Financial incentives are an important policy tool for encouraging prosocial behavior. This paper examines a simple element of incentive design – whether an incentive takes the form of a fee for bad behavior or a reward for good behavior – to assess how the framing of an incentive impacts the policy’s effectiveness. I determine whether small incentives and their design matter through the evaluation of two policies in the Washington Metropolitan Area aimed at reducing consumption of disposable grocery bags: a five-cent tax on disposable bag use and a five-cent bonus for reusable bag use.

Standard economic theory suggests that financial incentives will be effective if the cost an individual associates with changing his behavior is smaller than the incentive provided for doing so. This implies that the form an incentive takes, a tax versus a bonus, should not impact the policy's effectiveness as long as the two incentives are the same amount. If we assume that disposable and reusable bags are substitutes, both policies discussed above provide customers a five-cent incentive for using a reusable bag instead of a disposable bag. In contrast, evidence from the field of behavioral economics (Kahneman and Tversky, 1979) suggests that individuals perceive losses more strongly than gains of the same size. If grocery store customers are “loss-averse,” then the tax will be more effective than the bonus, even if the incentives are financially equivalent. This paper adds to a growing number of studies that test the effectiveness of economic incentives with these behavioral mechanisms in mind (Field, 2009; Fryer et al., 2012) and extends the literature to the context of environmental policy. In addition, this is the first paper to test for loss aversion in the field with very low-stakes incentives.

I collected a unique dataset on disposable and reusable bag use for over 16,000 customers at sixteen stores in three counties in the Washington Metropolitan Area before and after the implementation of a five-cent tax in Montgomery County, MD. Using a difference-in-differences analysis I find that reusable bag use increased by 33 percentage points just two months after the tax was implemented – an overwhelming response. In contrast, reusable bag use in bonus-only stores is only slightly higher than in stores that offer no incentive. These results suggest that, while the tax has a substantial impact on reusable bag use, a bonus of the same amount has almost no effect on behavior, evidence consistent with a model of loss aversion

The paper concludes by exploring mechanisms other than loss aversion that may have caused customers in stores charging a tax to use fewer disposable bags than customers in stores offering a bonus. First, while survey data suggests that customers are less aware of the bonus than the tax, the differences in awareness cannot fully account for the difference in effectiveness of the two policies. Second, I found no change in reported attitudes regarding disposable bag use after the tax was implemented, suggesting that changes in social norms are not driving my results.