[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.


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.


[2903] The 2015 revenue diversification was not due to GST per se

Because this entry is long, I will say it upfront: the diversification of 2015-2018 at its core was due to:

  1. Collapse in crude oil price, with Brent dropping from around $110 per barrel in early 2015 to about $40 per barrel by late December 2015. Half of the reduction in petroleum share of government revenue was due to the drop in petroleum prices, not GST.
  2. Higher taxes. The other half was due to higher taxes that came in the form of GST. Here, it is crucial to understand the difference between GST as a taxation system and the rates imposed. It is not GST per se that helped with the diversification. It was the higher tax rate. Indeed, the same could be imposed with SST with changes in tax rates.


The TL;DR version

Now that crude oil prices have collapsed, there are growing public concerns over the state of government revenue and louder talks for revenue diversification. Some groups have blamed the state that the government finds itself in now on the abolition of the GST.

They cite the 2015-2018 revenue diversification trend when the GST was in force, and the increased petroleum revenue share in 2018-2019 when the GST was no longer in place, as proofs that GST helped with diversification. And from there, their policy recommendation is clear: bring the GST back.

But such blaming and policy recommendation are simplistic. They breeze through the logic behind it without close inspection, and ending up misreading history and the factors at play. Needless to say, the policy recommendation problematic, at least it is made without eyes wide open.

Their logic is largely driven by reading the following chart while ignoring all the context:

A simple reading with GST firmly in mind (GST was introduced in 2015 to replace SST) would suggest GST was entirely responsible for the government’s reduced reliance on petroleum income, hence diversification of income. This is indeed the claim made.

But there were more than GST at play and the full context needs to be assess properly instead of being lazily stated via tweets.

Let us go through these two items in greater detail.

1: Falling share of petroleum income was due to fall crude oil prices

The first thing we need to realize is that the so-called diversification achieved in 2015 was in large part due to the drastic collapse of crude oil prices.

The best way to prove this is to go back to the 2015 Budget that provided a clearer picture how GST was supposed to diversify government revenue:

To do this, we need a 2-step comparison.

First, we need to compare the actual 2014 revenue share versus the budgeted 2015 revenue share to truly understand how much GST (we deal with the per se rationale in the next section) was planned to contribute to diversification. One as to remember that the 2015 Budget and all of its documents were prepared and released before the crude oil price dropped in a spectacular fashion by more than halving in less than 10 months.

Second, we need to compare the budgeted 2015 revenue share versus the 2015 actual revenue share. This will allow us to see how much of the diversification was due to collapse in crude oil prices, instead of GST per se.

To make it clearly, below is the items that need to be compared:

  1. Actual 2014 revenue share
  2. Budgeted 2015 revenue share
  3. Actual 2015 revenue share

First comparison. Judging from difference between actual 2014 revenue share and the 2015 budgeted figures, the plan was to diversify away from petroleum revenue by 4.3 percentage points (30.0% minus 25.7%). But remember, the collapse of crude oil prices had not been accounted for the 2015 budget. The assumed average Brent crude oil prices for 2015 made by the Najib administration was $105 per barrel, a start difference from the actual average price of $53 per barrel.

Second comparison. The drastic drop in petroleum prices put the 2015 Budget out of whack. So, instead contributing 25.7% of total government revenue, petroleum income share went down to 21.5% instead. (BN supporters had wrongfully claimed that the reduction of petroleum contribution from 30.0% to 21.5% had all been due to GST.) But as you can see, about half of that reduction was due to petroleum price collapse and nothing to do with GST. Meanwhile, SST/GST share grew above projection only because petroleum revenue fell. To double down on the argument, the 2015 actual total government revenue fell to 0.7%. That was how much petroleum was important to the government, even with GST in place.

The point here is that, collapse in petroleum price had a bigger role that many GST proponents cared to admit. In fact, many denied it altogether.

The oil prices slowly improved over the years, and you could see this in the increase in petroleum share in 2017 relative to 2016.

2: Higher tax, not GST per se, helped diversification

Now that we have determined that half of the reduction of petroleum contribution to government revenue from 2014 to 2015 was due to the collapsing petroleum prices instead of anything to do GST, we now can move on to the second point. That is, it was higher tax rate that helped the diversification, not GST per se.

This is a corollary from the old fact that we know and released by the previous government. That is, 4% of GST was equivalent to the current level of SST. With the GST introduced at 6%, this suggests that there was an effective 2 percentage points increase in consumption tax rate. It does not matter what form the tax hike came in, but the switch from SST and GST involved a tax hike worth 2 percentage point.

Indeed, the same increase in indirect tax revenue could be achieved with a hike in SST rates. There is always an equivalence between SST and GST.


So as you can see, stripped down to the very components of the revenue diversification of 2015, it was not the GST per se that contributed to it. Half of the diversification was purely due to collapse on petroleum prices and the rest very likely due to tax hike, and not the GST itself.

