The Durability of Legislative Benefits and the Role of the Executive Branch's Settlement Authority.

AuthorCutsinger, Bryan P.

This power over the purse may, in fact, be regarded as the most complete and effectual weapon, with which any constitution can arm the immediate representatives of the people, for obtaining a redress of every grievance, and for carrying into effect every just and salutary measure.

--James Madison ([1788] 2001, p. 303)

In the form in which we know this division of power between the legislature, the judiciary, and the administration, it has not achieved what it was meant to achieve. Governments everywhere have obtained by constitutional means powers which those men had meant to deny them. The first attempt to secure individual liberty by constitutions has evidently failed.

--F. A. Hayek (1973, p. 1)

  1. Introduction

    In the wake of the 2008 financial crisis, the US Department of Justice required Citigroup and Bank of America to pay large settlements for their role in the collapse of the residential mortgage-backed securities market. A fraction of these multibillion dollar settlements, which are intended to indemnify those harmed by the violators of federal statutes, was funneled to nonprofit housing counseling organizations that had had their subsidies reduced by Congress following the 2010 midterm elections. Critics of this settlement program argued that the administration was circumventing Congress's power of the purse, thereby removing what is theoretically an important constraint on the administrative state. (1)

    While this issue may seem trivial, the circumvention of the constraints intended to limit the state's fiscal activities undermines the effectiveness of the fiscal constitution, which in turn opens the door to an ever-increasing and largely unaccountable administrative state. As the opening quotation from James Madison suggests, the Constitution's framers believed that separating the power of the purse from the executive branch was an important limitation on the administration.

    The power to tax is the most obvious coercive mechanism the state possesses. For instance, under a decision rule wherein any member of the polity could undertake a collective action, the likelihood that external costs will be imposed on other members of the group increases (Buchanan and Tullock [1962] 2004). Moreover, electoral rules may be insufficient to prevent the abuse of the government's taxing authority, suggesting that rational individuals would also insist on nonelectoral restraints on the taxing authority at the constitutional level (Brennan and Buchanan [1980] 2000). (2) This insight explains why the US Constitution, for example, requires that all tax legislation originate in the House of Representatives: because it is ostensibly the most responsive to the people's demands.

    The settlement authority, I argue, is essentially an insurance mechanism that pays out when special interest groups lose their legislatively created benefits. In the framework I develop below, the government is treated as a vertically integrated monopoly that produces special interest legislation, or long-term contracts, between the legislature and special interest groups. This insurance mechanism is necessary because, unlike private contracts, the contracts between special interest groups and legislators lack external enforcement mechanisms that ensure performance. As a result, the durability of the benefits produced by these contracts is reduced, which in turn reduces special interest groups' willingness to pay for beneficial legislation. To counteract this defect, mechanisms such as the settlement authority are used to ensure the durability of legislative contracts, thereby increasing their demand.

    This paper is most closely connected to the literature on the durability of special interest legislation. Landes and Posner (1975) consider the role that the independent judiciary plays in the interest-group theory of government. They argue that rather than being a check on the activities of the legislative or executive branches, the purpose of the independent judiciary is to ensure the durability of long-term contracts between special interest groups and the legislature. Building on Landes and Posner, Crain and Tollison (1979a, b) explore both constitutional change and the role of the executive branch in the interest-group theory of government. In the former case, they find that constitutional amendments are a particularly durable form of contract between the government and special interest groups; in the latter case, they find that, like the independent judiciary, the purpose of the executive veto is to ensure the durability of special interest legislation. I contribute to this literature by showing how the executive branch, by circumventing Congress's power of the purse, uses its settlement authority to increase the durability of legislatively created benefits.

    In the next section, I argue that the executive branch's settlement authority increases the durability of special interest legislation by acting as insurance against legislative turnover. In section three, I provide preliminary evidence of my theory's validity by examining the three largest post-2008 financial crisis bank settlements between the Department of Justice and JP Morgan, Citigroup, and Bank of America. Section four concludes with a brief discussion of my theory's implications.

  2. The Settlement Authority as a Guarantee of Rent Durability

    In the special interest theory of government, legislative outcomes are the product of a rivalrous process wherein special interest groups compete with one another by offering pecuniary or in-kind contributions to legislators in exchange for beneficial legislation (Tollison 1988). (3) This legislation can take many forms, such as restrictions on entry or subsidies, though the former tend to be more common than the latter unless restrictions are put in place to prevent rent dissipation. Regardless of the form the legislation takes, however, the result is the same: surplus is transferred from a group that is typically dispersed in nature, such as consumers or taxpayers, to a more concentrated group, such as bankers. The price that special interest group members are willing to pay for this legislation is, among other things, a function of the legislation's value to the group's members and the group's ability to overcome the collective action problems associated with coalitions. Thus, in the political marketplace, legislation is sold by the legislature and purchased by special interest groups.

    An additional determinant of the price that a special interest group is willing to pay for beneficial legislation is the expected durability of the benefit (Crain and Tollison 1979a, b; Landes and Posner 1975). This legislation is essentially a long-term contract between a special interest group and the legislature. The longer the beneficial legislation is expected to last, the greater the price that a special interest group would be willing to pay. However, unlike private markets where legal mechanisms exist to ensure contractual performance, the political marketplace lacks similar mechanisms to guarantee that the legislature upholds its end of the bargain. The lack of such mechanisms reduces present value of, and consequently the demand for, beneficial legislation.

    Two factors erode the durability of beneficial...

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