1. STEVEN KACZMAREK
GENE D. BALAS, CFA
631 574 2474
Info@EastEndWealthManagement.com
www.EastEndWealthManagement.org
September 2012
Public C hoice Theory and the Politics of Instant Gratification
the fiscal cliff approaches on January 1,
Aswhen automatic spending cuts,goes into hikes2013,
tax rate
and
elimination of certain deductions
effect, we
must consider how we got to this point – and how to
get out of it, if we can. The effects are economic, but the
causes are psychological, sociological and political. Let’s
explore the causes of why we are here, with a mountain of
federal government debt that rivals our economic output,
on top of debts states and cities owe, not to mention our
own personal obligations. While it may seem strange to
consider, perhaps entirely logical decisions led to a rather
illogical state of affairs.
First, politicians do not simply appear in office. We elect
them. We should hopefully know what policies they
support beforehand, and we might reelect them based on
what they did while in office. If we had any objections, we
could have made a different choice. Our obligation – and
certainly that of all elected officials – is to vote for what
is in the best interest our nation. As we will see, however,
people acting entirely rationally can act in a way that is
in the best interest of the fewest people at the expense of
that of the most.
Politicians make all sorts of promises, and at least some
of us seem to believe them. A car in every garage – with
lower taxes at the same time to boot! Who wouldn’t vote
for such things? But remember, if it sounds too good to be
true, it probably is. No matter how clever at legislating,
politicians haven’t been able to outlaw the rules of simple
math. To balance a budget, income must be greater than
or equal to expenses. It’s just that simple.
But really, it’s quite complicated. At this point, we must
introduce a concept known as public choice theory.
Public choice theory uses modern economic tools to study
problems that are generally in the realm of political science.
From the perspective of political science, it explains how
voters, politicians and bureaucrats all act in rational selfinterest, but which results in political decision-making
outcomes that conflict with the preferences of the general
public. Several public choice scholars have been awarded
the Nobel Prize in Economics, notably James Buchanan
(1986), along with others, including George Stigler
(1982) and Gary Becker (1992).
Delving into how this theory works in practice, consider
the example of special interest groups – those lobbying
efforts by corporations or other agents who want spending
for a particular project. By itself, one individual project
might be a “small” amount compared to the federal
budget. Lobbyists work hard to get projects done.
Even though the public might oppose excessive spending
in principal, few members of the public have the time or
energy to combat the intensive lobbying efforts for the
many individual projects that go before lawmakers. After
all, one project by itself might seem like not a large sum
to the government, but it is a very big deal to the special

2. interest group in question. Not to mention, of course,
voters in a district that benefits from these projects will
certainly not complain. Instead, they might be more,
not less, likely to vote for a politician who proposes these
spending projects, even if it might be considered by others
to be “wasteful.”
As such, the cost/benefit relationship is distorted.
Proponents invest much more in the outcome than those
who might oppose the measures, simply because those few
people stand to gain quite a bit, compared to individual
members of the public, whose costs, individually, are quite
small. Suppose a new, hypothetical “bridge to nowhere”
costs $30 million to build. But is it worth me fighting
about it when its costs average out to be ten cents to me
(and every other American)? Am I even a voter in that
representative’s district?
It’s in my own, individual best interests not to fight this one
hypothetical project. This is not the most productive use
of my time and energy, especially given my poor chances
of succeeding in a one-man effort against a lobbying firm.
Hence, even if I am angered by excessive spending, I
am acting in an entirely rational fashion to ignore this
particular project, preserving my own resources of time
and energy, but acting against the nation’s long term best
interest.
Then there are other reasons beside the money involved.
Politicians might feel a bit more powerful and might feel
like they have a bit more clout on Capitol Hill, if they
can get the project in question passed. More importantly,
politicians might want a new career as a lobbyist
themselves at one of those firms after leaving government.
It always helps to play nice with someone who might be
your new boss.
All of this means that many small bad decisions get
multiplied into a much bigger problem. There are 535
members of the US Congress, with plenty of opportunity
for special interest spending to be introduced.
Meanwhile, voters in each district are focused only on
the policies proposed – and the results delivered – by
only their representative when casting a vote, reducing
the accountability of the institution as a whole. Costs are
diffused, while benefits are concentrated, and all of it is
someone else’s money, anyway.
Thus, public choice theory shows that individuals are
acting in a rational fashion, focused on their own selfinterests, leading to a very poor outcome for the nation
as a whole. That leads us to our current dilemma. We’ve
seen debts grow and grow after many, many years of deficit
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spending. All those little sums of individual projects have
added up in a very, very big way. What were we thinking?
Perhaps we were just hoping it would all go away. For
decades now, we’ve engaged in mass delusion; that
somehow, growth would subsume the need for restraint.
We’ve believed that the magical powers of some yet-tobe-determined force would create powerful economic
growth that would obviate our need for balancing
budgets. But one must never build a budget or economic
models based on just hopes and wishes; yet that is what
we, as a country, have done.
We’ve had ample opportunity to see that this hasn’t
worked, over decades, if not entire generations. We’ve
spent more than we’ve earned in the difficult 1970’s and
in the prosperous 1980’s. We did it again in the booming
1990’s, except maybe for a year or two, and then again in
the austere 2000’s. We’ve had ample opportunity to see
that there is no economic genie that will grant our wishes
for the problem to simply go away.
We could have voted for politicians that were realistic,
but people don’t like to hear Debbie Downer giving a
political speech. A salesman always sells more cars than
the engineer who knows how they work.
