Perverse Incentives

In making policy, it seems that sometimes the possibility of unintended consequences is not considered. Unfortunately, whether by oversight or some other force, policies get created which create perverse incentives. Our complicated tax law has got people doing all kinds of unproductive things in order to get around paying taxes. In our welfare programs, we have some systems in place which actually make or keep people impoverished.

For example, consider a program which provides health insurance for families below the poverty line. For a family of four, this would be an income of $21,200 annually. If a job offer were extended to the father of this family for $30,000 per year, without health insurance, should he take it? It appears so, but actually, he might be worse off. If the health care benefit he is receiving is worth $12,100 per year (the average annual premium for an employer health plan covering a family of four), then in the first case, he is making practically $33,300; in the second case, he is only getting $17,900. The perverse incentive is for him to stay below the poverty line by staying underemployed.

What do you get when you extend welfare benefits to unwed mothers? Why, more unwed mothers, of course. This, in turn, creates more poverty. I’m sure the designers of our welfare programs did not intend to make more people impoverished. The fact is, when you pay for something, you get more of it.

The No Child Left Behind Act seems like a good idea, right? I mean, nobody wants to leave a child behind. The Act requires that schools show improvement in student test scores. This provides an incentive for the school to encourage low-performing students to drop out before they take the test. Oops.

Or, consider the various Digital Rights Management schemes which make it harder to copy and access music, movies, or video games. It seems like a good idea, right? But there are some fair uses of copyrighted material which DRM prevents, like saving your movies to your computer’s hard drive so you can watch them without having to bother with the discs. Since pirated content doesn’t have these restrictions, it creates a perverse incentive for people to pirate content instead of buying it, which is exactly the opposite of what the designers intended.

Instead of blindly reforming, we need to carefully consider all the implications of a policy before implementing it. There is an ecological balance, and if you adjust one side of the equation, you’ve got to deal with the other side, too.