The Budget Surplus: A Public Choice Explanation *

Transcription

1 The Budget Surplus: A Public Choice Explanation * Russell S. Sobel Department of Economics P.O. Box 6025 West Virginia University Morgantown, WV Draft Date: November 19, 2001 Abstract Rapid federal expenditure growth and budget deficits became commonplace during the 1970s and 1980s. Public choice models explained this by continual special interest group pressure for spending, rationally ignorant voters, and shortsighted politicians finding deficit financing attractive. Recently, however, there have been budget surpluses and a slowdown in government expenditure growth. To date, only pure public finance explanations (mostly factual accounting stories) have been offered for the recent budget surpluses. This paper uses public choice theory to explain this turn of events. If public choice models are correct, they should explain the trends in both time periods. * I would like to thank Tom Garrett, Randy Holcombe, Jon Vilasuso, and Gary Wagner for helpful comments.

2 The Budget Surplus: A Public Choice Explanation I. Introduction Throughout the entire 1970 to 1990 period, federal government expenditure growth was rapid, and large federal budget deficits were a commonplace event. The public choice literature was able to explain this phenomenon with models of continuous special interest pressure for increased spending coupled with rationally ignorant voters, and shortsighted politicians who found deficit financing attractive [see, for example Congleton (1992)]. The role of special interest group pressure in determining government outcomes has been well documented in the literature both theoretically and empirically. On the theoretical side, Becker (1983), shows how competition between interest groups determines government policy. While few scholars doubt the prevalence of interest group influence in today s government, Holcombe (1992) provides evidence that interest groups were active and important in determining policy even prior to the U.S. Civil War, and Holcombe (1999) shows that interest groups were important in the critical modern-era transition to government growth in the late 1800s and early 1900s. While interest groups undoubtedly influence the outcomes of government (i.e., aggregates such as total spending), they may also influence the incentives to finance that spending with debt instead of taxes. In what is perhaps the best comprehensive work on the issue, Congleton (1992) discusses the relationship between interest groups, government spending, and debt financing and how this mix is influenced by imperfect information on the part of voters. One conclusion reached in his paper is that imperfect information allows special interest groups to have a disproportionate impact on policy choice in a manner that indirectly increases incentives to use debt finance. 1 1

3 The late 1990s, however, saw a striking turn of events when for the first time in almost a half century, the federal government ran a budget surplus for three consecutive years. Research focus has now shifted away from explaining the debt, and examining its impact, to issues such as what are the causes of the recent surplus and how should it be spent. However, to date, all academic research exploring the recent surplus attempts only a simplistic public finance explanation, a factual discussion of growing revenues and slower expenditure growth. This literature is typified by Alesina (2000) who provides an overview of this literature as well as his own public finance explanation for the surplus. He concludes that [t]he current budget surpluses have been the result of: 1) the exceptional performance of the American economy since 1991, a performance which has generated a surge of tax revenues; 2) low interest rates and 3) a large reduction in defense spending as a share of GDP. While certainly it is the case that one can always look historically at the data and see which categories of spending have fallen or risen the least, or note that revenue has grown faster than usual, this ignores the entire underlying process that generates government spending. While it is true that the lower demands on national defense (the so called peace dividend ) did free up some resources, and that faster revenue growth has provided more resources, neither of these are uncommon events historically speaking. Never before in recent history has the U.S. federal government had trouble finding how to spend additional revenues, nor how to reallocate money when one program is less draining than usual on the budget. The real issue is why political entrepreneurs have not found it attractive to spend this money elsewhere, and what has changed such that deficit spending is no longer the optimal policy from a political standpoint. If the public choice models that so easily explained the rapid expenditure growth and large deficits were indeed descriptive of the political process, then they 2

