06 Sep 2007Working Paper Summaries

The Excess Burden of Government Indecision

by Francisco J. Gomes, Laurence J. Kotlikoff and Luis M. Viceira

Virtually all U.S. policymakers, budget analysts, and academic experts agree that the United States faces a very serious, if not a grave, long-term fiscal problem. Yet few policymakers will publicly say how or when they would fix it, perhaps because they fear being the bearer of bad news and getting voted out of office. Delaying the resolution of fiscal imbalances incurs two costs, however. First, it leaves a larger bill for a smaller number of people to pay. Second, and of primary interest to this research, it perpetuates uncertainty, leading economic agents to make suboptimal saving, investment, and other decisions, and reducing welfare. This research identifies and measures this "excess burden" of government indecision and finds that it is economically significant. Key concepts include:

Whatever policymakers gain from delaying bad news, delay fosters and exacerbates economic uncertainty.
As individuals wait to learn the level of future Social Security benefits, the fact of having to wait materially affects their consumption, saving, and portfolio decisions. Most important, it reduces welfare. The result of government indecision, in this instance, can exceed more than .5 percent of individuals' resources, a significant amount.
The excess burden is highly sensitive to the degree of risk aversion, the number of years one must wait to have the policy uncertainty resolved, and the size and probability of policy changes.
People experience sizable welfare gains from learning early about future changes in benefits and tax rates regardless of their attitudes toward risk or the uncertainty they face about their own labor earnings.

Author Abstract

Governments are known for procrastinating when it comes to resolving painful policy problems. Whatever the political motives for waiting to decide, procrastination distorts economic decisions relative to what would arise with early policy resolution. In so doing, they engender excess burden. This paper posits, calibrates, and simulates a life cycle model with earnings, lifespan, investment return, and future policy uncertainty. It then measures the excess burden from delayed resolution of policy uncertainty. The first uncertain policy we consider concerns the level of future Social Security benefits. Specifically, we examine how an agent would respond to learning in advance whether she will experience a major Social Security benefit cut starting at age 65. We show that having to wait to learn materially affects consumption, saving, and portfolio decisions. It also reduces welfare. Indeed, we show that the excess burden of government indecision can, in this instance, range as large as 0.6 percent of the agent's economic resources. This is a significant distortion in of itself. It's also significant when compared to other distortions measured in the literature. The second uncertain policy we consider concerns marginal tax rates. We obtain similar results once we adjust for the impact of tax rates on income.