Allowance, Taxes And Potty Training : Planet Money It's really, really hard to create the right kind of economic incentives — even if you're a professional economist, and all you're trying to do is teach your kids to use the toilet.

Allowance, Taxes And Potty Training

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(SOUNDBITE OF TV SHOW, "EVERYBODY HATES CHRIS")

TERRY CREWS: (As Julius) I'm not giving you money for walking around doing nothing. An allowance? I allow you to sleep here at night. I allow you to eat them potatoes. I allow you to use my lights. I allow you to drink my Kool-Aid. I allow you to...

(SOUNDBITE OF SONG, "DENTAL CARE")

OWL CITY: (Singing) I brush my teeth and look in the mirror and laugh out loud as I'm beaming from ear to ear. I'd rather pick flowers...

ALEX BLUMBERG, HOST:

Hello and welcome to PLANET MONEY. I'm Alex Blumberg.

CHANA JOFFE-WALT, HOST:

And I'm Chana Joffe-Walt. Today is Friday, August 20. And that was a clip from the TV series "Everybody Hates Chris" you heard at the top of the show. And on the podcast today, turning time spent with your little brother into billable hours - in other words, what happens when an economist pays an allowance to his kids?

BLUMBERG: But first, our indicator from Jacob Goldstein. Jacob, what do you got for us?

JACOB GOLDSTEIN, BYLINE: I've got for you 0.47%. That is the yield on two-year Treasuries as of this morning. And it's an all-time low.

JOFFE-WALT: OK. So just to be clear, yields - this means that if you lend the government $100 for two years, they will pay you $0.47 a year in interest, which is amazingly low. Inflation is around 1% a year. So the $101 you would get from this investment two years from now will actually buy you less stuff than $100 today.

GOLDSTEIN: And what this means more broadly - right? - is investors think the future of the economy - it's really pretty bleak. They expect inflation to be very low, and that tends to correspond to slow economic growth. And more generally, Treasuries are considered one of the safest investments in the world. People buy them when they're afraid to buy stocks and when they're worried about the economy overall.

BLUMBERG: And the fact that yields on treasuries are so low means, in effect, there's a whole bunch of people that want to buy Treasuries. And this has sparked a debate about whether or not there's actually a bubble in Treasuries.

GOLDSTEIN: And it's really pretty striking, right? The whole idea that there even could be a bubble in Treasuries - it's kind of weird because you think of this as this super boring, super safe investment, not some kind of, you know, go-go Las Vegas subdivision that people are going to flip. And the very existence of this debate, I think, points to how worried people are about the economy and how willing people are to buy Treasuries in spite of these ultra-low yields.

BLUMBERG: Of course, houses used to be something that was considered very safe and boring as well.

GOLDSTEIN: Like safe as houses - wasn't that an expression?

BLUMBERG: I think that was a phrase. Exactly.

GOLDSTEIN: Safe as Treasuries.

BLUMBERG: Well, thank you very much, Jacob. It was a pleasure, as always.

GOLDSTEIN: Thanks, guys.

BLUMBERG: All right, Chana, on to the podcast - to a world free of politicians where economists get the chance to live the way they want.

JOFFE-WALT: Right. So we spend a lot of time hearing economists bemoan how politicians are constantly mucking up what would otherwise be perfectly good economic policy. Like, I've done many interviews with economists telling us, you know, basically, we're giving great advice to politicians. We write these great papers. We advise them. And time after time - climate change, health care, taxes - politicians ignore our basic economic principles when they design their policies.

BLUMBERG: And most importantly, they say politicians don't pay attention to incentives as a way of getting people to do what you want. Or accidental incentives where you're encouraging people accidentally to do something you don't want.

JOFFE-WALT: So today on our podcast, an economist actually gets to write all his own rules for once in an environment he completely controls - his own personal economics laboratory.

BLUMBERG: And he gets to try to enforce them. We sat down with him and his collaborator to talk about it.

JOFFE-WALT: How are you doing?

BEA GANS: I'm well, thank you. How are you?

JOFFE-WALT: Good. Thank you for coming in. And who's that person sitting next to you?

BEA: Daddy (laughter).

JOSHUA GANS: Hi. How are you?

JOFFE-WALT: Good. How are you doing?

GANS: All right.

JOFFE-WALT: That giggling there is Bea. She's an 11-year-old. And the guy she calls Daddy is also sometimes known as...

