Mental Accounting: How to Justify Spending That Can't Be Justified
We've all done it: Convinced ourselves that our tax refund is really “free money” and therefore can be spent on a big-screen TV, vacation or fancy dinners.
Call it “intaxication,” defined by one clever Washington Post reader as “euphoria at getting a tax refund, which lasts until you realize it was your money to start with.”
Intaxication may not be a real word, but the phenomenon is. A new study shows that taxpayers can easily justify spending what is actually part of their salary on things they don't need.
Amar Cheema, an assistant professor of marketing in the Olin School of Business at Washington University in St. Louis, says many people keep “mental accounts” of their money to control spending. But that mental accounting can get fairly creative – at tax refund time and at the holidays, for example – making it easy to overspend.
To compensate for buying too much, consumers invoke an “un-incurred” cost, Cheema says, such as not signing up for a cable TV service that would have cost $400 a year.
“Consumers are motivated to define expenses and shape mental accounts in a way that allows them to do what they want to do rather than what they should do,” Cheema said in a statement. “Our research identifies loopholes that people exploit so they can do what they should not do–overspend, incur debt… in sum, make poor decisions.”
Cheema and University of Toronto professor Dilip Soman explain the concept in their paper, "Malleable Mental Accounting: How Individuals Manipulate Mental Accounts to Justify Attractive Consumption and Spending Decisions."
Cheema explains that most people create two kinds of mental accounts – budgetary accounts for food, housing and entertainment, for example – and transaction-specific accounts, for occasional purchases like a refrigerator or opera tickets.
Problems crop up when consumers don't know how to categorize a purchase. And when the tax refund arrives in the mail, mental accounting gets pretty flexible.
"Let's say I have wanted to go on a vacation to Miami for a while, and I may apply this refund money to my 'vacation' budgetary account to justify taking that vacation, which is what I want to do, rather than paying off some of my mortgage, as I should do," Cheema says. "In doing so I exploit the ambiguity associated with the purpose of the account, and find a way to spend on luxuries that I was trying to otherwise control."
How can consumers control spending? Cheema says people should draw definite boundaries and clear definitions of spending categories. Unjustified spending also occurs less often if you must be accountable to someone else. So if you're thinking about spending the tax refund on that Miami trip, tell your spouse - you may realign your priorities.