Replugging Old article on the New Tax regime: Income tax changes should pass the nudge smell test fully

In the Budget speech today, FM Sitharaman made many changes in the personal tax regime. One of the changes was on the new tax regime.

We are also making the new income tax regime as the default tax regime. However, citizens will continue to have the option to avail the
benefit of the old tax regime.

What is rhe new tax regime? In the 2020-21 speech, FM had announed the new tax regime. Under the old regime, there were many exemptions. Under the new regime, the tax slabs were made lower and there were no exemptions.

In an earlier moneycontrol article, I had suggested to make new tax regime the default regime for easier switch. I had also argued that people should be able to go back to the old system if they find less benefits in the new system.

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How do Behavioral Approaches to Increase Savings Compare? Evidence from Multiple Interventions in the U.S. Army

Richard W. Patterson & William L. Skimmyhorn in this interesting NBER research do an experiment to increase savings in US army:

Information provision, choice simplification, social messaging, active-choice frameworks, and automatic enrollment all increase retirement savings. However, gauging the relative efficacy of these approaches is challenging because the supporting evidence spans widely different institutional settings, populations, and time periods.

In this study, we leverage experimental and quasi-experimental variation in a constant setting, the U.S. military between 2016-2018, to examine the effects of nearly two dozen experiments for four leading policy options (i.e., information emails, action steps, target contribution rates, active choice, and automatic enrollment) designed to increase retirement savings.

Consistent with previous literature, we find sizable effects of savings interventions on participation and cumulative contributions that increase with the intensity of the intervention.

We then exploit cost data to complete the first cost-effectiveness analysis in the literature. Our analysis suggests that active choice programs are the most cost-effective method to generate new program participation and contributions for small, medium, and large firms, while automatic enrollment is more cost-effective for very large firms.

Reserve Bank of India encourages cardholders to tokenise their cards: Can it encourage nudging too?

RBI issued a press release encouraging cardholders (both debit & credit) to tokenise their card information. Merchants store a lot of information about our cards on their network. This could lead to problems:

Currently, many entities, including merchants, involved in an online card transaction chain store card data like card number, expiry date, etc. [Card-on-File (CoF)] citing cardholder convenience and comfort for undertaking transactions in future. While this practice does render convenience, availability of card details with multiple entities increases the risk of card data being stolen/misused. There have been instances where such data stored by merchants, etc., have been compromised.

Given the fact that many jurisdictions do not mandate Additional Factor of Authentication (AFA) for authenticating card transactions, stolen data in the hands of fraudsters may result in unauthorised transactions and resultant monetary loss to cardholders. Within India as well, social engineering techniques can be employed to perpetrate frauds using such data.

Tokenisation helps prevent these frauds:

Given the foregoing, the Reserve Bank mandated that after December 31, 2021, entities other than card networks and card issuers cannot store card data. This timeline was subsequently extended to June 30, 2022. A framework for CoF Tokenisation (CoFT) services was also issued. Under this framework, cardholders can create “tokens” (a unique alternate code) in lieu of card details; these tokens can then be stored by the merchants for processing transactions in future. Thus, CoFT obviates the need to store card details with merchants and provides the same level of convenience to cardholders.

To create a token under the CoFT framework, the cardholder has to undergo a one-time registration process for each card at every online / e-commerce merchant’s website / mobile application, by entering the card details and giving consent for creating a token. This consent is validated by way of authentication through an AFA. Thereafter, a token is created which is specific to the card and online / e-commerce merchant, i.e., the token cannot be used for payment at any other merchant. For future transactions performed at the same merchant website / mobile application, the cardholder can identify the card with the last four digits during the checkout process. Thus, the cardholder is not required to remember or enter the token for future transactions. A card can be tokenised at any number of online / e-commerce merchants. For every online / e-commerce merchant where the card is tokenised, a specific token will be created.

Till date, about 19.5 crore tokens have been created.

To sign for CoFT:

Opting for CoFT (i.e., creating tokens) is voluntary for the cardholders. Those who do not wish to create a token can continue to transact as before by entering card details manually at the time of undertaking the transaction (commonly referred to as “guest checkout transaction”).

