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Too Clever by Half

June 9, 2010

Obama is taking this behavioural economics stuff pretty seriously, it seems. He now wants to “nudge” state agencies  into saving more… by allowing them to spend what they could save:

“To encourage cooperation, Obama also will ask Congress for new authority to let agencies keep half the savings they identify, administration officials said. The agencies could then put the cash toward higher priorities rather than surrendering it all for deficit reduction, as is typical.”

It’s nice to see, on the one hand, that the Obama administration seems to be aware that incentives matter — which incidentally is what Arthur Laffer points out while making the case for lower taxes. It also shows the prinicple-agent problem between the White House and the bureaus: if the departments claim they have no capacity for savings then how is Obama to tell whether that’s true?

But — and you knew there was going to be a ‘but’ — will the half-half rule incentivise agencies to find any savings potential, let alone as much savings potential as possible? From what the French Cowboy gathers, the Obama administration has already set a savings quota of 5%. So if the bureaus are ordered to come up with 5% savings isn’t that equivalent to simply cutting the budgets by 5% (or by 2.5% since they’re allowed to keep half)?

The half-half rule implies that the agencies have it in their power how much they’re willing to save. If that’s the case, then the 5% are an arbitrary quota that agencies can safely ignore. If, in the other case, agencies can be contrained to give up some of their budget (and you’d think that they can be, considering all that executive power and such) then what’s with the need for inefficient incentives?

Also, letting agencies keep half of their potential savings makes no sense either way. If the agencies decide they want to make no budget cuts then they can simply claim that they have no possibilities to save without seriously undermining their work. According to the incentives logic of the Obama administration, this claim would be even more credible in the half-half setup than outside of it because agencies “lose” the 50% of savings they could keep if they found any.

If agencies want to make savings, eg because they fear arbitrary budget cuts if they don’t show up with something, then it’s still completely in their discretionary power how much savings potential they declare. Whatever the level (and you won’t see any beyond 5%), the Obama administration will be unable to argue that more can be done, because, by their own logic, it’s in the agencies’ own interest to find savings of which they will be allowed to keep one half.

So the basic question is: are our brave civil servants that stupid? When they’re told that they can keep half of what they find that could be given away, do they think that they gain from finding something to give away? Or do they realise that, in this scenario, they’d still be better off not finding anything to give away? I fear that Obama is overestimating the agencies’ proneness to make logical mistakes.

The French Cowboy’s last quibble with this mouse trap: Does the Obama administration realise that 2.5% of savings are not going to get us very far in terms of deficit reduction?

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