The Reason of Rules: Constitutional Political Economy

Geoffrey Brennan.
Brennan, Geoffrey and James M. Buchanan
(1919- )
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Indianapolis, IN: Liberty Fund, Inc.
Pub. Date
Foreword by Robert D. Tollison.

Chapter 6Politics Without Rules, I:
Time and Nonconstrained Collective Action

I. Introduction


In the preceding chapter, we attempted to demonstrate that individual behavior in collective choice is likely to reflect shorter time horizons than comparable behavior in private or individualized choice, and for individually rational reasons. The person who may be willing to wait privately, to behave with prudence in order that he or his heirs may secure the fruits of long-term investment in human or nonhuman capital, may, at the same time, be unwilling to wait collectively, as reflected in expressions through political decision-making institutions. Because of the necessary attenuation of individually identifiable rights or shares in the fruits of collective or governmental "investment," individual time horizons in politics are shortened. If this underlying hypothesis is valid, it would follow that as modern societies have become increasingly collectivized or politicized, there has been a shift toward a higher discount rate implicit in the allocation of the economy's resources.


In this chapter we shift our attention to the less abstract and more practical level of real-world politics. But we should stress that we do not go all the way; we dare not enter the realm of historical or descriptive institutional detail. In a sense, our discussion remains abstract in that we examine the predicted workings of idealized models of politics in democracies as these models might be expected to work in confrontation with the problems of modern experience. Analytic models of politics assist us in understanding why these familiar problems persist in modern political life. Such an understanding, however, is a by-product of the primary function of the analysis here, which is to offer support for constitutional rules or constraints on practical political grounds.


Our purpose is to develop the intertemporal theme with the aid of distinct and familiar examples drawn from economic problems of the 1970s and 1980s in the United States and other Western nations. We shall discuss the "high-tax trap," the "inflation trap," and the "public-debt trap," all of which demonstrate the general problem of imprudence in modern democratic polities, different countries having experienced these separate problems in differing degrees of relative importance. The inferences to be drawn for our larger and more comprehensive theme become clear as the analysis is developed; governments can be induced to take the long view only if they are appropriately constrained by constitutional rules that do not now exist. These reasons for rules emerge from an understanding of the workings of modern political economies.

II. The Social Discount Rate


The discussion in this chapter is related to a long-continuing topic in the theory of economic policy, often treated under the rubric of "social discount rate." Traditionally, and especially since Pigou's Economics of Welfare, published early in this century,*40 economists have concerned themselves with the normative question, At what rate "should" society discount the future? How "should" the utility of future generations be weighted in the making of present-period decisions? More particularly, economists have asked, Is the interest of future generations sufficiently weighted by discounting at the market-determined rate of return on capital investment, the rate that market institutions install as a parameter for private-investment decisions? Should the collectivity as such make its own investment decisions on the basis of the market-determined rate of discount, and if the market rate is "too high," should the collectivity, as a unit, replace the market behavior of individuals in all or in part of the investment or capital accumulation activity of the society?


These questions are intrinsically interesting, but for our purposes the implicit assumptions that prompted economists to ask them are more revealing. Almost without exception, the economists who asked these questions assumed that once a satisfactory normative solution could be agreed on, a benevolent government could, and presumably would, implement this solution. Never once did these economists pause to ask themselves whether government, as it is actually observed to operate, could or would implement the "optimal" discount rate that emerges from the careful exercise in normative prescription. In other words, the welfare theorists worked without a positive theory or model of governmental-political behavior, either implicit or explicit.


"Public choice," the area of research with which we have long been associated, emerged in the 1950s, 1960s, and 1970s to fill this truly awesome gap in normative analysis. Within properly defined limits and appropriately qualified, public choice does offer a positive theory of how politics works or, stated somewhat differently, offers a panoply of theories about the working of politics under different sets of postulated rules and institutions. It is on this analytic structure that our conclusion about the political discount rate is grounded. The "social discount rate" generated in the operation of modern political decision-making institutions will be higher than that rate of time preference exhibited by persons in their private behavior. This statement takes the form of a testable hypothesis; it is not a normative proposition. It may well be that persons exhibit personal time preferences in market behavior that are "too high" when judged against some extraindividual criterion. To make such an argument one must resort to value norms that are not necessary in making the positive statement about relative discount rates in market and political behavior. We can say that the discount rate embodied in the political process is higher than that embodied in the operation of the competitive market without invoking our own private variant of a social welfare function.