And this before accounting for refunds that were unpaid, which points to the fact that the GST net collection was lower than whatever reported under the cash-basis format that the government used.

Before I end, I would like state that I am pro-GST. I made this clear when reviewing Pakatan Harapan’s 2018 manifesto. And in fact, to accommodate the anti-GST sentiment (really, anti-tax hike sentiment) I had proposed that the GST rate be reduced to 4% from 6%. But the abolition promise was hard to overturn, and it was the price to pay for institutional reforms Malaysia badly needed after years of abuse.


[2800] What is the fiscal deficit status now?

Back in January, the official deficit projection for 2015 was revised up by the government to 3.2% of GDP from 3.0% due to the falling energy prices. I concluded then the new target was achievable if government revenue would increase by at least 1.2% YoY. It was a reasonable target eight or nine months ago.

Unfortunately, a lot of things have happened since then and that 1.2% YoY revenue growth does not look easy anymore. That means, the current deficit target seems incredible now.

I have updated my sensitivity analysis. I think the fiscal deficit this year will likely be around 3.5%-3.9% of GDP. I did a tighter projection for work but I can afford to cast a wider net here.

Below is a table of deficit-to-GDP, dependent on revenue and NGDP changes this year. I have highlighted several cells in red corresponding to my expectations.

2015 Fiscal deficit sensitivity analysis

The assumptions (projections?) are:

  1. 0%-2% revenue contraction
  2. 4%-5% NGDP growth.
  3. For government spending growth, I imputed 1.2% YoY into my model, which is the exact increase the government announced from its budget revision back in January. I do not expect any spending cut due to… hmm… some political imperatives and I suppose, Keynesian tendencies within the government. I am unsure how the Monday announcement would affect spending as details are scarce so far but my gut feeling says it will not matter.

The weaker revenue is mostly due to depressed petroleum tax collection, lower petroleum royalties and lower dividend. I am a bit unsure how other taxes, especially company and individual income taxes, will change. But what we do have is the first half data and individual income tax collection is already down by 33% YoY, partly, I guess, because of the earlier tax cuts. Company income tax collection rose strongly however, increasing 43% YoY but judging from earning reports so far, I think the second half will be very different.

The 1MDB Minister Prime Minister Finance Minister will table the government budget on October 23. We will know more then.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
p/s — It would be interesting to compare current assumptions with past ones:

  1. My current expectation is based on 1.2% spending growth, 0%-2% revenue contraction and 4%-5% NGDP growth. These are part of the three assumptions listed above.
  2. Back in January 2015 during the revised budget, the assumptions were 1.2% spending growth, 1%-2% revenue growth and 4%-5% NGDP growth.
  3. The original 2015 official projection, shared in October 2014, was 3.2% spending growth, 4.5% revenue growth and 9% NGDP growth.

You can see the drastic change in projections and assumption since October 2014. Maybe a table will be clearer for comparison:

Malaysian deficit ratio target change


[2670] Be careful with the no-default narrative

There is a narrative going around in Malaysia that a government which has a majority of its debts denominated in a local currency can never default on its borrowings. For the purpose of clarity, it is the case where a national government has control over both its fiscal and monetary policy.

I have trouble with that narrative. In case of locally-denominated government bonds, it does certainly make default less likely than the case of foreign-denominated borrowings. But, that is of no guarantee of no-default.

A government for instance can certainly refuse to service its debts even if it is more than capable of fulfilling its obligation. Outright refusal happens very rarely and this is world, it is probably an absolutely disastrously crazy thing to do but I only highlight it to show that a government can default at any time and in this case, voluntarily. The debate about the debt ceiling the United States is an example of voluntary default; without further borrowings, the United States may have to default on its loans payment although it definitely can close down some of its government services before having to resort to defaulting.

Notwithstanding voluntary default, in the case of locally denominated government bonds as a sufficient condition for the outcome of no-default is dependent on the ability of the government to raise more debts to service its preexisting financial obligation when there is revenue shortfall. It depends on several matters. That includes the willingness of the central bank to monetize government debts, its willingness to commit seigniorage or the willingness of the private sector or anybody else which includes foreigners to purchase the government debts.

The most relevant factors to consider are the willingness of the central bank to monetize government debt or to commit seigniorage (money printing).

A fiercely independent central bank can easily refuse to do both, especially when the central bank has a commitment to price stability. In normal times, debt monetization and seigniorage do contribute to inflation in a big way. Without the central bank and without the power of a monetary authority, the government will default.

So, the truth is that a government cannot default of its locally-denominated debts if the central bank cooperates with the government. And if the central bank does decide to cooperate, there is cost to that cooperation.

In talking about that no-default guarantee especially within Malaysian context which both sides of the political divide do misrepresent and wrongly contextualize economic issues in supporting convenient political positions, the cost of the no-default scenario is not discussed.


