In the previous post, I proposed a Federal Budget more aggressive and fiscally proactive than that of the Republican-led House of Representatives. However, the plan suffered from a critical principal-agent problem in bringing the budget into surplus--that politicians lack any incentive to do so. Democracies have a deficit bias.
Therefore, an incentive plan, deemed a Fiscal Accountability Act (FAA), is needed to re-align incentives. In this post, I show how such a plan would be calculated and its impact on the House Budget.
The Bonus Plan - The Participants
In an FAA, all elected members of Congress and the Executive Branch, counted as 537 persons in this case, would be eligible for a bonus as a function of GDP growth and the change (reduction in) government debt.
Politicians would be rewarded for fostering rapid GDP growth. In this plan, they would be eligible for a share ('the Bonus Factor') of real GDP growth, measured in dollars, beyond a certain threshold (the 'Participation Threshold').
The Participation Threshold
Even a mediocre and unmotivated Congress and Executive should be able to produce 1.5% real GDP growth, and therefore no bonus is due for GDP growth below this level. Real GDP growth above the Participation Threshold, here defined as real GDP growth of 1.5% per annum, would be counted into the Bonus Basis, the dollar number from which Bonuses are calculated.
Change in Government Debt
In addition to being paid for solid GDP growth, politicians would be punished for increased government debt and rewarded for decreased government debt. The amount of the change in nominal terms would be counted into the Bonus Basis. In other words, if the government borrows, it must produce additional GDP; otherwise borrowing is actively discouraged.
The Bonus Basis
As calculated in this model, the Bonus Basis is the change in real GDP above the Participation Threshold, plus/minus the (decrease)/increase in government debt, measured in US dollars. Pretty simple, really.
The Bonus Factor
The Bonus Factor is the percentage of the Bonus Basis (GDP growth and debt reduction) which will be paid out to the Pool Participants (the above-mentioned 537 politicians).
In a corporation, the bonus to senior management is typically on the order of 3-6% of profits. In an economy, the "profit" is GDP growth. The government, of course, is a very large entity, and therefore the Bonus Factor is much lower. I have proposed 0.25% of the Bonus Basis.
The Bonus Pool
The Bonus Pool is the Bonus Basis multiplied by the Bonus Factor. The Bonus Pool, measured in US dollars, is the sum of money in aggregate to be distributed to all the Participants (elected politicians) in any given year. Each Participant is entitled to one 537th share of the Bonus Pool.
This formula produces bonuses per Participant on the order of $1 million per year under CBO growth assumptions and my previously posted budget proposal. The bonus has two purposes. First, it is intended to motivate politicians to maximize growth and minimize debt. Second, it is intended over time to draw into government the most talented members of society best able to create sustainable prosperity. The difference between lackluster and modestly competent management of the economy is worth well over $1 trillion / year in 2024. And in this matter, no group of managers in the world has a greater impact on the creation and preservation of wealth than those occupying Congress and the White House.
This post does not address the matter of vesting, but the reader should assume a multi-year (4-5 years) vesting period with a clawback provision.
With that, let us consider a specific example predicated on my version of the House Budget.
In the above plan, real GDP grows per CBO assumptions, that is, by about $500 bn per year representing approximately 2.1% real annual growth. Real growth above the 1.5% threshold is typically around $110-140 bn, and this amount applies in the calculation of the Bonus.
The deficit is reduced and debt paid down per my previous post, and this change in added to (or subtracted from) the Bonus Basis, as the case may be.
The GDP growth and debt reduction elements are added to create the Bonus Pool Basis. Thus, for example, in 2024, GDP growth above the Participation Threshold is $134 bn and debt reduction is $168 bn, adding to a Bonus Basis of $301 bn.
This sum is multiplied by 0.25% to create the Bonus Pool for payment to elected officials and typically amounting to $500-750 million dollars per year. This constitutes an annual bonus of approximately $1 million or so per elected member, with about half the value coming from debt reduction. It is by this mechanism that we ensure adherence to maintaining a primary surplus for purposes of paying down debt.
The CBO takes a grim view of US GDP growth potential, holding it at around 2.1% over the projection horizon. The US government is expecting a feeble decade of growth. But what if the bonus plan incentivized Congress and the President to try a little harder to create growth. Let's assume with better management, the US economy could grow by 2.8% per year--more in line with historical growth rates. What would be the implications?
Below we see the impact on the Budget, Kopits version:
In this case, government revenues rise with GDP, as the percent of revenues as a share of GDP is unchanged from the base model. Spending on entitlements rises, but is offset by reductions in interest payments, as enhanced revenues allow faster repayment of debt. The budget surplus is much larger, rising to 1.5% of GDP. Debt as a share of GDP falls from 73% to 42% in 2024, compared to 47% in the base model.
Real GDP is $1.0 trillion higher than base in 2024, and cumulative GDP is $4.0 trillion higher over the period as a whole. Government debt is $2.5 trillion lower than in the base case by 2024.
Bonuses are also much higher.
Bonuses increase rapidly as GDP increases from the 1.5% Participation Threshold. In addition, higher growth allows more rapid repayment of debt, and therefore debt-reduction linked bonuses also rise. Overall, bonuses increase by about $1 million / member / year in the higher GDP growth version.
As can be seen from the budget above, the total cost of bonuses in the Federal budget is negligible. The $4 trillion increase in GDP compared to the base will have cost $10 billion in bonuses over the projection period. That's about $3 per US citizen per year for bonuses. Essentially nothing. The annual benefit is on the order of $10,000 / household in 2024.
There are those who believe the quality of national governance matters and that elected officials today are not motivated to either maximize growth or provide long-term fiscal sustainability. Some believe this is due to misaligned incentives, which currently favor the political and economically inefficient and ineffective allocation of societal resources to favored voting blocks. Those who adhere to this view will seek incentive structures which counter-act these non-market failures of democracy. This incentive plan is one such approach.
To my mind, such a plan would inaugurate a golden age of governance, when government would be primarily about making things better, not about splitting up the pie. It would make macroeconomists the highest paid professionals in the world, and bring prosperity to places that have never known it. This is the direction we should take.