III. The High-Tax Trap


The three main examples we shall introduce are familiar from economic policy discussions of the early 1980s. The "high-tax trap" is a term we shall use to refer to the set of considerations often summarized under "supply-side economics." Our analysis of this trap, or dilemma, offers a basis for imposing limits on the government's taxing authority, even in a setting where the taxpayer and the beneficiary groups are largely coincident in membership.*41 That is to say, we model government democratically in the sense that it is presumed to be responsive to the demands of citizens both for expanded state services (and transfers) and for lower tax rates. The dilemma emerges here from the disparity in time horizons between the two separate sets of behavior, private and political.


Is it possible to say that tax rates are "too high" except by reference to some value-laden normative criterion that suggests the existence of some "optimal" size of public or governmental outlay relative to the private or market sector of an economy? In a nonevaluative sense, we could say that taxes are "too high" only if everyone expressed agreement on such a proposition, with members of the government (politicians, legislators, and bureaucrats) as well as direct beneficiaries included in the group. But surely the members of the group, the recipients of net transfers in particular, would never agree to any reduction in the size of the public sector, as measured by the amount of outlay and, indirectly, by tax revenues. So it would seem. Without some normative standard for judgment, we would never expect to obtain general agreement on the proposition that governmental outlays are too high.


This proposition is not, however, the same as the statement that tax rates are "too high." It is at least logically possible that tax rates may be so high that tax revenues are actually lower than they would be at lower rates. In this case, of course, there should be general agreement among all parties on the need for a rate reduction, if not a revenue reduction.


The simple arithmetical relationship between tax rates and total tax revenues came to be widely discussed under the "Laffer curve" rubric in the early 1980s in the United States, since the relationship was brought into political prominence by Professor Arthur Laffer. As many critics pointed out, the relationship was articulated in writings as far back as the time of the Moors, and possibly even the early Greeks. And, indeed, there is little more to the relationship as such than the mathematical properties of a simple functional form. Some such relationship must exist so long as any inverse behavioral response of taxpayers to tax rates is predicted.


Pointing out that such a rate-revenue relationship must exist, however, is not the same as suggesting that modern fiscal systems are described by locations on the "wrong," or inverse, portion of the schedule or curve, that is, at a position where a decrease in tax rates would increase rather than decrease tax revenues. In some of the journalistic advocacy of "supply-side economics" in the United States of the early 1980s, the arguments seemed to suggest that this position was, indeed, characteristic of the existing fiscal structure.


The initial reaction of public-choice economists is surely to reject the behavioral model that would be required to generate such a position. It would seem impossible that any rationally motivated governmental decision process could have allowed tax rates to reach such levels. Why would rates have been allowed to become so high as to reduce total tax revenues, since such rates would not be to the advantage of taxpayers, program beneficiaries, or politicians? It would seem to be in no group's interest to sustain such a fiscal structure. Behaviorally, location along the inverse segment of the relevant rate-revenue curve seems bizarre, quite apart from the limited results of empirical studies that also suggest response elasticities that fall far short of those required to generate such results.


The initial reaction of the public-choice economists may, however, be less definitive than at first it seems, and a more sophisticated examination of the political decision matrix within which tax and outlay decisions are made, along with an analysis of individual responses to these decisions, might suggest a plausible scenario that might well produce the position on the "wrong" side of the rate-revenue relationship. The central element in this scenario is the disparity in time horizons between private and public choice.


Let us assume, possibly as a counterfactual, that the fiscal structure is in the position indicated. There is an inverse relationship between tax rates and total tax revenues. Is there any behaviorally meaningful path through which the system might have reached this position?


