Nobel Prize pundits (Science, October 18, 1996) credit successful applications of William Vickrey's idea to areas such as the spectrum and Treasury debt auctions, as a contributing factor in the award of Vickrey's prize. Why not now, in Vickrey's honor, extend the idea to expenditure allocation affecting distributive Federal programs? Following Vickrey's idea, an incentive-compatible approach to grant-in-aid design for distributive programs was initially set forth in an unpublished paper (Clarke, 1981), entitled "Reforming the Grant-in-Aid Pork Barrel," and was briefly described with respect to "A Limited Fund Mechanism" for allocating Superfund by Tozzi and Clarke (1983). More recently, Brough, Clarke and Tideman (BCT, 1995) described a compensated incentive-compatible approach first elaborated by Tideman (1979) to airport slot management and noise regulation. This method, described in BCT (1995) effectively separates the allocation of a resource (i. e. airport slots) from distributional questions, i. e., whether airlines should be entitled to landing rights as opposed to communities or the public at large. The method is an adaptation of the second price auction (Vickrey, 1961) and Clarke's demand revealing method for public goods allocations (Clarke, 1971).
Figure 1: Interest Rate Determination for State Revolving Fund (SRF)
Table 1: Agenda Setting (2 options)
Table 2: Agenda Setting (3 options)
In this case, Vermont is able to organize a complementary set of expenditures (using say a portion of 10% of its unified grant or $6.7 of $67 million), including those of New York's $100 million, to effect a $.7 million addition to total net benefits. With the selection of option C rather than the next highest option A, there is a slight improvement to New York, a $.2 million "leakage" (disbenefit) to other regions, and a $.8 million improvement for Vermont.
To effect this selection, Vermont would make a GPP payment of $.1 million because in the absence of its expression of net benefit, option A would have been chosen by a vote of $19.8 million to $19.7 million, or $.1million.
These pivotal payments are, of course, small change and could be considered as small adjustments in the interest rate on funds charged to the relevant beneficiary jurisdictions and their private partners. For example, if a base interest rate of 7% yielded some $75 million in present value over 20 years, over and above the $107 million in New York and Vermont capital investment in Option C, pivotal payments of a few million would be a small element in their decision calculations.
Also of importance is the incentive structure driving the agenda setters -- the National committee and the potentially cooperative (or competitive) executive officers as well as the Commission. The above example provides a convenient vehicle for introducing a specific incentive structure to properly motivate these actors. Following Bailey's constitution (1996a), a possible set of incentives would include payments that are a positive function of budget size (.1%), social gain over the status quo (3%) and a negative function (0.5%) of harms. For the advisory committee, this would be about $95,000 when we compare Option A over the status quo (B). Now if a private party is able to convince the committee to add in something like Option C, the incentives might be some 10 times larger. In addition to the small positive reward for budget size (0.1%), the incentive would be 30% of the net social gains less 5% of the harms. This would be shared between the private party and the committee.
The private party could also shop in regional and local legislative fora, putting together options that would compete formally with those advanced by the national committee. There would also be strong incentives to use funds earmarked for particular projects in areas where they may not be used most efficiently. For example, we have a lot of smaller states (like Vermont) as well as in the West and Hawaii that get a lot more in transportation funds than they pay in Federal gas taxes. The GPP gives them the choice of (1.) saving the funds if the opportunity costs are high enough (and reducing their own gas or other taxes with the interest proceeds), (2.) spending the funds for improvements that will improve the use of our cultural heritage while advancing conservation goals or (3.) more traditional projects (airport improvements and highways). To the extent that projects are financed through beneficiary taxes (including land rents), then the local taxpayers are able to invest the funds in projects elsewhere at rates approximating the social cost of capital.
National Resource Allocation: Combining the Pivotal Mechanism and Thompson Insurance
We now present a situation where the efficient rent seeking on the part of potential competitors (the national committee, the EOs and private parties) is very aggressive. Large projects with high rates of return are identified, along with reasonable cost sharing and beneficiary-tax plans that can be approved under the aegis of the Electoral Commission (and appropriate state authorities), so that the incentive-based rewards from selection of the more aggressive projects promise to be substantial.
Let me address first the issue of when we go from agenda setting with the pivotal mechanism to combined pivotal/Thompson representative referenda. The national committee, of course, uses the pivotal mechanism in its deliberations and to the extent this leads to the wisest decisions, no referenda will be needed. This will also be true the extent to which the potentially competitive EO's tailor regional/local solutions to achieving the highest net social benefit.
