Categories
Economics

[2924] Would a rule-based progressive corporate income tax be better than an arbitary windfall tax?

I would think yes. A long answer follows:

Malaysian glovemakers have reaped quite a fortune from the Covid-19 pandemic. Top Glove’s 2020 financial year net profit soared to nearly RM2 billion from RM400 million the year before (approximately 5 times higher). It is not the only one striking gold. Another large glovemaker Hartalega had its half-year net profit for 2020 rising close to RM800 million compared to slightly below RM200 million in the same period last year (about 4 times higher).

The extraordinary profit has made windfall tax a popular notion among some crowd. Member of Parliament Syed Saddiq Syed Abdul Rahman and his party MUDA are lobbying the government to impose windfall tax on Top Glove and other glovemakers.

Top Glove paid nearly RM400 million worth of tax in the 2020 full financial year. For Hartalega, they paid almost RM200 million out of their half-year revenue. A proper windfall tax could easily double that. That is a lot of JASAs that could be funded.

Windfall tax is arbitary and carries corruption risk

I am not all too comfortable with windfall tax. The problem is its arbitrariness and with arbitariness, corruption risk. At the very least, its arbitrary nature creates room for negotiation between businesses under the microscope and the authority exerting the tax. The bigger the business, the stronger the concern for corruption is.

Rule-based approach addresses corruption risk

Assuming we are merely interested in getting that additional revenue only, I think there is a better way to do so. We can possibly design a rule-based approach mimicking windfall tax. That is progressive corporate income tax.

In search of a mimic

Currently, the Malaysian corporate income tax is flat, with rate imposed at 24%. (Well, it is not that simple. Our corporate income tax is somewhat progressive, but only for SMEs. SMEs pay 17% income tax on the first half a million of net income, and then 24% for any profit above that. Yes, two brackets.)

There are some debates on why corporate income tax is flat and not progressive. I will not be going there and it is a whole other debate to be had.

But strictly from tax collection perspective and for the purpose of finding a mirror policy, I would think progressive corporate income tax would be better than an arbitrary windfall tax. Better in the sense that it mirrors windfall tax collection while minimizing corruption risk.

The challenge is to finding such a mimic is this: how could we generalize the brackets and the tax rates so that it could capture supernormal profit across industries fairly, while not punishing the others?

That is a difficult question to answer because each company or sector has its own typical profit level. For instance, a supernormal profit level as currently enjoyed by glovemakers are terrible figures for giants like Petronas during normal times.

In any case, theoretically, a progressive corporate income tax mimicking windfall tax would have a J-curve (or even an L-curve): mostly flat rates for most income brackets, but rises dramatically for supernormal bracket.

Hybrid?

Alternatively, we could add an if-then function to the corporate income tax code: if your yearly net profit is above a certain level and it grows by more than 400% (or some superprofit benchmark) compared to the previous year, then you would face a tax rate higher than 24%. This would be a hybrid between progressive corporate income tax and a windfall tax, and it would still be rule-based.

Categories
Economics

[2923] Watch out for the current balance in Budget 2021

The fiscal balance gets a lot of attention from the press on Budget Day. It is usually in deficit (it has been so since the 1990s) and the theme has always been fiscal consolidation. Even when Pakatan Harapan was in power, reassessed the government’s fiscal goal and raised its 2018 fiscal deficit from a projected 2.8% of GDP to 3.7%, the consolidation narrative was intact and bought by credit rating agencies.

This time the fiscal deficit will be much larger. Understandably so given the current economic condition brought by extraordinary circumstances. I would think any mention of fiscal consolidation would be inappropiate.

But the more important figure this time around would likely be a different kind of balance: the current balance.

Definitions

For the uninitiated:

  1. Fiscal balance is the product of all of government revenue subtracted from all of government expenditure. Here, total expenditure is the sum of operating and development expenditures.
  2. Current balance is all of government revenue minus only the operating expenditure.

By definition, operating expenditure involves the day-to-day running of government, like paying wages, interest payment, grants, subsidies and various supplies and services. Development expenditure involves investment into some kind of long-term assets.

There is a logic behind the division between the two expenditures (although it is being increasingly questioned in the past year). As the reasoning goes, the government’s daily operating concerns should be fully funded by the government revenue. This prevents the government from borrowing for non-capacity improving purposes.

Accounting and law, but not economics

But it feels the distinction between the two expenditures is blurry because money is fungible. More than anything else, the distinction exists in concrete terms only because of accounting definitions operationalized by the law. In Malaysia, all borrowings (specifically MGS, GII and Treasuries as I understand it) must be used for the purpose of development expenditure. This is specified by the Loan (Local) Act 1959 and the Government Funding Act 1983. In the 1959 act, it is written so in Part II and in the 1983 act, Article 4. More precisely, any borrowing raised must be deposited into the government’s development fund, which is used for development expenditure, and not operational spending.

