You’ve heard the expression “retire in place”: You stop putting in a real effort at work because your employer never fires anyone. The web is full of anecdotes about cushy jobs where you can retire in place and spend your 8-to-5 playing Words With Friends or Diamond Dash.  

Sure, people retire in place in both the public and private sectors, but when it happens in the public sector those workers still boost GDP.  But really, if we were being honest, we’d say that those workers, putting in little effort and producing little value, are mostly just getting transfer payments: Cash, almost for free.  

This is a big distinction in national income accounting: Is that dollar of government spending a “purchase” of valuable output or a mere “transfer payment”–a check with few strings attached? That’s an economic question–a question of benefits and costs.  It’s no mere question of accounting–of orderly arithmetic.  And it’s an economic question that matters: The first kind shows up directly in GDP while the second does not show up directly (though of course either can show up later when spent on consumer or capital goods).
The transfer payment/government purchase distinction shows up lots of places: I often tell my students that we could automatically raise GDP by tens of billions every year just by having the Bureau of Economic Analysis declare that all unemployment insurance benefits are actually salary payments for engaging in a government-funded task called “job search.”  No change in government spending, just a change in what we call the spending.  

Here’s one big area where I think we should change what we call one type of government spending: Medicare and Medicaid.  Currently, these types of spending are counted as transfer payments (BEA PDF here) and so when we measure GDP they show up in C, consumer purchases.  I think they should show up in G, government purchases.  These medical purchases are so tightly controlled by the government that doctors–oops, “medical service providers”–have become and should be considered government contractors just like defense contractors or construction firms.  

The Medicare and Medicaid programs, where an individual’s decision to go to a doctor causes the government to cut a check to the doctor, reminds me of an example from the legendary chapter 6 of Buchanan and Tullock’s Calculus of Consent.  They consider..

..the extreme decision-making rule where any individual in the [city] can, when he desires, order collective action. It is perhaps intuitively clear that such a rule would not be desired by the average individual [ahem], but we need to find a more rigorous proof for this intuitive observation…Now assume further that any individual…may secure road or street repairs or improvements when he requests it from the city authorities. It is evident that the individual…will not take the full marginal costs of the action into account.
When I read that example years ago of an imaginary city where any one person could order her government to spend money, I thought it was too unrealistic, a mere ivory tower invention.  Surely no government would set up a rule where any one person at any time could so easily impose a cost on everyone in the polity. 
But then I realized that I lived in that society: That’s exactly how Medicare and Medicaid work.  You’re 66 and want to go to the doctor?  Sure, as long as your visit fits into CMS guidelines the check will get cut.  And when it gets cut, it will count, strangely, as a transfer payment, not a government purchase of goods and services.  
[Interesting Medicare overpayment story here, Washington Post via Russ.]