By Cass R. Sunstein
Cambridge, Mass.: In this period of political dysfunction, we could use some good news. Fortunately, there is some. Small reforms, costing little, can have a major effect on people’s lives.
Consider the area of education. Low-income students are less likely to apply to selective colleges than their high- income peers. That’s a big problem, because students who attend selective colleges can obtain significant economic returns, and those returns are especially large for low-income students. What might be done to encourage them to apply? Research by Harvard University economist Amanda Pallais provides some intriguing answers.
Before 1997, those who operated the ACT allowed students to send reports of their test scores to three colleges free; any additional report cost $6. In 1997, the ACT increased the number of free reports to four.
The small step made a big difference. Before 1997, 3 percent of those who took the ACT sent out four reports, whereas 82 percent sent out three. After 1997, 74 percent sent out four reports, whereas 10 percent sent out three. Although the increase in actual applications wasn’t so dramatic, it was nonetheless significant for both low-income and high-income students.
Here’s the crucial finding. After 1997, more low-income students who took the ACT ended up attending selective colleges. The apparent reason is that the shift from three to four reports led low-income students, but not their high-income counterparts, to apply to stronger colleges.
That wider net mattered. Pallais shows that as a result of attending more selective colleges, lower-income students received a significant boost in their expected earnings. Her striking evidence suggests a small proposal: Next fall, both the ACT and SAT should make it easier and cheaper for students to send out free reports. The benefits could be very high.
In 2009, Congress enacted the Credit Card Accountability Responsibility and Disclosure Act. One of its provisions is a small nudge: Every month, companies must disclose the interest savings from paying off the full balance within 36 months, instead of making only minimum payments every month. The goal of the nudge is to show consumers that if they keep making minimum payments, they might well lose a lot of money.
It is easy to be skeptical about disclosure requirements of this kind. Will consumers pay any attention? It turns out that many of them do so. Sumit Agarwal of the National University of Singapore (along with co-authors from the University of Chicago, New York University and the U.S. Treasury Department) finds that the consequence of the nudge was to reduce interest payments by $74 million a year.
In the scheme of things, that isn’t a huge amount of money. For the 3 million or so borrowers who changed their behavior, the annual savings were only about $24 each. But the example demonstrates that disclosure requirements can have real effects. And Agarwal and his co-authors have much better news.
The CARD Act contains a series of seemingly modest provisions designed to limit credit-card fees. For example, companies are forbidden to impose fees on cardholders who go over their credit limit unless the cardholders agree to “opt in” to authorize that practice.
In addition, banks must give cardholders a 45-day advance notice of rate increases, and they must inform cardholders of their right to cancel the account before such increases go into effect. Late fees are generally capped at $25 a month, and no such fee can exceed the minimum payment. Cardholders must also be provided with statements that inform them exactly how long it would take to pay the outstanding balance if they made only the minimum monthly payments.
What is the effect of these provisions? The answer is that they have produced substantial decreases in both over-limit fees and late fees — thus saving U.S. credit-card users no less than $20.8 billion annually. Notably, cardholders with low credit scores appear to be the biggest beneficiaries.
At this point, every economist will emphasize that there is no such thing as a free lunch. We might speculate that while some consumers are benefiting from the fee limits, others are picking up the tab, perhaps through increases in interest rates, or perhaps by decreases in the availability of credit cards.
But Agarwal and his co-authors are unable to find any such effects. They do find a modest increase in annual fees for cardholders, but that increase amounts to less than 10 percent of the $20.8 billion total. In their words, “the CARD Act brought about an across-the-board reduction in borrowing costs.”
Needless to say, the U.S. is in a period in which ambitious reform proposals tend to run into serious political obstacles. But in countless domains, small initiatives, often taking the form of mere nudges, can have stunningly large effects. Both public and private institutions need to pay careful attention to evidence and data — and to draw inspiration from recent success stories.
Sunstein, the Robert Walmsley University professor at Harvard Law School, is a Bloomberg View columnist. He is the former administrator of the White House Office of Information and Regulatory Affairs, the co-author of Nudge and author of Simpler: The Future of Government. He can be emailed at email@example.com.