Definition
Information frictions are barriers that prevent economic agents from acquiring, processing, or acting on information that is relevant to their decisions, even when that information is technically available. In tax and transfer programs, information frictions arise when eligible individuals do not understand the program's structure, incentives, or eligibility rules — causing them to forgo benefits, make suboptimal labor supply choices, or fail to claim refunds to which they are entitled. Information frictions are distinct from other behavioral biases in that they predict standard optimizing responses once information is provided, making them amenable to field-experimental identification: if an information intervention shifts behavior in the direction predicted by the fully-informed optimum, the pre-intervention deviation was caused by the friction.
Key Ideas
- EITC and the budget constraint: The Earned Income Tax Credit (EITC) creates a non-linear budget constraint with a phase-in (implicit subsidy to work), a plateau (flat benefit), and a phase-out (implicit marginal tax). Standard labor supply theory predicts that workers on the phase-in respond to the subsidy by increasing hours; workers on the phase-out respond to the implicit tax by reducing hours. If workers do not understand this structure, their labor supply does not respond to the kink points.
- Chetty and Saez (2009) field experiment: In a randomized experiment at H&R Block tax preparation offices, tax preparers in the treatment group were trained to explain the EITC budget constraint to clients as they completed their returns. The information treatment caused significantly larger bunching at the EITC phase-in/plateau kink for clients who received the explanation — confirming that pre-treatment non-optimization was driven by lack of understanding of the credit structure, not by other factors.
- Heterogeneity by tax professional compliance: The treatment effect was substantially larger for clients whose tax preparers actually complied with the treatment protocol (intent-to-treat underestimates the local average treatment effect (LATE) for the treatment-received complier population). This compliance heterogeneity identifies which preparers effectively communicated the information.
- Program complexity as friction source: Complex tax codes with many brackets, credits, and phase-outs generate large information frictions. EITC eligibility depends on filing status, number of children, investment income, and earnings level — a multi-dimensional calculation that many eligible workers cannot perform without assistance.
- Distinction from Tax Salience: Tax salience concerns whether a tax is perceived at all at the moment of a relevant decision (e.g., sales tax not displayed until checkout). Information frictions concern whether the full structure of an already-perceived tax or credit is understood. Both reduce behavioral responsiveness to policy incentives, but through different mechanisms.
- Health insurance take-up and the adverse selection inversion (Goldin, Lurie, and McCubbin 2021): The Affordable Care Act (ACA) imposed penalties on uninsured individuals who failed to enroll in available marketplace coverage, yet many penalized households remained uninsured. An Internal Revenue Service (IRS) randomized informational letter experiment (N = 4.5M households) showed that simply informing these households about available options increased coverage by 1.3 pp — revealing that salience and complexity barriers, not rational low-benefit selection, drive mandate non-compliance. Crucially, the marginal enrollees induced by the letters were high-benefit individuals whose mortality fell significantly (−6.1 basis points 2-year all-cause mortality for ages 45–64). This inverts the standard adverse selection logic: because frictions selectively impede those who would benefit most, eliminating frictions improves market efficiency and reduces mortality. See Medicaid and Mortality.
Why It Matters
- Policy design: If information frictions reduce EITC labor supply responses, the extensive-margin employment effect of the credit (often cited as evidence of the credit's effectiveness) may understate the full potential effect under perfect information. Conversely, simplifying the credit structure could amplify behavioral responses.
- Take-up and leakage: Information frictions simultaneously cause under-take-up (eligible workers who don't claim) and incorrect claiming (workers who claim ineligible credits). Both are empirically documented in the EITC literature.
- Generalization and stakes: Information frictions operate in health insurance choice (ACA marketplaces), retirement savings (401(k) default effects), and disability program take-up. The DI Application Costs and Take-Up literature documents that application complexity deters high-severity applicants alongside low-severity ones. Goldin, Lurie, and McCubbin (2021) demonstrate that health insurance information frictions can have lethal consequences: the uninsured households impeded from enrolling by salience barriers had significantly elevated mortality that was reduced by a simple informational letter.
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