[2606] Dear The Edge, direct tax collection did not “soar”

Among all the local newspapers in Malaysia, I reserve my utmost respect for The Edge. Unlike other papers, it has critical analyses and is less susceptible to explicit political bias. The Star and the New Straits Times (the NST especially) are political hacks. Others like the The Sun which can be objective more than once are just not in the big league yet. As for the Malay dailies, well, I will hold my tongue lest I digress from what I intend to write here.

Notwithstanding my respect for The Edge, I am disappointed after reading its front page yesterday. In big bolded letters, the headline “Rise and rise of IRB”[1] painted the picture of soaring direct tax revenue but failed to give the proper context behind the massive increase. The headline is misleading because really, there was no soaring growth.

As mentioned in the article, direct tax revenue is expected to increase by nearly 60% in 2013 compared to 2010. To be exact, approximately 54%. That is the highlight and there is no context except the point about improved tax collection efficiency. I disagree with the point on improved efficiency and I will come back to that later.

I need to state why the highlight of “almost 60%” increase is the source of my disappointment.

Here is the proper context for the massive increase. In 2009, there was a recession and that hurt tax collection in general. In fact, in 2009 and 2010, collection was depressed. Collection only improved in 2011 as the economy fully recovered from a very global recession. You can see it from the following graph:

Some rights reserved. Creative Commons. By Attribution 3.0. By Hafiz Noor Shams

Note what happened in 2009 from the graph.

The following may show just how impressive the so-called almost 60% increase is:

Some rights reserved. Creative Commons. By Attribution 3.0. By Hafiz Noor Shams

Upon recovery, it is only expected that collection improved and such improvement should not be breaking news. It is a reversion to mean with respect to growth. It would be breaking news if there was no reversion to mean, i.e. revenue continued to be depressed.

And here is how the reversion to mean as far as growth is concerned is really unimpressive. Average growth of direct tax collection was only a mundane rate of slightly less than 7%. The rate is calculated from the last peak before the 2009 recession. Maybe, I am a little bit verbose. The last peak happened in 2008.

Why did I calculate it from the peak (and not from the trough)?

The trend before the recession appears to represent the business as usual trajectory. If there was no recession and the economy more or less continued to grow as it did prior to the recession, then that would represent the business as usual case (calculating from the trough as the article did is, to put it politely, wrong for the purpose of the article. Calculating from the trough will paint an excessively bright picture that is worthless in ascertaining reality. Most of the times, we want to know whether we are back on track, not how well we have grown from the depth of the recession. Point: You can have the economy growing by 100% from the trough and you can still be worse than the local peak before the recession. That particular growth does not overcome the total loss in output). Hold on that thought on business as usual as I address the article’s assertion of improved tax collection efficiency.

Remember the average 7% growth? That is based on the expected direct tax revenue in 2013 compared to 2008 base.

If there was improved efficiency, previous average growth should be lower than 8%. Improved efficiency must suggest better collection and somehow, better growth. Unfortunately for the hypothesis, past average growth was higher than 8%. Between year 2008 and year 2000, direct tax revenue grew at the average of 12%.

But would the 2000-2008 period not be arbitrary a pick?

Maybe and so, let us calculate the average growth from 1970 to 2008. The average growth rate was 13%. I took 1970 as the beginning because that is the earliest data I could get from BNM Monthly Statistical Bulletin and so, I hope that will dismiss any accusation of arbitrariness on my part.

So, it appears that the normal long run growth (a.k.a. business as usual) is something between 12% and 13%.

And what was the average growth since 2008? 7%. Yes, I am repeating myself.

If improved efficiency could be translated into improved average growth, then clearly there was no improvement and in fact, there was an efficiency loss in direct tax collection (I do not like the term efficiency as used here but I will let it slide).

But I am not making that argument about efficiency here. All I want to suggest as far as tax collection efficiency is concerned, efficiency is a non-issue. It is an insignificant issue. A short and simple analysis should have revealed that and clearly, The Edge team failed to do the necessary analysis.

Now, because the current average growth since 2008 is below the long run average, one must expect tax collection growth to be strong if reversion to mean (in terms of growth) is a reasonable assumption, and it is. It is happening after all.

Finally, the article sounded as if direct tax revenue had soared by 60% but the 2013 numbers are projected numbers. I do not doubt it will ”soar” when used in the wrong context. I just think it is important to not represent expectation as things that have happened. This is something that The Edge is not alone being guilty of misrepresentation.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — KUALA LUMPUR: The mainstray of the federal government’s revenue over the last three years is from direct tax collection — mainly from individuals and companies — which has increased by almost 60%. Based on estimates of the federal government for 2013, the total revenue is RM208.65 billion, of which RM121.95 billion comes from direct taxes, a testament of the Inland Revenue Board’s (IRB) efficiency. [Rise and rise of IRB. Sharon Tan. The Edge. October 1 2012]