Tuesday, June 16, 2009

Govt has no plans to implement GST

The Malaysian government's confirmation that it has no plans to implement the Goods and Services Tax is a sensible decision.

The GST is a consumption tax. It is effectively a value-added tax. From a theoretical standpoint consumption taxes are intended to be broad-based and indiscriminate. It is an efficient source of revenue to governments.

The reality is that consumption taxes like GST are effective only when certain elements are in place. What are these elements?

First, you need to have a large middle-class base. This base provides the foundation upon which a large group of taxpayers with a significant disposable income provides the source of GST revenue. It is the consumption from this large middle-class base that drives a GST scheme.

Second, you need an economy that is in growth mode to gain acceptance.

The key is, of course, the first point. Malaysia has a narrow middle-class base. Only a small segment of income earners actually pay income tax.

Third, which is a corollary of the first point, the income disparity in Malaysia is still great.

The most widely accepted measure of income disparity is the Gini Coefficient. To amplify this point, I can do no better than to extract a recent post by my blogger friend, Sakmongkol AK47 here, where he displayed the following:

<Gini Coefficients by countries:

Country

HDI

GINI

Singapore

0.902

42.5

Malaysia

0.793

49.2

Thailand

0.768

43.2

Philippines

0.753

46.1

Indonesia

0.692

34.3

Vietnam

0.691

36.1

Cambodia

0.568

40.4

Laos

0.534

Source: UNDP Human Development Report

A commonly-used measure of development is the Human Development Index (HDI) devised and calculated annually by the United Nations Development Programme (UNDP). The HDI is preferable to a simple measure of per capita income because it takes into account other factors as well, including life expectancy and other measures of general 'well-being'. In the UNDP's 2004 Human Development Report, Malaysia ranked 59 out of 177 countries. With an HDI score of 0.793, Malaysia is just on the threshold of the UNDP's own definition of a 'Highly Developed Country', which is a score of 0.800 or above.

9 comments:

hishamh said...

You left out a couple of other preconditions required for GST, bro.

First, if and when GST is implemented, there must be a one time, permanent cut in income taxes. This is will balance the revenue gain to the government against the extra tax burden for tax-payers, while also gaining greater voter acceptance.

Second, companies across the whole supply chain must be prepared in terms of systems and acounting treatment to implement GST. Since GST is a value-added tax rather than a gross tax, it is far more complicated to manage than the existing sales and service taxes. The last I heard, nobody was really ready yet.

Your point about income inequality is interesting to me, because I've been investigating this question for a couple of months now. The Gini coefficient may be the most popular measure, but it isn't ideal since it only compares the highest income bracket to the lowest.

The actual picture is a bit more nuanced, although there isn't any question that income inequality is too high in Malaysia. I haven't fully compiled the Gini figures yet (there are some discrepancies between different Malaysia Reports that I haven't been able to reconcile) but the short story is that income inequality rose rapidly during the early NEP years, fell during the industrialization years, rose again in the 1990s, then has been gently falling since 2004.

A current breakdown of income can be seen here:

http://voyager8.blogspot.com/2008/11/malaysian-household-monthly-income.html

Note the odd 'M' shape to the income curve which applies to all races except Orang Asli.

And a very interesting resource from Google Books, if you want to dig deeper:

http://tinyurl.com/nqfa9n

ewoon said...

It's laughable that spinmeisters can even come up with a tax they ridiculously label "valued-added tax."

Value-added for who, whom, what? If i am not mistaken it's a cruel joke on the dumb tax-payers! Can you hear the dark lord smirking, grunting, saying something like "ya, it's value-added because it takes brilliance in me to come up with the idea. you pay for my brain power. hahaha." wtf.

Anyway, it's a temporary consolation that it has been put off for now.

BTW, all taxes are hidden inflations to screw all and sundry especially the middle-class (a perfect way to kill the goose that lays the golden eggs isn't it?) Ultimately, when all are sufficiently robbed blind by all kinds of taxes there will only be 2 classes of people left.

"Royalty" and "slaves." Welcome to a monetized world.

Ever asked this? Why do we humans have to pay for anything on this earth anyway when everything has been given to us free by Almighty?

de minimis said...

Bro hishamh

As always, I am indebted for your kind contribution and comments. It makes my blog look good, man!

Bro Eric

Water and Air is already being bottled. Both have "added-value". Waste is being processed and repackaged as fertilizer, etc. Everything is monetized, indeed. Maybe soon there will be a tax on every breath we take and exhale since it has a "carbon footprint".

It's another version of what has happened to Wall Street. It's abstract economic thinking run amok. Hopefully, we can do something about it.

hishamh said...

ewoon,

The term value-added doesn't refer to the tax itself, but rather to the way it's calculated. It's actually fairer and more efficient than the current sales and service tax.