4 should also be able to explain what has changed to cause the recent budget surpluses and relatively slow expenditure growth. This paper attempts to provide a public choice explanation for the recent budget surplus within the context of a special interest model of government expenditure. First, I present some data on government financial trends. In this section, I conclude that the recent budget surplus must be explained in terms of the causes for why federal expenditure growth has slowed down so dramatically, beginning in about Next, data is presented on interest group activity in the United States. My final conclusion is that the recent financial situation in the U.S. federal budget is caused by the dramatic slow down in interest group activity that began in the late 1980s. II. The Current Federal Budget Situation: A Brief Overview The best place to begin the analysis is with a brief glimpse at the federal budget situation and how it has evolved to where it is currently. Figure 1 shows real federal government outlays and receipts for the period since 1970 (all financial data throughout this paper is adjusted to fiscal year 1996 dollars). 2 [Figure 1 about here.] As can be seen in the figure, the current situation in which federal receipts exceeds outlays clearly (and uninterestingly) is mathematically the result of two factors, faster revenue growth and slower expenditure growth. On the receipts side (the dashed line in the figure) it is clear that as a result of the robust economy during the 1990s, the trend growth rate of revenue was substantially higher in the 1990s than in prior years. Certainly additional revenue made it easier to balance the budget, but this is true only if expenditures did not grow sufficiently consume all of the additional revenue. At other times 3

5 in U.S. history when revenue growth has accelerated (such as with the adoption of the income tax earlier in the 20 th century) the federal government had no problem increasing expenditures by more than enough to consume the additional revenue. In other words, additional revenue is not an explanation in itself for the surpluses without an added reason for why government expenditure did not grow respectively. But not only did government expenditure not grow in step with revenue, as can be seen in Figure 1, the trend rate of expenditure growth actually fell during the 1990s relative to the previous decades. This change is examined more closely in Figure 2. [Figure 2 about here.] Figure 2 shows actual federal outlays, as well as a trend line extrapolated forward using the data. It is clear in the figure that the break point in the trend is between fiscal years 1990 and The average annual real growth rate of federal outlays between 1970 and 1990 was 3.3%, but this has fallen to 1.2%, or about one-third of its previous level, since Figure 3 shows total federal outlays as a percent of GDP over this same period. [Figure 3 about here.] The image presented in Figure 3 is perhaps even more striking than the previous figure regarding the slowdown in government expenditure growth. A percent of GDP, federal government outlays have been on a consistent downward trend recently. Despite being measured differently than in Figure 2, the break point in the expenditure trend again appears to be around The strong downward trend in the relative size of federal outlays is a complete reversal of the pre-1991 upward trend (which is shown by the dashed line in the figure). As a share of the nation s income, federal 4

6 spending has been continually decreasing despite the fact that revenue has been growing as a percent of income. While growing revenue since the early 1990s has given the federal government more resources, our political process has decided to not use those additional resources to increase spending, as it had previously. Prior to 1991, the federal government continued to increase spending, seemingly almost unconstrained by the level of revenue generated. During the previous decades, the desired level of spending continually exceeded revenue, and this additional spending was financed through borrowing. While there is no question that the higher revenue growth recently has provided additional resources which have made it easier to balance the budget, the real issue to be explained lies on the spending side of the equation. When looking for an explanation for what changed, for the underlying causes that have generated the current budget surplus, it is clear that the expenditure side is the key to unlocking the answer. Why has federal expenditure growth, which had been so strong and continuous for decades, suddenly ceased? [Figure 4 about here.] To understand the significance and uniqueness of the slowdown in expenditure growth, Figure 4 shows per capital real federal expenditures over the entire history of the U.S. federal government. First, there are three major wars that clearly impacted the federal budget. These are the Civil War, World War I, and World War II. But abstracting from these war-time jumps in spending, the more important phenomenon is the overall trends in the figure. Prior to the 1920s, federal spending on a per capita basis was not only small, but more importantly, it grew little. However, beginning around the 1920s, expenditure growth began and continued, unabated, throughout the rest of the period into the 5