Let us look first at the utility or preference functions of those who participate in the process from which governmental fiscal decisions emerge. We can, at one extreme, think of all fiscal decisions as being produced by the operation of majority voting rules, with all members of the community equally franchised to participate in the determination of the outcomes. The analysis is sufficiently general, however, to allow for differential powers of collective influence among different groups of constituents. In any case, those persons who participate in the making of collective decisions will wish to make outlays or expenditures through the political unit. They will need such expenditures either to finance "good things" (governmentally financed goods and services and transfers) and/or to line their own pockets or those of their friends and constituents. In either case, we can stipulate that funds, or revenues, are desired by those who participate in collective decision making. Revenues are "goods" in the utility functions of persons who ultimately make fiscal choices, whoever these persons may be.


At the same time, however, the levy of taxes is required for the acquisition of these revenues. (We shall, in this section, ignore the prospects of revenue generation through either money creation or debt issue; these prospects will be discussed in the two following sections.) In some way or another, funds must be extracted from citizens in their private economic roles or capacities. This taxing process will be painful, regardless of the model of governmental decision making that is postulated. In utility-function terminology, taxes or tax rates become "bads" rather than "goods." In some Utopian sense, persons in collective-decision roles would ideally prefer to spend without having to levy taxes. And the worst of all worlds for these persons would be some requirement that taxes be imposed without any accompanying outlay of funds on desired programs. These results remain true whether or not the taxpayer and the beneficiary groups are fully, partially, or not at all coincident in membership.


Note that to this point, we have said nothing at all about the time dimension. We have not dated the revenue flows the government expects to receive as a result of the imposition of a tax or an increase in the tax rate. We now postulate that those who participate in collective decision making are motivated by short-term considerations, for reasons analyzed in the previous chapter. By "short term" in this application, we mean that fiscal decisions are considered with reference to a time period shorter than that relevant to the private or individualized adjustments to tax-rate changes. We do not need to define the time horizon that informs individual collective choice in more detail than this; we require only that the effective time horizon embodied in governmental fiscal decisions be less extensive than that embodied in taxpayer response to tax-rate changes.


We know, of course, that taxpayer adjustments to tax-rate changes take time. In response to rate increases, persons must seek out and find nontaxable substitutes for the tax base, or at least substitutes that are taxed at differentially lower rates, whether the tax is imposed on a source or a use of income. Persons must shift investment to nontaxed or low-taxed opportunities and must invest in opportunities that are complementary to those directly advantaged. Individuals must learn about, and take advantage of, legal loopholes, which may have to be invented by lawyers and accountants. The whole analysis here depends only on the plausible assumption that in considering the revenue potential of a tax or tax-rate increase, the participant in governmental decision making operates on the basis of a shorter time perspective (a higher discount rate) than the one that describes the adjustment of persons as taxpayers to a posttax equilibrium.


For simplicity, let us postulate that full adjustment to a tax-rate change takes ten years, a period of adjustment that has been informally estimated to be relevant in modern fiscal systems of Western nations. Let us postulate, furthermore, that the time horizon effectively informing the behavior of participants in the making of collective political decisions on taxes (and spending) is five years or less. There are, of course, many reasons to support this postulated disparity in the time perspective for the individuals in the two separate roles, only one of which was discussed at some length in the previous chapter.


Given the postulated discrepancy in time horizons, "political equilibrium" will be established before "taxpayer equilibrium." That is to say, the individual as a participant in the political decision-making process will try to attain a position where the trade-offs between tax rates and tax revenues faced in fiscal reality, over the relevant time period, are equated with the subjective trade-offs between these two arguments in the utility function. So long as the individual, as a fiscal decision maker, values the "good" measured by increased funds higher than the "bad" measured by the tax rates required to generate such funds, he will "vote for" or support increases in tax rates. Both of these variables will be measured with respect to the period of time over which the funds are anticipated to provide benefits and without direct regard to the period of time that might be required for full taxpayer adjustments. As such, these individual participants in fiscal decision-making processes will be uninterested in the fact that taxpayers will take ten years to attain full equilibrium adjustment to the current tax rates, even when, at another level of consciousness, they may realize that they are the same persons who are involved in the quite separate roles. As political decision makers, individuals are concerned with the flow of revenues from taxes, and with the program benefits therefrom, only for a period of five years or less.


