In “Behavioral Economics Foils an Obama Tax Cut?” (Bloomberg Businessweek November 10, 2011), Drake Bennett reports, “New research finds that a trendy economic theory backfired on the Obama Administration. Or did it?
In the past decade, this new set of ideas about economic behavior has gone from the margins of academia to the intellectual mainstream. In 2002 one of its godfathers, the psychologist Daniel Kahneman, won the Nobel Prize in Economics, and the years since have seen a growing list of best-sellers (Malcolm Gladwell’s Blink, Richard Thaler and Cass Sunstein’s Nudge, Dan Ariely’s Predictably Irrational) describing and drawing on its findings. Unlike neoclassical economists, behavioral economists don’t see people as rational actors coolly weighing costs and benefits. Behaviorists argue instead that people rely on a set of instincts, biases, and cognitive shortcuts to make decisions, which often lead them to choices they come to regret. We save too little and spend too much, we stick with the status quo even when it costs us money, we avoid smart risks and take dumb ones.
You don’t shop; your inner ape does?
In 2009 this theory held obvious appeal to the incoming Administration. If the country’s ills were in part the result of poor financial decisions people made unconsciously, perhaps those problems could be fixed through behaviorally informed public policy. The Administration’s first big legislative push, its stimulus bill, presented an opportunity to test some exciting new ideas on a national scale.
One of them was to give people tax rebates in dribs and drabs, instead of in lump sums, based on the behavioural economics theory:
A series of slightly bigger paychecks feels like an increase in income and is more likely to be spent.
(The government wished to encourage spending.)
That’s not what happened in practice, according to Sahm, Slemrod, and Shapiro. In a study of the 2009 stimulus, based on 500 telephone interviews, the authors found that only 13 percent of Making Work Pay recipients reported that the tax credit would lead them to increase spending. This was just half of the 25 percent spend rate the researchers found for the traditional lump-sum tax rebate in President Bush’s 2008 stimulus.
The reason the Making Work Pay program flopped is obvious: If a family gets a $750 cheque – and there is an outstanding need, like new laundry machines – they’ll probably spend it on the new machines.
If, however, the money comes in dribs and drabs, they may not even notice it because it is not solving any obvious problem. They neither spent it nor saved it; they just lost track of it. No wonder they reported that they wouldn’t increase spending on its account. This is not an instinct, a bias, or a cognitive shortcut; it’s a reflection of the fact that only the very poor have the time to deal in small change.
The fact that no one even considered this possibility illustrates the problem with applying these new EP-driven theories to anything approaching reality.
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