Loss Aversion and Strategic Choices in Cutting Budgets

Abstract

Scholars of cutback budgeting have pointed out for decades that when confronted with fiscal stress, policymakers often make budgetary choices that sacrifice the fiscal health and organizational capacity of their jurisdiction in order to avoid political conflict. This line of research could be strengthened by an overarching theoretical framework that explains the set of decisions observed. Additionally, most research has not attempted a systematic classification of budget choices. As a result, it is often not clear whether scholars are simply singling out the problematic decisions while failing to give credit for the “good” ones. This analysis draws on theories of behavioral economics, in particular those associated with loss aversion, to develop a broader theory and typology of cutback choices. This theoretical framework suggests that many cutback choices take advantage of commonly observed cognitive “errors” such as anchoring and time-discounting to mask or mitigate perceptions of loss. the analysis then goes on to show how this typology can be used to classify and analyze the universe of budgetary choices made in a state, specifically Georgia's fiscal choices during the first year of the Great Recession.