In the illustration here, however, taxpayers will not have made the full behavioral adjustment within five years. From this result follows the simple fact that the government can expect to collect more revenues per period at any given tax rate (above some initial starting rate) within a five-year period than it can expect to collect over the full ten-year sequence.*42 Hence, the fiscal process that embodies the shorter time horizon will exploit taxpayers more fully than would a process embodying a time horizon equal to, or longer than, the period of taxpayer adjustment. Taxpayers can be squeezed more fully by a governmental decision process that reflects interest in short-run revenue flows than by a process that incorporates a genuinely long-term perspective. As a familiar nontax example, the OPEC oil cartel was able to exploit oil consumers more before individuals adjusted the size and efficiency of the vehicle fleet than it was able to do after the adjustment took place.


Given sufficient time, of course, taxpayers will adjust to any given tax rate, and the coincidence of political and taxpayer equilibrium must ultimately be attained. In this full equilibrium, two separate conditions must be met. The trade-offs within the calculus of the persons who participate in governmental decision making must be equal, and taxpayers must be fully adjusted to the current tax rate. Such a full-equilibrium position might well be located in the range of the long-term rate-revenue schedule where rates and revenues are inversely related, although the precise location would have to be empirically determined. But the analysis suggests that because the long-term relationship is irrelevant to the political decision process, the generation of a position on the inverse segment of this relationship or schedule is not "collectively irrational," in that there need be no violation of the precepts of rationality by those who participate in political decision making.


If, however, such a position were reached, and if it were recognized as such, why would political decision makers not react by reducing tax rates? The answer is the reverse side of the tax-rate increase coin. By cutting tax rates, government would find revenues reduced in the time period relevant to those who participate in political decision making. Even a shared presumption that a reduction in tax rates would generate an increased stream of revenues per period, after, say, ten years, would not affect the decision of those who, by our postulate, remain interested in revenue flows only over a five-year sequence. The maintenance of high tax rates would ensure higher revenues over this relevant period. The revenue-enhancing effects of a possible tax cut are long run, not short run.


Within the time perspective of the early 1980s, the critics who opposed the naïve supply-side economic arguments were correct. Tax-rate cuts were predicted to and did reduce revenue flows; budget deficits were increased, especially since outlays were cut very little, if at all. Whether the critics would have been correct within a time horizon allowing for full taxpayer adjustment will never be known, because pressures for tax-rate increases, for short-term revenue reasons, emerged as early as 1982.


This is the setting for what we call the "high-tax trap." Individuals who participate in the making of political decisions cannot, even if they fully understand the situation they are in, readily escape from this dilemma. Given the absence of constraints on the fiscal proclivities of the collectivity, along with the existing rules and procedures for generating fiscal decisions, the individual who adopts a genuinely long-term perspective in his role as a participant in politics is behaving irrationally. In this setting, the argument for binding constraints on governmental fiscal authority becomes evident. Only if some means can be found to limit the ability of governments (political coalitions) in subsequent periods to depart from a reflectively evaluated and presently preferred long-term fiscal program will the individual participant find it advantageous to support the separate elements in such a program. Only through constitutional change can the institutions of modern politics be adjusted to ensure that, within these institutions, persons will have incentives to act in accordance with what they recognize to be the long-term interest of the community, as well as their own.*43

IV. The Inflation Trap


There are many similarities between the high-tax trap and the inflation trap, which we shall analyze in this section. The similarities are readily explained once it is recognized that both traps have essentially the same behavioral basis, which we have summarized as the disparity between the discount rate embodied in the choices made by individuals in their separate roles as public and private decision makers.


The United States, along with other Western countries, found itself caught up in an inflation in the 1970s that seemed to be continuing unabated. The inflation persisted despite the widespread recognition that a national economy operates less efficiently under an inflationary than a noninflationary regime. In a long-term perspective, inflation is clearly not in the interest of any group. But the short-term perspective that informs the decision calculus of those who participate in politics seemed to prevent them from initiating the action that would have been required to restore effective monetary stability.


