By Vinay Kumar Kalakbandi
On June 30, 2017, at midnight, the Goods and Services Tax (G.S.T) was rolled out. The Prime Minister and the President awkwardly pushed buttons on a large mysterious box, and the letters, G.S.T dawned the parliamentary screens, followed by a well-produced music video. The video ended by rechristening G.S.T. as “Good and Simple Tax”.
The fundamental idea behind GST is simple. Eliminate the tax on tax in a supply chain, and bring all the indirect taxes under one unified tax umbrella enabling a seamless flow of goods and services.
This not only promises to reduce the overall tax burden on people but is also thought to bring in a higher compliance rate due to input tax credits.
I am not going explain G.S.T. in much detail here because I assume that the reader would have already figured out the basic idea of G.S.T. Apart from educational videos and newspaper infographics, you may have come across many memes that poke fun at the complexity of it.
Several online services and software vendors advertized that they were ready for the Goods and Services tax. The government faced a lot of criticism suggesting that IT systems were not prepared for the tax.
Using the concepts of behavioral economics, I started to think about whether our brains are ready for the Goods and Services tax at all.
Overall, it is a complicated piece of legislation, and it is difficult for everyday people to wrap their heads around how exactly this works and the impact that it would have on them.
I’m not saying that this is ineffective in any way. It is essential to incorporate everybody’s opinions in a democratic process, and the government has done a commendable job of doing so.
However, based on analysis made by several media outlets, it seems like there would be a slight decrease of about 5-7% in the overall tax burden if we consider the basket of items usually purchased by the entire household.
So this should be good news. However, this is where the way we’re wired as humans begins to kick in.
As per my understanding of behavioral economics, one’s losses make one more unhappy than one’s gains. This psychological underpinning of humans is known as reference dependence, which is one of the fundamental principles of Prospect Theory that Nobel laureate Daniel Kahneman and his colleague Amos Tversky had proposed.
In the case of G.S.T., the tax rates of some commodities have gone up while for others the tax rates have come down. This means that losses attributed to increasing tax rates and gains attributed to decreasing tax rates happen simultaneously.
However, human nature is such that the impact of the losses gets blown out of proportion. So, even though the G.S.T. might result in a net gain for the consumer, the common person might still feel that things have gotten more expensive than before.
This might make people dislike the legislation. But, the people’s disapproval is the not the biggest problem the government would face.
Studies in behavioral macroeconomics have shown that today’s inflationary expectations would result in tomorrow’s actual inflation.
This means that inflation could happen based on the subjective belief that things have gotten expensive, irrespective of whether they have actually gotten expensive or not. So there is a good chance of higher inflation in the coming months. And inflation is never good for the government in power.
Inflation may also occur due to the profit-seeking behavior of retailers. Prices of goods and services are usually sticky. Further, upward revisions of prices are more likely than downward revisions of reference dependence.
Why reduce the price when the customer is already willing to pay the current price!
Most people would want to point at the anti-profiteering clause where businesses are, by law, expected to pass on the benefits due to tax cuts to the consumers, failing which their GST registration would get canceled.
But we don’t know if it is possible to detect profit mongering behavior. For products that are governed by the M.R.P., it may be relatively easy to monitor profit mongering.
For the service sector, however, especially those that are running at a net loss (like Ola, Uber, Flipkart), profit mongering detection would not be easy.
Further, the regulation just says “cancellation of GST registration” which is an extreme measure. The penalty is not proportional to the crime. This usually results in the legislation being applied only in extreme cases, thus diluting its purpose.
The macroeconomic reality of a country is shaped by the amalgamation of individual behaviors of millions of consumers and retailers alike. How our brains are wired to process information would have a major role to play in the success or failure of G.S.T.
Could there have been a better time to start G.S.T.?
I don’t think so.
The economy was booming, and inflation was quite low. This was the perfect time to take such risks. Whether the risks will pay off or not is up to how the government manages public perception and behavior.
I believe there is a long way ahead and much like the video that played on the screens of the central hall, this is only the dawn of G.S.T.