ps2_2007_02_28 - Psychology and Economics Problem Set 2...

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Unformatted text preview: Psychology and Economics Problem Set 2 Professor Botond Koszegi Due March 8, 2007 1. Many families with low incomes qualify for the Earned Income Tax Credit (EITC). The EITC is essentially a work subsidy: for any $1 the family makes working, the government adds some prespecified amount depending on the number of children, other income, and so on. Many families eligible for EITC get a substantial payment from the govern- ment; for example, a payment of $2,000 on a family income of $15,000 is not atypical. Two facts about how EITC is paid out are interesting to note. First, families can receive EITC either in smaller installments added to the household heads paycheck each month, or as a big lump sum in the form of a tax refund the next year. Most families choose the latter option. Second, once families get their paperwork to file taxes, most rush to a tax preparer such as H&R Block in an effort to get the EITC refund as early as possible. If they file for taxes normally, they get the refund in a few weeks. H&R Block offers a very expensive re- fund anticipation loan so that families can get the refund even earlier, in a day or two. The implied interest rate is often well over 100%. Nevertheless, many families take the refund anticipation loan. (a) Argue that these facts are inconsistent with dynamically consis- tent decisionmaking (exponential discounting). (b) Provide an explanation for these facts using hyperbolic discount- ing....
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ps2_2007_02_28 - Psychology and Economics Problem Set 2...

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