Tuesday, August 18, 2009

GST and Budget deficit: Any robbery of Peter or Paul?

The goods and services tax (GST) proposal has been a non-starter in Malaysia for nearly a decade now. The Malaysian government's reticence on the matter may, in large part, be due to the burden that the GST, which is an indirect and consumption tax, will have on lower-income Malaysians. For, to raise the ire of the lower-income groups may be the straw that breaks the proverbial back of the camel from a socio-political standpoint.

This is something that hardcore economists and tax professionals often ignore in the continuing quest for fiscal purity and neatness of design. It is, however, a matter of political life-and-death for political leaders.

So, do we take the long-term view that tends to favour the GST? Or, shall we take the short-term view that avoids the possible alienation of lower-income groups caused by the temporary but, potentially disruptive effect, of a consumption tax? Let us not forget that over the past 2 decades Malaysians, especially lower-income groups, have enjoyed consumption subsidies (a policy that has made us lazy and inefficient). How will they react to a consumption tax?

The inconvenient matter of the budget deficit
As if to make algorithm of policy-making even more complicated there is that inconvenient matter of a ballooning budget deficit which, for 2009, is expected to be at 7.6% of the GDP of Malaysia. That's a lot of debt. At the height of the economic crisis in 1998-1999 the budget deficit was slightly above 5% of the GDP. This is a source of concern.

All the bond-raising exercises by the Malaysian government that has so excited the Malaysian person-on-the-street in recent months is obviously intended to deal with funding the budget deficit. But, at some point, these bonds will be redeemed and, at specific annualised intervals, yields will have to be serviced.

Which leads us to the curling observations made by Prof Emeritus Datuk Dr Mohammed Ariff Abdul Kareem, executive director of the Malaysian Institute of Economic Research (MIER). He believes that tax revenues for 2009 will fall below projections. Tax revenue, as we know, is the primary source of income for any government.

Dr Ariff also noted, as many of us has, that the government operating expenditure has been ballooning. Coupled with the stimulus packages, this can only mean that the funding mismatch between revenue and expenditure is likely to push the budget deficit to 8% of GDP or, higher.

So, the Malaysian government may have a fiscal problem although it will be interesting to consider the extent to which the borrowings from the public generated by the government bonds, such as the 1Malaysia Savings Bond, will be able to ameliorate the revenue shortfall.

A renewed call for GST
Anyway, Dr Ariff pointed to the need for the broad-based GST as an important fiscal policy option that the Malaysian government needs to seriously look into implementing. There have been many "dry runs" conducted over the past decade. The narrow-based income tax has become insufficiently efficient as a source of fiscal revenue.

The other rationale for GST that many taxpaying Malaysians may find appealing, is that implementation of the GST will support the argument that Malaysian income tax must be reduced.

Will GST have a salutary effect to reduce income tax?
I still maintain that a top corporate income tax rate of 18% would be an excellent strategy that will put Malaysia back on the map for foreign corporate HQ planners now based in Hong Kong and Singapore. Many foreign executives believe, correctly, in my biased opinion, that Kuala Lumpur is a much better place to live in than the other cities mentioned. KL is imperfect and, it is that imperfection that endears KL to visitors. Imperfection means character (let this also be understood by people who feel the desperate need for cosmetic surgery, especially those who believe that an impassive facial expression caused by Botox is more alluring than cute wrinkles, but, I digress).

A commensurate reduction in personal income tax would, then, also be order.

Planning for GST implementation needs a 2 to 3-year gestation because there will be a tsunami of paperwork. Rush the implementation and Malaysia will feel like a living hell for paper-pushing punishment.

So, it is true that I am going from cool to lukewarm with GST.

The context of policymaking
But, to put the whole matter into the proper context again, it will be necessary for our economic managers to consider the matter holistically. To a Malaysian breadwinner who earns a monthly salary of RM1,200-00, a 2% GST on basic necessities can be a big deal, especially if he or she needs to pay the rent, the hire-purchase on the motorcycle and, tuition for the children (yes, even poorer people want their kids to have tuition).

Don't just formulate policies by sitting in the ivory towers of Putrajaya. Serious and sincere efforts must be made to turun padang to study the impact of economic policies before implementation. But, judging by the decision to reverse PPSMI, many of us don't think that Cabinet members believed Najib when he said that the era of "Government knows best is over".

Postscript: here's something relevant to the topic from Reuters which was carried in Malaysiakini:

M'sia relying too much on Petronas, new taxes needed

The International Monetary Fund has cautioned Malaysia not to delay plans to introduce a goods and services tax (GST) and to remove subsidies to ease pressure on its budget.

The taxes were proposed in 2005 but were shelved due to political and inflationary pressures and since then, Malaysia's budget deficit has surged and will hit 7.6 percent of gross domestic product this year.