To illustrate, let's take that bottle of water.

The water bottler sells the bottled water to a wholesaler at say RM0.30 per bottle, of which RM0.20 is the production cost.

Let's say GST is 5% - the actual tax cost to the wholesaler will be 5% x (0.30-0.20)=0.005, for a total cost of RM0.305 per bottle.

The wholesaler sells the water to a retailer at RM0.40, with tax calculated at 5% x (0.40-0.305)=0.00475, for a total cost of 0.40475 per bottle.

The retailer then sells the bottle to consumers at RM0.50, with tax accruing of 5% x (0.50-0.40475)=0.0047625, for a total final cost of RM0.5047625 per bottle.

Total final tax take is approx RM0.0145 per bottle, or about 2.9% of the final retail price. The other 2.1% falls on the primary resource producers i.e. the water and plastic bottle suppliers, from their "value-added" activities.

The key point here is that while consumers will have to bear the same final tax burden and revenue remains unchanged from a flat tax system, the actual tax burden within the production process is levied on the entire supply chain rather than right at the end on the final seller.

And as I said, to equilibriate the tax burden (VAT typically causes a one-time price rise), GST must be implemented in conjunction with an income tax cut.

This actually works to the benefit of actual taxpayers (primarily middle class and above), but not for the benefit of low-income earners where more of income goes to consumption.

Hence the importance of what de minimis pointed out about income inequality.

donplaypuks® said...

I am not convinced that we need a huge middle class for the introduction of GST/VAT. Singapore and Australia have introduced it successfully in recent times.

We already have a sales tax regime with administration offices in all the States. So, piggy-backing on it will be easy for a broad-based GST/VAT system.

I do know that our Govt has been mulling over GST for some 10 years and the latest decision is not the end of that subject.

But what is relevant is that we need a broad based tax system that brings as many as possible into the
tax net. This consumption tax is also fairer in that you have a choice - you pay as you spend. Of course certain items like milk, medicine, schoolbooks, financial transactions etc will be exempt from GST.

Our income tax system has too many loopholes and poor enforcement to maximise collections. We all know about hawkers, restaurant owners, doctors, dentist, contractors and lawyers who have abused the cash only system. There are also many who are not require to pay income tax, by law.

If a reasonable rate of GST is coupled with a corresponding cut in income tax rates (as in S'pore), then the Govt will have set itself up well for the future. Wherever GST/VAT has been introduced, revenues have been on the rise as the Economy grows.

The Govt might want to re-think on this issue. I was in S'pore when it introduced GST. They spent something like two full years to educate the public and provide sufficient time for businesses and corporations to upgrade their hardware and acccounting systems. It took off very smoothly.

Of course they can call it GST or Value Added Tax or spin it as they like, but like a rose by a thousand names, it is clearly a TAX, one of the two certain thing in our lives!!

de minimis said...

It should be noted that both Singapore and Australia has a substantial middle-class.

Peter said...

Just to point out a few inaccuracies here - first water is likely to be zero-rated meaning you will not pay GST on the home supply of water. As for a bottle of water this is one of the biggest blights on our planet. Why are we still focused on water consumption from plastic bottles that destroy our environment. These things should be taxed, they should be taxed like cigarettes / alcohol with a SIN tax.
Hishamh in his calculations of the likely cost of a bottle of water skips a few key points of any GST / VAT system and that is that throughout the chain of supply the GST charged by the seller to the buyer is not a cost but a credit, a deduction. This is the fundamental difference from the current sales/service tax regime which results in a compounding of the tax. A GST / VAT system changes that so that the GST charged is not a cost to business, instead it is a tax that is borne / passed onto the final consumer. Your example fails to take into account the GST credit that the wholesaler / retailer would be entitled to. Your example has the bottle of water being sold for less than it costs - is this Malaysian boleh or what?
Furthermore, the GST will make Malaysian exports more competitive in world markets by removing any of the imbedded domestic taxes from goods made here and sold overseas. The GST is not a cost to business, it will actually lower the cost of doing business, this should have the result of making Malaysia a more attractive destination for foreign business, this in turn creates jobs, new jobs mean more tax revenue for the Government, more tax revenue means the Government can fund projects / infrastructure or even lower taxes for the middle / low income groups.

So to say that revenue stays the same is totally inaccurate. In every country that has adopted a GST recently (Australia, Canada, Singapore ..) tax revenue from GST has exceeded expectations. It has also allowed (forced) those governments to lower other taxes such as personal income and corporate taxes. Lowering these taxes further increases the attraction of foreign business/workers to come to Malaysia.

