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

[2904] Reintroducing GST now means austerity

Is this the right time to reintroduce the GST?

No.

It is definitely the wrong time to reintroduce the GST at the previous rate of 6%.

Why is it the wrong time?

Because in time when economic growth is dropping off the cliff, having GST at 6% is essentially having an austerity program. It will exacerbate the situation. If you are worried about government finance, remember, government finance is not the economy. Do not forget that.

Why is it an austerity?

The current SST level is approximately equivalent to 4% of GST. Possibly slightly higher than 4% as the new SST has been improved to cover new items. Having GST at 6% is effectively a tax hike from the status quo.

And a tax hike in time of economic slowdown will make the downturn worse. A tax hike is austerity.

How about GST at 4%?

No. Just do not mess with it at this time. There will be an appropriate time to do so. Do not be so noob about it.

Categories
Economics

[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.

Now…

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.

Conclusion

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.

Categories
Economics

[2891] SST did bring (core) prices down in September 2018

The shifts from SST to GST, and back to SST were controversial. There were debates on its effects on inflation and living costs. While the GST introduction led to a one-time rise in price level and that, I think, has not been widely disputed, the effect of SST reintroduction on price level has been more contentious. Pro-government camp would would claim that SST reintroduction did bring prices down, while the opposition would disagree, and citing various examples where prices went up (both real and made-up instances).

Did SST bring prices down?

The answer, on aggregate, is yes. Here is the main chart central to my argument. This chart shows core price level.

In April 2015 when the GST was introduced, prices went up by 1.19% month-on-month (after adjusting for seasonality). And in June-September 2018 when the SST was reintroduced, prices fell by 1.32% month-on-month (also after adjusting for seasonality).

Now, the long explanation.

Core prices instead headline prices

There are various factors affecting prices. It can be difficult to extract and isolate each factor out. But the official core inflation series does a relatively good job filtering out various factors, most notably items with volatile prices affected by seasonality. This cancels the noise (enough) that we can see price effects of tax regime changes.

Using core prices as our starting point, did the SST bring prices down?

Month-on-month versus year-on-year

The answer, again is yes… from month-on-month perspective.

This section is a bit dry and digresses into discussion on measurement. You might want to skip this as skipping it would not hurt the “yes” explanation by too much. If you are not skipping, let us move on with the agenda.

Month-on-month is a better way to observe things than year-on-year. This is because there are multiple significant supply-induced for the past few years. For instance, because of the SST which was reintroduced in September 2018, we would have to wait until September 2019 until its effects on prices disappear from year-on-year perspective. These changes make year-on-year unreliable as a change measurement. If we insist on using year-on-year as a measurement for policy purpose, we will risk making the wrong call based on a massive structural break, never mind the 12-month recognition lag.

Year-on-year does control for seasonality, unlike month-on-month and that is its strength. But it is not great at handling (structural) breaks in series. And as far as consumer prices are concerned, Malaysia has experienced too many breaks at least since 2015 when the GST was implemented. The last big break was in February 2019 when petrol and diesel prices were capped at its current ceiling. I expect one or two more major breaks in the next 12 months.

This is why there is a need to move from year-on-year to seasonally-adjusted month-on-month (or quarter-on-quarter whenever relevant) measurement. Seasonally-adjusted month-on-month addresses problems of structural breaks and seasonality, which makes it better than year-on-year by a mile.

Additionally, changes in a series could be seen immediately through month-on-month. This significantly removes the problem with recognition and policy lags.

Our familiarity with year-on-year and stubbornness to move away from it is part of the reason why too many people panicked over “deflation” earlier this year, when in fact, it was just a mathematical artefact arising from a massive structural break, or two, or three.

Effect of shift to GST in April 2015

Now that is out of the way, we can start directly discuss about how GST changed the price level.

The raw month-to-month price change in April 2015 was 1.28% (below is just the month-to-month change for the chart above).