This is where nudging can come. Instead of keeping it voluntary, one could enroll citizens automatically into the program. They can opt out of tokenisation if they wish to. An experiment worth doing?

 

The id and the nudge: where Freud meets behavioural economics

Briana S Last, a doctoral candidate in clinical psychology at the University of Pennsylvania in this aeon article:

We are not perfectly rational. This is obvious to anyone who has eaten more than their fill, exchanged harsh words with a friend, or taken the wrong turn on their morning commute. Less obvious, though, are the ways in which our thoughts, feelings and choices are systematically biased. Behavioural economics, a field that bridges insights from social psychology, cognitive science and economics, emerged in recent decades to explain the constraints on human rationality – uncovering a still-growing list of biases and heuristics, or mental shortcuts. Behavioural economists have also harnessed research findings to improve judgment and decision-making through simple interventions (often called ‘nudges’).

Though the field’s discoveries are genuinely novel, its intellectual influences run deep. Its founders drew inspiration from the 20th century’s most famous theorist on the irrational unconscious: the founder of psychoanalysis, Sigmund Freud. The notable convergences between Freud’s ideas and behavioural economics are a testament to the durability of theories that divide thinking into two processes. Their divergences point to the distinct historical and political moments in which these psychological paradigms surfaced. Freud and behavioural economists have picked up on something distinct, maybe even intrinsic, about the way we think – but they have done so with very different emphases and to describe disparate realities.

 

What would Hayek make of behavioral economics?

Interesting debate between Cass Sunstein and Mario Rizzo on whether Hayekian ideas and behavioral economics go hand in hand:

F.A. Hayek was one of the 20th century’s most influential economic, political, and social philosophers—and a Distinguished Senior Fellow at the Cato Institute. Cass Sunstein, currently at Harvard Law School and formerly the administrator of the Office of Information and Regulatory Affairs under President Obama, invokes Hayekian concepts for a theory of “libertarian paternalism,” which uses behavioral economics to justify a range of public policy interventions to frame individual choices in ways intended to nudge them toward better outcomes. Mario Rizzo, an economist at New York University, disputes the Hayekian justification for this vision. In May, they participated in a Cato policy forum to discuss these differences as well as which is the better interpretation of Hayek’s insights.

Zomato nudges for reduction in plastic cutlery but maybe needs to relook at its nudge statement..

Zomato is the buzzword not just in the food world but also in the finance world with its recent IPO which led to intense discussions in media over its valuation.

This blog is about Zomato’s recent steps to lower plastic cutlery usage using the ideas from nudging theory.  Richard Thaler, founder of nudging says we need to tweak the default choices for the intended behaviour. So to push people towards higher savings, change the default choice towards higher savings.

Zomato has done something similar as its CEO Deepinder Goyal in this blogpost explains:

On the Zomato app, customers always had the option to skip cutlery with their order. However, very few customers used that option. We learnt that it wasn’t because they always wanted the cutlery, but because they weren’t making an active choice. Defaults almost never get changed by customers during product flows. 

We surveyed thousands of our customers, and a whopping 90%+ of them said that they didn’t really need plastic cutlery with their orders. Keeping this in mind, we decided to change the default mode for cutlery – customers will now have to explicitly request for cutlery, tissues, and straws, if they need it. This is now a ‘opt-in’ instead of a ‘opt-out’. 

We all know that plastic is bad for the environment. But did you know that a single plastic spoon can take 200-500 years to decompose? Millions of such plastic spoons get consumed every day, and we all contribute to it. This seemingly small change on the Zomato app will help save up to 5,000 kilos of plastic in one day – that is up to 2 million kilos of plastic in a year. 

This is another small step towards cutting down the carbon and environmental footprint of our food delivery business.

Interesting. Let’s see whether this nudge leads to desired consequences.

However, I think Zomato could have done a better job in designing the nudge statement.

When you say ‘Don’t send cutlery tissues and straws’ and it has an automatic tickmark in the box, it is confusing. People might end up unticking the box leading to plastic cutlery being sent.

A better statement could be ‘Send cutlery tissues and straws’ and keep the tickbox unmarked. Once someone ticks, a message could appear saying go green by saving plastic.

