1. Prof. John F. Nash, Nobel Laureate (N. L.) expounded the game theory (which was earlier written by someone else) during 1950’s. He was awarded the Nobel prize in the year 1994. During the intervening decades, he passed through several crises including schizophrenia.

2. Game Theory is essentially a subject of Mathematics. This theory has been applied to Economics. Let us try and apply it to Income-tax Practice. Before applying the Game Theory, we will apply known economic theories- which we have learned during graduation - to the tax practice.

3. I attended a conference on Game Theory addressed by N. L. Prof. John Nash, Prof. Amartya Sen & others. Whatever I heard there is applied to our tax practice & given below.

4. I do not understand much about Game Theory. Hence whatever I say below may be incorrect. However, if you find something which is of interest to you, consider it.

5. In this paper, paragraphs (1) to (9) are for applying our known economic theories to tax practice. Then paragraph (10) states very briefly, the Game Theory. It is left to the esteemed delegates to apply the Game Theory to the tax practice.

1. In Economics, a “Rational Person” is defined as under:
    
   “An individual who tries to maximise his own satisfaction (utility) is considered a Rational Person.”
   Quite a simple definition. Probably, few can find fault with it.
    

2. Frustration in Tax Practice.
    
   Have you ever felt frustrated that an income-tax officer is demanding bribes and not accepting your claims which are perfectly legal and justified! Let us develop this issue of frustration in tax practice in different manners. I am taking a few illustrations of some possibly honest & dishonest individuals. These illustrations are to explain a theory and not to praise or criticise anybody.
    
   Let us assume Mr. HCA is an honest chartered accountant.
    
   Mr. HIT is an honest income-tax officer. 
    
   Mr. HTP is an honest tax payer.

   1. HCA is frustrated because:

      1. the income-tax officer - before whom his case is pending-; is asking for bribes, not accepting appropriate claims; & not doing the agreed jobs after taking bribes.

      2. The client wants to get the work done at the lowest of the fees. Makes extra-ordinary demands. On completion of the work, does not pay the fees.
          

   2. HIT is frustrated because:

      1. People do not pay the taxes.

      2. Tax Professionals protect dishonest assessees.
          

   3. HTP is frustrated because:

      1. The tax officer is corrupt.

      2. The Chartered Accountant takes cuts from the bribes. And so on.
          

3.  If by chance, HCA has to deal with HIT & HTP, no one will feel frustrated. Everyone is happy.
    

4.  If a dishonest CA meets a dishonest tax officer for the assessment of a dishonest assessee, again, everyone is happy.
   In real life however, honest people have to confront dishonest people & then the problem starts.
    

5.  Now, have a fresh look at the concept of rationality.

   1. When the tax payer does not pay the legitimate taxes due from him, he is simply maximising his satisfaction. Hence he is a rational person.

   2. When the tax officer takes bribes, he is also maximising his satisfaction. A rational person indeed.

   3. The poor chartered accountant wants to be a rational person, and wants to maximise his satisfaction. I do not know about the chances of his success. However, he also tries to act rationally.
       

6.  Now, do you find fault with the definition of a rational person!
   Do not mix economics & philosophy. It is not the job of an economist to advise or preach what a person should or should not do. His job is simply to analyse the economic behaviour of a person and present a hypothesis to explain the behaviour. He is not recommending anything. He is simply trying to explain the economic behaviour.
    
   For example, the law of Physics says that when a person will jump from 5^th floor terrace, he will crash his bones & die. Now you cannot complain about the law. You can’t say - why such a nice man died. Know the law. So that you won’t jump from terrace. Understand economic theories & you won’t feel frustrated.
    
   If you expect everyone to act rationally, you should not feel frustrated when people indeed act rationally. If you still feel frustrated, you have not understood human behaviour.
    

7.  A person who is called “Rational” in Economics, is called a “Selfish” person in our normal parlance. Next stage is - “ Greedy”.
   Economic terminology is without the colours of morality. Good for objective analysis. Our normal parlance is coloured.
    

8. Utilitarian Behaviour.
    
   When everyone in the society acts in a manner that the sum total of the satisfaction of the whole society is maximised, it is called utilitarian behaviour. This brings in philosophy, ethics, morality & so on. It covers economics as well as behaviour other than economics.

   1. If for a moment, we assume that all the politicians, all the bureaucrats, and all the contractors acted honestly, probably, we would get all the five year plans fulfilled with much lower taxation. The country would prosper and there would be no infrastructure bottle necks. The industry would boom and there will be far more work then the existing number of chartered accountants can do.

   2. If we assume that all the tax payers were honest, probably we can reduce the tax rates by 50% and still get the same amount of revenue. What is your estimate of the ratio of tax paid vs. tax evaded!

   3. If we assume that - all the chartered accountants were honest - - - there would be haven on earth.
      A combination of all honest people all around can mean that we can reduce the tax rates to half and increase production & incomes by manifold.
       

9. Current Recession.
    
   Today India is facing a recession. One of the reasons is the recession in stock market. The chief reason for depression in the stock market and the reason for failure for new public issues is that investors have lost confidence in the system. Present the same circumstances in another fashion.

   Sr. No.	Actor in the Drama	Acting	Remarks
   1.	Promoters & Directors	Rationally.	Make public issues, buy imported cars, go on international tours with family and enjoy yourself.
   2.	Merchant Bankers	Rationally.	Get maximum commissions and promote anyone for a public issue as long as he can pay the fees & the commissions. If the public issue offers a chance to make a killing on share market premiums; go for it.
   3.	Stock market operators	Rationally	Canvass any public issue as long as you can make a killing on share market premium. Once you have made the killing, do not worry if the price crashes and the investor holds dud shares.
   4.	Small Investor	Rationally.	He is least bothered about the management or the project. If someone offers a share with face value of Rs. 10 at a price of Rs. 40 with a promise that the price will rise to Rs. 100; he will rush for it. He will mortgage his home & office, subscribe to the shares and hope for the best.
   5.	When the public issue does not satisfy everyone’s greed, everyone feels frustrated, public issues fail, economy comes to recession.

   When everyone acts “rationally”, or greedily; everyone looses confidence in everyone else. In a crisis of confidence, whole economy goes down.
    

10. Game Theory.
     
    The Game Theory says that a rational person would expect another person to behave rationally. Based on this expectation of a rational behaviour, he will transact a business.
     
    There are people who are great experts in human psychology. They assess the other person, his moods and behaviour; and accordingly make their proposals. Their entire business is planned on expectations of other persons’ behaviours.
     
    Imagine an HCA making all the representations before a tax officer ignoring the Game Theory. He does not understand the expectations of the tax officer and goes on arguing legally. Imagine the HCA preaching to his client honesty in business dealing. When the client takes away the audit from him and allots to another person, the HCA feels frustrated. Is there any fault with the client! Is he not acting rationally!! Is the fault with - the absence of understanding of the Game Theory by the chartered accountant!!
     
    When you expect that a large number of players in the market behave rationally; and you also know the difference between and consequences of rational behaviour; as well as utilitarian behaviour; how do you act!?

Rashmin Sanghvi
29th January, 2003.