According to a piece in the May 18th CQ Weekly (“The Tax Man Studies Human Nature”) an application of behavioral economics is going to save American taxpayers about $900 million over the next decade through the elimination of the “advanced earned income tax credit.”
The advanced earned income tax credit allows to those who qualify for the EITC to get a little bit of the credit in every paycheck rather than get one large check once a year. Strict rationality would dictate that workers would choose the advanced option because they get the money sooner and can save or invest it as they choose. But only about 3% of those eligible for the EITC have signed up for this option. People prefer one big check once rather than a series of little checks during the year.
Why the apparently irrational choice? As the article puts it, “Jennifer Romich, an assistant professor at the University of Washington School of Social Work, interviewed workers who claimed the EITC and found that most of them prefer waiting for a lump-sum payment that can be devoted to big-ticket items such as a new piece of furniture or a security deposit on an apartment. These people expressed doubt they’d have the self-control to just set aside the money if they got a bit week after week.” In this light, the choice is entirely rational – people are choosing what makes the most sense given the realities in which they operate.
A mistake often made by advocates and policy analysts is the assumption of rational behavior. Those who are trained to carefully weigh risks (such as scientists and doctors) treat it as obviously true that people will – or should – weigh the scientific and medical risks using the same criteria as scientists and doctors do. Similarly, economists and experts on specific policy areas think that everyone else will – or should – weigh the same information and come to the same conclusions the experts do. Such assumptions of strict rationality is unwarranted (given the scientific research on behavior, such an assumption is actually irrational).
People behave in ways that make sense to them – we behave in ways that make sense to us. That behavior is based on predispositions, irrelevant anecdotes, quirks, our own knowledge of our own bad habits, and who knows how many other little things. The behavior is rational in that it makes sense (“intendedly rational” is the term of art) even if it is not strictly rational in the classic sense.
Policymakers and advocates would do well to keep behavior economics and the advanced EITC lesson in mind as Congress works its way through health care reform, trying to set up series of incentives for doctors, insurance companies, and the public to behave in ways that save us all money and make us all healthier.
