Behavioural science - real-world applications
One interesting example of behavioural economics at work in society, was shared by Owain Service, CEO of CogCo and former Deputy Director of the Prime Minister's Strategy Unit, at our most recent Financial Wellbeing Forum. In 2017, Service and his team looked at messages sent by HMRC in regards to tax payments - specifically towards those who had outstanding payments. Historically, one standard letter, written in dense and complicated ‘legalese’, was sent to individuals who needed to pay taxes - which had roughly a 33% success rate. With the help of the behavioural insights team, four additional letters were tested among trial groups:
“Nine out of ten people pay their tax on time. You are in the minority that does not pay their tax on time.”
“Nine out of ten people in your local area pay their tax on time. You are in the minority...”
“Nine out of ten people with a debt like yours pay their tax on time. You are in the minority...”
“Nine out of ten people with a debt like yours, in your area, pay their tax on time. You are in the minority...”
The last letter was most effective - and overall the experiment increased the percentage of recipients who go on to pay their outstanding taxes by 6% (from 33% to 39%) - in context, in the 3 weeks in which this experiment ran, it drove roughly a £3 million increase in tax payments.
The success of these letters comes from introducing a social dimension to the way people pay their taxes, letter one creates a comparison with other tax-payers, letter two introduces the ‘neighbour effect’, letter three creates a sense of community, and so on. Much like the first example of how you choose your lunch each day - by introducing the actions of other people into the decision-making process, individuals are influenced into making certain decisions, whether they’re acutely aware of it or not.
How does behavioural science impact how we manage our money?
‘Mental accounting’ was a term coined by Richard Thaler (Nobel-prize winning economist), to broadly explain the way in which people value money in their minds, based on subjective criteria; for example, money that is gifted or unexpected should not be treated more frivolously to money that has been earned at work - according to Thaler’s work - every ‘dollar’ should be valued equally. To put a complicated concept in simpler terms - let’s look at a few examples:
- Take an individual who is saving cash in a jar for a dream holiday, but who is also carrying credit card debt; they don’t use the holiday money to pay down their debt, because they have mentally deposited it elsewhere in their budget, and have attached importance to it. This is an example of mental-accounting bias, where despite having the option of using this money to pay down their debt, the individual does not, as mentally it is not available for them to use.
- Similarly, imagine someone unexpectedly receives a tax refund. Instead of using it responsibly, such as paying off debts or saving, they might decide to spend it on non-essential items like a luxury purchase. This behaviour occurs because they mentally label the windfall as ‘extra’ or ‘free’ money, separating it from their regular budget and feeling justified in using it frivolously, even though financially responsible choices might be more beneficial. This is another example of mental-accounting bias.
Almost everyone will have experienced this concept in some form or another when it comes to managing finances, and it calls back to the idea that no human makes entirely rational decisions, as we are constantly influenced by external factors, be that our peers, our emotions, and so on. This is why it is essential to grasp an understanding of how behavioural science helps us understand how humans make decisions, and optimise systems and mechanisms to mimic those processes more closely.
