The case for the Goods and Services Tax — Shaun Liew

JANUARY 14 — Since the Goods and Services Tax was implemented in April, parents in Kuala Lumpur faced sharp increases in the prices of school uniforms and stationery. Sherena, a tuition teacher, felt the pinch in the more than 6 per cent increase in spending. “For the past five years, it has only cost me RM300 to RM400 for my two girls. But this year, I have spent close to RM700,” she said.

Backtrack to May 15, 1969 and the streets of KL would have looked deserted. A general election had just occurred two days before, and the results sparked a racial riot between the Chinese and Malays. Then, the New Economic Policy was enforced to rebalance social and wealth inequalities and heavy government spending ensued.

Since the NEP was implemented, there were only five years that government earned more than they spent up until now. Budget deficits did not seem a problem then: more urgent to resolve was the politically fuelled tension between the Malays and Chinese due to wealth disparities. But spending more than what the government earns requires borrowing from investors, who must be convinced that a default will not happen.

Being in debt is the norm

In today’s world, investors lend to countries like Malaysia so spending on infrastructure, pro-poor programmes, and public services can be maintained. Countries in return pay interest. Some countries have no debt, or very little; others, too much. Nonetheless, being in debt is the norm; having too much debt, however, is not (The debate on sustainable debt is put on hold here; we assume it is not sustainable.).

Investors have hinted concern at Malaysia’s capacity to sustain its debt and if not addressed, they would pull out their funds and make it more difficult for Malaysia to borrow again. So, the idea is to reduce the deficit, hence reduce the debt.

Like fuel subsidy cuts, the Goods and Services Tax is one way the government is assuring investors that the debt can be sustained. Days before Budget 2014 was revealed in Parliament, the ringgit strengthened against the US dollar as investors welcomed the GST – it would help cut the deficit from 4 per cent to 3.5 per cent as planned. In April 2015, investors are assured yet again as Fitch Ratings maintained the government’s A- for its long-term loans.

The GST was one reason an A- was maintained. Any downgrade would have signalled the growing inability of the government to control its finances, and investors would have been scared off. It would be more difficult to borrow and spend on government programmes if it had happened.

The question then is this: how did we end up here?

The problem of government-owned enterprises

When the NEP was enforced, government agencies called Non-Financial Public Enterprises (NFPEs) proliferated to carry out the country’s development agenda: rebalance wealth and social inequalities.

But these are government agencies. They are different from private businesses in the sense that there is no incentive to maximize profit or minimize costs since they have the support of the government. Malaysia Airlines suffered from inefficiency problems, and 1MDB is on an asset selloff at large discounts to lower its level of debt.

In his essay Public Sector Resource Management, Dr Narayanan of Universiti Sains Malaysia also highlighted two other problems in terms of government managing its resources. The first is misguided spending.

Misguided spending

Government expenditures are divided into two types: development and operations. The former is to create new goods and services to raise the economy’s productivity; the latter, to maintain these existing goods and services.

In 2000, every ringgit spent on development required twice the amount for operations; by 2009, it required three times the amount. Operational expenses consist of ballooned salaries, debt payments, and skyrocketing subsidies that do not even reach those who need it most. These things do not encourage innovation and productivity gains – why is the government spending so much on them when they can spend on infrastructure and R&D instead?

Allocated spending for different ministries was also misguided. Between 2000 and 2009 there was no real security threat to Malaysia. Despite this, security spending exceeded health, housing, and communications. Why not use more funds for public housing and hospitals instead of French submarines?

The prime minister said the submarines would expand our naval capabilities. But against what threat? China because of disputes in the South China Sea? But Malaysia’s top trading partner is China. Both countries value trade as it translates to the economic well-being of its citizens. It would be politically damaging to both sides should any conflict arise.

Third World tax regime

The second problem is our faltering revenue sources, which can be blamed partly on the “Third World tax regime” as Narayanan put it.

As much as a government’s spending needs to be prudent, its tax system must be able to support this. In Malaysia most tax revenue comes from personal incomes, corporations and petroleum; together they make up about half of all tax receipts.

Raising personal and corporate income taxes discourages work. The GST, a tax on consumption, would encourage more savings, investments, and job creation. Such was the logic when Singapore implemented the Goods and Services Tax for the first time in 1994.

The Singaporean government at that time also argued that taxes from income would decline due to an ageing population. In Malaysia the dependency ratio has been declining, but there are concerns that the ageing population will still pose a problem in the next 10-15 years.

But still incomes taxes have suffered a steady decline partly due to low coverage. Of Malaysia’s 10.5 million workers, only a million pay any personal income tax. The situation is similar for corporations: only 16 per cent of companies were registered in 2007 for paid tax. Petroleum suffers a different fate: volatility in global oil prices cause tax revenues to fluctuate. All-time highs in 2008 managed to rake in RM27 billion. When oil prices plunged two years later, revenue from petroleum taxes plunged 30 per cent.

