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Friday, 29 August 2014

Spending to save – the paradox of modern life

Crawford Hollingworth on how the Obama administration tapped behavioural economics to formulate a tax rebate plan that would get people spending again after the 2008 recession.

We have seen plenty of examples of the way behavioural economics can be used to help us save money – impulse saving apps are one example; self-contracting could also help. But at the same time western governments are facing one of the largest recessions in recent history, and they need us to spend in order to save the economy.

In the US Barack Obama’s administration has been one of the first governments to really make use of behavioural economics (he was even using it on the campaign trail). It has experts like Cass Sunstein and others advising on issues like voting and how to make policy more effective. A particular example related to the recession was how they designed a tax rebate to encourage spending.

Following the 2008 financial crisis the Obama administration looked to boost consumer spending. To aid this they designed two tax rebates in 2009 totalling more than $235bn. Yet with behavioural economics in mind, the rebates were delivered in small amounts through people’s pay checks rather than in one lump sum.

This was a very careful plan based on mental accounting. Experts predicted that people would not notice these small – almost token – amounts of money, and therefore would be more likely to spend them and help the economy to prosper. After all, what is the point in mentally accounting for what is effectively loose change?

In a New York Times/CBS News Poll in September 2010, fewer than 10% of respondents knew that the Obama administration had lowered taxes for most Americans. Half of those polled said they thought that their taxes had stayed the same; a third thought that their taxes had gone up, and about a tenth said they did not know. Notably, citizens could have opted to have their rebate paid as a lump sum, but as this was not the default setting there doesn’t seem to have been much uptake.

Framing the windfall has an impact too. A recent study by business professors Nicholas Epley and Ayelet Gneezy showed that when a tax rebate is presented as a bonus it is more likely to be spent than when it’s presented as a rebate. Similarly, if a sum is thought of as wealth, it is more likely to be saved. If it’s considered income, it’s more likely to be spent.

Crawford Hollingworth is a founder of The Behavioural Architects

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