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Economics Society

[2927] M40 classification mischaracterizes the middle class, weakens the middle class and in doing so, weakens democracy in Malaysia

Who are members of the middle class in Malaysia?

Theoretically, they consist of those in the middle income distribution. The middle class is a relative position between the poor and the elites, however both are defined.

But it is not that simple. On Wikipedia alone, there are plenty of dimensions to be considered beyond income. Among the factors are education, nature of employment, social status and even as fluffy a factor as lifestyle. Wealth is another marker, which is related to income but perhaps better except its data is not as easy to get.

In Malaysia, perhaps for over 10 years now, we have chosen a specific way to define it. We do it through income distribution. We have the bottom 40 percentile households in terms of income distribution defined as the poor (the B40), the next 40 percentile households are understood as the middle class (the M40), and the top 20% household income earners are taken as the rich (T20).

The classification is needed to operationalize certain policies like conditional cash transfer that Malaysia has. Household income, whatever its weakness, is an easy proxy of status. It is needed for targeting purposes. You lose something, but it does the job. Arbitrary, but convenient and it works.

Our problem is that the same convenient arbitrary classification that works is beginning to have an unintended negative effect on social discourse. Familiar to the definitions used by the government for implementation convenience, the public is beginning to associate the M40 as the middle class, and the middle class as M40, when in fact, there are middle class people falling outside of the M40 group. Additionally, there are people inside the M40 who are not really members of the middle class. The shorthand of B40-M40-T20 is dividing the middle class crudely and consider some members of the middle class as members of the elites.

It creates a class war against the middle class just through misattribution arising from arbitary statistical definition.

The middle class is special because they are largely the flagbearers of progressive values. With such values, they function as a check-and-balance mechanism in any society. Members of the middle class are not poor and that allows them to spend more time on matters other than livelihood issues. Things like corruption, environment or something that is well above something that is similar to the bottom of Maslow’s hierarchy of needs. At the same time, they individually are not rich enough to have outsized influence on society like few elites. Yet collectively, they check the power of the elites thanks to their education level. They are the bulwark preventing the elites from abusing power. They are the ones crucial in keeping a democracy from becoming crass majoritarianism.

When members of the middle class are considered as elites, middle class values would be condemned as elitist. Once identified as so, the same values would be rejected by the majority because they feel the values are meant for the few.

This is the danger of the M40 classification. The misattribution makes the middle class alien to the poor as the elites are, but without having the same influence the elites have. This weakens the roles of the middle class in protecting democracy from abuse by the elites, and from majoritarian excesses.

That is one of the costs of the B40-M40-T20 classification. It breaks the middle class, and then artificially and implicitly labels middle class values as elitist. With that, the roles of the middle class as the moderating force in our society gets weakened.

In short, the M40 classification mischaracterizes the middle class, and weakens the middle class’s role in moderating Malaysian democracy.

Categories
Economics

[2884] Is the “middle class” overtaxed?

Recently, there was a column complaining about taxes on the middle class, claiming the middle class is being overtaxed.[1]

The origin of the complaint is easily understood because a slew of measures have announced by the government and those new taxes include departure levy and the imposition of sales and service tax on some digital services. These are generally taxes on not-so-basic goods and in more than some instances, they are arguably luxury goods.

The new taxes are part of the government plan to diversify its revenue and widen its revenue base. These are highly targeted taxes, and it hits specific groups instead of the wider population, which fits the philosophy of the government that is anti-broad base taxes like the GST.

I am not here to debate the philosophy and I take that as a constraint to policymaking. Instead, I am here attempting to explain whether the middle class is overtaxed.

The short answer in this day of too long, didn’t read culture, I would argue, is no.

Here comes the longer answer to a difficult question.

THE STARTING POINT: GOVERNMENT REVENUE AND INTERNATIONAL COMPARISON

It is a difficult question requiring some homework to be done. After thinking about it, I think the best starting point for the discussion is total taxes collected by the government from individual taxpayers. We know this number as it is accessible online from both the Treasury’s and the central bank’s database.

The actual total 2018 revenue figure is not available yet but we know the government has estimated it to be RM236 billion. For 2017, the government collected RM220 billion.

This may look large but in context, it is a very low figure. At about 16% of GDP, it is well below the average for a class of countries that includes Malaysia. Data from the IMF shows that “emerging market and middle-income economies” on average have their government revenue at 27% of GDP. Here for the extra boom: Malaysian government revenue is so low that it is closer to the levels seen among low-income countries that averaged at 15%. In advanced economies, the revenue level is about 36% of GDP.[2]

The low revenue-GDP ratio, and by implication the low tax burden, should give you an idea of how low the tax burden is in Malaysia relative to other countries. It is already a libertarian wet dream.

It is importantly to realize that not all of government revenue is collected from individuals. Based on official 2017 figures, I estimate at most 48% were collected from individuals in the form of income tax, consumption tax along with various duties, licenses and fees. This is an upper estimate because it is difficult to know who paid those duties, licenses and fees exactly without delving deeper into the data; it is highly likely a significant portion is paid by companies instead of individuals. This means, total taxes collected from individuals for Malaysia is about 8% of GDP.

This number gives insight to the question of tax burden because government revenue derived from individual taxpayers is the tax burden of the taxpayers. And when government revenue from these sources is low, it suggests the tax burden on individuals is low.

The rest of the revenue comes from companies and other sources like asset sales.

