroelectric dams.

Sources:
(1) OMB, "Analytical Perspectives," Budget of the United States Government: Fiscal Year 2005.
(2) US General Accounting Office. Budget Issues: Budgeting for Federal Insurance Programs,
September 1997, GAO-AIMD_97-16.

Real pork reduction often requires inside knowledge

Differentiating good spending from bad is sometimes easy, with the most colorful waste emblazoned in newspaper headlines.  More often, however, separating the prudent from the wasteful requires specialized knowledge about specific federal programs, and often about what specific legislative language is actually doing.  Challenging this pork before it passes into law may require advance knowledge of pending legislative initiatives or riders.  Those best positioned to make many of these judgments are, unfortunately, also who most benefit from the pork:  the elected officials (and their staffs).

Current electoral pressures encourage informational obscurity rather than transparency.  Get it through without lots of attention, then brag about it to constituents.  Real structural change requires establishing constraints on Congressional spending that create joint incentives to spend prudently rather than recklessly.  Until 2002, Pay-as-You Go rules required any expanded entitlements to be offset by tax increases or spending cuts elsewhere in the budget.[i]  This helped ensure that pork spending could not simply be shifted from direct spending to tax breaks.  However, these rules are gone, did not encompass all forms of federal value transfer, and relied on an ability to accurately predict tax revenue losses that might not have been as precise as was needed.

Another potential solution, described in a paper I wrote in February of 1996, looks to borrow from the corporate model.  The objective to more closely align the incentives of Congress as a whole with those of the US taxpayer.  Though the names and the issues facing Congress have changed, the structural problems remain.

Read Accountability and the Elected Official:  The Case for Pay-for-Performance for Congress and the President

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