However, I could be wrong as well. Zomato could do an experiment with both the nudges and see which one works better. Even better to share the data with researchers!

Zomato should also strongly nudge the various restaurants and outlest who send food to lower plastic while sending food. One is surprised how much food outlets rely on plastic in most cities in Ahmedabad whereas they could easily opt for greener options for sending some kind of non-curry food.

Mapping Behavioral Economics and its Interdisciplinary Practices

Alexandre Truc of University of Quebec at Montreal  in this paper:

Interdisciplinarity in behavioral economics (BE) has often been described as limited or decreasing since the 1980s.

In this article, we investigate the interdisciplinary practices of behavioral economists using quantitative techniques. We find that following an intense period of knowledge transfer among a handful of individuals, interdisciplinarity between economics and psychology has decreased in BE since the 1980s. However, this decreasing interdisciplinarity in BE has been compensated for by the rise of BE in the wider field of economics.

While individual BE articles have become less intensely related to psychology, the growing number of BE articles in economics as a whole has intensified the overall interdisciplinarity between economics and psychology. Moreover, the decreasing interdisciplinarity between economics and psychology in BE has not resulted from a return to a self-sufficient economic approach.

Instead, we observe a rise in the importance of management studies, as well as a variety of other disciplines in the social and natural sciences, as behavioral economists have diversified their interdisciplinary relationships since the 2000s.

Finally, the level of interdisciplinarity between economics and psychology in behavioral economics remain higher than the average economics’ article, making the specialty distinctively interdisciplinary.

 

A Review of Nudges: Definitions, Justifications, Effectiveness

Luca Congiu  and Ivan Moscati of University of Insubria (Italy) in this research piece:

In an influential book published in 2008, Thaler and Sunstein suggested a novel approach to policy making based on the notion of a ‘nudge.’ Roughly speaking, a nudge is defined as an aspect of the decisional context that steers people’s decisions by acting on their cognitive biases. The book generated an intense debate, over the course of which concerns were raised about: (1) the exact definition of nudges, (2) their ethical justifiability, and (3) their effectiveness. In this paper, we review the nudge literature by focusing on these three concerns.

 

We are all Behavioral, More or Less: A Taxonomy of Consumer Decision Making

Victor Stango & Jonathan Zinman in this new NBER paper:

We examine how 17 behavioral biases relate to each other, to other decision inputs, and to decision outputs. Most consumers exhibit multiple biases in our nationally representative panel data. There is substantial heterogeneity across consumers, even within similar demographic/skill groups. Biases are positively correlated within person, especially after adjusting for measurement error, and less correlated with other inputs—risk aversion, patience, cognitive skills, and personality traits—with some expected exceptions. Accounting for this correlation structure, we reduce our 29 decision inputs to eight common factors. Seven common factors load on at least two biases, six on clusters of theoretically related biases, and two or three are distinctly behavioral. All but one common factor is distinct from cognitive skills. Factor scores strongly conditionally correlate with decisions and outcomes in various domains. We discuss several potential implications of this taxonomy for various approaches to modeling influences of behavioral biases on decision making.

What explains the differences between rising stock markets and declining economic prospects?

Prof Robert Shiller in this Proj Synd piece:

The performance of stock markets, especially in the United States, during the coronavirus pandemic seems to defy logic. With cratering demand dragging down investment and employment, what could possibly be keeping share prices afloat?

The more economic fundamentals and market outcomes diverge, the deeper the mystery becomes, until one considers possible explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics. After all, stock-market movements are driven largely by investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself.

That is because most people have no way to evaluate the significance of economic or scientific news. Especially when mistrust of news media is high, they tend to rely on how people they know respond to news. This process of evaluation takes time, which is why stock markets do not respond to news suddenly and completely, as conventional theory would suggest. The news starts a new trend in markets, but it is sufficiently ambiguous that most smart money has difficulty profiting from it.

