(Ir)Rational Consumer Responses: Effect of Uncertain Tax Changes

38 Pages Posted: 7 May 2020

See all articles by Sumit Agarwal

Sumit Agarwal

National University of Singapore

Debarati Basu

XLRI - Xavier School of Management

Pulak Ghosh

Indian Institute of Management (IIMB), Bangalore

Bhuvanesh Pareek

Indian Institute of Management (IIM), Indore

Jian Zhang

The University of Hong Kong - Faculty of Business and Economics

Date Written: April 13, 2020

Abstract

In this paper, we employ a unique tax experiment and dataset in a highly salient tax rate environment to examine consumer response to complex and uncertain tax reforms. Tax reforms raise some fundamental questions in public finance: How does consumption respond to tax change? How is the tax burden distributed among the stakeholders? More importantly, are these answers conditional on whether the tax regime (and not the tax rate) is salient? We find that unpredictability of tax policy changes induces imperfectly rational consumption response. The tax regime complexity does not allow clear tracing of price change despite full information about tax rate changes and so, consumers also respond to notional price changes. This notional response is based on inaccurate beliefs about the impact of visible tax changes on real commodity prices and thus, consumers hoard even those goods that experience a price fall post reform. We further analyse commodity pricing to see how businesses respond and provide evidence of skewness in pricing response post the reform. The burden of tax increase is passed through more than the benefit of tax decrease. Both these aspects, irrational hoarding and an asymmetric transfer of tax benefit to final consumers, are welfare reducing. This is important from a policy perspective since it highlights issues created by complex tax policies.

Keywords: Indirect Tax; Behavioural Economics; Policy Reform; Substitution; Tax Pass-Through; GST

JEL Classification: D12, H22, H30, H71

Suggested Citation

Agarwal, Sumit and Basu, Debarati and Ghosh, Pulak and Pareek, Bhuvanesh and Zhang, Jian, (Ir)Rational Consumer Responses: Effect of Uncertain Tax Changes (April 13, 2020). Available at SSRN: https://ssrn.com/abstract=3574474 or http://dx.doi.org/10.2139/ssrn.3574474

Sumit Agarwal

National University of Singapore ( email )

15 Kent Ridge Drive
Singapore, 117592
Singapore
8118 9025 (Phone)

HOME PAGE: http://www.ushakrisna.com

Debarati Basu (Contact Author)

XLRI - Xavier School of Management ( email )

C H Area (E), Jamshedpur, Jharkhand
831001
India

HOME PAGE: http://https://acad.xlri.ac.in/facprofile/index.php?701

Pulak Ghosh

Indian Institute of Management (IIMB), Bangalore ( email )

Bannerghatta Road
Bangalore, Karnataka 560076
India

Bhuvanesh Pareek

Indian Institute of Management (IIM), Indore ( email )

Prabandh Sikhar
Rau-Pithampur Road
Indore, Madhya Pradesh 453331
India

Jian Zhang

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

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