According to Nobel Laureate Richard Thaler, people are unable to make the right choice and one should actually nudge them to a default choice which makes it easier for the consumer
As I was trying to figure out the Union Budget 2020-21, I came across this interesting initiative by the Nobel Prize Committee that awards the coveted prize in the economics category. The committee has started a podcast of Economics Nobel Laureates and the first person to feature in the podcast was none other than Professor Richard Thaler.
Thaler won the prize in 2017 for his super interesting work on behaviourial economics. The classical economics is based on this rational person who is able to make the right choice amid numerous options. Thaler questioned this rational approach and argued that people are unable to make the right choice and one should actually nudge them to a default choice which makes it easier for the consumer.
In the podcast, Thaler is asked the question whether he has come across ideas or initiatives which actually go against his nudge approach? Thaler calls such evil nudges as sludges. He points to an example from a website which allowed you to read things for free or one pound for a month and charge more for subscription post the first month. However, cancellation required one to call up the website in London two weeks before, which was a hassle.
Worse, the website would just keep billing the credit card as you shared the card details while paying the one pound for the first month. So, this was like the Hotel California song ‘We are programmed to receive. You can check out any time you like, But you can never leave!’
Thaler says people should avoid such sludges and design nudges in the interest of consumer welfare and make it easier to enter and exit choices.
The same applies to government programmes as well. In fact, in 2016, Thaler defined sludges on Twitter as: “Government programme designed to make compliance as difficult as possible.” And what could be a better government programme than income tax to pass this nudge/sludge test?In the Union Budget 2020-21, FM Nirmala Sitharaman announced a new income tax structure to simplify the regime. Under the new tax structure, three more slabs were added (table 1) but it will not have the deductions and exemptions available to taxpayers. The FM said there are currently more than 100 exemptions and deductions and she has removed 70 of them in the new simplified regime. The new tax structure shall be optional for taxpayers and one can continue to remain in the old structure and avail of exemptions and deductions.
|Table 1: Comparing old and new tax structure|
|Existing Tax Structure||New Tax Structure|
|0 - 5 lakhs||Exempt||0-5 lakhs||Exempt|
|5 – 10||20%||5-7.5||10%|
10 lakhs and above
|12.5 - 15||25%|
|Above 15 lakhs||30%|
Does this new tax structure pass the nudge smell test and simplify taxes for people?
The answer is a mixed one. First, the new tax structure without deductions and exemptions does pass the test as it is simpler compared to the old system which had so many of them.
Second, it adds slabs and makes the system more confusing and does not really pass the smell test. The FM could have stuck to the three slabs and introduced the new taxation rates without exemption/deduction. This would have made it easier for people to compare. The GST (goods and services tax) case does tell us that more slabs and tax rates leads to problems for tax filers.
Third, which system leads to more benefits for people? The FM announced that “in the new tax regime, substantial tax benefit will accrue to a taxpayer depending upon exemptions and deductions claimed by him. For example, a person earning Rs 15 lakh in a year and not availing any deductions etc. will pay only Rs 1,95,000 as compared to Rs 2,73,000 in the old regime. Thus his tax burden shall be reduced by Rs 78,000 in the new regime.”
However, there have been calculations by tax experts that one could actually lose Rs 7,800 in the new regime as the FM has included only exemptions under Section 80 C in her calculation whereas there are other exemptions as well. The FM also said the new regime will lead to revenue forgo of Rs 40,000 crore per year for the government. Does this the figure include all the exemptions and deductions?
Four, the FM claims that “it is almost impossible for a taxpayer to comply with the income-tax law without taking help from professionals”. The purpose of the new structure is also to help taxpayers get rid of the professional help. With the multiple changes, it is unlikely that one can do away with the professional help. One way to do so is to list the new structure as a default option for taxpayers but the speech does not mention the same.
Five, going back to Thaler’s advice and the Hotel California song, the tax system should allow individuals to move back to the old system in case one finds more benefits in the older structure. It should not be the case that one enters the new system and cannot exit.
Overall, the government’s objective to simplify the I-T system is a welcome one. It does pass the nudge smell test on some counts, but misses on some others, which needs rethinking and reworking. The government had decided to set up a Nudge Unit within Niti Aayog last year and if the unit is indeed functional, it is a great idea to run the new income tax structure through them.
In future, all the tax changes should be made to pass the Nudge smell test. This will help in the overall design of the taxation system and help it make a win-win proposal for all.Amol Agrawal is faculty at Ahmedabad University. Views are personal.
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