Using prospect theory to explain 22 stock market anomalies

Nicholas Barberis, Lawrence Jin and Baolian Wang in this new NBER paper:

We present a new model of asset prices in which investors evaluate risk according to prospect theory and examine its ability to explain 22 prominent stock market anomalies. The model incorporates all the elements of prospect theory, takes account of investors’ prior gains and losses, and makes quantitative predictions about an asset’s average return based on empirical estimates of its volatility, skewness, and past capital gain. We find that the model is helpful for thinking about a majority of the 22 anomalies.

 

Bank of England/Financial Times Schools blog competition results: Behavioral economics reaches schools!

Bankunderground blog announced the results.

The winner is South Wilts Grammar School. The winners wrote on using behavioral economics to reduce disposable coffee cups.

One sees people carrying their bags in shopping stores to avoid paying extra for the plastic bag at the store. Why don;t we see something similar for coffee at cafes?

To help save the planet and gain a competitive edge, cafes should obey a basic rule of behavioural economics by switching from offering discounts for customers who bring their own cups in favour of charging more for disposable ones.

Consider the astronomical success of the introduction of a 5p charge on plastic bags by British supermarkets. Volumes plummeted by over 86 per cent — an unexpectedly high proportion when the majority of consumers would not even pick up a 5p coin if they saw it lying in the street.

Yet there has been a muted response to the more substantial discounts offered to consumers bringing re-usable cups to cafes for their morning coffee — of up to 50p at Pret A Manger. Up to 55 per cent of shoppers remember to carry their reusable grocery bags to save just 5p, while fewer than 2 per cent of coffee drinkers bring their own cup.

Given that they could save up to ten times as much, why are consumers responding to two seemingly similar scenarios in profoundly different ways? I put it down to the behavioural economics theory of ‘loss aversion’.

Loss aversion arises when the cost associated with giving something up is perceived as greater than the benefit that would accrue from the acquisition of the same thing. This behavioural concept is clearly evident in how consumers react to bringing a re-usable bag or a re-usable cup.

There are many instances in which suppliers offer monetary incentives to promote environmental practices even when it may be significantly more effective to introduce a fine. Just a tweak of policy can often have a disproportionately positive effect.

So to encourage the use of re-usable cups, scrap the discount and introduce a small charge for those who demand disposables. This would play to consumers’ tendency to go to greater lengths to avoid a loss than to seek an equivalent gain.

Starbucks is the first large coffee chain to have rolled out a charge (of 5p) on their paper cups. Given a fantastic consumer response — with three times more people now bringing their own cup — it is baffling why other businesses are not taking the same approach. 

One possibility is that they worry the practice may make them less price competitive: charging 5p for a cup amounts to raising the price of the product for the majority. However, if businesses like Starbucks are transparent about the environmental benefits of the 5p charge, as many supermarkets have been, it could actually increase competitiveness by attracting the rapidly growing number of environmentally conscious consumers. Tackling climate change may begin at the level of the individual. But if businesses can nudge their customers to consume sustainably then by applying behavioural economic theories such as loss aversion, we will have a significantly greater chance of controlling waste before it takes an irreversible toll on the environment.

This is really interesting. Behavioral economics reaches schools!

Does the new income tax structure pass the nudge smell test?

My new piece on the Budget 2020. I apply Thaler/Sunstein’s nudge principles on the new income tax structure.

On some aspects the new system passes the nudge test on others it does not..

Between nudge and sludge are lessons for India

Nice Mint piece by Puja Mehra differentiating between nudge and sludge:

• Sludge is excessive or unjustified friction such as paperwork burden that slows or halts a behaviour or action. It makes life difficult to navigate and can be frustrating
• The nudge philosophy is that the chosen option makes choosers better off as judged by themselves

Sludge often has costs far in excess of benefits and can hurt the most vulnerable members of society. Sunstein says firms, universities and government agencies should regularly conduct sludge audits to catalogue the costs of sludge and decide when and how to reduce it. The streamlined passport issuing service in India, designed to speed up processes, may have followed an informal kind of sludge audit.

 

Niti Aayog looking to establish India’s nudge unit..

Interesting development.

Niti Aayog is looking to hire behavioral economists/researchers to establish India’s nudge unit…

Before Thaler and Economic Survey, there was TMA Pai/Syndicate Bank

In the Economic Survey 2018-19 tabled today, there is a chapter on how Indian government is using behavioral economics/nudging to improve public policy.

