Archive for July 21st, 2018

When I argue against tax increases, I generally rely on two compelling points.

  1. Higher taxes will undermine prosperity by penalizing productive behavior.
  2. More money for politicians will trigger more spending, so red ink will increase.

When I argue against centralization and urge Swiss-style federalism, I also rely on two very strong points.

  1. Local governments will be more responsible if they raise and spend their own funds.
  2. Competition among local jurisdictions will encourage better public policy.

Now let’s mix these issues together by looking at some academic research on what happens when politicians get a windfall of revenue from a  centralized source.

Well, according to new research from Italy’s central bank, bigger government means more corruption.

…large financial transfers from a central unit of government to lower levels of government…come with the risk of exacerbating the agency problem due to the fact that the funds are collected at a higher level and then managed locally with typically little transparency on the actual amount of resources received by each local area. This moral hazard problem may increase incentives for local administrators to extract rents from the funds received. …growing evidence suggests that illegal practices and rent seeking are still often associated with the receipt of transfers from a central government. …we investigate the relationship between financial transfers from a central level of government to local administrations and the coincident occurrence of white collar crimes at the same local level drawing from the case of EU funding to Southern Italy. …The South of Italy has been one of the largest recipients of EU funds: in the most recent programming period it received 25 billion euro out of the 35 billion total allocated to Italy and managed at the local level. The empirical analysis exploits a unique administrative dataset of criminal episodes in Italy and matches them to the records of all the transfers from the EU to each single municipality over the period 2007-2014. We find evidence of a significant positive relationship between EU funds and the occurrence of corruption and fraudulent behaviors in the recipient municipality in the same year. …the robustness analysis we performed provided evidence that the correlation between transfers and corruption that we estimate is likely not just spurious or due to confounding effects

As far as I’m concerned, these results belong in the “least surprising” category. Of course you get more corruption when government gets bigger.

Now let’s look at another study. A few years ago, academic scholars produced even more compelling research from Brazil.

The paper studies the effect of additional government revenues on political corruption and on the quality of politicians, both with theory and data. The theory is based on a version of the career concerns model of political agency with endogenous entry of political candidates. The evidence refers to municipalities in Brazil, where federal transfers to municipal governments change exogenously according to given population thresholds. We exploit a regression discontinuity design to test the implications of the theory and identify the causal effect of larger federal transfers on political corruption and the observed features of political candidates at the municipal level. In accordance with the predictions of the theory, we find that larger transfers increase political corruption and reduce the quality of candidates for mayor. …The empirical findings accord well with the implications of the theory. Specifically, an (exogenous) increase in federal transfers by 10% raises the incidence of a broad measure of corruption by 12 percentage points (about 17% with respect to the average incidence), and the incidence of a more restrictive measure—including only severe violation episodes—by 10.1 percentage points (about 24%).

By the way, this persuasive research isn’t just an argument for smaller government and fewer transfers.

It’s also why foreign aid generally has harmful effects on recipient countries. Handouts line the pockets of the political elite and enable a bigger burden of government.

It’s also one of the reasons why I’ve referred to the International Monetary Fund as a “dumpster fire.” That bureaucracy leverages its money (the U.S. is the biggest backer) to encourage higher tax burdens and more redistribution in countries that already are suffering from too much bad policy.

The two studies we’ve reviewed today are simply an exclamation point.

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