How did we get into the dilemma? Is there a way out that can be other than temporary? An answer to the first question, which is perhaps essential to any attempt to answer the second, requires that we summarize the history of ideas in economics, at least since the impact of Lord Keynes. We shall do nothing more than sketch the bare outlines.


Keynes was successful in imposing on the mind-set of economists of the middle years of this century an abstract model of a high-unemployment, underutilized economy. And Keynes was surely correct when he noted that the ideas of academicians ultimately influence the actions of politicians. In the initial Keynesian model, demand brings forth supply, and increases in demand sop up underutilized manpower and capital, without creating increases in costs and prices. There are no supply-side constraints in the model, and quite literally, public spending is costless in terms of effectively displaced alternatives. This simple model appeared in the textbooks of all economics students after World War II, including all of those who later became the political leaders and opinion molders of the 1960s and 1970s. And surprisingly, the simple Keynesian model remains in many of the textbooks of the 1980s.


As early as the 1950s, however, there were indications that the Keynesian model is wrong in a critical respect. Supply schedules are not flat, to revert to familiar geometrical reference. Supply curves slope upward. Increases in demand, even in an economy with some or even considerable unused capacity, generate pressures on costs and hence on prices, at least in some sectors, especially if monetary policy is accommodating. This newly found post-Keynesian relationship between inflation and the rate of unemployment was accepted as an empirical reality of the late 1950s and 1960s. Its definitive version was presented by A. W. Phillips in 1958.*44


The "Phillips curve" dominated macroeconomic policy discussion during the 1960s. This curve, or relationship, depicts the trade-off between unemployment, on the one hand, and the rate of inflation, on the other. The central idea is that a positive rate of inflation generates a reduction in the rate of unemployment (or an increase in employment). Once the existence of such a trade-off was accepted by economists, they began to temper their earlier enthusiasm for continued increases in aggregate demand to stimulate the economy, but they stayed within the broadly defined Keynesian model by talking about an "optimal" rate of inflation, based on the notion that optimality is attained when the trade-off between inflation and unemployment in the utility function of the political decision maker matches that dictated by the Phillips relationship. A little inflation seemed to be but a small price to pay for increased employment and output.


Things did not quite work out as the economists of the 1960s had foreseen. What the Phillips curve macroeconomists failed to reckon with was the time dimension of the inflation-unemployment trade-off. To be sure, there was empirical evidence that an increase in the rate of unanticipated inflation could generate a temporary increase in employment (a reduction in unemployment). But after a time, employment (and unemployment) seemed to settle back to a natural rate, a rate that was not basically affected by the now anticipated rate of inflation but that was, instead, dependent on structural characteristics of the economy, on such things as the flexibility of labor markets, the spatial location of employment, the skill level of particular employee groups, minimum wage and union restrictions, levels of unemployment, disability, retirement compensation, and a host of like factors. Economists came slowly to learn that no permanent and continuing increase in employment could be sustained by some optimally chosen and maintained rate of inflation.


At this point in our potted macroeconomic history, however, public-choice economists had something to contribute. Once those who participated in the making of governmental decisions had been led to think that a little inflation was the route to higher employment, even if such stimulus proved to be temporary, the same individuals were tempted to repeat the exercise, generating a second round of inflation in exchange for a second short-term, or temporary, increase in employment and output in the economy. The simple logic of short-run response built into the political mechanism seemed to suggest that politically induced inflation would accelerate, at least for many rounds of adjustment.


Such was the state of the macroeconomic game, so to speak, until the mid-1970s. Since the late 1970s, however, more sophisticated models of political-economic interaction have been developed. These models indicate that there may emerge a political-economic equilibrium closely akin to that discussed earlier under the high-tax trap. Politically induced inflation need not continue to accelerate to levels of hyperinflation. A political equilibrium may be reached well short of such levels. An equilibrium of this sort will be attained when the internal trade-off of the participant in political decisions, which embodies the short-term perspective of modern democracy, matches the inflation-employment trade-off dictated by the short-term Phillips relationship, while at the same time the inflation rate is fully anticipated, ensuring that the solution satisfies the long-term Phillips relationship.*45


Such a full political equilibrium necessarily satisfies the conditions of the Phillips relationship for both the short and the long term. That is to say, unemployment is at its "natural rate," but there is also a continuing and fully anticipated inflation. In such an equilibrium, there is no longer any short-term incentive for the governmental decision maker to generate more inflation, and furthermore, individuals are fully adjusted to the rate of inflation that exists.