7 1990s. The slowdown in expenditure growth in the 1990s can clearly be seen in the figure. But this figure shows that the recent slowdown is indeed remarkable given the prior 70 or so years of continuous growth. In per capita terms the recent slowdown in expenditure growth is unparalleled during the 20 th century. In this section, I conclude that the recent budget surplus must be explained in terms of the causes for why federal expenditure growth has slowed down so dramatically, beginning in about The surplus cannot be explained by the more rapid revenue growth during the 1990s because in prior years additional revenue growth was just met by further expenditure growth (that often outpaced revenue growth). In turn, the slower expenditure growth cannot be explained by a mere story of why some expenditure areas (such as defense or interest payments) began consuming less resources in the 1990s, because these resources could have simply been reallocated elsewhere. After all previous wars, for example, the federal government had no trouble reallocating resources to continue expenditure growth. The federal budget is the result of a complex political process with many actors. Any explanation for the slowdown in expenditure growth must explain why the politically optimal level of overall federal spending has ceased to increase (and has begun to decrease) beginning in the early 1990s. III. Special Interests and Government Expenditures Previous literature attempting to explain the growth of government expenditures during the 20 th century has focused on how the number, types, and expenditures of interest groups affect the total size of government spending. 3 In these models, it is interest group activity which creates transfers through the 6

8 political process, causing increased government spending. Here, additional special interest group resources devoted to rent seeking activity result in additional government activity. In essence, interest group activity through lobbying produces new legislation and thus directly increases the level of government spending. An explanation for the recent slowdown that is consistent with this body of interest group literature would be that a slowdown in interest group activity has decreased the pressure on government expenditure growth. To test this hypothesis, this section takes a closer look at how changes in interest group activity correlate with the slowdown in government spending growth that began around In this section I attempt to show that it is a reduction in interest group activity that is responsible for the decreased pressure on the expenditure side of the federal government budget. Interest group activity manifests itself in many ways in the federal political process. Political action committees (PACs) give large donations to the campaigns of federal candidates, as well as spend millions each year lobbying in other ways, such as providing legislators with in-kind gifts such as free trips, free meals, and free recreational activities. In exchange, legislators draft new legislation, sponsor bills, and vote for bills that may be favorable to the interest group. Any change in interest group activity will thus become visible in the measured output of legislation. Figure 5 shows the number of measures enacted by congress since [Figure 5 about here.] The total height of each bar in the figure represents the number of measures enacted during both sessions of congress combined. The components of each bar show the number enacted in the first session (bottom half) and second session (top half). From the beginning of the data in 1969 until 7

9 around 1990 there was a relatively flat trend in the number of measures enacted by congress. Beginning around 1990, however, there has been a downward trend in the number of measures enacted by congress. Thus, not only has the level of expenditure growth itself been down, but also the production of new legislation, new bills has been down as well. This same trend in measures enacted in Figure 5 is also visible in data on the number of measures introduced. In essence, there has been less production on the part of legislators throughout the 1990s than in prior years. While this data is consistent with reduced interest group activity, there may be many other possible explanations as well for this recent downward trend in legislation. To get a clearer picture of interest group activity at the federal level, Figure 6 shows the number of registered federal PACs from 1974 to present. [Figure 6 about here.] The single largest category of federal PACs is corporate PACs so in Figure 6, both the total number of PACs and the number of corporate PACs is shown. After rapid growth in the number of registered PACs throughout the 1970s and early 1980s, the late 1980s and 1990s saw a completely different atmosphere. The total number of registered federal PACs leveled out, remaining fairly constant throughout the late 1980s and actually began decreasing in the 1990s. This is not only true for the total number, but also for the largest subcategory, corporate PACs. Using this as a measure of interest group activity at the federal level implies that interest group activity was rapidly growing in the U.S. prior to the mid 1980s but began slowing down and actually decreasing throughout the 1990s. This reduction in interest group activity in the federal political process is consistent with less pressure on the spending side of the federal government budget. 8

