What is the True Cost of Incentives?
Behavioral Economics | Public Choice
Economics is based entirely on incentives. They drive all actions and motivation. There are two types of incentives, Positive and Negative. Each comes with its own cost.
Positive Incentives
Positive incentives are structures that are set up to encourage beneficial activities and behaviors. You are recognized for your actions through benefits, money, status, and power. Feels like you are being rewarded for doing the right thing.
An example would be the government offering tax breaks for charitable donations. The government wants more people to donate to charity so they incentivize you by rewarding the people who donate.
Read more about how People are not Inherently Altruistic.
Negative Incentives
Negative or perverse incentives try to limit a type of behavior that is deemed disadvantageous or harmful. You are disciplined or penalized through taxes, laws, and limiting your power. Feels like you are being punished for wanting to do something.
An example would be the tax on cigarettes. The government wants people to smoke fewer cigarettes so they tax them to encourage your to buy less of them. Increasing the price will decrease the quantity demanded. This is called a sin tax. It is a tax on items that are considered undesirable, another example would be a tax on alcohol.
Negative Bias
Negative result bias is when we treat negative outcomes a lot worse than we would a positive outcome of the same magnitude. This is seen in many aspects of our life. We are hurt more by criticism than we feel good about compliments. We remember traumatic experiences more than we do positive ones.
Negative Incentive Bias
A small negative incentive feels like a greater cost to us than a larger positive incentive would be a benefit. Psychologists say this can have an effect on how to respond to situations.
A negative incentive where we are taxed or punished for a behavior feels a lot more impactful than a positive incentive where we are rewarded for good behavior.
Cost of Incentive
Since negative incentives are more impactful than positive ones we respond to each incentive type differently.
Negative
We respond to negative incentives as being too harsh or destructive. We see them as limiting our options and freedom. Because of this, it is typically met with resistance. This is exactly what happened when the EPA tried to overstep its legislation, read about the EPA and its agenda here. Negative incentives cost almost nothing to implement but you can be sure people will not be pleased with the implementation.
Positive
On the other hand, our responses to positive incentives are quite different. We don’t value them as much as maybe we should. They aren’t seen as being very valuable or impactful. Almost goes unnoticed.
The tax code which is a slew of positive incentives gets ignored by a large portion of the population. Although I don’t have any statistics on this, I am confident you personally haven’t exhausted all of your tax benefits. Either because you don’t think it is worth it or it just goes unnoticed. To have positive incentives become more impactful you need to increase the benefits. This increases the cost of the incentive.
It costs more to put in place positive incentives than it does to put in negative ones. But there is more pushback with negative incentives than there is with positive ones. These are the costs of incentives. Finding the correct incentive type and balance is the key to a good incentive structure.