GANS: Joshua Gans, economics professor, Melbourne Business School.

JOFFE-WALT: So, Alex, Joshua is an economist from Melbourne, Australia, and he's visiting this year at Harvard. And he is 11 years into his experiment, running his own economically pure world, implementing all the principles at his disposal to influence the behavior of society. And in this case society is a small one. It's his own family. Bea is his oldest of three kids.

BLUMBERG: Now, his first opportunity to use the power of economics to improve society - in other words, to improve the behavior of his children - came when Bea was 2 and unfortunately still in diapers. The authorities, he and his wife, were getting tired of cleaning up after Bea, but Bea was perfectly happy with the system that existed. This provided Joshua with his first opportunity to change her behavior with properly structured incentives.

GANS: We actually gave her a reward for when she was toilet training. We gave her a reward for, you know, sitting on the toilet to get used to the whole thing. And it used to be the reward of jelly beans. And she worked out that all she had to do was sit there all day, if necessary, and she'd be - and something would eventually happen and she'd get a reward.

JOFFE-WALT: Bea, do you remember that?

BEA: Well, I do remember playing my parents. I don't remember that exact example, but I do remember playing. I do remember realizing the tricks and using them to get jelly beans and chocolate frogs and stuff.

JOFFE-WALT: What did you do?

BEA: Well, my sister noticed - she noticed she got a special treat every time anything came out. And so she'd go every 20 minutes and somehow she managed to squeeze something out every 20 minutes. So every 20 minutes, she was getting candy every 20 minutes.

GANS: You invented that one.

BEA: Yeah, I - OK, I invented that one. I don't particularly remember it, but yes.

GANS: Actually, Bea did something more insidious when her brother was toilet training.

BEA: Oh, I remember that.

GANS: You want to say what happened when your brother was toilet training?

BEA: Well, I realized that if I helped my brother go to the toilet, I would get rewarded, too. So I'd be - and I realized that the more that goes in, the more comes out. So I was just feeding my brother...

JOFFE-WALT: (Laughter).

BEA: ...Buckets and buckets of water and - yes, yes.

GANS: That was my idea. It didn't really work out too well. The idea was to get everybody involved in cooperation in this public activity of her brother's toilet training. And so she got a reward, as well, for success. Unfortunately, as you hear, she gamed the system.

BLUMBERG: So this is a problem you hear about all the time in the real world. You design an incentive system, but you can't guarantee that the people won't abuse that system. You know, are they trading in their own clunker for cash, or are they trading in somebody else's clunker? Is it really a clunker? You know, are people using the tax break to build the middle-income housing? Are they using it for luxury condos? It's this problem that exists in the real world all the time.

JOFFE-WALT: And you often hear about that it's really hard to get the price of the incentive right. And, I mean, in this scenario, not only did Bea learn the rules to game the system. It took Joshua three children to truly learn the right price. So he tried one jelly bean to get the kids to use the bathroom. Then that wasn't enough. Then two jelly beans still turned out to be too low. And it wasn't until the third child that Joshua hit on the right price, which apparently was a chocolate frog.

BLUMBERG: A chocolate frog - well, everybody knows that - a chocolate frog. But it wasn't just jelly beans and chocolate frogs. Joshua had another tool in his economics toolkit to help influence the behavior in his family. I refer, of course, to the allowance.

JOFFE-WALT: Or as this paper from the Journal of Economic Psychology calls it, Alex, an intergenerational transfer payment.

BLUMBERG: Are you telling me there's an economics literature on allowances?

JOFFE-WALT: There are at least six papers on the economics of allowance that I have read, and I'm sure there are more. So - and basically, they all have one thing in common, which is that they all kind of outline the motives for paying an allowance. And there are sort of two main ones. One is as an exchange for service provided. So, you know, you wash the dishes or walk the dog, clean your room. You get an allowance. And the other motive would be to teach budget constraint.

BLUMBERG: Which I guess is economics for teaching kids that money doesn't grow on trees.

JOFFE-WALT: That's another way of saying it. They do not use those words in these papers. So this second motive seemed like it would be really useful for Joshua around the time Bea was 5 because she was constantly asking for things. They'd go to stores, and she wanted yo-yos, or she went on a tear about needing Heelys, which are those shoes with wheels on them.

BLUMBERG: Yeah, I have a couple pairs.

