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Nudges

How can we encourage large corporations, or small families, to conserve energy? Or Harley Davidson types to wear helmets? What about getting my mom to kick her smoking habit? University of Chicago economist Richard H. Thaler and law professor Cass Sunstein say that all it takes is a little nudge. Thaler and Sunstein believe that “choice architecture”—usually not in the form of explicit regulations or laws—”can be established to nudge us in beneficial directions without restricting freedom of choice.” The following are some examples:

Save More Tomorrow. Richard Thaler and Shlomo Benartzi proposed a four-step approach that they call Save More Tomorrow (SMarT) that overcomes several psychological biases. They suggest that employees who are not contributing to their 401(k) plan can begin to do so by agreeing to the following plan:

  1. The employee is asked to agree to the plan well in advance; that is, the decision does not have any immediate ramifications.
  2. The plan starts by having the employee agree to begin contributing at his/her next pay raise with a small contribution rate, such as 2 percent. By combining a pay raise with the contribution, the employee still sees a small increase in pay but also begins the contribution.
  3. The employee agrees to increase the contribution rate at each pay raise until a preset maximum level is reached.
  4. The employee can opt out of the plan at any time. Although the hope is that employees will not opt out, the ability to do so makes them more comfortable about joining the plan.
  5. The SMarT plan requires the employees to make decisions far in advance, and then the status quo bias works to their advantage because they do not take the option of opting out of the plan.

This plan was tested at a midsize manufacturing company whose savings participation rate was low. The 315 employees had an average savings rate of 4.4% of their earnings. They were asked to increase their contribution by 5%. Those employees who claimed they could not contribute the 5% were offered the SMarT program. The program was made available to 207 employees, and 162 employees agreed to join. These employees had a low savings rate of 3.5%, on average. The 153 employees who did not join the SMarT plan either did nothing or made a one-time increase in their savings rate. On average, the people who did not adopt the SMarT plan had a savings rate of 5.3%. The effect of joining the plan was dramatic. After three pay raises, those who had joined the SMarT plan had increased their savings rate from 3.5 to 11.6%. Those who did not join the SMarT plan increased their savings rate from 5.3% to only 7.5%. The dramatic increase in the savings rate associated with the SMarT plan was beneficial to those employees because they began saving more for their retirement.

Quit smoking without a patch. CARES (Committed Action to Reduce and End Smoking) is a savings program offered by the Green Bank of Caraga in Mindanao, Philippines. A would-be nonsmoker opens an account with a minimum balance of one dollar. For six months, she deposits the amount of money she would otherwise spend on cigarettes into the account. (In some cases, a representative of the bank visits every week to collect the deposits.) After six months, the client takes a urine test to confirm that she has not smoked recently. If she passes the test, she gets her money back. If she fails the test, the account is closed and the money is donated to a charity.

The early results from this program have been evaluated by MIT’s Poverty Action Lab and look very good. Opening up an account makes those who want to quit 53 percent more likely to achieve their goal. No other antismoking tactic, not even the nicotine patch, appears to have been so successful.

The Automatic Tax Return. No sensible choice architect would design the current income tax system, which is famous for its complexity. Withholding was a major advance that simplified life for everyone. Ordinary people and the Internal Revenue Service would benefit even more if the process could be made more automatic. A simple step, suggested by the economist Austan Goolsbee, is the Automatic Tax Return. Under this approach, anyone who does not itemize deductions and has no income (such as tips) that is not reported to the IRS would receive a tax return that is already filled out. To file, the taxpayer would need only to sign it and mail it (or, even better, go to a secure IRS Web site, sign in and click). (Of course, the taxpayer would be required to make changes if her status changed, or if she started receiving unreported income.)

Goolsbee estimates that this proposal would save taxpayers up to 225 million hours of tax preparation time and more than $2 billion a year in tax preparation fees. True, many people don’t trust the IRS, so here’s one way to assure them that our tax collectors are honest: if there’s an error, you get the money back, plus a bonus (say, $100).