Unemployment at this full equilibrium is as high as, or possibly even higher than, it would be if there were no inflation at all. To the extent that inflation creates any inefficiency in the economy, the full equilibrium seems clearly to be nonoptimal. It would seem to be in the interests of all persons to reduce or to eliminate the rate of inflation.


A trap exists, however, because any reduction in the anticipated rate of inflation will, according to the short-term Phillips relationship, generate short-term increases in unemployment, as, indeed, the United States witnessed in serious fashion in 1981 and 1982. The participant in political decision making will not normally base decisions on a time horizon sufficiently long to make the reduction or elimination of inflation rational, even if the long-term benefits of such action are completely recognized.


In such a setting, the incentives of the participant in politics can be modified so as to ensure choices based on a long-term perspective only if the discretionary authority of the collectivity is restricted. The political decision maker can act with prudence in investing in long-term disinflation only if he can be assured that political coalitions, in subsequent periods, will not reinflate in response to short-term utility considerations. This general point was widely recognized in the macroeconomic policy discussions in the United States in the early 1980s. But there seemed to be a surprising failure to draw the proper inferences to the effect that constitutional limits on the monetary authority of the collectivity are necessary to resolve the dilemma.

V. The Public-Debt Trap


Our discussion of the public-debt trap will be brief, since this trap is in most respects identical with the two macroeconomic applications of the public-private discount rate disparity already examined. In analyzing the high-tax trap, we neglected public debt as a source of revenues. The introduction of the public-borrowing option clearly expands the possibility frontier of the participant in political choice.


Even if the effects of public-debt issue are recognized by all members of the polity (which seems a highly questionable assumption, although it is not vital to our argument here), the shortened time horizon in politics will make this financing option preferable to taxation over some initial ranges of outlay unless there are constitutional or moral prohibitions on debt issue. By borrowing the funds with which to finance currently enjoyed "goods," the participant is postponing the day of payment. Governments can borrow at or below the market-determined rate of interest. But the discount rate that informs politics is higher than the market rate of interest, for reasons already discussed. Hence, the short-term benefits expected from outlays will exceed the short-term costs computed as the present values of anticipated future tax payments discounted at market rates. This calculus remains valid even for the person who realizes that in the long run, a debt-free fiscal structure is preferable to a debt-ridden structure. By forgoing the benefits of debt-financed current spending, however, the person is not able to insure against the long-term tax liability that debt service and amortization imply. A political coalition in periods subsequent to that in which current fiscal choices must be made may wholly undo any effects of current-period fiscal prudence. There is simply no rational basis for an individual to support, to "vote for," fiscal prudence in the operation of ordinary democratic politics. Public debt will tend to be overextended relative to any plausible long-term arguments for the use of this fiscal instrument. The political equilibrium between debt and tax finance will be distorted in favor of debt, and tax rates will be excessive for the reasons already analyzed, at least by the criterion of the long-term interests of the members of the community.


Precisely the same logic applies, of course, to the possible repayment or retirement of an existing public debt. The participant in ordinary politics may recognize that debt retirement now will benefit the whole community in the long run, but given nonfiscally constrained democratic decision processes, there is no means of guaranteeing that debt retirement now will, indeed, have the long-term effects that are preferred.


As in the two previous examples, incentives that will induce the individual, as a participant in politics, to behave in accordance with his (and the community's) long-term interest can be provided only through some limitation on the powers of political coalitions (governments) to offset or destroy the effects of long-term "investmentlike" choices that might be made currently.*46

VI. Other Examples


Through the analysis of three familiar policy issues from the macroeconomics of the 1980s, we have presented the public-private time discount disparity in stark and simple form. Many other examples could be examined outside the macroeconomic area of inquiry, but only a few will be noted in passing here.


