August 27, 2012 | Center for Policy Innovation Discussion Paper on Budget and Spending
Abstract: America is never going to fix its structural fiscal problems until we recognize that we face a political science problem more than an economic policy problem. The legislative process has become increasingly unable to crystallize the public mood into policy decisions and enact them, and this has contributed to the steady and alarming erosion of public confidence in Congress and the executive branch. To address this, we need to apply the lessons of game theory to the challenge of achieving action on deficits and debt. By learning from negotiators who use game theory, such as arms controllers, we could make progress in such areas as entitlements and revenue.
An increasing number of Americans are contemplating the beginning of next year with both fear and dread. That is when dramatic fiscal changes are due to take place. These include sharp increases in tax rates, huge cuts in national security, and major reductions in health care and other programs.
It is important to recall, however, that we face this grim prospect because of legislation intended to produce a very different result. The idea behind the legislation setting up a fiscal “Supercommittee” last year was that by creating the right incentives, there could be a landmark bipartisan deal that would avoid the drastic changes we now have to contemplate.
Specifically, the legislation sought to create an “Armageddon” scenario that would push panel members towards a significant agreement, since failure to reach a pact would trigger deep cuts in defense and domestic discretionary programs in 2013 as well as additional cuts in projected Medicare spending. On the revenue side, the scheduled sunsetting of the Bush tax changes threatened a sharp increase in rates. But it turned out that these threats failed to produce concessions during the negotiations, and the Supercommittee collapsed. So now the country faces the prospect next year, under current law, of huge tax increases and what many consider to be dangerously deep reductions in defense and other programs.
Meanwhile, fear continues to grow about the potential economic consequences of America’s long-term enormous annual deficits and rapidly accumulating debt. Mounting debt risks a loss of confidence by international lenders and may threaten a sudden future financial crisis that could be far more severe than the country endured in 2008.
But the fears prompted by the failure of Congress to agree on a solution to the fiscal situation are not only economic in nature. There is also a widely held feeling in the country that the failure underscores a governance crisis in America, compounding the economic crisis. To Americans, this makes our predicament especially frustrating and dangerous. The worry is that the American political and legislative system has become incapable of resolving hard issues, and this poses a threat to American democracy itself.
That worry has contributed to the public’s trust in government falling to an all-time low. It’s true that Winston Churchill once said that you can always count on Americans to do the right thing—after they have tried everything else first. But to many Americans, it appears that their lawmakers are incapable of trying.
How is it possible to deal with these twin crises? Getting the right thing done requires two critical actions.
The first requirement is well understood: There needs to be a serious public discussion about the ideas to combat the fiscal problems facing America. That means lawmakers and policy organizations need to offer the American people fully developed proposals that reflect their visions for the future of the country and that would be real solutions.
The Heritage Foundation rose to that challenge last year with its plan Saving the American Dream, which would bring the nation into permanent fiscal balance without raising taxes. Other organizations and some politicians have also laid out detailed proposals based on very different visions for the nation. Elections are occasions to debate such visions.
Second, to help address the governance crisis, policymakers need to take a fresh look at the deep-seated difficulties our legislative system has in reaching agreement on major but sensitive issues. That’s a political science problem, not a policy design problem. Even if the next election results in a significant gain by one party with a set of ideas, achieving politically sustainable long-term fiscal solutions likely will still need wide agreement in Congress. Whether or not one agreed with the Supercommittee approach, its failure underscores just how difficult it is to create the right dynamics to build broad support for decisive action.
How could we create a different dynamic? As a thought experiment, let’s imagine that we gave the challenge of reaching a budget agreement to arms control negotiators rather than to the budget experts and leaders who have so far failed to make much progress. Why might this seemingly bizarre idea be helpful? Not because arms controllers know more about budgets, but because the challenge of reaching a broad agreement needs to be seen primarily as a political science and negotiation problem, and arms controllers see the process of reaching agreements in that way. So it could be helpful to draw on the expertise of those officials and experts who in their field are routinely engaged in what economists and political scientists refer to as “game theory.”
Game theory is the branch of analysis that explores situations in which one person’s best choices in a negotiation are dependent on the choices made by others. It recognizes that there may be common goals or fears that can induce rational cooperation between adversaries despite the desire of each side in the policy/political process to be as successful as possible at achieving its own objectives. And in these situations, a better understanding by each side of the other’s motivations, fears, goals, and perspective—which influence each side’s attitude to proposals—is critical to achieving a mutually beneficial agreement.
The Prisoner’s Dilemma is a textbook example. In its simple version, two men are arrested and will be tried for robbery with the prospect of 10-year sentences. Lacking enough evidence to convict, the prosecutor makes the following offer to each man:
If you confess and your partner remains silent, I’ll drop charges against you and your partner will serve 10 years, but if you remain silent while your partner confesses, he goes free and you do 10 years. If both of you confess, I will agree to five-year terms to get two convictions. If you both remain silent, I recognize I’ll have to settle for one-year terms on minor charges.
