The Perverse Effect of Spending Caps

Abstract

Spending caps have become popular as a means to curb public expenditure. But the effect of spending caps is unsettled both theoretically and empirically. The most thorough treatment of the issue is provided by Ferejohn and Krehbiel, who argue that it is necessary to take preferences of politicians into account when analyzing the effect of spending caps. They conclude that spending caps may have both desirable and perverse effects, i.e. lead to lower and higher spending. Unfortunately Ferejohn and Krehbiel’s model has never been tested and it is not clear how it fares theoretically in systems with more than two issues. This article makes two contributions. First, it generalizes Ferejohn and Krehbiel’s model to cover systems with as many issues as in real world budgeting. Second, it provides an empirical test of this model. To avoid problems of measurement and endogeneity, the test is conducted as an experiment. It confirms the general model, supporting the claim that spending caps have predictable but counter-intuitive effects on spending.