Are our brains GST-ready yet?

At the stroke of midnight, on the 30th of June 2017, as the entire country was being put to sleep by the long speeches in the central hall of the parliament, many (like me) struggled to stay awake to witness our Tryst with Destiny - Part 2, the roll out of the “landmark” Goods and Services Tax (GST). As the Prime Minister and the President awkwardly pushed the buttons on a large mysterious box, the letters G S T dawned on the parliamentary screens followed by a rather intelligent use of industrial and domestic noises of a well-produced music video. The video ended by rechristening GST as “Good and Simple Tax”.

The fundamental idea of GST is definitely 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 within the nation. This not only promises to reduce the overall tax burden on the people but is also touted to bring in higher compliance rates due to input tax credits. I am not going explain GST in too much detail here since I assume the learned reader of this article would already have figured out the fundamental idea of GST already through online videos, CA friends, finance professors, etc.

Apart from the educational videos and newspaper infographics, you might also have come across memes poking fun at the sheer complexity of our GST. Several online services and software vendors advertised that they were GST ready. The government faced a lot of criticism piled up saying our IT systems aren’t GST ready. Being a fan of behavioral economics which primarily deals with how our brains are wired to act predictably irrational ways, I started to wonder if our brains in the first place are GST-ready?

Overall, it is a complicated piece of legislation, and it is difficult for the common man to wrap his head around how exactly this new regime is going to impact him. I am in no way implying that this is bad and ineffective in any way. It is imperative to incorporate the opinions of all the stakeholders in a democratic process, and the government has done a commendable job of doing so.

Prima facie, based on analysis made by several media outlets, it seems like there would be a small decrease of around 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 are wired as human beings start kicking in.

It is fairly well known in behavioral economics that losses loom larger than gains, i.e., losing 100 rupees makes you more unhappy than gaining 100 rupees makes you happy. This psychological underpinning of humans is known as reference dependence which is one of the fundamental principles of Prospect theory as proposed by Nobel laureate Daniel Kahneman and his colleague Amos Tversky.

In the case of GST, the tax rates of some commodities have gone up while for others the tax rates have come down. This means that losses attributed to increase in tax rates and gains attributed to decrease in tax rates happen simultaneously. However, human nature is such that the impact of the losses gets blown out of proportions. So, even though the GST might result in a net gain for the consumer, the common man might still feel that things have gotten more expensive than before. This might make the common man dislike the legislation. However, common man’s disapproval is the not the biggest problem the government would face.

Further, studies in behavioral macroeconomics have shown that today’s inflationary expectations would result in tomorrow’s actual inflation. This means that Inflation could happen simply based on the subjective belief that things have gotten expensive, irrespective of whether they have actually gotten expensive or not. So there is a fairly good chance of higher inflation in the coming months. And inflation is never good for the government in power.

Inflation might also occur due to a profit-seeking behavior of retailers themselves. Prices of goods and services are usually sticky. Further, upward revisions of prices are usually are more likely than downward revisions, again due to reference dependence. Why reduce the price when the customer is already willing to pay the current price! So there is a threat of businesses not passing on the benefit due to a reduction in tax rates.

I know most of you want to point me towards 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. However, whether it is even possible to detect profit mongering behavior is doubtful. For products which are governed by the MRP, it might be relatively easy to monitor profit mongering. For the service sector, however, especially those running on 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, therefore, have a major role to play in the success or failure of GST.

Could there have been a better time to start GST? Definitely not. Our 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 totally up to how the government manages, amongst other things, 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 GST.

About the Author : Prof. Vinay Kumar Kalakbandi, is a faculty at IMT Hyderabad. He has been a faculty with IIM Raipur and holds a fellow of IIM Bangalore, and M.Tech from IIT Bombay. He teaches advanced operations electives including Service Operations Management, Retail Supply Chain Management along with basic operations management course in the Post Graduate Program. His research area includes area of Behavioral Operations Management, which focuses on the impact of human behavior on performance and decision making in the context of operations.

By Vinay Kumar Kalakbandi, Assistant Professor, Institute of Management Technology Hyderabad