A perverse incentive is a term for an incentive that has the opposite effect of that intended. Perverse incentives by definition produce unintended consequences.

For example:

• Some social welfare programs only give money to people with no job. Some argue that this discourages people from working because they would lose welfare benefits if they became employed. According to these critics, this leads to a net increase in poverty. This effect is called the 'Welfare trap.' In some cases, this incentive is countered by gradually phasing out benefits (for example, reducing benefits by 50 cents for each dollar earned), thus preserving the incentive to seek even part-time work.

• Paying the executives of corporations proportionately to the size of their corporation is intended to encourage them to grow their companies by growing the bottom line (and not their earnings per share). However, it may cause them to pursue mergers to grow their companies, to the detriment of their shareholders' interest.

• Any system of performance-related pay for corporate executives can induce unacceptable risk-taking, unless there are penalties for poor performance.

• Funding fire departments by the number of fire calls made is intended to reward the fire departments that do the most work. However, it may discourage them from fire-prevention activities, which reduce the number of fires.

• In India, a program paying people a bounty for each rat pelt handed in was intended to exterminate rats. Instead it led to the farming of rats.

• In computer security, users are encouraged to use passwords which are difficult for an attacker to guess. However, assigned passwords which are too complicated may be hard to remember, leading users to write them down rather than memorizing them — and many attackers can find the written passwords more easily than guessing the user-selected weak ones. (Today, some security researchers suggest that it's actually better to use complicated passwords but write them down, as long as they're written down only in a safe place such as the user's wallet, rather than on the desk. Written passwords can also not be compromised with distance, ie. an attacker from a remote location cannot find the written password.).

• Setting the same minimum tarriff for crimes of different severity may increase the incidence of the most serious crimes. For example, the practise of executing thieves may lead to an increase in murders, since the thief has an incentive to kill any witnesses to avoid being convicted - he will not be any the worse off if caught. This is the root of the saying "Might as well be hung for a sheep as for a lamb".

• An airline may promote a marketing campaign with one of their local newspaper partners, giving new subscribers 500 frequent flyer miles on the airline. The goal is to broaden newspaper circulation (and raise the attractiveness of the newspaper to advertisers). A few enterprising people work out that it could actually be cheaper to subscribe to multiple newspapers-- hundreds of subscriptions to the same address-- than buying a ticket to a far off destination. This massive subscription effort simply costs the newspaper (the entity who pays the airline for mileage awards), yet new readership has not increased at all.

• Banning the sale of various recreational drugs may make drug dealers more likely to sell to minors. When it is illegal to sell to minors but legal to sell to adults, drug dealers have an incentive to refuse to sell to children. When all sales are equally punished, selling to minors may be safer for the dealer.

• Some insurance contracts or social entitlement regulations can give opportunity to change behavior in an unforeseen way so as to take advantage of them in a perverse way (moral hazard, free rider).

• In the Soviet Union, bread was mandated to be cheaper than the grain used to make bread. Thus, pig farmers fed bread rather than grain to their pigs.

• Where libraries and similar institutions charge a fee for copying, but not for printing, users may print multiple copies of a document — which could cost the institution more than free copying would.

• The United States and The Netherlands have a tax deduction for mortgage interest on one's primary residence. While this was intended to promote home ownership among the middle and lower class, some wealthier people with a secure income obtain mortgages with lower down payment, longer term, or both than they would otherwise choose and invest the amount saved at the time of purchase. The government effectively subsidizes the investments.

• To prevent police brutality, police in some areas are no longer issued nightsticks. However, this may encourage them to use their metal flashlights instead, causing worse injuries.

• During the Vietnam War, the Central Intelligence Agency and South Vietnamese intelligence conducted a covert operation called the Phoenix Program, which was assigned to detain or kill Viet Cong sympathizers. South Vietnamese and American combatants were offered a reward for each enemy, dead or alive. This allegedly resulted in the killing of more innocent civilians than hostile fighters.

• Digital Rights Management schemes are often used to discourage illegal piracy by preventing copying of content. Pirated content usually does not contain DRM, so people who do not want DRM in their content have a perverse incentive to pirate it.

• Asset forfeiture laws are intended to reduce use of illegal drugs by preventing drug-dealers from benefiting from their crimes and thereby making drug-dealing less attractive. If the forfeited property (or proceeds from selling it) is used for law-enforcement then police may have a reason to postpone action against a known drug-dealer until there is more property to seize, with the result that more people buy the drugs.

• No Child Left Behind Act-type laws require schools to show smooth improvement in their students' test scores. Thus, schools may benefit from having poorer performance one year in order to show 'improvement' the next.

See also

• Side-effect
• Kludge
• Moral hazard
• Murphy's law
• Perverse effects of vaccination
• Unforeseen effects of species introduction
• Unintended consequences
• Tragedy of the commons

References

• John Sloan III, Tomislav V. Kovandzic and Lynee M. Vieraitis. Unintended Consequences of Politically Popular Sentencing Policy: The Homicide-Promoting Effects of 'Three Strikes' in U.S. Cities (1980-1999). Criminology & Public Policy, Vol 1, Issue 3, July 2002.
• http://www.local.dtlr.gov.uk/review/consult/fire.pdf
• UPI story: Study: 3-strikes laws increase homicides

Market failure