Alistair Darling and George Osborne agree on something - you can pay people to do good. The Shadow Chancellor's proposal to pay households for recycling waste and the Chancellor's reform of vehicle excise duty to encourage us to buy greener cars, are both founded on the belief that financial incentives can help to turn folk green.

However, when politicians agree, it's often a sign they are all wrong. Incentives don't always work.

Of course, few people will trade in BMWs for Priuses merely to save a couple of hundred pounds. But that's not the problem. Even supporters of incentives acknowledge that they only work at the margin, and most of us are not on the margin.

Instead, the danger is that incentives can backfire. For example, if prices of high-emitting cars fall as a result of Mr Darling's plans, they will become more affordable for boy racers. So the most dangerous drivers will have more powerful cars, and we'll have more deaths on the road.

There's worse - if you pay people to do good, they actually do less than they would without payment. Magnus Johanesson, of Stockholm School of Economics, has shown this. He asked Swedish women to give blood, some voluntarily and some in exchange for a small sum - 50 kronor, just over £4. He found that whereas 52 per cent were willing to give blood for nothing, only 30 per cent offered to do so if paid.

This isn't an isolated finding. Bruno Frey, a professor at the University of Zurich, has estimated that people who work for nothing for political organisations in Switzerland put in more hours than volunteers who get paid a little.

Financial incentives, then, can crowd out altruistic behaviour. Introducing payments changes the meaning of activities, reducing good works to cash transactions. When Swedish women were asked to give blood for nothing, they thought: “Giving blood is good; I'll do it.” But when they were offered payment, they reacted: “50 kronor is not worth my time and trouble.”

Likewise, people might respond to Mr Osborne's plan by thinking: “I used to think recycling was good. But if it's worth less than £7 a week, it's not worth my time.”

You might object that people who care about the environment aren't really altruistic, but merely want to be seen by others to be caring.

But financial incentives can crowd out this motive too. Say people buy hybrid cars to signal to their neighbours that they are green. Tax breaks will weaken this signal. Instead of looking at a hybrid car and thinking: “its owner cares about our future”, people will think “he's just exploiting a tax break”. The signalling motive for buying a “green” car thus diminishes, so - at the margin - fewer will be bought.

Dan Ariely of the Massachusetts Institute of Technology has shown this possibility. He and his colleagues asked Princeton University students to press the letters Z and X on a computer as many times as possible within five minutes, with each click raising money for the American Red Cross. They found that students who did the task in private made just 548 pairs of clicks while those who did so in public made 822. Which shows that people are motivated by the desire to show others that they care.

However, when clickers received side-payments themselves, as well as to charity, the number of clicks made in public fell to 702. Financial incentives crowd out signalling motives.

There's another problem - adverse selection. Many blood donor organisations refuse to pay for blood because it would attract bad donors: drug addicts whose infected blood would have to be thrown away. Similarly, people who take up recycling only because they are paid to do so are likely to only sort their rubbish carelessly, imposing costs upon the recycling centres.

Even previously conscientious recyclers might become sloppy, as what was once a labour of love becomes a mere job of work. Uri Gneezy, of the University of California at San Diego, has shown this. He gave students at Haifa University an IQ test, with some students paid a little for good scores, and others paid nothing. Those who were paid nothing got better scores, because they regarded the test as a bit of fun, and put in more effort than those who expected only small prizes.

So, incentives - carrots - can go wrong. Would fines - sticks - work better? Maybe not. A fine, says Professor Gneezy, is just a price. Fines deter people not by hitting their pocket, but by signalling that a social norm has been broken. Without the norm, a fine can actually attract more law-breaking, as people think the price worth paying. Which raises the question; do carrots and sticks help to support norms, or undermine them? If they support the norm, they can work - as for example, when fines were introduced in the early 1980s for people who didn't wear seatbelts. But if they undermine the norm - by converting altruistic activity to a mere cash nexus - they can fail.

It's hard for politicians to manipulate behaviour successfully - and harder still if they believe people are motivated merely by money.

Chris Dillow is an economics writer at the Investors Chronicle

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