In terms of your UN/ HDI / Gini scale and index those are interesting figures, but you should point out that every country on your list EXCEPT Malaysia already has a GST type system. I don’t think that Thailand, Laos, Vietnam or Philippines has a larger middle class than Malaysia (do they?).

hishamh is correct that businesses will need to be ready for the GST. I assume this is why the government delayed the introduction in 2007 because companies were not or would not be ready. The GST was announced in 2004 in the 2005 Budget. Malaysian business has had 5 years to get ready - what have they been doing?

You are right thought both businesses will have to get prepared as will the government authorities. The government will need to develop a plan to offer some type of GST relief / rebate to the low income Malaysians who will be hit by higher costs. This is similar to the types of reliefs announced by the Singapore government and operated in Canada under the GST low income credit.

hishamh said...

Peter, thanks for the clarifications - I stand corrected. I appear to have confused VAT methodology with GST.

What I'm gathering from your description is something like this:

Business 'A' sells to wholesaler, collects x% in GST, which is remited to the government. Wholesaler sells to retailer, again collecting x%, but gets tax credit for the GST paid by 'A'. Retailer sells to consumer, collects x% for the government, and gets tax credit for GST paid by wholesaler.

Is my understanding of this correct?

BTW:

1. I used the bottle of water as an example simply because de minimis brought it up as a possible example. I could have with equal facility used widgets.

2. Your point about GST allowing for a cut in income taxes is as far as I know also incorrect - in every case I've read about, a cut in income taxes has had to be used to persuade the public on the adoption of VAT/GST, not as a consequence of improved tax revenue.

3. I'm not surprised that tax collection improved under a GST system - that's obvious since it is a broad based consumption tax that would effectively broaden the tax base. And Malaysia's income tax base is very, very narrow - something like just 8%-9% of the working population actually pays income tax.

4. Which is the point of second part of de minimis' post - implementing GST will disproportionately effect low-income earners and worsen the disparity in incomes. I've checked three countries so far (Singapore, Australia and Canada) and only in Australia did income shares and income inequality stay stable. The other two showed income inequality rising.

On that score, income tax cuts would be an insufficient incentive for adoption, as the loss of purchasing power in the lower income groups will not be matched by equivalent tax benefits elsewhere.

Peter said...

hishamh you're only confused if you are referring to GST as the current Gov't sales/service tax which does currently result in tax cascading.
What MoF is proposing is the Goods and Services Tax also known in Europe and elsewhere as the VAT (Value added tax).
Malaysia's GST will operate just like a VAT and your new calculations are correct. If you actually plug in #'s and the % GST is likely to be levied at (say 5% as with the current rate of sales/service tax that is hidden in many of the goods/services bought in Malaysia) you will end up seeeing that throught the chain of supply the total amount of GST paid to the Gov't is the same amount paid by the final consumer.

As for cuts in other taxes. Places like Singapore had to do that because the GST was a brand new tax, they were not replacing any old Sales/Service tax or Manufactuers tax (in the case of Canada). Singpaore introduced GST as part of a package of tax measures including income tax reductions.

Canada however is a good example to note that when GST was introduced the highest marginal rate of tax of 29% applied on all income over some figure around 45K. Today 29% tax only kicks in on incomes over 126K. In 1998 the highest rate paid by a 60K worker was 26% today is 22%. By shifting the tax bands workers in lower / middle income groups are paying less or no tax at all. This cannot be attributed soley to the success of the GST but in that same period up until the recent crisis, Canada was posting multi-billion dollar surplus budgets.

Lets be fair, in Malaysia only a very small % of people are paying income tax (I think its 10% or less). So how is the gov't going to ensure that any inflationary impact from GST is mitigated to those who are not paying tax? This is the real challenge. There has been talk of "incentive packages" such as those introduced a year or 2 back in Singapore as well as some relief for the elderly throught special refunds/rebates. Canada is able to cater for its low+middle income earners by way of a GST credit. However, this (if I remember correctly) requires each Canadian (of family) to file a tax return. I doubt that would work here in 1MY.

This is not the only way the low income Malaysians will be catered for. Many of the basis necesssities such as food, education, health, public transport will be sectors where no GST is charged. Many small restaurants also will likely not register for GST as the registration threshold will be set high. This should result in no additional or minimal addition costs. However, if those small makan / ali maju shops did register for GST should their prices not go down from the derived cost savings? An interesting calculation indeed don't you think?

Furthermore, the adoption of a GST which is cost neutral to business should attract additional FDI into Malaysia and bring additional foreign businesses here. That means more jobs, whenever you are creating more jobs this generally raises incomes. Higher incomes paying lower income tax surely would be welcome by most Malaysians.

As Nor Yackop stated Malaysia is going to have to suffer some short term pain to prepare for the long term. Its better to do it now then be forced to adopt a GST once the Petro dollars start running out.