Perverse Incentives and a Government Doomed to Collapse
  (January 14, 2010)

We form and fund governments to solve problems. So what do we do when government devolves to a tangle of perverse incentives?

As I worked through the Survival+ critique of the status quo, it struck me that the built-in incentives in any system are far more powerful predictors than the ideology used to justify the system.

Foir example, the sickcare system (a.k.a. "healthcare") in the U.S. is doomed for a very simple reason: the incentives are all perverse. Care providers make more money by billing for needless or even harmful tests, procedures and medications, patients have no incentive to maintain their health or choose lower-cost care options (nobody even knows how much care costs before "buying" it), and the government systems (Medicare and Medicaid) are fundamentally open-ended--if you qualify, then we pay all your bills, no questions asked (hey, we only glance at 3% of the bills presented, 97% we pay automatically).

Construct a system with these perverse incentives and it is doomed to implode as everyone piles in to exploit the windfall. It's really not that hard to understand.

Another causal factor I cover in Survival+ is the concept of marginal returns. Let's start with the idea that government of any size, shape or form is formed to solve problems inherent to the human condition: the tribe in the next valley is starting to come over and steal our food, if we let this continue we will starve to death, etc.

In areas without government, or with government which does not view this as a problem it is tasked with solving, disabled people who can't work are either beggars on the street or they are cared for at home by their families.

In the U.S. and other wealthy post-industrial economies, government has come to accept disabled citizens as its responsibility.

So government establishes a program to aid disabled citizens who can no longer work (or no longer work in standard settings, for whatever reason: physical or mental disabilities or perhaps a mix of both). Let's say 40 pages of regulations and guidelines are written to define who qualifies and how the stipend/aid is distributed.

Since humans seek to exploit any and all windfalls, then "free money" programs are big targets for exploitation via fraud. So another 400 pages of guidelines are written to set up auditing, tighten the qualification process, enable appeals from those turned down, and so forth.

Since we live in a legalist society, then various legal claims and lawsuits are filed regarding the guidelines, and soon it takes 4,000 pages to cover all the exemptions, exceptions and refinements needed to clarify exclusions and various types of aid for different populations of disabled citizens.

Over time, new administrators seek to make their mark by improving service, and more legal challenges result in more refinements. Eventually the full body of documentation guiding the program reaches 40,000 pages, and the costs of operating the program exceeds the benefit of having such a massive body of rules and regulations.

At some point, the program is so rigid and costly than any budget cuts are not just "unfair" but "impossible." Or the cost of litigating the cuts exceeds the savings, and so on. This is the threshold of marginal returns. Put another way: it now costs $10 to "save" $1.

Without conscious design, the system becomes riddled with and then ruled by perverse incentives as various "fixes" incentivize ways to get around the barriers to windfall exploitation. Since the program is open-ended (an "entitlement"), then there is no feedback loop to limit expansion and complexity.

The system is now doomed to inevitable implosion/collapse.

In private enterprise, the company either goes bankrupt or enters a brutal downsizing/ reorganization which essentially throws over the entire status quo.

With government, that is impossible because the status quo is heavily defended by politically potent protected fiefdoms with asymmetric stakes in the game of preserving their share of the tax revenues (and the funds borrowed by government).

With that context, let's turn to this first-hand report from correspondent Cathy K.

I read your weblog daily and appreciate your way of looking at things. Your blog has really helped me learn to think. I have an issue I have never seen addressed in any blog I read and I wonder what your thinking might be on it. I used to have a hard time believing my government is doing this to me and now I just wonder how to fight it. My story:

I was on social security disability for less than ten years related to a back injury received at work. I received a Ticket to Work from social security, part of a program ( designed to get people off disabilty and back to work. I used this program for what it was intended and went to nursing school and got a RN degree. I also lost 100 pounds, resolved a lot of health problems, quit taking all the medications ordered for me (against my doctors advice) and resolved all my health problems. I have not been to a doctor in 6 years now and make a decent living as a RN and receive no government assistance. Win-win, right?

Apparently not. Upon my return to work, I received a bill from social security for around eighty thousand dollars. And they really sent me a bill with a payment envelope and asked me to place a mark by either charge or check for the full amount.

Social security had determined me not to be disabled since I returned to work, even though I did so under the auspices of their Ticket to Work program. I applied for their program, got approved for their program and their program paid for my nursing education.

I appealed of course. The monthly bill has now fallen to $16,000. This is apparently based on a month in which I made too much money (3 pay periods in one month) so any money from that date forward is now owed back to them. I reported the overpayment at the time, explaining that there were three pay periods in the month and my employer was too short staffed to allow me not to work for the one pay period (if I wanted to remain employed).

I made three hundred dollars too much money that month to qualify for benefits. I reported it at the time and I lost my following months benefits. The month after, social security continued to pay me as though the situation was resolved. Which I assumed it was as social security continued to pay me for two years following that. Until I went back to work.

I have of course appealed this overpayment as well. In the meantime while I wait for 2 or 3 years for social security to host this appeal which apparently has to happen before a judge, this debt has gone to collections and is on my credit report. The whole thing has been extremely frustrating and my local social security office appears to believe that every penny of that $16,000 came from their own personal pockets.

I feel like I did what I was supposed to do through this whole experience, used the ticket to work program for what it was intended, worked really hard to turn my health around and saved the government a ton of money, and am being punished for it. I can not even believe it is legal to put this on my credit report until the appeal has been resolved.

The actions of social security seem so counterproductive to me and finding a way to resolve this situation has been impossible as the right hand literally does not know what the left hand does. Nor does it care. Maybe there are other people in this boat who know what to do. I am discouraged.

Thank you, Cathy, for sharing your situation. I have zero knowledge of the intricacies of SSI (the Social Security program for disabled people who can no longer work) but based on what little I have seen it seems the incentives are indeed perverse: qualifying is arduous, but once you're "in" then as long as you don't do something foolish like try to get paying work, then you are "home free" and will receive the benefit for the rest of your life.

It doesn't take any special genius to see the incentive are perverse, no matter how well-meaning the original intent. In other words, perhaps it makes sense that the government should "get its money back" if it paid for someone to get retrained.

On the other hand, if the retraining is going to save the government hundreds of thousands of dollars in benefits it will not have to pay in the future because the person no longer draws the benefit (not to mention the tax revenues the government will now collect from them), then perhaps the retraining should be viewed as an investment which "earns" a solid return for the government when the person returns to work.

Or even if there is some "moral imperative" for the disabled person who managed to get paying work to "pay back their benefits," then couldn't the government turn the $16,000 into a student loan which accrues at a very low interest rate and which can be paid back over a number of years? After all, what's the difference between a disabled person learning a new trade and a student going to college on student loans?

The indifference of the bureaucracy is also evidence of perverse incentives: if you can't get fired for incompetence or poor customer service (or in the case of Medicare, if you get paid even if your care was poor or needless), then naturally your service will be indifferent because there is no incentive for it to be better/excellent.

Nothing fancy about incentives: they're either positive or perverse/negative.

The entire State (all levels of government) has devolved into a tightly woven tangle of perverse incentives for employees and citizens alike. True reform is impossible because the entrenched fiefdoms will wield their inordinate political power to fight any modest "reform" tooth and nail.

People ask me, "why do you think the status quo will implode?" Here's your answer: perverse incentives and protected fiefdoms with asymmetric stakes in the game.

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--Walt Howard, commenting about CHS on another blog.

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