Behavioural economics and tax cuts as stimulus

Drake Bennett in Behavioral Economics Foils an Obama Tax Cut? writes that in a 2009 stimulus bill, the Obama administration used theories from behavioural economics to dribble out tax cuts over a period of time rather than pay them in a lump sum (as was done with the cash handouts in Australia). This was done because:

... policymakers believed that parceling out the money piecemeal, rather than sending it to taxpayers in a lump sum, had two advantages: It could start sooner, since people didn’t have to wait for the check; and it was more likely to work. By giving people the sense that their incomes had grown, doling out the money paycheck by paycheck was supposed to make recipients more likely to spend it, thereby lifting the economy.

Subsequent research has shown that the opposite was true:

That’s not what happened in practice, according to Sahm, Slemrod, and Shapiro. In a study of the 2009 stimulus, based on 500 telephone interviews, the authors found that only 13 percent of Making Work Pay recipients reported that the tax credit would lead them to increase spending. This was just half of the 25 percent spend rate the researchers found for the traditional lump-sum tax rebate in President Bush’s 2008 stimulus. Of course, 2009 was a worse economic climate than 2008, and that might have played a role in the change. To control for this, the researchers looked at one-time stimulus payments that went to retirees at the same time that Making Work Pay was going to working households. The retirees, too, reported much higher spending rates than the Making Work Pay households, who got their money in a steady drip.

So, the behavioural economists were wrong. Should we stop listening to them then? (I can image Dan Ariely asking this very question in one of his podcasts). Well, actually we should keep listening:
The biggest criticism of behavioral economics is that it remains little more than an interesting grab bag of exceptions to traditional economic theory—TED-conference fodder gleaned from lab studies that are pale approximations of real life. However, as both Thaler and Slemrod point out, there are important questions that neoclassical economics simply doesn’t deign to answer.

Traditional economic theory predicts that the design of a tax credit like Making Work Pay should have no effect on its efficacy: A tax cut is a tax cut, whether it comes in a check, reduced paycheck withholdings, or, for that matter, a briefcase full of cash. How money is delivered should have no effect on whether people spend or save.

Yet if, as Sahm, Slemrod, and Shapiro argue, lump-sum payments are more effective than Making Work Pay, then behavioralists might have something to cheer about, too. That is, after all, exactly the type of effect that these economists would go looking for, even if it’s not the one they predicted. Should it hold up, the finding might best be seen as a refinement rather than a refutation. “I disagree with the idea that this disproves behavioral economics or contradicts it,” says Michael Barr, a University of Michigan law professor and former Assistant Treasury Secretary in the Obama Administration. “The basic insight is that how you give the money matters, and this supports that.”

So the behavioralists may be right after all: People don’t act the way economists predict they should. The trouble is that they don’t act the way policymakers want them to, either.