The "punishment dilemma" and the "Samaritan's dilemma" were examined by one of us in earlier writings.*47 Neither of these focuses directly on the time discount discrepancy. Both, however, illustrate the temporal dimensionality issue and point to the need for imposing commitments. In the punishment dilemma, a short-term utility-maximizing strategy dictates weighting the disutility of the punishee or criminal much more heavily than any long-term maximizing strategy would suggest. As a result of short-term maximization, policy tends to "coddle criminals"; crime increases, and we suffer the long-term consequences. A genuinely long-term perspective would suggest increases in both the certainty and severity of punishment, but unless participants in democratic politics could be assured that future political coalitions would not reverse current reforms, the necessary costs of imposing such reforms would continue to outweigh the benefits promised in the longer term.


In the Samaritan's dilemma, much of the problem of the modern welfare state is explained. A short-term maximizing strategy calls for heeding the obvious sufferings, here and now, of those observed to be needy. Such strategy calls for the financing of assistance, despite the recognition that increased transfer payments generate long-term increases in the number of indigents. A strategy of austerity with respect to eligibility for transfers would increase the ranks of the self-reliant in the long run. But unless the individual who participates in politics today can be assured that such a strategy will be adhered to in the future, the austerity policy applied today may seem unduly callous and cruel.

VII. Conclusions


In this chapter, primarily through the use of three applications from macroeconomic policy, we have tried to demonstrate in practical and relevant terms the basic logic of, or reason for, the imposition of binding constraints or rules on the activities of collective units or governments. The theme of the disparity between the rate of time discount applied in public and in private choice, possibly by the same person, has been used to show that the political concentration on temporary or short-term benefits, a concentration that is inherent in the structure of unconstrained majoritarian politics and also in other nonconstrained governmental decision-making procedures, to the relative neglect of long-term considerations, may produce results that are desired by no person or group of persons in the community—hence, the use of the word "trap" or "dilemma." In short, the results produced by the short-term perspective in modern politics may be "Pareto pessimal."

Notes for this chapter

A. C. Pigou, The Economics of Welfare, 4th ed. (London: Macmillan, 1932).
The basis for imposing tax limits that emerges from the argument here is quite different from the one we offered on the basis of a contrasting political model in our earlier book, The Power to Tax (Cambridge University Press, 1979). There, we stated that taxes tend to be "too high" because of the revenue-maximizing proclivities of government, which was modeled as one player in a two-player game with taxpayers. In that analysis, there was no dilemma aspect such as is examined here, and the set of questions concerning the time horizon for adjustment did not arise.
In terms of simple geometry, this result becomes immediately apparent. Although we shall not depict it here, the short-run "Laffer," or rate-revenue, curve above the initial tax rate will always lie outside the long-run, or full-adjustment, curve.
In collaboration with a colleague, one of us has developed the "high-tax trap" analysis in some detail. See James M. Buchanan and Dwight R. Lee, "Tax Rates and Tax Revenues in Political Equilibrium," Economic Inquiry 20 (July 1982): 344-54; "Politics, Time, and the Laffer Curve," Journal of Political Economy 90 (August 1982): 816-19; and "The Simple Analytics of the Laffer Curve" (paper presented at the 38th Congress of the International Institute of Public Finance, Copenhagen, August 1982).
A. W. Phillips, "The Relation Between Unemployment and the Rate of Change in Money Wage Rates in the United Kingdom, 1861-1957," Economica 25 (November 1958): 283-99.
See Finn E. Kydland and Edward C. Prescott, "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy 85 (June 1977): 473-91.
For analysis of the debt dilemma along lines that are in many respects similar to those presented here, see James M. Buchanan, "Debt, Demos, and the Welfare State" (paper presented at a conference on the welfare state, Civitas, Gesellschaft zur Forderung von Wissenschaft und Kunst, Munich, West Germany, October 1983).
See James M. Buchanan, The Limits of Liberty (University of Chicago Press, 1975), ch. 8; and Freedom in Constitutional Contract (College Station: Texas A&M University Press, 1977), ch. 12.

End of Notes

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