"Legislation has been drafted and the necessary administrative infrastructure has been laid out. However, in the current uncertain environment, no timetable for a rollout has been set," Malaysian officials said in the IMF's annual report on the country, published on Friday

Malaysia's budget deficit has ballooned at a time of strong oil and commodity prices and state oil company Petronas provides half of government revenues. Excluding revenues from oil, the deficit was 11 percent of GDP in 2008, the IMF said.

The report comes as Malaysia is readying its 2010 budget and as the government tries to rally support after record losses in state and national elections in 2008.

Economy hit hard by global downturn

Malaysia's economy is set to contract by up to 5 percent this year and with exports equivalent to 110 percent of gross domestic product it has been hit hard by the global economic downturn.

"They will try as best as they can to delay the implementation of GST.

"How long they delay will depend on how whether they can find new sources of revenue to reduce the over dependence on oil and gas income," said Bank Islam senior economist Azrul Azwar Ahmad Tajudin.

Last month, the government deferred plans to hike gas and electricity prices, fearing a repeat of anti-government protests that saw its popularity slump in 2008.


hishamh said...

I have a feeling that GST won't be imposed on necessities, if and when it gets implemented. There's also a few other goods, such as books, which the government might want to zero-rate for development reasons.

But that makes the case for a GST much weaker as it falls on items that people want rather than need - demand elasticities would be shallower, which would imply a bigger demand response for a given price increase, which further implies a bigger potential impact on tax revenue.

I'm curious if anyone has done any pre/post studies on the effect on consumption - it seems to me that it should be weaker, especially given our narrow tax base.

I'm also wondering whether we should not first start at slowly abolishing our overt and covert consumption subsidies first.

I'm still flabbergasted that the government in 2008 had to spend the equivalent of 3x our annual spending on healthcare, on petrol subsidies.

satD said...

haiya bro de minimis....

How bout death tax! hit the rich boys first la then only target all the small fries like us.....

Even the current service tax is being abused big time by those who do not deserve to charge it...

Peter said...

hishamh - correct correct correct as Lingham would say. Basic necessities will not be sugject to the tax (they will either be taxed at zero% or exempted). Items such as health, education and public transportation (non-airport taxis, buses, trains etc) will also not be exempted.
Studies have been conducted on a wide ranging baskets of Malaysian goods to determine what the effect/impact of the GST will be on such items. Recall that many of these goods and sevices will already be subject to the current Gov't sales or service tax.
One example of how all Malaysians might benefit from the GST is that the price of a new car (lets say Proton or Perodua) should decrease in price. The cost of building that car should decrease and for Proton to maintain margins the price of the car for the consumer should then theoretically also go down.
Once the GST is in place and we are in a fully functioning/ vibrant and growth oreinted economy then the subsidies can be removed. Too much radical change at once would be too much too handle I would think.
Mind you had the gov't made these tough choices in years past when they were the clear majority in govt - then none of this would matter today. malaysians would pay a fair price for petrol along with all the other "controlled" intems such as cooking oil, sugar and now face-masks!

Peter said...

Correction - I should have said "non-airport taxis, buses, trains etc) will also BE exempted.

That is these essential items/basic necessities will indeed be free of the GST either through exemption or zero-rating (taxed at 0)

sorry for any confusion.

Peter said...

de minimis et al - you may have noticed the plethora of news articles talking aout the right time for Malaysia to adopt the Goods and Services Tax (GST). Did you also pick up on the news which has floated the idea of expanding service tax to include certain financial service fee's and charges?
What I dont understand is why Malaysian MoF would want tip toe around like this and not just plunge in now, full and completely into the GST. If they wait and delay soon people will be saying oh they can't you know election coming in 2013 (in fact maybe some are already using this as an excuse).
In any case, the projections and economic analysis are out there and warning that Tax Revenue and Petronas dividend revenue will be much lower for 2009 and 2010.
How long can Malaysia go on depleting all of its reserves?
Even Dubai and the rest of the oil rich Gulf States are on the verge of adopting their own VAT for the Gulf countries.

hishamh said...

Peter, under the current economic conditions it's not necessarily a good move to reduce the fiscal deficit, so I understand government reluctance to go ahead with GST. Falling tax revenues over the next couple of years are actually act as automatic stabilisers that should help support the economy if external demand continues to be weak and we continue to have an output gap.

But all this underscores your point about why it wasn't implemented when the economy was doing well a couple of years back.

Peter said...

RIGHT so keep in mind - we are not talking about a Budget 2010 that says GST will start in January 2010 but a plan, a timeline, something that actually resembles the Gov't having thought it through. If they continue with this version of "No new date" they are dreaming if they think Malaysian business will even begin to think about GST let alone get ready for GST.

The Gov't needs to announce a new start date for GST - likey sometime in mid 2011 - and then pretty much immediately after that announcement start the PR / advertising campaign to educate the public about the Malaysian GST.

My view is that if they delay now it will be an absolute disaster should they try and bring it in future / later years.

They should accept that they missed the best opportunity back under pak lah's rule...

Peter said...

de minimis et al

here is a good summary of how the GST / VAT should work - this is in the US context (since its very likely the US will adopt its own GST/VAT in the next few years)