Now here comes the tough part. We need to know who pays the 48%. This is a difficult endeavor to carry out without intense research because there are at least three types of taxes here: income tax, consumption tax and various duties. The nature of the three taxes is quite different from each other, hitting different segments of individual taxpayers.

What we know is that income tax makes up only about a 27% of the estimated revenue derived from individuals. Consumption tax makes up 42% and the rest belongs to a various other duties and fees.

INCOME TAX

The income tax hits only the non-poor. This is easy to determine.

The threshold to pay income tax is so high that only about 2-6 million people pay it out of a population of 32 million, and out of a labor force of 16 million with generally low unemployment rate. Again, this is a very low number and I have written why that is so back in 2017.

And since a person would only be taxed if his or her income is RM2,500 per month or more, (more accurately, RM30,000 or above annually), we know from the 2016 Household Income Survey published by the Department of Statistics that about 23% of individuals in the Malaysian labor force do not need to pay income tax. And with all the exemptions given by the government, this number can easily cover all of those in the bottom 40% income earners and slightly more. This is a theoretical number because not all income earners are registered taxpayers. They are people who should pay tax among the top 60% income earners who do not register as taxpayers.

Nevertheless, we can conclude that a huge chunk of the income taxpayers belong to the middle class (discussion on what is middle class can be complicated but for convenience, let us take it as the next 40% income earners).

Now, is it fair?

The income tax rates in Malaysia are progressive. That means the more you make, the higher your tax rate would be. It might not be as progressive as some people would like but the truth is, the tax rates in Malaysia starts from a very low base and it rises very gradually to cover the whole middle class. So low in fact that it is difficult to say if anybody is overtaxed on this front.

CONSUMPTION TAX AND OTHER TAXES

Consumption tax sweeps a wider segment of the population. The best proof is the that fact the GST generated RM44 billion for the government in 2017 and that was slightly double the RM29 billion individual income tax revenue.

But this government abolished the GST and introduced the SST in 2018. In 2019, the consumption tax is expected to collect only RM22 billion. And not all of the RM22 billon hits the consumers directly because SST is really two separate taxes: sales tax and service tax. For sales tax, it is really more of a production tax than a consumption tax: that means consumers do not bear the full burden of the tax. It is only the service tax that the consumers have to pay in full. Based on previous experience, service tax revenue formed about 40% of total SST, which further shows that the individual consumers do not pay the full RM22 billion.

In short, tax burden on the population as a whole has fallen, including the middle class after the GST-SST shift. To say otherwise is downright false.

Other taxes are quite small and transactions that attracted those taxes or duties happen at a very low frequency.

NEW TAXES

But the question is, would the new tax mitigate the reduced tax burden and in fact increase the tax burden on the middle class?

No.

No because the government has estimated that these new taxes would generate a revenue of about RM5 billion annually. That is considerably less than the RM22 billion drop arising from the GST-SST shift (that is the 2019 SST collection subtracted from the 2017 GST RM44 billion; the drop should be bigger because the GST collection in 2019 should be bigger).

There are plenty of new separate taxes and that creates a negative perception as if the tax burden is increasing on the middle class. But when all of that combined, total new tax collection would not be enough to negate the reduction in tax burden from the GST-SST change. The numbers show it and here is how it would look like in graphics:

As you can see, there is still a net reduction in tax burden after accounting the GST-SST change and the new taxes.

But, still, what about the middle class? How does the so-called middle class benefit?

GOVERNMENT SPENDING ON THE MIDDLE CLASS

But discussion on merely who pays taxes is not wholesome.

We have to talk about spending as well. At the very 10,000 feet view, the best number to suggest that the government is transferring money to the population or not is the fiscal balance. A surplus would mean on the net, the government takes in money from the population. A deficit means the government gives money away. And the Malaysian government has been experiencing fiscal deficit since the late 1990s.

But what about the middle class? The bottom 40% gets cash transfer and free income-replacement insurance but what about us the middle class?

Apart the subsidized petrol, subsidy for urban highway tolls in terms of compensation from the government to private concessionaires, the subsidized train rides, the subsidized residential electricity use, the subsidized water, subsidized healthcare, subsidized contraceptives, subsidized education, subsided this and subsidized that in the cities with its much better amenities, what else do the middle class get?

Of course, nothing.

I will leave you with a sketch from Monty Python’s Life of Brian.

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

[1] — I recently cycled 40 minutes in 33-degree weather just to save RM6 on parking when I went to a government clinic to collect my medication. I was a little peeved when the nurse told me that I could only collect two months’ worth instead of the usual three. She gave some excuse about records not tallying if patients are given three months’ supply. I suspect that government health facilities are yet again running low on medical supplies. But coming to the clinic once every two months and paying just RM1 for two packs of oral contraceptives still beats buying them at a pharmacy, where a pack can cost RM27.

So it annoyed me to read that, despite my efforts to save money, the Pakatan Harapan (PH) government is implementing three new taxes that disproportionately hit the middle class – a digital tax, a departure levy, and a tax on sugar-sweetened beverages. [Boo Su-Lyn. The overtaxed middle class. Malay Mail. April 12 2019]

[2] — Note: The IMF puts Malaysia’s revenue/GDP ratio at 20% in 2019 but this does not quite tally with Malaysian data [IMF Data Mapper. Fiscal Monitor. IMF. Accessed April 12 2019]