Game Theory and the Politics of Entitlement Reform

Mitt Romney’s choice of Paul Ryan as his running mate ensures that this Presidential election will be more than a simple referendum on Barack Obama’s handling of the economy over the last four years.  The election will now also involve a debate about the need for significant entitlement reform and the role of government.  Given that polls show the majority of Americans still oppose large changes in Medicare and Social Security, what will it take for Republicans to win this battle?

As I wrote in an earlier blog post, Republicans must hope that voter preferences line up a certain way and they must then fashion reform policies that match those preferences.  In evaluating major reforms to government programs, each voter usually takes the decisions of others as given: there is very little that any one person or group can do to influence others.  Government programs, including tax breaks, are spread out over a large number of beneficiaries.  Each beneficiary can decide how hard to fight in order to get or keep their specific program, but their decision usually does not influence what other groups do.

If reform decisions are made piecemeal, addressing one tax expenditure or spending program at a time, then each voter faces four different outcomes (see chart below).  First, let’s assume that the individual refuses to give up any program that benefits him.  In this case there are two possible outcomes.  If all other programs are reformed, we have Case I where the individual is a clear Winner: he gets to keep his government subsidy but no longer bears the cost of everyone else’s.  Other citizens may not be so generous, however.  In the more probable case where no one gives up anything, we revert to Case II, the Status Quo.  This is where we currently seem stuck.  There are reasons to think that being here is quite costly.  The nation’s main entitlement reforms are not sustainable over the long-term with out significant tax increases or difficult to achieve reductions in the cost of health care and current tax policy creates perverse incentives in many ways.  Moreover, because the government is in the business of handing out benefits, significant resources are devoted to seeking and defending favors from the government rather than to creating social wealth.

If on the other hand, the individual gives up his special benefit, the rest of society may reciprocate, leading us to Case IV,  which maximizes social welfare.  In this case government programs seek to maximize social rather than personal wealth, groups do not feel the need to spend large amounts of money lobbying Congress for favors, and resources end up wherever they are most valuable.  But more probably, the individual’s sacrifice will not result in significant reform.  In this Case IV the individual is clearly a Sucker.  He has lost his benefit but still has to bear his share of the cost of all the others.  Although the outcome may have significant consequences for the individual, society as a whole is virtually unchanged.

We can draw some conclusions from this game.  First, if every person makes his decision separately, then no one is likely to agree to entitlement reform.  No matter what others decide, individuals are always better off keeping what they have.  This makes it impossible to get to the Social Maximum.  Second, it might very well be true that everyone prefers the Social Maximum over the Status Quo, but because there is no way to  reach it, individuals effectively face a choice between the  Status Quo and being a Sucker.  Third, if the Social Maximum is to be reached, two things must be true.  First, individuals must prefer it to the Status Quo.  Second, there must be a global agreement in which everyone gives up their programs if and only if everyone else does the same.

There are good economic reasons for thinking that tax and entitlement reform would boost national welfare.  But it is not yet clear that the public perceives this to be the case.  For entitlement reform to happen, most voters must believe that they would be better off after reform than they are now.  There is not a lot of evidence that they do and I think that part of the reason is because they doubt that the gains from faster growth will be distributed widely.  But part of the reason may be because few people think true reform is possible.  They view their choice as being between the Status Quo and a Sucker.  Jumping to the Social Maximum requires a grand bargain in which reforms are considered en masse rather than individually.  That requires both leadership and vision.

Republicans must now develop that vision in some detail.  Most probably, it will have to involve aspects of fairness and income equality in addition to economic growth, because many people are more concerned with losing what they have than they are with gaining more.  It should also ask much more of the wealthy and privileged, of whom nothing has been asked and much has been granted.  And it will have to be broad.  Maximizing economic growth cannot be the only, or even most important, objective.  Developing and selling such a program will test the Party’s ability to understand and represent the average voter.  In the end, entitlement reform is inevitable.  We simply cannot pay all that we have promised.  The sooner we begin to straighten our balance sheets the better.  But that does not mean that Americans are ready for it or believe it can happen.

Finally, even if the Social Maximum is reached, the game goes on.  Each person is still better off if he can restore his program without giving up the other benefits of reform (Winner).  Thus government must be ever vigilant to prevent the type of  backsliding that occurred after the 1986 tax reform.  As long as government is in the business of handing out favors, the game of rent seeking and special interests will merely begin again.


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Filed under 2012 Race, Entitlements

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