Replugging (yet again) an old piece to show how How Dr T.M.A Pai nudged many decades before via Syndicate Bank, the bank he owed and developed over the years. Dr. Pai designed a savings product named Pigmy Deposits in 1928 which was nudged people into savings. It was based on similar principles developed much later by Prof Richard Thaler in 1990s.

The Economic Survey chapter discusses savings products designed elsewhere which resemble today’s Pigmy deposits but miss including Pigmy deposits in the list.

The application of behavioural insights to retail investor protection

Interesting report by IOSCO (HT: Regulation Asia)

Building on that important research, this report provides a literature review and reports on the results of a survey of IOSCO C8 jurisdictions focusing on how behavioural insights could be, and are being, used to respond to the following questions relevant to retail investor protection (the “Topic Areas”):

• Disclosure design: How can we apply behavioural insights to the presentation of disclosures to optimize retail investors’ absorption of essential information and resulting behaviour, and to what extent does the answer to this question vary for different segments of retail investors and different product types?
• Online interfaces: Many entities provide online interfaces primarily directed at attracting investments from retail investors. What design features, such as layout, reminders, and warnings, can online interfaces incorporate to help investors make informed investment decisions?
• Timeliness of information: When are retail investors most receptive to relevant disclosure or educational content (e.g., when the investor begins a new job or is about to make key decisions about retirement)?

This report acknowledges that, while behaviourally-informed measures in these areas have the potential to promote informed investor decision-making, their potential comes with limits. 

Disclosure and information, no matter how well-designed and no matter how well-timed their delivery, may not be sufficient on their own to achieve comprehensive retail investor protection. Standards of conduct imposed on the investment professionals on whom retail investors rely to recommend and manage their investments, as well as the regulation of investment products sold to retail investors, will continue to be part of the comprehensive set of measures employed by regulators to further retail investor protection.

 

Insights from behavioral economics for India’s policy issues

Prof Ashima Goyal of IGIDR in this paper looks at behavioral constraints in policy and behavioral strategies for reform:

A long day of intense and enthusiastic debate among a Panchayat of wise elders has generated valuable insights. One of the learning points repeatedly touched on through the day is the importance of coordination across regulators, government departments and policies. Moreover, Bibek Debroy in his talk extended it to the citizen—how can the citizen help the government achieve its tasks.

Criticisms made, however, point to the question of why policy has not been able to deliver— why is it India has under-performed in so many dimensions? From the macroeconomic perspective, higher growth and some reduction in poverty has been associated with a lot of volatility. Growth has not yet crossed the threshold above which it becomes self-sustaining. Participants of this symposium were long associated with policy. There is an old saying that India has good economists but poor policy. Post liberalization, however, there is more optimism—it is agreed India has excellent potential but the question is when is it going to be realized?

It may be helpful to try a fresh approach. This year the Nobel Prize was given for behavioral economics. It is useful to examine behavioral constraints in policy making, and in achieving the required coordination. First we will apply psychological concepts to understand policy inadequacies, and then go on to see how general reforms or better coordination can be achieved using psychological trigger strategies.

Hmm.

Behavioral constraints:

• Over-reaction post 2008 crisis leading to high stimulus.
• Once bitten twice shy: The overreaction led to over cautiousness
• Wanting to do everything best before growth leads to losses in output.
• Copying from others like inflation targeting (ouch!) without looking at India specific issues.
• Interpreting rules too rigidly: Flexible Inflation targeting has become strict inflation targeting. Some discretion is important.
• Narrow vision where policymakers miss the connections in the economy
• Excess weight to foreign reputation and external risks
• Economists in Delhi are more pessimistic than those in Mumbai. (what about other cities?)
• Do not see any change by focusing on lower growth rates..
• Optimism and assuming 9% growth is ours..

Likewise there is a list of behavioral strategies for reform.

