How behavioral economics could show up in the new stimulus package

The conventional wisdom of tax rebates has been to give them in one big chunk. It gets more money to people faster and cuts down on administrative costs. The problem is people don’t seem to spend the money. Why?

(B)ecause people don’t treat all windfalls as found money. Instead, in the words of the behavioral economist Richard Thaler, people put different windfalls in different “mental accounts,” which in turn influences what they do with the money…The key factor in these kinds of distinctions, Thaler’s work suggests, is whether people think of a windfall as wealth or as income. If they think of it as wealth, they’re more likely to save it, and if they think of it as income they’re more likely to spend it.

So what does this mean for making a rebate work? If you want people to spend the money, you don’t want to give them one big check, because that makes it more likely that they’ll think of it as an increase in their wealth and save it. Instead, you want to give them small amounts over time. And you want the rebate to show up as an increase in people’s take-home pay, because an increase in steady income is more likely to translate into an increase in spending. What can accomplish both of these goals? Reducing people’s withholding payments.

According to behavioral economics principles, the withholding, which is expected to be $500, could be handed out in small chunks, perhaps $50 at a time, rather than a single, large rebate.

That’s James Surowiecki in the New Yorker.

Tags: taxes