10 [Figure 7 about here.] Figure 7 shows the total dollar amount of PAC contributions to federal candidates over roughly the same period. The trends in contributions follow an almost identical trend with the number of PACs shown in the previous figure. There was rather rapid growth in PAC contributions that lasted until the mid to late 1980s when the trend begins to level off. Taken together, Figures 6 and 7 clearly show that prior to the mid 1980s there was rapidly growing interest group activity, while after that time interest group activity growth has halted and even begun to slightly decrease. It is important to note that while the slowdown in federal expenditure growth began around 1991 that the slowdown in interest group activity growth begins about 4 or 5 years earlier. This is certainly consistent with the idea that reduced interest group activity leads to lower pressure for federal spending. To further explore the strength of the relationship between interest group activity and government expenditure growth, regressions were performed on the data. To avoid problems of nonstationarity, all series were run in first-difference form (annual percent changes or annual growth rates). The number of registered federal PACs is used as the independent variable, and regressions are performed using two different specifications of the dependent variable, first simply the annual growth rate of outlays, and second the annual percent change in outlays as a percent of GDP. Because the expenditure data is given by fiscal year, and because the budget is determined approximately one calendar year in advance, the PAC data were lagged one year in the regression (i.e., fiscal year 2000 expenditure data is compared to calendar year 1999 PAC activity). 5 The results of the regressions are presented in Table 1, and a scatter plot of the raw data, along with the corresponding regression lines, is given in Figures 8 and 9. 9

11 [Table 1 and Figures 8 and 9 about here.] In both specifications presented in Table 1, the growth of PAC activity is a statistically significant determinant of expenditure growth at a 5 percent level. The coefficients can be interpreted as elasticities, so they would imply that a 10 percent growth in interest group activity is generally associated with about a 1.07 to 1.57 percent growth in federal spending. As is clear in Figures 8 and 9, there is a strong positive correlation between the growth rates of interest group activity and federal spending. Periods of rapid expenditure growth were associated with periods of rapid growth in interest group activity, while periods of slower expenditure growth were associated with periods of slower growth in interest group activity. IV. Conclusion This paper has documented that there has been a substantial reduction in the growth of interest group activity at the U.S. federal level beginning in the late 1980s. After several decades of rapid growth of interest group activity, it appears that it has leveled off and perhaps begun to decrease. Previous literature on the determinants of government growth point to interest groups as a main source of pressure for expenditure growth. Throughout the 1970s and early 1980s, rapid expansions in interest group activity are associated with rapid government expenditure growth. Recent reductions in the size and growth of interest group activity have led to a quite substantial reduction in the pressure on government expenditure growth. Because reduced expenditure growth is the underlying source of the current budget surpluses, I conclude that it is the reduction in interest group activity at the federal level that is responsible for this recent budget situation. 10

12 Other theories of the factors underlying government expenditure growth seem to be unable to account for the recent slowdown. Certainly, Wagner s (1958) hypothesis (now generally known as Wagner s Law), in which government grows faster than income because the demand for government is income elastic cannot explain why government growth has slowed so substantially during such a long period of economic expansion. Some may attempt to claim that the recent divided party split between congressional control and the presidency may be the source of gridlock which has slowed down expenditure growth. However, this did not occur until the mid and late 1990s and it is clearly shown here that expenditure growth and interest group activity had already slowed down to their current slower growth trends before this time. The same reasoning may be used to discount explanations based upon other policies (such as welfare reform) that simply occurred to late in the 1990s to be responsible for the slowdown in expenditure growth. I conclude that the reduction in interest group activity is the most plausible explanation for the reduction in the growth of federal expenditure growth that is responsible for the current budget surpluses. 11

13 Endnotes 1. Quote is from Congleton (1992), page Data taken from the Historical Tables section of the Budget of The United States Government for Fiscal Year 2001 available at The data presented here from that source for fiscal years 2001 through 2005 are estimates. 3. See Mueller (1989), Chapter 17 for an excellent review of the literature on government expenditure growth. The most cited works include Baumol (1967), Higgs (1987), Meltzer (1981), Peacock and Wiseman (1967), Wagner (1958), and Peltzman (1980). For a more recent analysis see Holcombe (1999) and Husted and Kenny (1997). 4. Data on measures enacted is the Statistical Abstract of the United States, U.S. Census Bureau (various years), and all of the data on PAC activity is from the Federal Election Commission web site ( 5. For example, the fiscal year 2001 budget (covering the period October 1, 2000 to September 30, 2001) was transmitted to congress on February 7,

