Elected representatives have little incentive to pursue the interests of those electing them once they are elected. This well-known principal-agent problem leads, in a variety of theories of government, to non-optimally large levels of government expenditure. An implication is that budgetary rules are seen as necessary to constrain politicians’ tax and spending behavior. Popular among such constraints are various Balanced Budget Amendment proposals. These approaches, however, are shown here to have serious limitations, including failure to address the central concern of spending level. An alternative approach is advanced here that relies on a Coase-like mechanism that transfers control of government spending to the voter. Prisoner’s Dilemma incentives and political competition are seen to be critical to the superiority of the present mechanism to approaches requiring budget balance.

The failure of our elected representatives to do what the voters wish upon being elected, due in part to special interest power, comprises an important principal-agent problem. As with other principal-agent problems1, elected representatives do not act in the best interest of those electing them because the former have informational advantages and different interests.2 One might argue that politicians are forced to represent the interests that elected them: to remain in office they want to return to a constituency and tell them that they have either lowered their taxes or brought them programme benefits. This would be fine except that a) politicians have, then, an incentive to run large deficits and b) politicians have incentives to promote expenditures that benefit them and not necessarily the American electorate, special interest abuses being of particular interest here.

The preceding problems are well known to public choice theorists3 and those developing models of government. For example, the special-interest model of government4, the monopoly model5, and the Leviathan model6, all display equilibrium spending that is non-optimally large and budget rules are seen as needed constraints on politicians’ tax and spending behavior.

Empirically, averaging over decades to smooth the impact of business cycles, the percent of GDP spent by the US governments at all levels—federal, state, and local combined—was 22.8 (1950s), 25.1 (1960s), 28.2 (1970s), and 30.6 (1980s). After small declines in the 1990s (accompanied by the only budget surpluses since 1969 in 1998-2000), the trend of increasing spending shares resumed, culminating in a 36.1 share in 2006.7 It would be difficult to argue convincingly that this growth pattern—with the combined government spending share rising from 7% in 1902 to a projected 35% in 2010—has represented the desires of the American people. It is more likely that pressure from a wide variety of special interests resulted in behavior at odds with the general interest. However, the possibility that voters might want a larger government is not ruled out by the mechanism proposed here to help solve the principal-agent problem in government spending.

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