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The temptation tax
Banerjee and Mullainathan offer a different explanation, one which shows how temptation might interact in a unique way with poverty. Suppose, they argue, that there are certain goods that people are tempted by, such as candy, or coffee, or cigarettes. Then suppose that as people get richer, they spend a decreasing proportion of their income on these goods; not a smaller absolute amount, but a smaller proportion. (There’s only so much money you’re likely to spend on cigarettes, no matter how rich you get.) Finally, suppose you’re realistic enough to know that you’ll be just as tempted in the future by these items as you are today.
In sum, your “long term self” knows that you will spend money on temptation goods in the future, but places no value on that spending. (Your long term self doesn’t like the fact that you’ll spend money on cigarettes, even though your today self wants it.) Knowing that you will spend this money amounts to a “temptation tax” on future wealth. This is a disincentive to save for the future. Why save today? After all, your future self will just squander the money on cigarettes!
But as you get wealthier, the effective “tax rate” is lower, because temptation goods are a smaller proportion of your income. With a lower tax rate, your disincentive to save shrinks. Perversely, if you expect to be wealthier in the future, you have a greater incentive to save and invest! Banerjee and Mullainathan show that this can create a poverty trap. When you expect to be poor in the future, you are less likely to save and invest, which keeps you in poverty. When you expect to be wealthy in the future, you are more likely to save and invest, which makes you wealthier still.
Here is the core article. For the pointer I thank Rachel Strohm, who tweets about Africa and economic development.
Posted by Tyler Cowen on September 30, 2009 at 07:38 AM in Economics | Permalink
Comments
> Perversely, if you expect to be wealthier in the future, you have a greater incentive to save and invest! Banerjee and Mullainathan show that this can create a poverty trap. When you expect to be poor in the future, you are less likely to save and invest, which keeps you in poverty. When you expect to be wealthy in the future, you are more likely to save and invest, which makes you wealthier still.
there is an explanation in here for the housing bubble as well
Posted by: babar at Sep 30, 2009 7:45:14 AM
This could also be an interesting analysis of why so much of the lottery ticket purchasing in the US takes place among poor people. I don't think people who buy alot of lottery tickets are hugely ignorant of the odds, but it could be that there's a mentality that any given small increase in net income isn't "worth" it, and that to overcome the amount you know you'll squander you need a massive change in wealth.
Of course there are alot of conflating variables to take into account here, not the least of which is addiction to gambling.
Posted by: Peter at Sep 30, 2009 8:19:16 AM
I wonder: could the same point be made about public deficits, whereby the role of temptation spending would be taken by social transfers? The idea came to me because I read this post right after an article about France's exploding public debt.
Posted by: Rubin at Sep 30, 2009 8:58:43 AM
I am sure this is a stupid question, but why would you save more if you expect to be wealthier in the future. If you expect to have more income, wouldn't there be a big incentive to not save?
Posted by: Paul at Sep 30, 2009 11:04:11 AM
One word to disprove this: Cocaine.
Posted by: Guillaume at Sep 30, 2009 11:19:09 AM
Do you actually believe this is how people think? Do you even know any people?
Sheeeeesh!
Posted by: CathyG at Sep 30, 2009 11:48:41 AM
"Your long term self doesn’t like the fact that you’ll spend money on cigarettes, even though your today self wants it."
Very Schelling-esque.
Posted by: Dave at Sep 30, 2009 12:05:08 PM
This is a disincentive to save for the future. Why save today? After all, your future self will just squander the money on cigarettes!
This doesn't work. If my present, cigarette-liking self can save the money today (rather than spend it on cigs), then why should my future self spend that money on cigs?
Is the assumption that I don't have any money for cigs now, but will later? But where is the money I'm saving, then?
Better to distinguish (1) those who could save now, but spend on cigs, from (2) those who could save now, and do so. Less interesting I'm afraid, but true.
(No moral slam on the smokes-buying poor. Poverty sucks, and if someone feels it so acutely he'd rather buy a cig than save towards maybe not being poor in 10 years, I can't evaluate the necessity of that choice, only its results.)
Posted by: Anderson at Sep 30, 2009 12:32:19 PM
Is it true that poor people don't save? Portfolios of the Poor suggests it's not.
Posted by: C at Sep 30, 2009 1:37:51 PM
Are candy, or coffee, or cigarettes really temptation goods? I mean what are u supposed to buy with 1 dollar a day? plain rice everyday? This money is spent on goods that make your life a bit more acceptable...Rich people are way more tempted by unnecessary things, like new Prada boots every week...it makes no sense to look at it as share of income as not much costs less than 2 cents!