In addition, we have utilized, in the Federalist setting above, representative referenda guided by the agenda setting activities of the committee and the EO's. However, they operated under budgetary constraints and inflexibilties that might not be always appropriate. In effect, we might carry the agenda setting process to the point that most of the parties are in reasonably unanimous agreement about most resource allocational decisions. However, a remnant of controversy remains to be addressed in the national budget game. In addition, this forum is the appropriate place to make determinations on the question of overall budget size, as instanced by decisions to permit subnational governments to dip into the deficit reduction set aside through a particular decisionmaking procedure designed to implement "truth-telling" in budgeting.
To also address questions when a project requires referendum consideration, we might apply certain tests. In the above examples, we could have required that no project where the ratio of material gains less redistributive harms is less than 1.2 would be considered. This is the point where the incentive payments (i.e. 3% of net gains less 0.5% of harms turns approximately negative, at a more precise ratio of 1.16). This might be combined with a presumption against a pure pivotal payment of any significant size -- if pivotal (GPP) payments are generated, a Congressional referendum might be called instead. In the examples previously presented, we would guess the referendum test would be passed as the payments would be regarded as insignificant. In the examples presented in this section, the GPPs are quite large, even though the preferred alternative satisfactorily, but barely, passes the 1.2 test.
The examples illustrate a participatory approach to budgeting that grows out of a 1979 debate (Ferejohn, Forsythe, and Noll vs. Clarke) about the use of demand revealing in making budget allocations, e.g. for the Public Broadcasting Corporation's Station Program Cooperative (SPC). When I advanced the view that demand revealing was also indeed a potentially superior method of public budgetary decisionmaking (Tideman and Tullock, 1976), critics Ferejohn, et. al. (1979) Riker (1979) and others questioned its superiority by illustrating the susceptibility of the method to defeat by coalitions via zero sum games of traditional politics, including the traditional budgetary process.
Bailey (1996) shows that the pivotal mechanism working together with Thompson insurance is relatively immune from coalitions. In addition, the pivotal mechanism preserves the truth telling integrity of Thompson insurance.
This section elaborates on the characteristics of the operation of the incentive-based budget procedure when there are major conflicts or controversies between 2 or more separately constituted bodies (the committee, the EOs, and private parties). The competitive process drives each body towards the most socially efficient solution, so there is likely to arise, at the margin, some small gain along with GPP payments, which is always the case if we were evaluating a continuum of budgetary choices. The conflicts also arise when the 2 or more committees are drawing up plans from two separate population samples (i. e. a regional advisory committee vs. a national one), or particularly when some specially chartered committee (essentially a private government) pursues plans at odds with the general population.
The following examples pertain to a wide variety of transportation issues (controversies over major mass transit or intercity rail investments in the New York region or the Northeast Corridor, building a new Interstate (I-31) or a NAFTA corridor through the heartland linking Canada and Mexico, or building a replacement bridge or tunnel for the Woodrow Wilson bridge in the Washington region). They are also being used, in a slightly different format, to illustrate national budgeting of air traffic control and airport investments.
In the current contexts, let me now introduce some ways of resolving the previously identified problems in relation to the actual budgetary parameters used in the earlier debate. I also posit fundamental differences between two competitive committees (national vs. regional) which allows me to explore further the properties of Bailey's approach to incentive compatible governance. In the following example, we have two alternative budgets (A and B) made up of different program packages -- see also tables 11-13 drawn from FFN and Clarke (1979) and reproduced here as Tables 3 and 4 -- that generate different patterns of net benefits for the users. The combinations based on gross costs and benefits presented in Table 4 boil down two most preferred packages, CDE and CDA respectively. Also, our nine regions have been cumulated into five where we have the result for the Middle Atlantic (Region 4), with 15% of the cost shares, presented in Table 3.
Table 3: Comparative Net Benefits for One Region
Note: With respect to illustrative budget allocations, the $3 billion total budget level in the example outlined here conforms closely to the FFN and Clarke model of demand revealing and an adaptation (by FFN) of Groves-type procedures in the allocation of an approximately fixed collective common user budget. We use the same gross payoffs, cost shares and net payoffs (after costs) as FFN and Clarke, the only difference being that all payoffs are multiplied by 10 to the 8th x a $30 budget level = $3 billion.