JOFFE-WALT: (Laughter) No, you don't.

BLUMBERG: (Laughter).

JOFFE-WALT: And then there was one thing that she wanted all the time.

BEA: Yeah, I have a bit of a candy problem.

JOFFE-WALT: So Joshua said to Bea, OK, if there are things that you want that are not necessities, you'll have to buy them with your allowance. And I'll give you an allowance - $5 a week - and at first, things were going really great.

GANS: First thing she did was actually spend it on a present for her mother. Do you remember what it cost?

BEA: Five dollars. So I spent all my allowance on a little key ring for Mommy, which she still has, except it's kind of fallen apart. But she won't give it up.

GANS: Which I thought was - which - we all got a warm glow as parents and - from that nice activity.

JOFFE-WALT: What things are covered by allowance, and what things aren't?

GANS: Our vision with all of this was that we would be the hard-nosed parents. We'd set this allowance and that we'd say no every single time a child expressed a preference for something. However, that just doesn't quite occur. Child comes forward with a very nice dress that she's found in a store, and we think - oh, we agree that's nice, as well. And all of a sudden, the credit card's out. So we haven't quite got to the vision. I think...

JOFFE-WALT: Then if she comes forward with a dress that you don't like, then it has to go to allowance?

GANS: Ones we - yes, ones we don't like, then it's far more likely to go straight to the allowance, although, you know, some of those, especially for our youngest child, are truly horrific. And I'm not even sure an allowance is going to cover it.

JOFFE-WALT: But that seems like that gets in the way of the idea of teaching budget constraint, right? If you have arbitrary rules about what is - you have to pay for yourself and what your parents pay for.

GANS: Yes. No, it does. It is very difficult, indeed. This is one of the problems with parenting in general and also with economics - is that you have plans. You have theories. You want to stick to it, commit to it. And you know that if you do that, it'll all work out. The problem is that you have to implement it, and that can be really quite difficult, especially in a moment-by-moment thing.

BLUMBERG: And it sounds like, in the system, what he ended up teaching was, these are the kinds of dresses that I like.

(LAUGHTER)

BLUMBERG: And if you find the dresses I like, you'll get them for free.

JOFFE-WALT: Right, as opposed to saving and not spending all of your money at once.

BLUMBERG: Right.

JOFFE-WALT: So this is a problem governments and authorities in a free market also face all the time. People in society want things that the leaders don't like, things that are bad for society or harm the environment. In Joshua's society, it was the same. His daughter wanted ugly dresses. She wanted tons of "Harry Potter" paraphernalia and candy, lots and lots of candy.

BLUMBERG: But fortunately, there is a great economic tool for that, as well. And here it is described very happily by Bea.

BEA: If you want to buy candy with your allowance, you have to pay to your parents an 100% health tax.

BLUMBERG: (Laughter) Taxes.

JOFFE-WALT: That's right. So this 100%, Alex - it might sound arbitrary. It is not. Joshua tried to calculate how much he needed to collect in taxes to compensate himself and his wife for any additional expected health costs of this candy consumption.

BLUMBERG: A hundred percent. That's a pretty hefty tax. But you know what? It seems to have worked.

GANS: That's it. I've no revenue from the health tax whatsoever, which is a bit of a shame because this might have been a way to claw back the enormous allowance that she's getting.

JOFFE-WALT: (Laughter) You've never paid the health tax?

BEA: Never. If - I realized, well, that's just a rip off. Why would I want the candy then? That's a pointless thing.

GANS: And I think she has forecast that if she started buying candy at the 100% tax rate, that we might put up the rate of taxes. And she's probably right. Now, of course, it's illustrating another poor bit of economics in that I'm not - we're not just relying on education to have our daughter make these decisions, but in some sense imposing our will through the tax on her. But I think it's actually...

JOFFE-WALT: Right, because a more free-market economist would say, she - if she understands the risks of eating candy, then she should be allowed to make that choice for herself.

GANS: That's right. But I guess we're not convinced that she quite understands those risks despite her ability to articulate them. I think actually, if we drop the health tax tomorrow, I think a eating binge would occur. That's, of course, another way of educating on these things. But we haven't quite gone that far yet.

BLUMBERG: This is a pretty serious nanny state that this economist has got going in his dream world.

JOFFE-WALT: (Laughter) I know, I know. So you have arbitrary rules and decisions about when you can and can't spend your own money, you know, on "Harry Potter" posters. You've got...