Posted by: Pierre-Louis at Sep 30, 2009 2:17:32 PM
And it's not just your future self. One of the problems with wealth creation in Africa is, purportedly, that people know that if they accumulate wealth they will be socially compelled to share with relatives. So they tend not to bother much (and neither do their relatives).
Do you actually believe this is how people think? Do you even know any people?
Do you really think it's beyond people to think, "Hey, you know, I'm just not very good at saving money. If I have it, sooner or later, I always blow it all. So there's really no good reason for eating rice and beans for six months to build up savings -- I've done it before, it's no fun at all, and I always end back up right back where I started anyway, so what's the point?"
Posted by: Slocum at Sep 30, 2009 3:31:27 PM
"When people live on the dole for years at a time they grow used to it, and drawing the dole, though it remains unpleasant, ceases to be shameful. ... But they don't necessarily lower their standards by cutting out luxuries and concentrating on necessities; more often it is the other wayabout-the more natural way, if you come to think of it. Hence the fact that in a decade of unparalleled depression, the consumption of all cheap luxuries has increased. . ... For, when you are approaching poverty, you make one discovery which outweighs some of the others. You discover boredom and mean complications and the beginnings of hunger, but you also discover the great redeeming feature of poverty: the fact that it annihilates the future. Within certain limits, it is actually true that the less money you have, the less you worry."
George Orwell, Down and Out in Paris and London
Posted by: Orwell at Sep 30, 2009 4:14:40 PM
You've posted on this topic before:
http://www.marginalrevolution.com/marginalrevolution/2007/08/the-persistence/comments/page/2/
Posted by: chris.ez at Sep 30, 2009 4:40:52 PM
--but it could be that there's a mentality that any given small increase in net income isn't "worth" it, and that to overcome the amount you know you'll squander you need a massive change in wealth.
I thought this was settled. You simply compute the expected utility of that dollar, and voila! If you're circumstances are lousy enough (like say, you view the coming hyperinflation or steady 10-12% inflation for 10 years as likely to destroy every last dime you have saved for retirement), what's the marginal utility of that dollar? What's the probability you'll become a millionaire with that dollar through hard work. vs through the lottery? For many people, the lottery is rational.
I smoked cigarettes because my utility in the present for them was high, and my value of future life low. We were always trying to kill ourselves anyway, so why not enjoy smoking? When I'd finally reached a point where the value I placed on my future was high, the smokes went away.
Posted by: Allison at Oct 1, 2009 12:32:30 AM
Pierre-Louis: The difference is that some people like the idea of having Prada boots, even in the abstract. (In fact, some rich-people luxuries might even be more enjoyable in the abstract -- things that add a lot of unexpected stress, like a big house.) No one likes having lots of candy and cigarettes in the abstract, only in the here and now.
Posted by: WillJ at Oct 1, 2009 1:57:13 AM
Is it true that poor people don't save? Portfolios of the Poor suggests it's not.
I haven't read Portfolios of the Poor yet but whether or not poor people save, we have to contend with two facts:
1. Poor people tend to borrow small amounts of money at usurious rates of interest (20%-50% per month)
2. Poor people spend money on lots of small things that add up to a significant chunk of their daily income. The typical example is that the poor in India might patronize a tea stall a few times a day in addition to maybe buying a few cigarettes or candies that sell for 50 paise or 1 rupee per piece. Text messaging and the explosion of cell phone ownership among the poor offers yet a new opportunity for "temptation spending."
These two facts suggest poor people could make themselves at least a little better off by cutting their consumption in #2 in order to avoid taking out the loans in #1. Most of them do not in fact do this, though.
Posted by: Ricardo at Oct 1, 2009 4:00:40 AM
Ricardo: evidence please.
Posted by: C at Oct 1, 2009 11:29:46 AM
Ahh, both coffee and cigarettes have very positive attributes; indeed, no society (so far) has been able to go without some form of a stimulant. It is just odd to me label these items as "temptation goods." Honestly, how much more of a temptation are they than say waffles or running*? It seems to me that is and is not a temptation good is what currently does and does not violate certain arbitrary cultural norms.
*Any serious runner will tell you that running is very addictive.
Posted by: Seward at Oct 1, 2009 1:59:48 PM