Now, things have come to a head. We’ve seen the disaster
that excessive debt has wreaked in Europe, and we’re
eager to avoid those problems now. We do recognize the
European model of generous spending has failed. But
perhaps Europe’s attempt of a solution of immediate
austerity does not work, either. Indeed, a starvation diet to
wean us off gorging on debt spending can lead to problems
with our economic health. Like a rubber band stretched
too far and snapping back in the opposite direction, is our
current fixation with rapid deficit reduction going too far
in the other extreme?
So, we might ask, can we have a better solution, perhaps
a more moderate approach to cutting the deficit rather
than try to do most of it all at once? What businesses
(and consumers) want mostly is to know what is going to
happen with taxes and spending; they aren’t necessarily
asking that all of these things happen right this second,
as long as they know that there is a credible plan. And a
more gradual implementation of this fiscal restraint can
give both businesses and consumers more time to plan
and adjust, rather than going off the fiscal cliff.
By now, many of you have heard about the federal belt
tightening that is scheduled to begin January 1, 2013. This
is because our two primary political parties are unable to
compromise, the same factor that Standard & Poors cited
when downgrading our federal government debt. The
2

3. Congressional Budget Office (CBO) reports that fiscal
tightening will lead to a recession in 2013. They detailed
their findings with a number of economic projections,
comparing if we go off the fiscal cliff (meaning lawmakers
do nothing), or if politicians change the current law to
reduce the impact of the fiscal restraint.
now must pay the price for decades of voters who seem
to always want politicians to give us more spending with
lower taxes. If we didn’t want to accumulate that debt in
the 1970s, the 1980s, the 1990s and the 2000s, we sure
had ample opportunity to break out of this debt snare
long before it hit a crisis.
Specifically, here’s what the economy might look like
without going off the cliff, that is, if current law is changed,
but current policies remain the same. (Remember that the
way the law is currently written, we will go off the fiscal
cliff. Lawmakers must change the current law to retain
taxes and spending as they are now to avoid the cliff.)
But as we learned, in our nation’s journey on the way
to the fiscal cliff, perhaps we weren’t as irrational, as
individuals, as an outside observer might think. Yes, who
would vote against the best interests of the country? But,
as public choice theory demonstrates, people acting in
a rational fashion can, ultimately, act against their own
best interests when viewed as citizens, members of the
nation as a whole, not individuals. That is the paradox.
»» In 2013, the deficit would total $1.0 trillion,
almost $400 billion (or 2.5% of GDP) more than
the deficit projected to occur under current law
(but it is still $91 billion less than in 2012).
»» Real GDP would grow by 1.7% between the
fourth quarter of 2012 and the fourth quarter of
2013, and the unemployment rate would be about
8% by the end of 2013 (basically, right near where
it is now), the CBO projects.
Now, here is what happens if we do go over the cliff
(remember, this happens if lawmakers simply do nothing).
»» The deficit will shrink to an estimated $641 billion
in fiscal year 2013 (or 4.0% of GDP), almost $500
billion less than the shortfall in 2012.
»» Such fiscal tightening will lead to a recession, with
real GDP declining by 0.5% between the fourth
quarter of 2012 and the fourth quarter of 2013,
and the unemployment rate rising to about 9% in
the second half of calendar year 2013.
»» Because of resource slack, the rate of inflation, as
well as Treasury yields, will remain low in 2013,
in the CBO forecast.
No matter how we got to this point, or what theories
explain it, we are in a difficult bind. Competing
paradigms now battle each other. With gridlock in place,
current law will undo decades of overspending relative to
our revenues in just one short year. Yes, we need to move
closer towards a balanced budget over a reasonably short
period of time, but a compromise solution certainly could
allow for, well, compromise, from lawmakers on both
sides of the aisle.
The only way that we can gradually descend from our
mountain of debt, instead of tumbling headlong off the
edge, is for the leadership of both parties to work together.
Unfortunately, that is less likely than not.
Maybe deliberately jumping off the cliff could still be
avoided. However, the problem is, economic troubles may
start sooner if businesses and consumers start cutting
back before the fiscal cliff arrives. By then, it may be too
late, as a recession may start, based on worry and doubt.
But relying on hopes and wishes rarely leads to prosperity,
either. Can there be a middle ground, a rational decision
process that leads to our mutual best interest, for all of us
and our nation as a whole?
Pick your poison: a recession now or more debt. The
CBO notes, though, long term, our economy will be in
better shape with the deficit reduced significantly. We
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4. B iographies
STEVEN KACZMAREK
Steve is the President of East End Wealth Management. He has over 30 years of experience in trading and risk
management in a wide range of markets. Most recently, Steve held the position of Managing Director at Legend
Merchant Group. His background also includes the positions of Partner at Schonfeld Securities; a proprietary trading
firm, NYMEX floor trader and Lieutenant, United States Army Reserve. Steve graduated New York University with a
degree in Economics.
As an active member of the investing, planning and trading community, Steve is a member of NAIFA and the Financial
Planning Association. Locally, he is the Chairman of the Southampton Youth Board, focused on youth issues on the
East End of Long Island.
gene d. balas, cfa
Balas has over twenty years’ experience in investment management. He currently writes economic commentary for
TheStreet.com’s RealMoney site. Previously, he was Director of Investments at Genworth Financial Asset
Management. In this role, he performed forecasts on macroeconomic conditions and determined the influences of
thematic drivers to develop investment strategy, He also headed the firm’s manager due diligence efforts. Prior to
GFAM, Gene was Director, Investment Management & Guidance at Merrill Lynch & Co. In that role, he advised
pension funds, endowments and foundations as to appropriate asset allocation strategy. In previous roles, he advised
both institutional and individual investors on asset allocation and manager selection decisions, beginning his career in
1989. He has an MBA from Columbia Business School and a BBA in Finance from the University of Houston, where
he attended on a full National Merit scholarship. He is a Chartered Financial Analyst.
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