14 Table 1 - Regression Results for Federal Spending and Number of PACs Dependent Variable Constant Annual Growth Rate in the Number of PACs (t-1) Annual Growth Rate of Real Federal Outlays (t) *** (3.806) ** (2.422) Annual Growth Rate of Real Federal Outlays as a Percent of GDP (t) * (1.888) ** (2.504) R Sample (Fiscal Years) Notes: Absolute t-ratios in parenthesis and * indicates statistical significance at the 10% level, ** at the 5% level, and *** at the 1% level. 13

15 Figure 1 Federal Recepits and Outlays (in billions of 1996 dollars) $2,500 $2,000 $1,500 $1,000 Receipts Outlays $ Fiscal Year 14

16 Figure 2 Federal Outlays: Actual vs. Pre-1991 Extrapolated Trend (in billions of 1996 dollars) $2,500 $2,000 $1,500 $1, % Average Annual Growth Rate % Average Annual Growth Rate 1991-forward Actual Trend $ Fiscal Year 15

17 Figure 3 Federal Outlays as a Percent of GDP 24% 23% Pre-1991 Trend Percent of GDP 22% 21% 20% 19% 18% 17% Fiscal Year 16

18 $7,000 Figure 4 Real Per Capita Federal Expenditures (Constant 1996 dollars) $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $

19 Figure 5 Measures Enacted by Congress Total Number 4,000 3,000 2,000 1,000 Constant Trend 1969 through 1990 Downward Trend Beginning in Second Session (Top) First Session (Bottom) Note: For only first session data available 18

20 Figure 6 Number of Federal PACs 5,000 4,000 Number 3,000 2,000 Total Corporate 1,

21 Figure 7 PAC Contributions to Federal Candidates $250.0 (millions of 1996 dollars) $200.0 $150.0 $100.0 $

22 Figure 8 Interest Groups and Government Spending Annual Growth in Federal Outlays 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -10% 0% 10% 20% 30% Annual Growth in Number of PACs (t-1) Note: Regression line shown by dashed line 21

23 Figure 9 Interest Groups and Government Spending Annual Growth in Federal Outlays % GDP 10% 5% 0% -5% -10% -10% 0% 10% 20% 30% Annual Growth in Number of PACs (t-1) Note: Regression line shown by dashed line 22

24 References Alesina, Alberto. The Political Economy of the Budget Surplus in the United States, Journal of Economic Perspectives 14, No. 3 (Summer 2000): Baumol, William J. The Macroeconomics of Unbalanced Growth, American Economic Review 57, No. 3 (June 1967): Becker, Gary. A Theory of Competition Among Pressure Groups for Political Influence, Quarterly Journal of Economics 98, No. 3 (August 1983): Congleton, Roger D. The Politics of Debt, Journal of Public Finance and Public Choice/Economia Delle Scelte Pubbliche 10, No. 1 (Janurary-April 1992): Higgs, Robert. Crisis and Leviathan: Critical Episodes in the Growth of American Government. New York: Oxford University Press, Holcombe, Randall G. The Distributive Model of Government: Evidence from the Confederate Constitution, Southern Economic Journal 58, No 3 (January 1992): Holcombe, Randall G. The Growth of the Federal Government in the 1920s, Cato Journal 16, No. 2 (Fall 1996): Holcombe, Randall G. Veterans Interests and the Transition to Government Growth: , Public Choice 99, no. 3-4 (June 1999): Husted, Thomas A. and Lawrence W. Kenny. The Effect of the Expansion of the Voting Franchise on the Size of Government, Journal of Political Economy 105, No. 1 (February 1997): Meltzer, Allan H. and Scott F. Richard. A Rational Theory of the Size of Government, Journal of Political Economy 89, No. 5 (October 1981): Mueller, Dennis C. Public Choice II: A Revised Edition of Public Choice. Cambridge: Cambridge University Press, Peacock, A.T. and J. Wiseman. The Growth of Public Expenditure in the United Kingdom. (2nd Edition) London: Allena and Unwin, Peltzman, Sam. The Growth of Government, Journal of Law and Economics 23, No. 2 (October 1980):

25 Wagner, Adolf. Three Extracts on Public Finance, in R.A. Musgrave and A.T. Peacock (eds.), Classics in the Theory of Public Finance, 1958, pp