Beyond Delegation: Agency Discretion when Budgets Matter

A fundamental result in the literature on congressional control of the bureaucracy is that optimal institutions take the form of limited delegation of decision-making authority to the agency. We revisit the question of optimal institutional design for cases in which the extent to which the policy is funded determines its effectiveness. In the optimal separating mechanism, the legislator imposes larger reductions of the budget for policies that go further in the direction of the agent's preferences (sufficiently high states); even more, in some states, than what the legislator herself would want to implement given full information. Policy overreacts to the agent's information in low states, and under-reacts in high states. For sufficiently high states, both policy and budget are below the first best for both the agent and the legislator. Our results imply that the optimal mechanism can not be implemented through delegation of authority to the agent.