Why Should We Not Protest for Consumption Tax Reduction? Consumption Tax Rate as a Partial Mechanism for Increasing Consumer Wealth

Abstract

We argue that in order for consumption tax reduction to be effective in increasing consumer wealth rather than benefitting suppliers, the tax field is insufficient by itself. We claim that due to cognitive biases, or heuristics, when the government changes consumption tax rates, officially to increase consumers' wellbeing, suppliers will be able to fix market prices above the normal equilibrium prices. We also claim that this effect is strongest in necessity and low-price products.

The article examines four regimes of product price display as a possible solution to this problem: the tax inclusive pricing rule common in EU countries, which requires suppliers to include the tax in the presented price of each product; the tax exclusive pricing rule common in the United States and Canada, which allows suppliers to present the price of each product without taxes; the net and total price rule that we suggest as the preferable solution, requiring suppliers to present net and final prices for each product; and finally, the comparative net and total price rule that is more costly to apply, which is similar to the net and total price rule with the addition of comparative data. We argue that the third rule is preferable since it effectively reduces the influence of heuristics, with minimum costs, therefore best promoting distributional justice and economic efficiency.

Keywords: Consumption Tax Rate, Behavioral Economics, Heuristics, Product Price Display

JEL Classification: K2, K34, D03