Note: The following post is a revised and expanded version of an earlier one on the paycheck cycle.

On the eve of each new month, a consumer ritual unfolds at Walmarts around the country.

At around 11 p.m. “customers start to come in and shop,” Walmart’s CEO of U.S. Business Bill Simon told a conference of investors last year (pdf of transcript here). Shoppers fill their carts with staples. Baby formula, milk, bread, and eggs. They browse until midnight when their government electronic benefits cards activate. Walmart’s dead-of-night sales zoom well above its daily average over the month.

Retailers have long known about this phenomenon, commonly called the “paycheck cycle,” in which cash-strapped consumers make big purchases when they get paid and are forced to cut back to the bone later in the cycle until the next paycheck arrives. In this tough economy, said Simon, the paycheck cycle is “extreme.” It can affect Americans at all income levels, but at the end of the month, that extremity is most crushing to the poor and the working class.

When money is tight, people buy less. When money is really tight, less means a smaller package. Retailers are now meeting that demand. Walmart has adjusted package sizes, stocking large pack sizes early in the month, and small pack sizes late. To compete with super discount dollar stores, it is offering micro-size items for under $1; a single paper towel roll, a four-pack of toilet paper, or a box with a handful of garbage bags. On a transaction basis, these goods are dirt cheap. As any good Costco member will tell you though, on a per unit basis, they are not. Walmart is not the only business adjusting; Heinz, Con-Agra, and Coca-Cola are going small too.

When you’re caught in the paycheck cycle, it’s one thing to have to cut back on movies and meals out at the end of the month. It’s another when you have to cut back on essentials. Or pay more for less. Ultimately, the penalty hits the poorest Americans the hardest. The Nudge blog calls it the Public Benefits Cycle Tax, and the implications for policymakers are still evolving. Right now, it’s a tax whose full financial and psychological costs researchers are trying to add up.

The paycheck cycle seems so avoidable. Spend smarter. Budget better. These common refrains sound so reasonable and simple, yet for anyone, rich or poor, who’s ever deposited a fat check on a Friday payday, the temptation to treat yourself just a little bit is tough to fight off. Wallets have a lot in common with waists.

When most economists look at us, they overestimate our financial discipline and underestimate our urge to splurge. In economics, the main doctrine for understanding consumption patterns is an idea called the Permanent Income Hypothesis, developed by economist Milton Friedman. Basically, it says people should take all of the income they expect to receive and smooth out their consumption evenly. Generally, this hypothesis has been used to explain spending over one’s lifetime, but the idea can apply over much shorter time frames like a month.

If you’re a starving artist or a self-employed freelancer, it can be difficult to estimate when your next paycheck will show up. Budgeting, then, can be tricky. But for those with steady incomes, accurately predicting a budget and then spending within its limits should be much easier. In fact, those on fixed incomes, like the poor and the elderly, should be the most likely to follow a smooth spending pattern. Yes, their budgets have to account for unexpected emergencies like a car repair or doctor’s bill, but so do everyone else’s.

Economists have spent years studying the Permanent Income Hypothesis. In reality, people, particularly those on fixed-incomes, aren’t smooth with their money. They’re lumpy. Melvin Stephens of the University of Michigan has looked at United States and United Kingdom spending cycles from a variety of income streams. One of his best-known papers, “3rd of tha Month” (pdf here), examines Social Security checks, which arrive in mailboxes on the third of each month. Those who rely on Social Security as the dominant source of income (more than 70 percent) exhibit the strongest spending fluctuations. In the week after the check arrives, spending on meals out, perishable food like eggs and fruits and vegetables, and entertainment like concerts jumps by some 20 percent. Eating healthy, a major goal of the Obama administration, is more likely during this period as more people eat fresh fruits and vegetables. But the nutrition can’t be sustained since most of it comes not from cooking at home, but through dining out, which drops off quickly.

Despite widespread recognition of the paycheck cycle, the implications for policymakers are still uncertain. The major reason is that its impact on an individual’s quality of life remains murky. One outcome of national interest is obesity. The USDA has reported on a proposed theory of how the timing of food stamps could lead to obesity. At the end of the month, with money tight, less food is eaten. Once the next month’s benefits arrive, food becomes abundant leading to binging. This boom and bust pattern of eating, if it occurs, could contribute to increased weight over time.

That’s a big if, though. A strong piece of evidence on this front so far comes from economist Jesse Shapiro, who has looked at the caloric intake of food stamp recipients over time. Like spending, calories consumed falls too, on the order of 10-15 percent over the course of the month. This pattern, he argues, does not happen because food stamp recipients want to eat more food at the beginning of the month. Nor does it happen because food rots, benefits are stolen, or people end up eating dinner at friends’ houses much more at the end of the month. (Paper here)

Instead, the pattern is consistent with a model of behavior much different from standard economic models.

Sooner is always better than later, but the standard model says people calculate how much less “later” is worth in a time-consistent manner. For example, I should weigh two goods the same whether they are offered today and tomorrow or a year from now and the day after.

This is not what most people do. They follow a model put forward by behavioral economists that says they show a great deal of impatience dealing with immediate choices and much more patience with long-term choices, a phenomenon known as hyperbolic discounting. So when offered the choice between $45 now and $50 tomorrow, many people will choose the immediate $45. However, when offered $45 in one year or $50 in one year and one day they will opt to wait the extra day.

Shapiro argues this view of human preferences better fits the data on caloric intake. If so, the best solution is some kind of a commitment mechanism to help a food stamp recipient resist over-consuming early so that she can enjoy more later. One suggestion is to split food stamp payments into smaller biweekly amounts. At least five states—including New York, Rhode Island, Massachusetts, and Michigan—already do this. But the behavioral economic view remains a theory much more than a fact.

With benefits delivered through electronic cards today, the additional costs of an extra pay cycle are much lower than in the days of mailed checks. But there are still additional costs. Without much better information about them and about food stamp recipients’ preferences for food, Shapiro is hesitant to suggest that all states follow suit.

Yale University’s Ebonya Washington and Justine Hastings are two of the latest researchers to put forward evidence for boom-and-bust spending that shoppers can’t help. Tracking grocery store receipts of a Nevada grocer by food stamp beneficiaries and others, they too find food expenditures on a yo-yo string. After a bump in food spending in the first week of the month, spending then drops 20 percent from the first to the second week, and continues downward through the rest of the month. These declines are driven by lower quantities of food, not lower quality. People aren’t switching the discount brands late in the month. They are buying less. (Paper here.)

Even if the monthly payment model is kept, the one-time payments could be staggered across the entire month so that each person’s government assistance benefits cards would be activated on different days. However, this idea could have serious unintended consequences as many other bills are pegged to the first of each month. Starting a paycheck cycle 10 days into a month, for instance, may lead to payment difficulties for other recurring items like rent and utility bills.

Washington and Hastings find another unfortunate side effect of the monthly benefit cycle: Higher prices on food. With more shoppers buying early, higher demand can support higher prices. From the beginning to the end of the month, Washington and Hastings found that prices fell three percent. This translates into a relatively small dollar amount ($3.50) on the average monthly food stamp bill. But a lot of people are out shopping early in the month and they spend much more on groceries. If these numbers are accurate, the costs of the Public Cycle Benefit Tax don’t just fall on the poor.