Editor’s note: This is the second of two columns on the importance of good information in economics. The first column is Markets and citizens need reliable information.
Good information is crucial to sound decision-making. Market economies and democratic political systems are not exceptions to the rule.
In large industrialized economies, investors need reliable information about corporations for capital markets to function efficiently. Bad information means that capital is used inefficiently and society gets fewer of its needs and wants satisfied.
In democracies, citizens need reliable information about what government is doing and what the likely effects of alternative policies may be. As it is for markets, bad information in government generally makes society worse off than if more trustworthy information were available.
It is clear that truthful information about both corporate finances and government finances benefits society. The problem is how to obtain it, and the task is different in the two different spheres of public life.
In virtually all societies, government has the legal right to regulate business activity. However, the private sector can voluntarily develop standards for itself, including ones regarding accounting and financial reporting. Countless industry and membership associations have worked to develop industry standards and codes of practice that generally have been beneficial to economic output and to our society as a whole.
But if such private sector standard-setting fails, government can step in. When financial disclosure standards adopted by industry groups fail to adequately serve the public, the SEC and other agencies can require more effective measures.
Government is different. First of all, problems in government largely involve budgeting or forecasting expected outcomes. This is inherently harder than recording and reporting actual transactions that have already taken place. Second, there is no external entity that can force the U.S. Congress to adopt financial reporting standards.
Moreover, under the traditions of our federal system, states have broad autonomy to handle their own budgeting, taxing and spending. While the federal government may have the constitutional authority to require states to adopt greater transparency in communicating fiscal matters to citizens, this is not likely to happen.
Unfortunately, it is clear that Congress and legislatures need some sort of external constraint to discipline how they estimate and communicate expected taxes, spending and budget deficits or surpluses.
It is not at all hard to find individual elected officials who privately deplore some of the monkeyshines in how expected outcomes of government financial actions are presented to the public. However, our political system is such that it is extremely difficult for our legislative branches to discipline themselves. They need “mutual coercion, mutually agreed upon,” to use a term coined by biologist Garrett Hardin.
Developing more accurate and transparent budgeting and financial reporting standards is not the only task that Congress finds impossible. Managing the money supply and closing military bases are politically even more difficult problems. Congress recognizes this. It lets the Federal Reserve handle the first and take whatever political heat ensues. It successfully has organized base closing commissions to handle the second.
These historical examples provide insights as to how Congress and state legislatures might reform themselves. The European Union, which repeatedly morphed itself over the past 50 years contributes others.
Here are three suggestions:
First, at the federal level, Congress should establish an entity that is isolated from direct political pressures, like a base-closing commission, to determine what might be done to improve the honesty and transparency of “scoring” tax and spending measures. Experienced elders from both parties, people like George Mitchell, Sam Nunn, Howard Baker and George H.W. Bush, could lend authority to such an independent body. In setting up the commission, include the provision that Congress will accept or reject its recommendations on an up-or-down vote without amendments.
Second at the state level, form a “coalition of the willing” among progressive states to establish a similar blue-ribbon commission to prescribe recommended practices for budgeting and reporting at the state level. Have the group include members from rating agencies, such as Moody’s, that have experience in evaluating and comparing states’ fiscal positions. If a core of progressive states adopts some code of “recommended practices” in reporting of state finances, bond markets will quickly impose pressures on other states that do not.
Finally, choose start dates well in the future. It is a lot easier for any elected body to commit itself to self-discipline if it does not have to start before the next election. But include measures to deter moving the start date forward. The EU took over six years in an ambitious effort to remove border barriers to business within its 12 members that culminated in 1992. It then took another seven years to introduce a single currency by 1999. But it achieved both actions because member nations were able to make early commitments toward a far-off goal and then use those commitments to overcome short-term political resistance to reform.
Recommended practice codes in state and federal finance won’t eliminate all uncertainty and won’t fix all temptations to dissemble. They would, however, provide greater support for fiscal honesty during those high-pressure final weeks of legislative or congressional sessions when temptations to pull out mirrors and puff smoke become most seductive.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.