Newsletters › The Deadweight Loss of Christmas

With Thanksgiving behind us, it’s time to think about gifts for the holidays. What better time to explore the economic concept of deadweight loss and the law of gift cards.

Deadweight loss is a term used to describe the costs to society created by inefficiency in the market. A good starting point for understanding the concept is economist Joel Waldfogel’s study, “The Deadweight Loss of Christmas,” which was recapped in his aptly named 2009 book, Scroogenomics. The first version of the study was conducted in January 1993 when, soon after winter break, Waldfogel asked students in his Yale Econ 150 class to list all the gifts they had received during the holiday season. Then, for each item, he asked the students how much money they would pay for the gifts. The students indicated that they would only pay 66% of the purchase price, implying that for every $3 their families and friends spent, $1 was deadweight loss.

In subsequent years, Waldfogel tweaked the wording of his surveys, polled more students, and concluded that the true deadweight loss of gift-giving is actually closer to 18%. In other words, giving the Large Holly Tin Gift Set that costs $99.99 at the Yankee Candle Company as a gift is (perhaps, at best) the economic equivalent of giving a gift of $82 in cash and flushing $17.99 down the toilet. Happy holidays!

The obvious solution, cash gifts, has an equally obvious drawback: tackiness. According to Waldfogel, cash gifts from parents, grandparents, and relatives at least one generation removed, have very little social stigma and are almost perfectly efficient. But cash gifts from siblings, boyfriends, girlfriends, regular friends, and spouses have a “cash stigma” of approximately $4 and half the price of the cash gift. Put another way, slipping a cool hundred dollar bill to your spouse on Christmas morning will only yield $46 of satisfaction – not very romantic and certainly not efficient.

That brings us to the next best solution: gift cards. There appears to be very little social stigma attached to gift cards. In fact, in a 2007 National Retail Federation survey, gift cards were the number one most wished for item. And gift card recipients often report receiving more satisfaction than the actual price of the gift cards that they use. That’s probably due to the consumer surplus effect, whereby we get more satisfaction from the things we select for ourselves than the amount we pay for those items. Have you ever been willing to pay $2 for a $1 can of Diet Coke or $8,000 for a $5,000 Hermes scarf? If so, you were the happy beneficiary of a consumer surplus.

But, according to Waldfogel, only 90% of gift card value ever gets redeemed. And that brings us to the legal issues in this month’s newsletter: Can your gift card expire and, either way, what happens to unclaimed gift card money?

As with many legal issues, the answer is: It depends. Until recently, there was no federal law regarding gift cards. However, the Credit CARD Act of 2009 created a baseline national rule. The CARD Act prohibits gift cards from expiring within five years from the date of purchase or when money was last loaded onto the card. But many states have stronger consumer protections, which are still valid. For example, with rare exceptions, gift cards cannot expire in California, Connecticut, Florida, Maine, Minnesota, Montana, Oregon, and Rhode Island.

Nonetheless, approximately $8 billion of gift card value goes unredeemed each year. What happens to that money? In some states, the money goes to the taxpayers. For example, in New York, if gift cards aren’t redeemed within five years, the balance must be reported and turned over to the state in accordance with New York’s abandoned property law. But in other states, the gift card issuers get a windfall. According to Waldfogel, “based on a rapidly developing body of historical experience, stores have determined that after about four years, unredeemed balances are likely never to be redeemed.” Thus, after four years, many stores book unredeemed gift cards as revenue. In 2006, Target admitted that it actually takes the percentage of each gift card purchase (based on the total amount that it anticipates will not be redeemed) and books it immediately as revenue. That same year, Home Depot reported $43 million in revenue from gift cards that were never cashed in.

Of course, it is far better to avoid these legal issues altogether and there is a very easy way to do so: Spend your gift cards quickly. On that note, we at Mandel Bhandari wish you a very healthy and happy holiday season and hope that each of your purchases results in a massive consumer surplus!