Table 4: Costs and Values of Programs to Regions
CDA (Option B) = $2.85 billion
The model created here now suggests that in lieu of the GPP payments to achieve the preferred outcomes (those shown in Table 5 being a theoretical upper limit that is reduced towards zero in large number interactions involving as many as 435 representatives), we substitute Thompson insurance. In the aggregate, region 4 buys .5 times (.510 less .232b) = .278b in insurance, receiving back a refund measured by an almost certain positive Thompson insurance surplus less incentive pay (see later discussion).
Note: *The GPP is calculated by the difference is net benefit to all others when the other option (B) is chosen in the absence of the region's expression of net benefit (i. e. region 4's GPP = 3338 - 3210 = 128 million). See also Clarke (1979, Table 13).
To illustrate further, we take Clarke's (1979) analysis of the critical choice between CDA and CDE in the FFN model (see Table 5). With our new numbers, this critical choice implies a difference of $3.0 vs. 2.85 billion in the annual budget, for a difference of $150 million. There is also another proposed reallocation of $600 million from expenditures on A to be spent on E. However, if we apply the incentive tax procedure to the gross aggregations shown above in making the efficient choice of option A over B, given the cost shares, the result is $282 million in penalty taxes or GP payments.
The Electoral Commission, of course, has the incentive to try to get as close as possible to the ideal efficient distribution of cost. With a good knowledge of benefits and costs, the Electoral Commission could allocate $282 million more to parties 2 and 4 (54.2% vs. 45% of the cost of having E vs. A) and 9.4% less to parties 3, 5 and 1. We get $150 million in social gains at no cost. The extent to which this result can be achieved will depend, of course, on available information (including how well the sample of the citizenry predicts benefits for the population as a whole), on the costs of further search (including the tailoring of programs by the executive officers to particular regional/local circumstances), as well as such factors/limitations as available tax and budget flexibility (i .e. reasonable uniformity in tax assessments at the subnational level).
The above example reflects a situation where there would be strong pressures for a Thompson insurance referendum, absent successful negotiations between the opposing parties (2,3, and 4 vs. 1 and 5). Absent such agreement, the parties would now ask the Electoral Commission for odds on either side winning. Let us take these as equiprobable. Also the preferences are expressed solely in terms of material gain with the result that A is selected with total compensation of $525 million paid to regions 1 and 5, while reducing their harm to .5 x $525 million = $263 million. There is also a Thompson insurance surplus of $75 million which would be used to make incentive payments and cover administrative costs with the remainder returned to the participants through the refund procedure described earlier.
Returning now to the incentive payments described briefly above in the context of the New York-Vermont examples, we have the national committee with the winning proposal (A) receiving approximately $29 million in incentive payments. Of this there is $2 million relating to budget size, part of which has been shared with the other committee for common elements (CD) in the proposed budgets. There is another $27 million (or $45 - 18 million measured by 30% of social gain less 5% of uncompensated harm). According to Bailey, there would also be smaller payments to the members of the Electoral Commission unrelated to budget size, thus inducing that body to make appropriate Lindhal tax-transfers, to the extent practicable, to maximize social gain while minimizing redistributive harm.
The idea that Congress or any legislative body would ever use preference intensity voting rules may seem farfetched (see also Mueller, 1996, Ch. 11, also with reference to the use of demand revealing). However, as shown in a related paper on aviation governance, it is easier to see a government-controlled corporation administering airports and air traffic control governed by procedures analogous to those contained herein. The corporation would be subject to strong agenda control and the use of preference intensity voting would carry right up to a representative referendum described in this section where some form of determining budget size and restrictions is obviously called for. At that point, we might have to turn to more conventional tools such as qualified majority rules in the traditional legislature to resolve contentious issues. Nevertheless, the relative properties, and advantages/disadvantages of the preference-intensity revealing rules should be a lively arena for research, also applied to particular institutional settings explored in this and related papers.
In this paper, I have applied the same principles of agenda control to the allocation of distributive programs by the Congress. Professor Rubin and other skeptics may be right about the potential reluctance of "real political actors" and the "general political science" to adopt such procedures in real political settings. However, this should not be viewed as resulting from technical or operational limitations as much as the obvious difficulties inherent in changing our approach to the exercise of power and influence in matters affecting public decisionmaking.