Category: Economics

Categories
Economics

[2164] Of a progressive GST?

There is a report by Bernama yesterday which states that a tax official claimed GST will not be inflationary due to lower GST rate compared to the rates of soon to be abolished sales and services tax. It is theoretically possible and I am leaning in that direction. One statement, however, troubles me:

KUALA LUMPUR, Feb 10 (Bernama) — The implementation of the Goods and Services Tax (GST) based on current estimates, will not lead to price increases due to the offset from the abolishment of the sales and services tax (SST), the Chairman of the Tax Review Panel in the Ministry of Finance, Datuk Kamariah Hussain, said Wednesday.

She said logically, with GST, consumers would pay 4.0 per cent tax compared with the current service tax of 5.0 per cent and sales tax of 10 per cent.

“GST is progressive rather than regressive, with tax incidence at the 4.0 per cent GST rate being lower than the current SST,” she said at the Affin Investment Bank forum on GST here Wednesday. [GST Will Not Lead To Price Increases, Says Tax Official. Bernama. February 10 2010]

Is GST progressive tax?

This is the first time I have heard somebody arguing that GST is a progressive tax.

To the best of my knowledge, GST is not a progressive tax. Why?

First, GST is a flat tax. There is only one rate. Therefore, it is not progressive in terms of rate structure. It is flat.

Second, a flat tax is regressive by the very nature that those earning relatively lower income will see greater fraction of their income taxed compared to those of higher income (it can be made less regressive by introducing exemption to staple food and other ingredients like sugar and salt). This makes it not progressive in terms of welfare.

So, in what way is GST progressive?

The only way I can think of that makes GST progressive strictly in terms of welfare, is by making way too many exemptions on goods typically consumed by the middle class and lower. In other words, practically, taxing only luxury items. Is that the case here?

There is no explanation in the article.

Categories
Economics

[2154] Of introduce targeted cash transfer instead of targeted subsidy

In spite of opposition that saw the streets of Kuala Lumpur filled with pro-fuel subsidy groups during the Abdullah administration, efforts to liberalize the fuel subsidy regime have gone a long way. Several arguments, including one that criticizes the untargeted and blanket nature of the policy have gained tremendous traction. The fact that it benefits those who do not need or deserve the subsidy is clearly one of the main motivators — the bigger drivers are probably cost and waste — behind the reformation of the policy.

The Najib administration is addressing this particular criticism. That has resulted in multiple novel moves and proposals from the federal government. Among the proposals reported in the mainstream media are different prices for different groups, a cap on subsidized fuel consumption and access to subsidy based on engine size. All of it tries to discriminate consumers at the pump. While the moves and proposals may reduce the size of fuel subsidy either in value or in quantity, the proposals under explicit fuel subsidy regime are too convoluted. The more convoluted the methods are, the more complex the implementation will be. That is a recipe for a disaster, policy wise.

I appreciate the government’s effort at making the policy more targeted and hence, making it less wasteful in terms of opportunity cost. Yet, these novel ways are unnecessary given the existence of at least one simpler alternative.

Just observe the recent attempt to limit the sale of subsidized fuel to foreigners at the border. So complicated was it that everybody was confused and in the end, it did not work. Consumers found ways around the restriction.

There is a better and much simpler way to do to this.

Before we proceed to that better and simpler policy, it is crucial for us to recall the purpose of the fuel subsidy. Its goal is ultimately to reduce the cost of living of the less well-to-do Malaysians. On top of that, fuel subsidy is not the only way to achieve that goal.

With that in mind, the better alternative to targeted fuel subsidy is a simple targeted cash transfer from the government to those who deserve it.

Why targeted cash transfer?

The first reason is that it paves the way for total elimination of fuel subsidy to free up the market. Since free prices signal scarcity, individuals and entities will make decisions that are more reflective of the reality of the energy market. On top of that, it creates real competition among pump owners. The same system of free prices already exists in the United States and Australia. Its effectiveness is proven.

Not only that, elimination of subsidy at the pump reduces consumption, all else being constant. That means lower carbon emissions. In times when carbon emissions are a worldwide concern and in light of the Najib administration’s promise to announce a carbon cut roadmap in the near future, this is an opportunity to integrate transportation and energy policies together environmental policy. Such integration is important given that, according to the International Energy Agency in 2007, the transportation sector was the source of 30 per cent of Malaysia’s carbon dioxide emissions in 2005.

