Bargaining over Mandatory Spending and Entitlements

Do mandatory spending rules improve society's welfare? To answer this, we analyze an infinite horizon dynamic political-economy model with two parties which disagree on how to split a fixed budget between public and private goods. We study the welfare implications of introducing two types of budget rules, mandatory spending on public goods and entitlement programs, the latter imposing constraints on the private goods' allocations that can be implemented. We model budget rules following the literature on legislative bargaining with an endogenous status quo. Under a mandatory spending rule on public goods, expenditures are governed by criteria determined by enacted law. In particular, previous year's spending bill is applied in the current year unless explicitly changed by a majority of policymakers. Entitlement programs, on the other hand, impose restrictions on the provision of private transfers through eligibility rules and generosity formulas that can only be modified with bi-partisan support. We find that entitlement programs induce over-provision of private goods and under-provision of public goods, whereas the opposite is true under a mandatory spending rule on public goods. We show that mandatory spending rules are typically associated with larger welfare gains than entitlement programs. The desirability of the rule, however, depends on the degree of political turnover: (i) with high enough political turnover, both budget rules are better than discretion, but (ii) entitlement programs can generate welfare losses when political persistence is large. This happens because entitlement rules actually increase the volatility of private and public consumption, and reduce public goods' provision significantly. Finally, we describe conditions under which budget rules would arise in a bargaining equilibrium.