How about the sales and services tax? The sales tax structure in Malaysia does not cover many people because it is imposed only at the manufacturer level, and when it goes through the supply chain to reach consumers, goods would have already become even more expensive (more than a 6 per cent increase). And the services tax? Its share in total taxes collected is too low to deserve any mention at 2.2 per cent in 2009.

The need for the GST

Unfortunately these three problems threaten the Malaysian government’s status as a prudent borrower. They threaten a downgrade in the government’s A- credit rating.

From the heavy spending of the restructuring programmes of the NEP in the 1970s, to the imprudence and inefficiencies of the NFPEs that help carry out these programmes, and the flawed tax regime that was unable to support this level of spending — we finally arrive at the decision to implement the Goods and Services Tax.

Other than the fact that it discourages consumption but encourages savings, the Goods and Services Tax is not subject to the volatility of oil prices. It depends on consumption habits, and these are relatively stable because it covers all citizens who spend on any goods or service. Also, the tax is levied on all stages of production. Wholesalers and distributors, who previously escaped the sales tax, cannot escape the tax now.

It is imperfect

But it has its negative effects too. An already debt-burdened middle class is suffering from higher costs of living. Furthermore it is seen as racially polarizing.

“For some Chinese, it is portrayed as Malays finally paying their dues. For some Malays, it has been painted as getting at the Chinese who have purportedly evaded taxes”, Bridget Welsh, a researcher of democratic studies of the National Taiwan University, wrote.

Finally, implementation is flawed. There have been numerous delays in circulating information of the new tax, and who knows how effective the taxman will be?

But even if the GST were to be implemented perfectly, will it be enough? No. Singapore did not become Singapore just because of the GST. It took comprehensive planning, from affordable housing to good governance — a wide set of synergistic fiscal policies coupled with institutions that uphold rule of law and meritocracy. Crony capitalism bred during the Mahathir era is another issue: business that thrives on “connections” distorts the functioning of markets. The Economist ranks Malaysia as third in this aspect, just behind Russia.

The Opposition alternative

Pakatan Harapan, the Opposition, would rather do without GST and would instead implement the capital gains tax and stamp out corruption in order to save the taxpayers’ money. In their 2016 alternative Budget, they estimate a saving of RM30 billion from anti-corruption measures. With the judiciary’s independence in doubt, this is easier said than done. To crudely highlight the government’s and Opposition’s policies respectively, consider these two scenarios:

1.     Since the GST was implemented in April until June, the government collected RM6 billion in GST.

2.     Since Sarawak Report’s 1MDB story became a sensation in July, RM2.6 billion is still an irretrievable “donation.”

And yet the Opposition still estimated to save RM30 billion from stamping out corruption. How long will investors wait before they see a downgrade? Or if Pakatan Harapan takes over, how long will they take before they implement the GST? Decades’ worth of mismanagement cannot possibly be reversed in a year.

Pakatan Harapan can continue hoping that it can generate more revenue in the long run by only stamping out corruption, but nothing of the already Third World-like tax regime Malaysia operates would change. The opposition would still need to implement the GST to reverse the health of Malaysia’s public finances in the meantime as it solves long-term problems like corruption.

Conclusion

Malaysian households are suffering from a myriad of problems already. They see the new tax in a new light of distrust in Barisan Nasional, especially after the 1MDB scandal began hitting headlines. But within this suffering comes the necessity to restore investors’ confidence in how the government manages its finances.

The GST comes as a temporary solution to solving the deficit problem. Without it, the programs that are already in place to support the poor and to restructure society may not receive the funding it needs. A downgrade from an A- would make it more expensive for the government to borrow, and would lead financial markets to have less confidence in Malaysia.

It is a painful trade-off, but it is not enough.

It will not solve how imprudent and inefficient government spending has been. Nor will it make any government less liable of financial scandals.

In the end, it is not all about how much is being taxed; it is about where taxes go. Any political party can have the backing of the public if taxes go to where it matters, and in a transparent manner. Statistics can continue to flaunt Malaysia’s impressive growth, but so long as public sentiment does not reflect that, any success story by 2020 would be a half-truth.

Until then, a middle-class Malaysian like Sherena will have to pay for the growing costs of school uniforms and stationaries. Maybe one day her government will commit to more investments in public schools to raise national education standards. When it happens the extra costs she has to pay today will be all worth it. Will it happen? She can only hope so.

* Shaun Liew studies Economics and Finance at the University of Leeds.

** This is the personal opinion of the writer and does not necessarily represent the views of Malay Mail Online.