Tax cuts as price controls

In practically every country on earth, the way a tax cut might work is this: 

• A bunch of similar cinemas sell tickets at around $20, including taxes. The way to think about the taxes is that the government tells them that they need to pay 28% on top of whatever they earn in taxes. So they do a spot of quick math, and tell everyone that they’re charging $15.63, while the rest is the government’s cut. 

• The government cuts the tax rate on movie tickets from 28% to 18%

• The cinemas now need to pay lower taxes

• Some cinemas reduce prices, but most keep them at $20.

• The government then does nothing. 

In India, the government did not do nothing, as NDTV Profit reported in 2020: 

The government’s GST probe body has held that Hyderabad’s Prasad Cinema profiteered as it failed to reduce ticket prices even after the applicable goods and services tax rate was reduced from 28% to 18% in January 2019.

…

The NAA found that Prasad Cinemas did resort to profiteering by way of either increasing the base prices of the services to maintain the same selling price when the tax was cut, or by not reducing the selling price in proportion to the reduction in the tax rate. The amount profiteered was held to be Rs 30,13,058 and the authority has ordered for the same to be deposited along with 18% interest which will be levied  till the time the money is deposited. The company has been given three months time for the deposit of the money.

Prasad Cinema failed to pass the tax cut onto the consumer. The tax went down and the ticket prices didn’t, and this is profiteering, under Section 171 of India’s Central Goods and Services Tax, 2016, which reads: “(1) Any reduction in rate of tax on any supply of goods or services or the benefit of input tax credit shall be passed on to the recipient by way of commensurate reduction in prices.” 

You can think of Section 171 as a sort of Lovecraftian price control that indexes your prices to what they were before the tax rate changed. It doesn’t matter if you priced your tickets at $10 or $300 as long as they are reduced when the government cuts the tax rate. This is strange, because: (1) Why are we talking about price controls? Movie tickets aren’t an ‘essential’ good; and (2) what on earth is this mechanism of price control, where it doesn’t matter what your prices are, as long as you cut them by ten rupees when the government cuts the tax rate by the equivalent of ten rupees? 

There is some logic here, if you think about it from the government’s perspective. When governments want to boost their popularity, or stem a rising tide of unpopularity, they want to lower prices. When the price of onions goes up, the Finance Minister panics, and thinks “wow, we could lose the next election!” and shouts, in the general direction of the closest Joint Secretary, “make the price of onions go down!” 

In India, for historical reasons, the bureaucracy has various levers to make prices go down. The tried and true one is to simply say “onions are ‘essential’ commodities, and I will tell you what the price of onions is.” If they feel the need for novelty, they might say “I will ban my farmers from exporting onions” because then the domestic market will be flooded with now unexportable onions, and prices will go down. 

A movie ticket isn’t an essential good, so it’s harder to make the case for price controls, and it isn’t an exportable good, so you can’t flood the Indian market by banning exports. But it is still a thing that it is politically expedient to reduce the price of. Enough Indians watch movies that the government might benefit somewhat by saying “movie tickets are cheaper now!” 

So a more sophisticated lever, now, is for the government to lower taxes on businesses providing some specific good or service (like movie tickets), with the expectation that this will lower the price, and communicate to the public that the government cares about making their lives easier. This is often a bad way to reduce prices quickly, because you have really cut taxes for the owner of the Prasad Cinema, not on the person buying the ticket.¹

But it is still good PR. You are the Finance Minister, and you have announced the tax cut, and people can say, “Good! The government cares about the people, and their obsession with Shah Rukh Khan.” This works well as communication on its own, but it works better if the price of movie tickets comes down too. The government is foregoing revenue by lowering taxes on something, and it wants to get what it paid for: a lower price. 

So they will use their version of a price control: instead of addressing the root cause—an uncompetitive market, a shortage in supply, etc.—you can address the effect: the price. The Joint Secretary is very used to just saying “let there be lower prices” and watching it become reality; and patience does not come naturally just because we are a more evolved economy now. Patience does not come naturally to the finance minister either, who wants her announcement of the tax cut to be closely associated with a real impact on the ticket prices. 

And so Section 171 is created, which is a way for the government to use tax policy as a magical tool to reduce prices. If there was any doubt that this was the case: 

In its defence, Prasad Cinema pointed out that the entertainment tax levied before introduction of GST was 17.30%. When GST was implemented and the applicable rate was fixed at 28% the cinema company did not increase ticket prices. Subsequently, on Jan. 1, 2019 the GST rate was reduced to 18%, yet it was higher than the earlier entertainment tax rate.

The DGAP contended even though the company did not increase the ticket prices when GST was introduced at 28%, that cannot be grounds for not passing the benefit to consumers when the GST rate was reduced to 18%.

The old antitrust joke goes: “If you charge more than your competitors, it’s price gouging. If you charge the same, it’s collusion. If you charge less, it’s predatory pricing.” But not until Section 171 did it become illegal to charge the exact same amount that you were charging yesterday. 

Section 171 is an instance of a legally mandated price morality that punishes even in absence of competition. In 2016, Prasad Cinema looked at a higher tax rate and said “I will not raise prices” and when it did that it acted as a Good Indian Capitalist should: resisting the temptation of profit. But when the tax rate was lowered in 2019, it acted in discordance with its dharma by failing to forego its current profits. Indian antitrust philosophy exhorts you to be inward-looking; it is weak to wait for competitors to engage in price competition with you. You must constantly be looking at your soul and asking: am I in price competition with myself? 

Unlike the price control methods of yore, this trick is repeatable! The Finance Minister can raise the taxes as many times as she wants, and sometimes the prices will stay the same and sometimes they will increase. But every time the Finance Minister announces lower taxes on something—lo and behold—the prices must come down. And if they don’t, the anti-profiteering authority will show up and chastise you for not engaging in price competition with yourself.

One can even ask: why don’t more governments do this? It seems politically expedient, even if in a crude, unlettered sort of way. Australia tried, and Malaysia tried, as extremely temporary measures — and they stopped pretty quickly.² They stopped because, like many modern economies, they have some faith in markets to decide prices. Taxes might have gone down, but maybe that happened on the day Tom Cruise’s new thriller dropped, increasing demand. Or the price of electricity went up, increasing costs. Or maybe the cinema has decided to open another screen next year, and is saving up money for the capital investment. That might be better for the consumer, but it just doesn’t take the form of the consumer benefit that the government wants: an immediate reduction in the price of the movie ticket. The free market might ultimately help the consumer, but it doesn’t act fast enough for it to help the Finance Minister too. 

Of course, if you are Prasad Cinema, this is all very unfair. During a GST cut, you are no longer a business, but one of the Finance Minister’s many election agents. People think you are getting a tax cut, but you aren’t. Your prices aren’t a reflection of your input costs or of supply and demand, they are a vehicle through which the Finance Minister speaks to the people and assuages their fears.