If that is wordy, the bottom line is this: the law demands that the current balance must never be in deficit.

Indeed, in the whole modern history of Malaysia, for the most parts, the government has maintained current surplus. The last time Malaysia had a current deficit was in 1987. See the following chart.

The thing with laws like this is, when it comes face to face with economic forces, the economics usually win. If the laws are to be followed down to the letters in this regard, the government would probably be forced to resort to some extraordinary measures.

Current deficit likely for 2020

For year 2020, regular revenue has been falling dramatically, while expenditure has likely gone up. The spending is not developmental in nature too. Things like wage subsidies sound more operational than developmental. As a result, it is likely for the government to face its first current deficit in more than 30 years and it should be big, if nothing is done.

Strict adherence to current balance restriction is one of the reasons why Malaysia is considered as having limited fiscal room to maneuver. Refer back to the chart and observe the small surplus since the late 2000s.

Change the law, loosen the artificial limit

The truth is, the restriction is artificial and it only exists because of the law and given the crisis we are facing, the law is counterproductive to the maintenance of our welfare and the health of the economy. The crisis that we are facing is just out of this world and traditional tools are inadequate to handle the situation well.

Here is a proposal: amend the Local (Loan) Act 1959, Government Funding Act 1983 and other relevant laws to allow for borrowing for operational spending. This will give the government greater flexibility, and more fiscal room to act.

Safeguards could be put in place if the restriction removal is too radical. For instance, we could demand the sum of 5 years’ worth of current balance must be in surplus. Such 5-year instead of yearly schedule could enable government finance to accommodate economic cycles better, and allow for more effective counter-cyclical spending.

Other current balance things to look out for

Finally, here are a set of things we should look out for when it comes to current balance:

  1. Extraordinary revenue measures. I probably mean something like extra dividend. The government has demanded and will be receiving an extra RM10 billion worth of dividend this year. Other entities we should look out for are the central bank and Khazanah. There are other entities with sizable reserves and money doing nothing that potentially could be given out as dividend to the government.
  2. Reclassification of spending. Despite the distinction between operating and development expenditure, the actual classification between the two can be fluffy. So, watch out for some operating expenditure being reclassified as development expenditure for accounting purposes. You know the joke about accountants. No? See the notes.[1]
  3. Off-budget spending done by companies owned by the Ministry of Finance Inc. Pakatan Harapan tried to rein in on this by making it more transparent and slowly bringing it into the book proper. The shift toward accrual accounting should make off-budget spending less controversial and irrelevant. But with this new government in place, progress toward accrual accounting is in doubt and commitment toward not using off-budget spending is likely non-existent.

Hafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reserved

[1] — For the fun of it:

A businessman was interviewing job applications for the position of manager of a large division. He quickly devised a test for choosing the most suitable candidate. He simply asked each applicant this question, “What is two plus two?”

The first interviewee was a journalist. His answer was, “22”.

The second was a social worker. She said, “I don’t know the answer but I’m very glad that we had the opportunity to discuss it.”

The third applicant was an engineer. He pulled out a slide rule and came up with an answer “somewhere between 3.999 and 4.001.”

Next came an attorney. He stated that “in the case of Jenkins vs. the Department of the Treasury, two plus two was proven to be four.”

Finally, the businessman interviewed an accountant. When he asked him what two plus two was, the accountant got up from his chair, went over to the door, closed it, came back and sat down. Leaning across the desk, he said in a low voice, “How much do you want it to be?”

He got the job.

Haha.

Categories
Economics

[2922] Malaysia’s Covid-19 type II error crisis

When faced with the unknown, we form assumptions based on what we know from previous experience. In science, it is fancier to call those assumptions as hypotheses. And hypotheses are meant to be tested. Those whom have done sufficient level of statistics will quickly understand this as hypothesis testing and at the very basic level, this is the philosophical foundation of whatever Covid-19 testing that exist out there.

The logical set-up is simple. There is a null hypothesis that a test seeks to reject. A failure to reject based on some benchmark means the hypothesis may have some truth to it, while a rejection means the alternative hypothesis is likely true. In the case of Covid-19 test, the null hypothesis would be “the person is heathy” and the alternative hypothesis would be “the person is unhealthy.”

Notice the use of ‘may’ and ‘likely.’ It expresses possibility. It reflects an element behind any statistical testing method: confidence. Confidence is an important factor because all testing are prone to error. We try to reduce it, but there is a minimum error level we have to tolerate. The errors come in two forms: it is possible to test a healthy person as unhealthy, and as we have witnessed in the past several weeks in Malaysia, it is also possible to test an unhealthy person as healthy.

When we tested a healthy person as unhealthy, that is known as a Type I error. Here, we rejected the null hypothesis when we should not. It is a false positive. As far as Covid-19 is concerned, this is an inconvenience to the person tested falsely. There will be cost involved, but the person will very likely be fine.