Thirdly, cash can be used for a variety of things and not just fuel. Maybe a beneficiary of such a cash transfer appreciates books or food more than fuel. This has the potential of increasing the beneficiary’s welfare higher than what a fuel subsidy policy can bring. If the beneficiary does appreciate fuel more than anything else, then he or she can simply buy the same amount of fuel he or she would have otherwise bought under the fuel subsidy policy. In other words, there are more choices. The economics behind cash transfer is clearly more welfare enhancing than a simple fuel subsidy.

The next question is, naturally, how to do it.

If the sale of subsidized fuel is to be limited, then the government will have a good idea about the maximum amount of money it needs to spend on fuel subsidy. Furthermore, the lower the cap, the higher the likelihood a beneficiary of the subsidy will exhaust his or her quota. From there on, certain statistical manipulations can give us the size of money transfer per capita required to make the cash transfer method the equivalent of the fuel subsidy policy in terms of value.

The cash transfer itself can be delivered to the deserving via the existing tax system. Here is another beauty of cash transfer. It pays only to those who have filed their taxes. Thus, this is yet another incentive for those who have yet to file their tax to finally do so.

For those who just want to fill up their vehicles, here is another reason to support a simple cash transfer instead of an explicit targeted fuel subsidy policy: no weird rule at the pump. With cash transfer, any discriminative method used to ensure that the policy is targeted is done not at the pump but during the transfer of cash. This makes its implementation simpler.

So, what about it that is not to like?

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

A version of this article was first published in The Malaysian Insider on January 19 2010. Unlike the TMI edition, I added several sentences and phrases here to emphasize or rather, to clarify that the cash transfer is targeted in a sense that whatever discriminative method introduced in a subsidy regime can be applied to cash transfer system.

Categories
Conflict & disaster Economics

[2150] Of aid and logistical challenges for Haitian earthquake victims

When the gods battle in Malaysia, the gods forgot Haiti.

As always, the affairs of men are too important to be left in the hands of the gods. Christian conservative Pat Robertson may disagree. Instead, he thinks god wants Haiti to suffer because Haitians made a pact with the devil.[1] Ah, the glory of god.

Thank goodness for the reasonable and capable Bill Clinton!

Former President Bill Clinton yesterday spoke of the need to send cash to Haiti instead of items like food and blankets.

[youtube]W6H2hnGaUbk[/youtube]

He reasoned that in Haiti now, there is simply no logistical capability to handle various items from abroad in huge quantity. Haiti’s principle airport inability to cope with the volume of aid material is one evidence of that.[2] With an earthquake that devastating, it is probably a prudent to assume that transportation infrastructure in the country’s capital — a major population center located too close to the epicenter of a major earthquake  — is unreliable now.

In economics, cash aid is the best kind of aid because only the persons on the ground know how the money should be spent, especially when compared to some kind-hearted donors living abroad. It is a case of imperfect information.

That statement is made barring the issue of corruption, which is a major motivation behind the need of material aid.

The probability of abuse of material aid is lower than the likelihood of cash aid abuse. This does not mean that there can be no abuse with material aid — somebody may get all the material aid and start selling them when it should be free— but in comparison, material aid does better than cash aid in terms of abuse prevention. Due to this as well as the horrible record of the government of Myanmar, I advocated material aid to the victims of Nargis back in 2008.

I am ignorant of Haitian politics but Haiti is located not so far away from Myanmar in Transparency International’s 2009 Corruption Perception Index.[3] It is classified as above Myanmar but really but comparison to Myanmar is not much of a comparison. Corruption is a serious there.

I have a lot of respect of former President Bill Clinton. He is the US President I respect the most out of Obama, the Bushes and him. When he said something, I would think twice before disagreeing with him. Indeed, as a libertarian, I should be agreeing with Clinton on his assertion of the superiority of cash aid. And sending money is definitely easier than sending material aid. Yet, I have trouble accepting his advice that cash aid is better.

Perhaps, as an UN envoy to Haiti, as well as a person that has been to Haiti, he knows more than me. His knowledge might not be as good as the victims themselves but it is likely better than mine who lives two oceans across from Haiti.

Still, what good is cash when everything is destroyed?

The economy may rebuild and spontaneous order will establish itself during this chaos but as Clinton said himself, there is no logistical capability to handle the kind of volume of aid material in Haiti at the moment. Okay but will local production be able to match the heightened demand for food, blanket, etc.?