The dilemma is that if each prisoner thinks narrowly only of his own goal of serving the least time, he will confess, hoping the other does not. That gamble means that each will serve five years at most. But if the prisoners recognize their mutual interest, they will cooperate by each agreeing to remain silent. If they stick by this agreement, they can each be sure of just one year, but they have to be confident of cooperation, because if the agreement is broken, the silent prisoner will receive 10 years.
The example illustrates that while there are costs associated with cooperation, it can avoid a far worse situation that would result from narrowly pursuing self-interest. This essence of game theory is relevant to budget negotiations and many other areas of negotiation: It turns out that pursuing the “best case” for one negotiator often actually results in a worse result for that same player than the alternative of cooperating with his opponent. It is also the case that by better understanding the motivations, goals, and fears of the other player, it is possible to craft an agreement that moves towards an outcome that actually improves the outcome for both sides.
While game theory may seem abstract, it is routinely used in several areas of policy and business. For example:
It is certainly a little disconcerting to compare solving the fiscal problem with negotiating a successful nuclear weapons deal, but the political dynamic is actually quite similar. While each side has a preferred outcome, a lack of cooperation makes it more likely that the result will be far less beneficial to each side, with potentially very damaging economic consequences compounding each side’s failure.
A problem today is that while the process of arms negotiation has a rich literature and protocols associated with it, and while top-level negotiators are well versed in the associated game theory, we are at a relatively primitive stage in applying the same techniques to finding a mutually agreeable solution to the budget and debt problem. It is in fact remarkable how little the principles of game theory are applied in practice to the area of budget and long-term fiscal reform when compared with other fields.
True, in academia, the principles of game theory shape many a graduate seminar discussion on fiscal policy, as they do in seminars on defense strategy and international relations, but they are largely absent in the day-to-day world of budget negotiations. Recalling the movie A Beautiful Mind, it is time for something like “John Nash meets the National Debt.” We need to draw on lessons from fields in which competition, cooperation, and negotiation are a routine part of reaching an agreement.
Arms controllers would explain that successful agreements in other fields indicate that three things are essential.
First, each side must attempt to fully understand the concerns and desires of the other side. Doing so makes it less likely that discussions will collapse with a bad outcome for both sides. A good understanding allows skilled negotiators to explore solutions that advance the agenda of their side in ways that are least problematic to the other side.
Second, it is critical to use rules and procedures, such as monitoring and enforcement, to build the trust and comfort level needed for confidence in any settlement. As Ronald Reagan put it, “Trust but verify.” If one or both sides cannot be confident that all the elements of an agreement will be delivered, there will be no agreement.
Third, it is important to appreciate that success does not have to mean that one side “loses” and the other “wins” or that the only way forward is to split the difference. Often, a good understanding of each side’s values and broader goals allows for a creative solution that enables each side to advance some of its goals.
Appreciating these elements could help us move towards a major budget agreement that wins broad support. That’s because in the fiscal debate, there are seemingly intractable positions that are actually more nuanced than they might seem. There are also internal tensions or contradictions that, if recognized, could pave the way for a broad agreement.
To continue the thought experiment of arms controllers running a future round of budget negotiations, what approaches and lessons might they incorporate? There are several, but two are particularly relevant to our recent experience with failed attempts to address the budget problem.
In creating the Supercommittee, Congress tried to set up an environment to mimic the conditions needed to push hard-headed negotiators towards an agreement by legislating a mutually unacceptable “Armageddon.” The statute passed by Congress and signed into law required automatic deep cuts in defense, Medicare, and other programs starting in 2013. They were to be so deep that the statute’s sponsors believed both parties would conclude that there must be a sweeping bipartisan agreement to avoid them.
On the face of it, this might seem to be right out of the arms control textbook—the prospect of nuclear Armageddon, after all, drove Reagan and Mikhail Gorbachev towards major weapons reduction.
But the Armageddon scenario created for the Supercommittee was to be an artificial and deliberately self-inflicted one very different from the fear of a catastrophic military action in international disputes—or, for that matter, a collapse in international confidence by foreign lenders. Those scenarios involve an “outside” risk from another source. A legislature creating a catastrophic adverse reaction for itself in order to increase pressure to do the right thing is quite another matter. That’s because it requires two key but dubious assumptions.
The weakness of these assumptions undermined the artificial Armageddon strategy. That’s why many observers of Congress do not believe that the full force of the 2013 taxes and spending changes will occur. They expect that there will be steps to “fix” (i.e., roll back or eliminate) many or most of the major budget reductions in the legislation and the large tax hikes from sunsetting provisions in previous statutes.
The failure of the Supercommittee would not be surprising to arms control negotiators. They recognize that the only nightmare scenario that actually forces action is one that is real and outside the ability of lawmakers to manipulate.
Successful arms controllers and other negotiators know the importance of exploring the underlying goals, values, and fears behind seemingly non-negotiable positions. They do this in an effort to find ways forward that address these perspectives of each side in a way that hopefully benefits both sides.
