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

[2117] Of contrasting elementary consumer welfare effect of income tax and GST

Since the latest fad in Malaysia is the goods and services tax, I thought I should share my limited knowledge on the matter. I am not an tax expert but I know my microeconomics and welfare analysis sufficiently enough to have an informed opinion on the matter.

Those that have done basic microeconomics will appreciate the tools of preference curve and budget constraint. These two tools are easy to work with and are crucial in understanding the effect of income tax and GST on consumer welfare.

To make the contrast clear, we would have to make two assumptions in the spirit of comparative statics.

First, we would have to assume a situation where there is one tax and not the other. To have both at the same time and not mutually exclusive will necessarily make effort at observing the differences between the two harder than it should. Further, no other tax exists. In reality, of course, both could happen at the same time.

There is also the assumption that both taxes produce the same amount of revenue for the government. Again, in reality, that does not have to be. In fact, in reality, even if both types of tax theoretically produce the same amount of revenue for the tax man, issues like tax evasion are not accounted for. In this specific area, GST is better than income tax.

Before we begin, it is essential to note that any kind of taxation reduces welfare. But taxation exists for a variety of reasons that to go into it will necessarily veer off the topic we are interested in.

First off, the effect of income tax for consumer is reduced income. Say a consumer has a certain amount of income, a portion of it will be taxed. As a whole, the consumer could buy less quantity of an item — that is any item — the larger the tax size.

The effect of GST, which is a type of quantity tax (specifically, consumption tax but I prefer the term quantity tax because it is more general), is exactly the same as income tax if the GST is applied equally across all goods. By applied equally, I am referring to a situation where the opportunity cost of one item in terms of other items remain the same. An example involving a barter system is probably appropriate: y amount of butter could buy x amount of cheese, before and after tax. To put it in simpler terms but less precise, all items are taxed at the same rate.

The addendum is that the tax will only be paid if a purchase is made. The only way of not being taxed is by not spending. Whether that improves welfare depends on preference of consumer. If a consumer is really a large saver, he or she would probably be better off under GST than under income tax. However, for the majority of us, I would imagine not spending would make our welfare worse off.

If GST is not applied equally, it is possible for the consumer to be better off under GST scenario than under income tax scenario. Consumers could simply consume untaxed goods. With no income tax, quantity of untaxed goods consumers could purchase in terms of the taxed goods would likely increase. The consumers however would really have to love the untaxed goods for that to happen. If — still under unequal GST scenario — consumers prefer the taxed goods to untaxed goods, then consumers will be worse off under GST than under income tax. In microeconomics jargon, these refer to corner solutions.

Typical analysis offers this result however: income tax grants higher welfare to consumer compared to GST, in a situation when GST is applied unequally across goods. Reason is that income tax does not affect opportunity of goods purchased. Unequal GST does and that may force the consumer to move away from his or her optimum consumption under taxed scenario.