BLUMBERG: There are subsidies enforcing an arbitrary dress code.

(LAUGHTER)

JOFFE-WALT: I know, you could only get the dress if he likes it. And he will match allowance money for books or things that he deems to have educational benefit as opposed to, you know, the health costs that he sees in things like candy.

BLUMBERG: And so what started as a simple economics experiment at home has evolved into this really complicated system with taxes and incentives and subsidies. And Joshua also faces this problem that economists call leakage, where people can go outside the system and get things cheaper. So just like people can cross state lines, for example, to get cigarettes or fireworks cheaper than they could in their own state, Bea can go to her grandmother's house for tax-free candy.

JOFFE-WALT: Oh, yeah. Yeah, to get candy, or to birthday parties, I would assume is also a form of leakage.

BLUMBERG: Exactly.

JOFFE-WALT: And then there's the most basic problem of all, which Joshua has actually never really solved - how much to pay. What is an appropriate amount to pay for the allowance? Because at this point, Bea is 11 years old, and he just set up the system where you get paid a dollar per year, so she gets $11 a week. And she's built up quite a lot of savings.

BEA: As soon as I turned about 9, I realized that's actually quite a bit of money. When I put it - if there are 52 weeks in a year, you multiply, and soon I'll be 10, and then I'll be getting $520 a year. And I'm like, yay, that was pretty cool.

GANS: I'm thinking I overshot.

JOFFE-WALT: Now you think you overpaid?

GANS: Well, the expect - it wasn't our intention that she was going to save the money as much as she does, especially given the demand for cash that we usually were receiving from her.

JOFFE-WALT: Joshua says when he sat down to design this system, the point was to teach Bea budget constraint, and now he's thinking that she learned that so quickly that he could have gotten away with paying her a lot less. Like, all the excess saving means he could have taught her everything he wanted to teach her for way less of his own money.

BLUMBERG: So in economics terms, he wasn't very efficient with his incentives.

JOFFE-WALT: Not at all.

BLUMBERG: Yeah. And, you know, Chana, I've been working on this story about Basel, which is this town in Switzerland where the world's banking regulators gather to come up with new rules for the banking system. But what's happening in Basel reminds me a lot of what's going on in the Gans family home. Like, they're coming up with all these incentives, but the rules are being gamed. It's hard to get the incentives right. What are the proper amounts? They're all wrestling with the same stuff in Basel.

JOFFE-WALT: Yeah. I mean, Joshua says, 2-year-olds versus parents are very similar to bankers versus regulators.

GANS: The problem is that that actually is not a just set-it-and-forget-it policy. That's something you have to manage and think about all the time. And when it comes down to it, that's the scarce resort a parent has. They don't have the attention to continually manage these things, whereas it seems the children have unlimited time to think about how to game the system. One of the things we - that governments get in - trapped on is that they come up with policies that they think are going to solve the whole problem. But when it comes down to it, the policies need constant adjustment. It's actually an issue of management rather than just setting in - setting the parameters correctly.

JOFFE-WALT: Alex.

BLUMBERG: Yes.

JOFFE-WALT: You're a new dad.

BLUMBERG: I am.

JOFFE-WALT: Good luck, man.

BLUMBERG: Thank you. Thank you. I guess I'm going to need it.

(SOUNDBITE OF SONG, "DENTAL CARE")

OWL CITY: (Singing) I've been to the dentist a thousand times, so I know the drill. I smooth my hair, sit back in the chair, but somehow, I still get the chills.

JOFFE-WALT: If you're looking to learn more about the economics of allowance, we're going to link to Joshua Gans' book, "Parentonomics" - I think I'm saying it correctly - on our blog, npr.org/money.

BLUMBERG: And let us know what you think about allowances and incentives for kids in general, or how your parents incentivized you - was it with allowance or was it with spanking?

JOFFE-WALT: Or praise.

BLUMBERG: Or praise. Oh, right, praise. We'd love to hear from you at our Facebook page, facebook.com/planetmoney. I'm Alex Blumberg.

JOFFE-WALT: And I'm Chana Joffe-Walt. Thanks for listening.

(SOUNDBITE OF SONG, "DENTAL CARE")

OWL CITY: (Singing) That's when dentists scream and lose their patience. Talking only brings the toothaches on...

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