"James Choi, David Laibson, Brigitte Madrian and Andrew Metrick (2003) have shown evidence that in order to encourage better economic behavior we may have only to institute economic institutions that make the good behavior the "default option." Most people let stand a default option that is suggested to them, and so merely setting up an institutional environment that requires people to make a tiny effort to deviate from the default option can be enough to encourage better economic decision making. As simple as this point seems to be, it has often eluded government policy makers. One suspects that their failure to see this point is a consequence of habitual over reliance on rational optimizing models of human behavior.

Shlomo Benartzi and Richard Thaler (2004) have shown through some experiments that people can be encouraged to save more if employers merely offer them a plan that specifies that their a fraction of their future pay increases will be automatically diverted into a savings program. By specifying that only future increases will be diverted, they make it easier for individuals to sign up for the program, overcoming a tendency for people to procrastinate in their savings decisions. By requiring that people make a little effort to cancel the program, they succeeded in preventing most cancellations. Their programs resulted in a quadrupling of the saving rate in 40 months, far more than any government tax incentives towards saving have done, and with no mandatory provisions.

Richard Zeckhauser and Jeffrey Liebman (2004) have shown how complicated schedules, such as schedules of tax rates relative to income, are a source of endless confusion to the general public. Complicated schedules can sometimes be used to victimize the public, as for example by cell phone companies that advertise low rates on calls made in accordance with a complex schedule, and profit from customers’ failure to comprehend the schedule. But, at the same time, a benevolent designer of economic institutions can use schedules to improve economic welfare by changing the psychological salience of factors that might inhibit constructive economic behavior. An example is the tax schedule involving the earned income tax credit, which encourages unemployed people to find a job by offering a negative tax rate on the salient first income. The earned income tax credit encourages them to make the psychologically difficult transition from unemployment to work. At the same time, the high marginal tax rates on subsequent income are apparently not noticed by most people, and do not operate as a deterrent to further work.

These, then, are concrete examples of behavioral economics offering us some real institutional alternatives to mandatory programs, and alternatives that have the potential to increase economic welfare."

Source: Behavioral Economics and Institutional Innovation, Cowles Foundation Discussion Paper, R. Shiller, January 2005