One may disagree with the arguments posed, but it is nevertheless an interesting and lighter way to assess Indian policy…

How to spot a nudge gone rogue

Dee Gill has a useful post on the topic:

Even the most popular and proven nudges sometimes fail spectacularly, prompting the targeted individuals to do exactly the opposite of what the nudgers intended. These damaging anomalies — nudges that inadvertently lead to a drop in retirement savings rates or to higher energy consumption, for example — often look very much like the successful nudges documented repeatedly in workplace and government settings worldwide. What makes these seemingly reliable tactics backfire?

A recent article in Behavioral Science & Policy teases out several triggers that can make a good nudge go bad. With examples from dozens of nudge studies, UCLA Anderson’s Job Krijnen and Craig Fox, along with University of Utah’s David Tannenbaum, explain how to recognize potential nudge catastrophes, in which programs to steer people toward specific decisions might go off the rails. The authors explain their research and that of other experts in the field.

Certain choice presentations, the researchers find, inadvertently prompt decision makers to dwell on a few specific questions: What do these people want me to choose, and why? What will others think of me if I take that choice?

These internal musings can be dangerous for choice presenters, according to the paper, titled “Choice Architecture 2.0: Behavioral Policy as an Implicit Social Interaction.” Sometimes people don’t make the choice intended by the nudge.

The researchers offer a checklist to help choice presenters identify situations likely to heighten these concerns. Recognizing the red flags and making what are often small changes in the choice presentation may keep a worthy nudge from becoming a spectacular failure.

For instance, the Dutch nudge for organ donations went rogue:

When the Netherlands wanted to increase organ donation in 2016, the country’s lower house of Parliament passed a bill changing the way citizens gave consent to donate. Rather than sign up for the program, as they had before, all citizens would be presumed donors at death unless they explicitly opted out.

The lawmakers were surprised when this worked badly.

The change the bill proposed — making the desired choice the default option — is a tried-and-true tactic used by governments, employers and marketers hoping to influence individual decisions. A nudge, such as a do-nothing option when every other possibility requires action, makes it easier for individuals to make decisions that align with their goals and preferences. Several European countries have nudged their way to stellar organ donation rates by assuming consent unless otherwise stated.

The Dutch, however, rebelled. With the new law to go into effect in 2020, the number of citizens refusing to donate broke records. An annual donor sign-up drive staged shortly after the bill passed registered almost six times as many signatures for non-donors as donors. The legislature eventually tamped down the backlash with some crucial adjustments to the bill. But the implications for people in the business of this sort of persuasion were troubling: A sure-fire nudge, one that had seemingly worked elsewhere, had gone rogue for the Dutch.

This happened as Dutch saw a wrong message behind the default design:

With this checklist of red flags, the Dutch organ donation nudge looks particularly risky. There was an overt change in the choice presentation, complete with a lot of press explaining the intentions of the change. The subject could hardly have been more personal and, as such, was likely to be intensely important to many. Many people apparently did not trust the government to recommend the best decision for them.

The 2.0 researchers do not focus on how the Dutch, or any nudger, can fix the potential problems their prescribed audits find. The different circumstances of each project will determine the specific actions needed. The Dutch got appeasement in part by allowing individuals to put the decision to donate or not onto their surviving relatives. Time will tell if the Dutch nudge encountered only a temporary backlash and, with the adjustment, will become successful.

An audit for social sensemaking can give choice architects a heads up that a project needs more thought — or perhaps a really good pilot test — before a potentially regrettable nudge is unleashed.

Nudge 2.0 is a nice name…

Why Corporate Finance is a misnomer and how behavioral corporate finance can help…

Interesting paper by Prof Ulrike Malmendier of UC Berkeley.

She starts the paper with this emphatic statement:

The field of Corporate Finance might well be the area of economic research with the most misleading name (followed by Behavioral Economics as a close second). Many of the research papers identified as “Corporate Finance” deal neither with corporations nor with financing decisions. In this chapter
of the Handbook, I first conceptualize the breadth and boundaries of Corporate Finance research, and then present the advances that have resulted from applying insights from psychology. I illustrate how the behavioral toolbox has allowed for progress on long-standing puzzles regarding corporate
investment, mergers and acquisitions, and corporate financing choices.

She says much of corporate finance is too narrow and fails to include topics which are relevant today: