The most recognizable tenet of Keynesian fiscal policy is that government should engage in deficit spending during economic downturns to “lean against the wind” and raise employment. Keynes, of course, did not envision perpetual deficits, with even bigger deficits during recessions—especially if they would raise the national debt-to-income ratio to such an extent that they would threaten insolvency and remove further stimulative spending from the set of available fiscal options. The ability to engage in Keynesian policy is thus impeded when a nation approaches a debt-related boundary, as America now has.

Such limitations also apply to social programs, the primary focus of much of federal spending. In the United States, entitlement spending accounts for over 70 percent of government expenditures and its reform is increasingly linked to discussions of deficits and growing debt-to-income ratios. Uneasiness related to this “entitlementationism,” like uneasiness related to Keynesianism, derives from its current association with national debt. Much of the health-care bill debate (as well as the debate over Medicaid, Medicare, and Social Security), for example, has to do not with the objectives of the programs themselves but with this alternative economic issue.

Continuing freely to apply Keynesian fiscal policy is today considered to be a middle-to-left-of-center political emphasis, while preventing dangerous levels of debt accumulation is generally considered a middle-to-right-of-center priority. Thus, it should be of interest to all parties to address both concerns while accomplishing positive social program outcomes—and, fortunately, there is guidance, consistent with modern economic principles, for doing so.

“Entitlementationism” is a concept that first surfaced in the mid-twentieth century—the period framed by the second term of Franklin Roosevelt and the Great Society years of Lyndon Johnson. It is the view that private goods such as health care, education, old-age consumption, and sometimes food, housing, and transportation can be effectively provided publicly. As a technical matter, economists distinguish between pure private goods, which provide benefits solely to the individual who consumes them, and pure public goods, such as national defense, which provide benefits to everyone.

The pairing of public and private provision of public and private goods results in four possibilities. Private provision of private goods through competitive markets is economically and scientifically supported as efficient. Public provision of public goods such as national defense (protection to everyone from enemies without) and law and order (protection to everyone from enemies within) is both a historically and theoretically valid government function. Private provision of public goods through market means can range from impractical to impossible and few polities have attempted it. The last pairing, public provision of private goods, particularly through entitlement programs, is primarily a twentieth-century phenomenon that seems to be running into trouble.

Modern Tools …

Is there a better way to accomplish entitlement objectives than through public provision of private goods? Low income is often correlated with low living standards and little access to good health care and education. Economists know, however, that lack of income is not intrinsically a health care problem, nor is it is a food problem, a housing problem, or an education problem; it is, of course, an income problem. Moreover, treating lack of income as if it were a health care problem (e.g., creating a program such as Medicare or a system of government health clinics) flies in the face of an economic principle of efficient policy referred to as “the intervention principle.” The intervention principle states that an economy that is run for the benefit of its members can best achieve an objective by its government intervening at the relevant price margin most closely connected to the object of interest.

Application of the intervention principle is straightforward. For example, if the social objective is to get the individuals in group A, who do not purchase health insurance, to do so, the lowest-cost way to accomplish this goal is to make purchasing health insurance more attractive to members of group A; this is achieved by precisely rewarding the purchase of health insurance precisely for the members of group A. Establishing government health insurance programs is not efficient for a number of reasons, including the fact that they tend to be too big to be precise. Government programs tend not to be targeted and usually provide goods rather than the prescribed incentives. In-kind giving (e.g. government-provided private goods or purchasing power such as vouchers or cash that can be spent only on the good) is inferior to cash, which can purchase the good in question but can be used for other necessaries by the recipient, as well, if warranted. Cash also does not encourage wasteful use as in-kind transfers do. (In-kind giving can lead to the following mindset: “I will accept the $100 of health care given to me, even if it is worth only $10 to me, because I cannot use that money for anything else.”)

Why would government engage in direct public provision of private goods rather than incentivizing their purchase (and handing out income) where needed? The primary justification for this is lack of information: If I want the individuals in group A to buy health insurance, but cannot identify who they are in order to incentivize the purchase, perhaps I should give everyone insurance; I know, however, that it will be disproportionately paid for by the rich and used equally or disproportionately by the members of group A. As just described, such entitlement programs will be more costly to society as a whole than targeted plans.

A companion to the intervention principle, the “incentive symmetry principle,” says that positively rewarding a desired action can be equivalent to negatively rewarding the opposite of the desired action. For example, rather than paying accused defendants to appear for their trials, the legal system applies the negative equivalent by making them post bond, which they lose if they do not show up. To make two reward systems equivalent in an economy sometimes requires making money payments to particular parties. For example, if food and insurance are the only two goods, you can make insurance more attractive relative to food either by raising the price of food or lowering the price of insurance. If the price of insurance is lowered, it eventually becomes affordable to everyone but creates an unnecessarily costly program, whereas if the price of food is raised, some may not then be able to afford insurance, even if they now want it.

Neither the intervention principle nor the incentive symmetry principle was known fifty years ago when most of our welfare programs were first enacted. When jointly employed, they form a powerful tool to lower costs and solve information problems as we now try to reform these same programs.

… For Modern Problems

Both the intervention and incentive symmetry principles apply in the case of health insurance (and for most other services provided by social programs), and they need to be taken into account by those struggling to lower costs while providing private goods. First, imagine the consequences of a hypothetical world where everyone is desperately interested in buying health insurance. Those who can afford to do so make the purchase. Those who cannot afford the purchase are invited to self-identify by visiting the government window and explaining their circumstances. If they qualify, they are granted cash. (We already know that the individual wants insurance because the motivation to buy insurance can be made as strong as we want as explained in the next paragraph.) So, without loss of generality, we may assume that the cash is applied toward insurance purchase. The necessary group self-identifies, so lack of information (i.e., inability to identify the group in need) is no longer an impediment. Ineffective in-kind programs are no longer needed, because outlays are granted in cash form and incentives satisfy the intervention principle. Relative to a broad-based entitlement program, expenses are low because they are targeted.

Next, consider the motivation to buy insurance. Incentive symmetry suggests that there are always alternative means to creating incentives, and one useful approach is to apply a broad-based tax that raises the price level by a given amount. (Some variant of a consumption tax, such as a value-added tax, would raise prices. If prices are raised high enough, they form the strong incentive: no one will pay five times more for their food and clothing if this can be avoided by buying health insurance.) Those who have health insurance would be rebated the tax or would not pay it at the point of purchase. Coverage can be verified in several ways, such as by swiping a card at the point of purchase. Another alternative is for rebates to be applied for periodically, as is done now for sales tax credits when federal taxes are filed. The net result is that there is a reward for buying insurance. Those with insurance face unchanged net prices, however, and thus pay no tax, and since everyone has the ability to buy insurance (though some self-identify to receive aid before buying it), no one will pay the incentive-creating tax. The incentive does its job without collecting any revenue or requiring any government outlay. Incentive symmetry informs the design of the incentive, and application of the intervention principle ensures that the intervention is targeted and rewards precisely the desired activity.

It is undeniable that improving the way we provide entitlements would lead to massive savings. The U.S.’s many entitlement programs each affect the deficit and debt differently, but let us take a look at Medicare. According to evidence cited by Thomas Saving, former trustee of the Social Security and Medicare Trust Funds, and John Goodman, President of the National Center for Policy Analysis, “seniors on Medicare use twice the health insurance as seniors who are still on private insurance, everything equal.” The suggestion—though more work would be required for a proof—is that entitlement programs that publicly provide private goods are financially inefficient and can be replaced by targeted interventions that are much less costly and no less effective.

Spending less ultimately leads to lower deficits and lower debt. This, in turn, frees Keynesianism and other social policies to be evaluated and implemented on their own merits.

Earl L. Grinols is a former Senior Economist for the President’s Council of Economic Advisors. He is currently Distinguished Professor of Economics at Baylor University. His most recent book is Health Care for Us All: Getting More for Our Investment published in August 2009 by Cambridge University Press.

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