But how do we know whether the 1.28% was fully due to GST?

That is a difficult question, really. But because it is core prices, significant amount of items susceptible to large volatile changes are out of the picture. Food items and fuel are out. Yet, there is still a problem. Our problem is that the core CPI is not seasonally-adjusted (as far as I understand it). In order to control for seasonality, we need to look at March-April change in other years and use that as a correction factor.

Here, we get into another problem, the official core series does not go to far back. Publicly, core series begins in 2015.

Nevertheless while keeping that in mind, April price change in 2016, 2018 and 2019 were either 0.08%, or 0.09% (in April 2017, prices rose 0.26%. I do not know why, and I am too tired to find out. So I am going to close my eyes and consider it as a outlier and pray hard. Please do not shoot me). To control for seasonality, we take the 1.28% and subtract 0.09% (the April average change in 2016, 2018 and 2019) from it. Through this, we can claim that the April price change due to GST—as far as core prices and the seasonality I have accounted for concerned—is 1.19%.

In short, GST quite possibly raised core price level by 1.19% month-on-month. Yes, GST did raise price level.

Effect of shift to SST in June-September 2018

Now, this part is not so straightforward because the transition from GST to SST lasted for 4 months. In 2015, there was an immediate transition from SST in March to GST in April. But in 2018, the GST was effectively abolished in June 2018 and was replaced with a 3-month tax-free period. The SST only came in September 2018.

As a result, direct comparison between the SST-GST shift (April 2015 core CPI), and GST-SST shift (September 2018 core CPI) could not be made. There are at least two reasons:

  1. First, in June 2018 when the GST was abolished, core price level dropped 1.43%. And it was a drop from GST regime to no tax period. This number does not help us answer our original question, which is whether SST brought prices down.
  2. Second, when the SST was reintroduced in September, core price level rose by 0.60%. This also does not help answer the question.

So, how could we make it comparable?

This chart shows the problem, and the adjustment required from price level perspective to make a fair comparison (blue is actual, red is adjusted).

The adjustment is: calculate the difference between May 2018 core price level (GST prices) with September price level (SST price level), while ignoring the free-tax period completely. Do this and we would get a price drop of 0.59%.

This is how it looks like in month-on-month changes (blue is actual, red is adjusted).

However, just like the SST-GST shift, we need to control for seasonality. And the average May-September change for 2015, 2016 and 2017 is 0.73%. The variance is not that big: for transparency, it was 0.72%, 0.79% and 0.68% rise for 2015, 2016 and 2017 respectively.

Controlling for seasonality, that means the GST to SST shirt brought core price level down 1.32% (that is -0.59% plus -0.73%).

Conclusion: SST brought core price level down

As a summary, after accounting from seasonality:

  1. SST-GST shift raised core price level by 1.19%
  2. GST-SST shift cut core price level by 1.32%

Some comment on the results: I had expected the SST-GST and the GST-SST shifts to bring prices up and down by about the percentage point. Right now, there is a difference because I think there are still some important factors that have not been controlled. It is possible that one of them could be forex rate.

Caveat and other business

There is a important clarification here. These results do not mean core prices in September 2018 when the SST was reintroduced were lower than core prices in May 2015. Between May 2015 and September 2018, headline and core prices rose for a variety of reasons. Rather, the two changes in 2015 and 2018 were one-time changes, or structural break in core price series. You could see this from the price level charts above.

This brings us to inflation. The remarkable thing is, at least from the naked eyes, inflation (in the sense of general rise in prices) remains largely the same throughout the changes. Another way to say is that, the slopes of the lines (GST and SST) are about the same. What happened was a shift in price level, which is what this whole post shows.

And finally, I want to show you this chart.

The black-shaded area was caused by GST (specifically, GST at 6% minus GST at 4% – GST at 4% has been cited as the equivalent of SST around 2014-2015). If GST were never introduced, core price level would likely have be lower by that shaded area.

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]