When we tested an unhealthy person as healthy, that is Type II error. Here we failed to reject the null hypothesis when we should. It is a false negative. In our Covid-19 context, this has a life-threatening consequence.

Between the two errors, a false negative is clearly the worse mistake to commit.

This is why adhering to strict and fulltime quarantine is important. Based on what we know from public health professionals, 14 days is the reasonable period for a quarantine. Centers for Disease Control and Prevention in the United States for instance stated that any symptom would manifest itself between 2 to 14 days. If we are truly sick, regardless of test results, there is a very high likelihood the truth will be discovered.

In Malaysia, we have ignored the risk of Type II error so that the ruling class could get their convenience. After violating safety and health procedures regarding social interactions during a time of pandemic, too many Malaysians—the politician class generally, the ruling class particularly—were just too happy to rely on testing to determine whether we are free of Covid-19, without understanding the underlying risk.

Worse, the authority was just too happy to short-circuit the process as if there is no error in testing. Whether the local health authority was strong-armed into it, we do not know. What we know is that quarantine time for those coming from high-risk areas in Sabah was 3 days, and not 14 days. Unlike the 14-day period, there is no scientific explanation why 3-day period were appropriate. In fact, a 3-day quarantine period is inconsistent to what we have been informed by health authority about the nature of Covid-19.

Because of the complete ignorant trust in testing method and failure to understand the risk of Type II error by a group of people—ministers no less—we Malaysians now have to suffer a pandemic wave bigger than we had earlier.

We all have sacrificed to fight Covid-19. We went through a severe lockdown. We worked from home. We stopped going out. We wore mask however uncomfortable the experience was. We were successful in flattening the curve, until the selfish men and women undid our success.

These ignorant, arrogant men and women have triggered a type II error crisis in Malaysia. They all should resign to atone for their sins.

Categories
Economics

[2921] A map of East Malaysian districts based on the 2019 median household income

So, I have managed to complete the map for Sabah and Sarawak yesterday after posting the map summarizing median income across Peninsular Malaysia at the district level. Here it is:

Some rights reserved. Creative Commons. By Attribution. By Hafiz Noor Shams

Just like the immediately previous post, these districts are colored based on the median household income, based on data from the 2019 Household Income Survey.

Out of 67 districts:

  • 20 districts have median of less than RM3,000 per month
  • 26 districts between RM2,999 and RM4,000 per month
  • 13 districts between RM3,999 and RM5,000 per month
  • 5 districts between RM4,999 and RM6,000 per month (Kuching, Samarahan, Miri, Penampang, Putatan)
  • 2 district between RM5,999 and RM7,000 per month (Kota Kinabalu and Labuan)
  • 1 district between RM6,999 and RM8,000 per month (Bintulu)
  • None with RM8,000 per month and above

This map is a bit of a challenge to me because unlike Peninsular Malaysia where I pretty much know almost all of the districts and their location, I could not immediately locate many of Sabah and Sarawak districts immediately.

Sarawak especially has complicated divisions, districts and subdistricts. The subdistricts threw me off a bit and I had to spend a little bit more time to draw Sarawak.

And a few notes:

  • Kuching has a spillover effect on neighboring districts. But I had expected Kuching to be more prosperous from median perspective. At least a green, but it is not.
  • Bintulu has the oil and gas effect, just like in Terengganu.
  • Miri gets a spillover effect from Brunei (and O&G)
  • Kota Kinabalu (and Labuan) is an exceptional prosperous city amid a state of reds.
Categories
Economics

[2920] A map of Peninsula Malaysian districts based on the 2019 median household income

This is something that I have always wanted to see but I do not think I have seen them in the media. So, I decided to do it myself.

This is a map representing the median household median income for all Peninsular Malaysian districts, based on data from the 2019 Household Income Survey.

Some rights reserved. Creative Commons. By Attribution. Hafiz Noor Shams.

Out of 90 districts:

  • 3 districts have median of less than RM3,000 per month (all in Kelantan)
  • 29 districts between RM2,999 and RM4,000 per month
  • 24 districts between RM3,999 and RM5,000 per month
  • 16 districts between RM4,999 and RM6,000 per month
  • 9 districts between RM5,999 and RM7,000 per month
  • 3 districts between RM6,999 and RM8,000 per month (Klang, Johor Bahru, Kulai)
  • 6 districts RM8,000 per month and above (KL, Putrajaya, Gombak, Petaling, Sepang and Hulu Langat)

There are a lot of reds in the map but it is worth to remember, the map is not weighted by population. There are much more people living in the non-red districts than in the red ones.

On another point, Terengganu offers a contrast to the red-orange Peninsular east coast.

I used a Wikipedia map as the base and then colored it based on 7 income classifications I made. I have not done the same for Sabah and Sarawak because… the number of administrative districts there is humongous. And it took me about an hour to do this map alone.