You have probably also heard a lot about government waste. In fact, there are good reasons for thinking that governments might not spend money as carefully as you or I, namely weak incentives and lack of information on how to spend the money effectively. Suppose you get an A on your economics midterm and decide to spend $100 on a treat for yourself. What’s the best possible use of that $100? A new pair of jeans? A dinner date? Part of a ski trip? Whatever the answer, you have good information about your wants and needs and you have good incentives to shop carefully—researching quality, comparing prices, and searching for high value—after all, your enjoyment and your money are at stake!

Now suppose that you must spend $100 on a gift for someone else. (Perhaps you are obligated to exchange Christmas gifts with your coworkers.) You still want to get value for your money but your information about what the recipient wants or needs is much less and your incentive to investigate and research quality are diminished compared to when you were spending the money on yourself. One economist, Joel Waldfogel, estimated that billions of dollars are wasted every Christmas because most gifts cost the giver more than they are valued by the recipient.4 To avoid this waste, we give the administrative assistants in our department cash. But Christmas might not be as fun if every present under the tree was money.

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Now suppose that you must spend someone else’s money on a gift for someone else. (Perhaps your boss gives you some money to buy a Christmas gift for one of her other employees.) You probably don’t want to waste the money entirely (perhaps your boss will notice if you pocketed the cash) but you don’t have good information about what the recipient wants or needs and now you are spending someone else’s money so your incentives to shop carefully are very much diminished. A lot of government spending falls into this category—some people spending other people’s money on yet other people. As a result, we should not be surprised when a lot of government spending results in some waste and inefficiency.

In Afghanistan and Iraq, for example, the U.S. spent over a hundred billion dollars on reconstruction efforts, but audits revealed many billions of dollars in waste, fraud, and abuse. Projects were started and never completed. Hospitals were built but never provided with equipment to operate. Fraud was rampant. On one project the auditor questioned 40% of the costs it reviewed, including $900 for a control switch valued at $7.05. Perhaps most infamously, $10 billion(!) in shrink-wrapped packages of $100 notes was flown from New York to Iraq but then simply disappeared.5

Spending in Iraq and Afghanistan was probably especially likely to be wasted because the U.S. government lacked information about local wants and needs, which were very different from those of people in the United States, and because the ultimate boss—the American taxpayer—was far away and could not easily monitor how the money was being spent. Problems of information and incentives, however, plague all kinds of government spending, both at home and abroad.

Government spending can be wasteful but if a politician claims that he or she will pay for new spending programs or tax cuts by cutting “waste”—beware! First, the problem of government waste is not due to a few bad apples but rather due to deeper problems of information and incentives that are difficult to solve. Second, our trip through the federal budget shows that cutting waste may sound good, but the reality is that most of the money is being spent on the big programs. Consider Social Security, the largest government spending program. Social Security transfers cash—it’s like the perfect Christmas gift recommended by economists—and because the program is well-known, it’s well monitored. As a result, despite some fraud, the overhead costs of the Social Security program are low.

Overall, it’s difficult to cut spending on big programs without cutting benefits. If we want more spending on those programs, ultimately taxes must rise or we must cut spending somewhere else. If we want lower taxes, spending and benefits must fall. There is no such thing as a free lunch.

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