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Incentives are life and death

Ideas@TheCentre – The CIS newsletter (Sydney), 2 December 2011

If there was one word to sum up the whole body of economic theory, it would have to be ‘incentives.’ People act on incentives. As William Stanley Jevons (1835–82), one of the founding fathers of neoclassical economics, put it, the whole economy is ‘a calculus of pleasure and pain.’ Greece is playing out a most macabre application of incentives.

Greece may be the madhouse of the world economy, but there is method in its madness. According to a report in The Lancet, the number of HIV infections in Greece has skyrocketed. The increase was partly due to the termination of drug rehabilitation and street-work programs as a result of government austerity measures. But there was a more chilling explanation.

Drug addicts – acting on incentives – are injecting themselves with the deadly virus to qualify for ‘benefits of €700 per month and faster admission onto drug substitution programmes.’ The incentive to get higher welfare benefits plus access to medical treatment obviously is a strong one – particularly for people who have little left to lose.

It is not the first time economic research has revealed the strange consequences of people acting on incentives. One of the classic economic papers, ‘Dying to save taxes,’ was about how some people in the United States were successfully prolonging their lives by a few days to reduce the estate-tax liability of their heirs.

Australian economists Joshua Gans and Andrew Leigh came to a similar conclusion after studying the effects of the abolition of federal inheritance taxes in 1979: ‘in the very short run the death rate is highly elastic with respect to the inheritance tax rate.’ In other words, people managed to live a bit longer to beat the tax office.

Tax incentives certainly are a matter of life and death, as was confirmed by Germany’s introduction of parental benefits from 1 January 2007. Research by the University of Bolzano showed how German mothers delayed giving birth by a few days to qualify for the benefits.

Incentives matter. If policymakers kept this basic insight in mind, they would design better policies. It might also save the Greek government money it would otherwise spend on AIDS treatment.

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