Economic Incentives

Economic incentives are financial rewards provided to people to alter consumption and production patterns in an economy. The main purpose of the economic incentives approach is to influence human behavior to produce desired results naturally. It is a type of monetary motivation that the government or businesses offer. These can be in the form of money, bonuses, tax rebates, or subsidies.

Economic incentives can be intrinsic or extrinsic based on the source of motivation. It has huge macroeconomic effects, like stimulating commercial activity and increasing people's participation. It allows the government to keep control of the economy and helps businesses increase sales. Common incentives include salaries, subsidies, tax credits and rebates, discounts, etc. 

• Economic incentives are rewards that influence the citizens' or consumers' behavior by delivering financial motivation. 
• It can be anything related to cash like discounts, cash back, etc., or a move with an indirect monetary value like selling complementary products or extra quantity for free.
• There are two types of economic incentives- intrinsic and extrinsic. The former is related to an individual and their beliefs, whereas the latter is concrete and comes from outside, like money.
• Incentives are extremely beneficial to the economy but have their downsides, too, like increased tax burden on people, difficulty in ascertaining effectiveness, etc. 

Economic incentives approach is a common practice adopted by governments and businesses. It is a strategy through which financial impetus is provided to the general public to stimulate the desired action.

For example, consider a company ABC, which introduces a new printer model. As a pre-launch offer, it decides to provide 40% cashback to the first 100,000 customers. It is an attractive offer, and customers buy the printer. Here, the cashback is the incentive or the reward.

But it doesn't mean that economic incentives always have to be financial rewards, it just needs to have a significant monetary value. Like, in example mentioned above, if the company decides to offer ink cartridges for free with every printer, that too will be sufficient to encourage purchases because the two items are complementary, and again the cartridges have a monetary value.

Similarly, take the case of country X, which deals with population issues. On average, every couple has three kids in the country. With the growing population, the government encourages the single-child policy by taking up the child's educational expenses until under-graduation. It assures parents about the security of their children.

Governments and companies use positive economic incentives to motivate people to perform actions toward the social and economic welfare of their ecosystem.

It is important to be familiar with the two types of economic incentives – intrinsic and extrinsic. Intrinsic incentives are internal to a person and deal with an individual's philosophy and beliefs. For example, charity is a type of intrinsic incentive purely motivated by a person's mindset or belief system. On the other hand, extrinsic incentives come from outside sources and often have huge monetary value, motivating people through offers, discounts, etc.

Economic incentives approaches are largely associated with the government and its activities. For example, the government often provides subsidies to citizens to take up a certain course of action they recommend. For instance, governments incentivize manufacturing firms that use renewable energy sources.

As a result of this motivation, people are interested in adopting the measures suggested by the government. There are economic incentives for environmental protection, agriculture, renewable energy alternatives, electric vehicles, etc., provided by the government. Some countries even give incentives to a single girl child. 

But the government is not just involved in propelling economic activity; sometimes, it restricts activity too. It is done through economic disincentives, which discourage consumption or production. For example, suppose the country has high inflation, and the government increases the interest rate on borrowings to reduce public consumption.

Economic incentives may not always be positive. Sometimes the government or organizations can also punish people in a certain way for their choices. Fines and penalties like those implemented for carbon emissions are an example.

According to Harvard Business Review, extrinsic incentives backfire when it conflicts with intrinsic incentives. Let's consider the example provided by social researcher Richard Titmuss. People donate blood because it makes them feel valuable and of service to society. However, if the government puts a price tag on it and subsidizes people who donate blood, some would lose their motivation to do so, as it is against their ethics or because they do not want others to believe that they did it for the money. Hence, the effort to motivate becomes the villain here.

Let us understand the different types of economic incentives approach taken by governments and companies based on the need of the situation and their financial condition through the discussion below.

• Tax Incentives: Commonly referred to as tax benefits, these reductions or deductions from paying tax motivate taxpayers to spend in a particular area or certain items. For instance, the mortgage interest deduction in the United States incentivizes citizens to purchase a home.
• Subsidies: These are government incentive projects that allow a particular section of society or a particular type of business to thrive. In India, the agriculture sector enjoys no Goods and Services Tax (GST), and various subsidies to purchase tractors and agricultural equipment are provided to protect them from falling prey to debt traps.
• Rebates: Tax rebates refer to the deduction or provision of a specific amount for spending on a specific installment or item. In many countries across the world, governments provide a particular amount for their citizens to install solar panels to reduce carbon emissions.
• Negative Incentives: Also referred to as disincentives, are additional charges to a taxpayer who does not purchase a certain item. For instance, an individual not purchasing health or life insurance can be penalized during their annual tax filing.

Let us understand the concept of positive economic incentives and other such incentives given by governments and companies with the help of a couple of examples.

Example #1

Country XYZ has been red-flagged a couple of times in the past year due to high levels of pollution. From a detailed analysis of the situation, the environment welfare minister found that the majority of its population used cars even if there were well-established public transport and carpooling was also at a negligible level.

The top officials from the department met the finance minister and the financial advisor of the country to devise a plan to tackle the situation by not forcing their people but providing them with incentives that motivate them to abandon using their cars as frequently as they currently use.

They decided to provide a 15% tax rebate on yearly public transport receipts tracked through a card through which they could pay for the transport. They also directed large corporations to encourage their employees to take the carpooling services provided by the company at marginal costs.

As a result, the pollution levels could be controlled below hazardous levels for the time being while the government planned an extensive afforestation drive.

Example #2

The high installation and maintenance costs of solar panels and batteries discourage many users from adopting the technology. So, the United States government provides tax credit facilities to citizens who install solar power systems at home. 

With tax credits, a percentage of income tax is credited to the citizens, which reduces the total tax amount. As a result, it can serve as a major push for prospective consumers to install solar panels. According to Forbes estimates, in 2023, consumers can expect a tax credit rate of 22 – 26%. In 2021, the discount rate was averaged at 26%. 

Let us understand the advantages of taking the economic incentives approach through the points below.

• Economic incentives can be largely beneficial to society. It helps manage the economy and keep it under control.
• Incentives by businesses can be advantageous to both consumers and firms.
• Government subsidies encourage people's participation in the economy and reduce inequality by supporting the needy. 
• As all employees like to be recognized for their efforts and acknowledged through some means that motivate them to work harder and smarter, these incentives act as a morale booster.
• It also serves as a reliable metric to judge the level of work an employee has done or even the investment choices of taxpayers.

However, that is just one side of the coin. Incentives have negative implications too. Let us understand them through the explanation below.

• It increases government expenditure considerably, which leads to increased taxation and national debt.
• The efficiency of transferring these incentives to the people in developing and under-developed countries is debatable. The businesses that offer incentives might exploit people and reap profits. 
• It is also rather complex to measure the extent of success of incentivizing national goals. In some cases, it might even lead to monetary loss for the government. It can also work in counter-productive ways if employees start feeling entitled to these incentives and could be demotivated to work in their absence.
• It might also create a sense of inequality as some people are at the benefit of these motivators and some might not be eligible.

This has been a guide to Economic Incentives and its definition. We explain its examples, types, advantages, disadvantages, and government incentives. You can learn more from the following articles –

• Environmental Economics
• Economic Shortage
• Economic Bubble