October 11, 2015

Why Government Decisions That Seem Stupid Are Often Rational, Although Flawed

Why governments, businesses, educational institutions, and non-profits consistently make certain kinds of bad decisions are quite different from what we understand. In this blog, I will touch upon a few of them.

Why federal, state and local governments have created horrific retiree medical benefit obligations.

We assume that elected officials and those they appoint to head government agencies are mindlessly stupid in agreeing to large, open-ended and permanent retiree medical benefits. We understandably ask: “What were they thinking?”

They were not stupid or irrational, but were responding to a flawed accounting system at all levels of government. Private sector, pension and post-employment medical benefit obligations trigger accounting charges that include two components: the current year obligations and a portion of the total obligations for future years. This accounting became effective in 1987 for pensions and 1991 for retiree medical benefits, as a result of two Financial Accountable Standards Board directives.

However, these standards were never applied to governments. Governments remain on the “pay as you go” system (which means that only current year obligations are included in an income statement). The Government Accounting Standards Board now requires governments to disclose its future pension and retiree medical obligations on their balance sheets, but the calculation is not included in government income statements.

The well-intentioned requirement that state and local governments “balance their budgets” every year has actually made this problem worse. Governments trade current year salary and wage increases for much larger future benefit obligations, because the wage and salary costs appear on the government’s income statement, but future benefit costs do not. The most extreme application of an accounting rule that wildly understates future liabilities occurred in Connecticut when Government John Rowland entered into a 20-year collective bargaining agreement with Connecticut’s state employee labor unions that traded concessions for 1997 and 1998 for much larger retiree benefits through 2017.

Similarly, at a federal government level, the Congressional Budget Office looks at all expenditures over a 10-year period to determine whether they are “revenue neutral.” CBO “scoring” of legislation only looks out 10 years, not for the full life of an obligation.

Why there are so few primary case doctors and so many specialists in the United States, with the result that we have wildly expensive, but disappointingly ineffective, health care.

Before the early 1990’s, the United States had a more balanced population of primary care providers and specialists, and their pay levels did not vary greatly, although specialists were paid more. The percentage of medical school graduates who chose primary care residencies, as opposed to specialist residencies was similarly balanced.

However, today, less than 5% of medical school graduates are preparing to be primary care physicians. The gap between primary care and specialist pay is huge, and the ratio of primary care physicians and specialists is lopsidedly skewed toward specialists.

What happened?

The answer is an obscure, but extremely important, adoption in 1992 of a new Medicare payment methodology called the “relative value resource based scale,” created at Harvard University between 1986 and 1988. RVRBS, as it is called, rewards physician task complexity, specialist training, and greater care intensity, and it has been criticized, I believe appropriately, for insufficiently rewarding results.

It also has the unintended effect of inducing physicians to use more complex diagnostic test processes, and to engage in complex procedures, even when simpler ones would work as well.

Why does it cost the government so much to do anything and why does it take so long?

The answer to this question is simple to articulate, but extremely difficult to change. Over the last several decades, government contracting changed from a relatively simple process in which the goal was to acquire the best product or service at the lowest cost to a horrifically complex process in which contracting was designed to serve many other objectives, most of which add cost, time, complexity, and, often risk to a project.

Some policies are understandable. Governments should not discriminate on the basis of race, gender, religion, or ethnicity in awarding contracts. Other contracting objectives are sensible in theory, but need to have the regulatory and contracting processes applicable to them simplified. For example, environmental reviews on government projects are absolutely necessary, but they have degenerated into opportunities for people opposing them to delay and defeat them.

Other requirements add cost, but without adding value. For example, the Davis-Bacon Act, enacted in 1931, was designed to keep the government from taking advantage of the large pool of unemployed construction workers by paying them below-market wages. The problem today is that the definition of “prevailing wages” bestows rich pay and benefits on construction workers employed on government-funded projects. Trying to change this archaic definition would be politically suicidal for elected officials of either party.

Many technical purchasing requirements are too detailed and inflexible. They over-regulate in some respects and under-regulate in others. For example, there are hundreds of pages of regulations on school buses, but school buses are not required to install seat belts.

The Defense Department has a number of technical specifications designed to enable ordinary items to be usable in a wide range of hostile environments. Years ago, there was a story about a “$600 toilet seat.” Actually, the Defense Department wanted a toilet seat cover with the ability to function in extreme conditions on aircraft, but Defense Department requirements exceeded what was necessary. The addition of complex and time-consuming procurement processes inflated the cost of an item that we can buy at Home Depot for $12.

Why does this happen? No one requirement creates this ridiculous price level, but the Defense Department accepts a variety of inputs in building requirements. The combination of these inputs guarantees that the item will be far more expensive.

Government procurement requirements are costlier for another well-intentioned reason. Governments trying to avoid overcharges from overhead allocations require vendors to create completely separate accounting systems and billing processes, and to create supporting documentation that is not required for private sector transactions.

Why? Members of the media and elected officials often zero in on one problem and create a firestorm of attention and criticism on it, however trivial. Government officials see their careers derailed because of a story that has a lot of legs in the mass media.

As a result, preventive tool government procurement officers use is an exceptionally elaborate system for supporting every decision governments make.


Elected and appointed government officials make decisions that, at first glance, look irrational or stupid, but are really excessive or flawed responses to what we demand of them:

  • Balanced budgets, but without proper long term accounting for capital expenditures like the rebuilding of bridges and tunnels;
  • A technical standard for paying doctors that was based on the flawed view that the greater the complexity of what the doctor does, the more he or she should be paid, as opposed to paying doctors for results; and
  • A set of government purchasing requirements that try to cram as many requirements as possible into a product or service specification and to document the procurement process as thoroughly as possible, without regard to acquisition costs.

The answer is not to criticize government, but to attack the underlying root causes:

  • Government accounting for retirement benefits needs to be aligned with the more sensible accounting demanded of the private sector.
  • The way we pay doctors has to change. Thankfully, the Affordable Care Act, although flawed in many respects, is ushering in a new results-based payment system called “accountable care,” thanks to great work by Drs. Mark McClellan and Elliott Fisher over the years, and a lot of work by many stakeholders.
  • Governments have to do a better job balancing their oversized appetite for goods and services to accomplish too many policy goals.