Incentives Matter

“Show me the incentive, and I will show you the outcome.”

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Photo by Jonathan Cooper on Unsplash

Charlie Munger, the right-hand man of Warren Buffett and vice chairman of Berkshire Hathaway, once said, "Show me the incentive, and I will show you the outcome."

As humans, we have been wired since birth to pursue our self-interests. The relationship between incentives and outcomes seems like a no-brainer: reward (positive incentives) behavior, and you will get more of it; punish (negative incentives) behavior, and you will get less of it. For example, bonuses will motivate most of us to work harder, and the threat of revoking our driver’s license will compel most of us not to exceed the speed limit while driving.

Yet, some politicians seem to never understand how incentives work. They keep imposing policies that either ignore or offer the wrong incentives. Consequently, they usually get a different result than they had hoped for.

The most recent example is the Biden administration’s announcement that starting May 1st, homebuyers with good credit will be charged more to subsidize homebuyers with bad credit. According to the Wall Street Journal, "Under the rule, home buyers with a good credit score over 680 will pay about $40 more each month on a $400,000 loan, and upward depending on the loan size. Those who make down payments of 20% on their homes will pay the highest fees, which the government will use to subsidize higher-risk borrowers through lower fees." The stated goal of this policy, of course, is equity—to narrow the racial gap in homeownership and help more low-income and first-time buyers own homes. With such a noble goal, what could go wrong?