In Middle East border negotiations, for instance, the real issue is security rather than real estate, so finding creative ways to guarantee security can yield progress in who should own trees and houses. In the debate over retirement entitlements, there is an array of concerns, from the dread of economic insecurity to strongly held ideas of fairness, that have to be understood and addressed first if there is to be progress on budget and health system changes.
Thus, it is important to recognize the underlying goals, values, and fears in the struggle over taxes, spending, and deficits. To most Americans and their representatives, fiscal debates are not really about numbers and bookkeeping. They are actually about profoundly different visions of the appropriate size, scope, and purpose of government and about ideas of justice.
Competing visions of government and justice will continue to be debated by the American people, and over time, there will be shifts. That broad debate will set the broad parameters of the budget policy discussions, but without careful efforts to appreciate and accommodate the underlying desires and concerns, gridlock is likely to continue.
Consider three examples where a better understanding of goals, values, and fears could be critical to making progress on the budget and debt.
Example 3: The “land for peace” problem. The timing and sequencing of steps by either side in a proposed agreement are also crucial if there is to be success. For example, let’s say for the sake of argument that conservatives were pondering a package of revenues of the kind discussed above in return for the promise of spending reductions. Even in this seemingly win-win situation, many on the right would still be very reluctant to accept a deal because of what one might call the “land for peace” problem.
As Middle East negotiators well understand, it is very difficult to get one side to agree to a tangible and potentially irreversible immediate step, such as land concessions, in return for a future promised action, such as a promise to live in peace. This is because if the agreement were to break down later, then one side would lose the land but get no peace while the other side would gain the land without delivering on the peace. Similarly, no sensible arms negotiator would give up a class of vital weapons this year in return for a promise by the adversary to eliminate an equivalent weapons system next year. If the timing of required steps in a proposal is asymmetric so that one side could gain by reneging after the other side has made concessions, it is very unlikely that the proposal will become a firm agreement.
This is why most on the right resist budget agreements that require a commitment to tangible revenues now (such as a permanent change in the tax code) in return for a promise to phase in future spending reductions in entitlements and other programs. The reason is that if the left reneges, then those on the right are stuck with tax increases in statute without the promised future spending reductions. This is more than a theoretical fear, since it has been a familiar pattern of budget “compromises” for decades: Tax rates are raised permanently in return for reductions in entitlement spending that may require future Congresses to enact them, and many of the spending reductions do not materialize.
This is a classic land-for-peace, your-weapons-system-first proposal that no serious negotiator would accept. But even seasoned politicians sometimes do, to their regret. Ronald Reagan described the budget agreement in 1982, which immediately rolled back some tax cuts in return for the promise of future spending curbs, as perhaps his biggest mistake as President.
It is true that, in theory at least, the land-for-peace problem does not concern only the right. Politicians on the left would be leery of committing to, say, a change in the Medicare entitlement in return for a revenue commitment on the right if they believe that commitment might be broken. Historically, that has not been the typical reneging scenario. Obtaining promised real future entitlement reductions seems to be the more common challenge. Still, each side needs an assurance that a budget agreement will somehow be guaranteed over the long term—not much different from arms agreements.
For any major agreement to be consummated, therefore, there has to be a high degree of probability that both sides and their successors will stick to it over time. If there is a legitimate worry that in the future, one side will walk away or could bend the agreement to its advantage, an agreement is unlikely. That worry is a significant aspect of the current impasse.
No agreement on the long-term budget is likely if either side perceives itself to be vulnerable to the “land for peace” problem. This is why, for a truly successful budget agreement, three operational rules are crucial.
So there is a need both to make long-term budgets more predictable and to make the default automatic adherence to specific long-term spending and revenue agreements. That would mean moving towards a real long-term budget (say, 30 years), with revenue and spending programs automatically adjusting to those agreed numbers rather than—as today—requiring a future Congress to make the adjustment.
Doing so would mean effectively ending the distinction between “discretionary” and “mandatory” (or “entitlement”) program spending, most notably in the case of retirement programs. The current status of these programs means that they take precedence over other forms of “discretionary” spending, such as spending for housing assistance, defense, roads, and most federal education funds. Moreover since entitlements require the government to pay the cost of specified benefits, their costs are merely a forecast rather than subject to a predictable and legislated budget.
We are never going to fix our structural fiscal problems until we recognize that we face a political science problem more than an economic policy problem. It is true that the size and scope of government and the degree to which it is financed by current or future revenue commitments are ultimately matters for the American people to decide. These broad and fundamental issues need to be resolved through elections. But as we have seen in recent years, the legislative process has become increasingly unable to crystallize the public mood into policy decisions and enact them. This has contributed to the steady and alarming erosion of public confidence in Congress and the executive branch.
To deal with that, we must get our legislative process back on track to carry out the will of the people, recognizing that the people’s voice is often nuanced and even contradictory. Learning some lessons from those who use game theory in other fields to achieve progress towards shared goals might be a good way to get started on that task.
—Stuart M. Butler, PhD, is Director of the Center for Policy Innovation at The Heritage Foundation.