I doubt so.

Even if local production is able to do so, would the logistics be able to cope to the traffic of goods? Would local production be able to produce everything autarkically?

Clinton is right. There is no logistical capability in Haiti. But I think that problem adversely affects the effectiveness of both cash and material aids. I am not saying aid should not be sent at all. What I am saying is that the problem with logistics might not impact the relative desirability between both types of aid by too much.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — American televangelist Pat Robertson has blamed the devastating earthquake in Haiti on a pact between the impoverished nation’s founders and the devil.

It is feared that up to 100,000 people may have lost their lives when the magnitude 7.0 earthquake flattened massive areas of the capital Port-au-Prince yesterday.

Speaking on his television program The 700 Club, Mr Robertson said the pact happened “a long time ago in Haiti”. [Haiti disaster blamed on pact with devil. ABC News. January 14 2010]

[2] — International relief to quake-devastated Haiti was reduced to a trickle this morning after the capital’s airport was overwhelmed by a sudden influx of aid planes, as the country’s President said 7,000 victims had already been buried in a mass grave. [Bottleneck paralyses Haiti relief efforts. Kim Landers. Craig McMurtrie. et al. ABC News. January 15 2010]

[3] — See [Corruption Perception Index at Wikipedia. Accessed January 15 2010]

Categories
Economics

[2143] Of stimulus may bite back in 2010

Economics has been labeled as some sort of a discipline that predicts the future. The application of various models and efforts at testing its various hypotheses that sometimes result in the affirmative may have contributed to that reputation but it is not about predicting the future. Rather, it is about finding lessons from the past, learning from it and applying it for future endeavors. More humbly perhaps, it serves as a cautionary tale.

In this spirit, what one may expect in 2010 in terms of the national economy?

Many things obviously, and it is beyond me to list it in an exhaustive manner. Given my mischievous agenda against the state in general, I will focus on only a few. That, and based on standard economic theory, two parts of the economy may deserve some attention in light of what happened last year. Two components of Malaysia’s gross domestic product are investment — specifically private sector investment — and net exports or really, exports.

Why?

Economic theory suggests that increased government spending adversely affects net exports and ambiguously affects overall investment after some time. For those who keep tabs on the local economy, the fact that the government launched two massive measures to stimulate the economy should be common knowledge. In promoting it, the government touted it as unprecedented. It is exactly because the size is unprecedented that the concern is legitimate, possibly in a way that is unprecedented too.

The same theory highlights that government spending places upward pressure on interest rate and the exchange rate.

With additional government spending on top of normal spending, it is reasonable to hold the position that the current interest rate is higher than would under a situation without such spending. Higher interest rate means higher cost of borrowing and that itself is a disincentive to invest, especially for the private sector, even if the effect on overall investment is ambiguous. The fact that the government financed its additional spending by borrowing locally further strengthens the phenomenon of crowding out the private sector. With the government expounding on the idea of having the private sector as the driver of Malaysia’s economy, the divergence between the government’s past actions as well as its theoretical consequences and the government’s words creates a noticeable dissonance — but the sun always rises in the east and so, what is new, eh?

The same effect on interest rate is applicable to the exchange rate. In doing so, it makes Malaysian exports more expensive compared to a situation without the stimulus and foreign goods cheaper. It depresses exports, given all else the same. The likelihood of depressed exports is even more worrying given the economy of Malaysia’s trading partners.

For instance, in the United States, which is a major destination for Malaysian exports and really, the world, there is fear that once its stimulus spending runs out some time in the second half of 2010, its recovering economy would go to the other direction, possibly reflecting the artificial nature of economic recovery based on government spending. Should the US economy take a nosedive again, Malaysia’s exports will take a hit, as it had earlier. It would be a double whammy for the exports component.

The importance of the exports component to the Malaysian economy cannot be overemphasized. Despite rhetoric heard these days of the need to move away from the export-driven model, there is no realistic way to make contribution of domestic demand to Malaysian economy a close rival to foreign demand for domestic goods without devastating the local economy. The chasm between the two is just too great to close. This is not to say that improvement of domestic demand is unwanted but Malaysian consumers are simply unable to consume as much as the export markets, even if Malaysia would suddenly become a high-income country tomorrow. Anybody who harbors a dream to remove the centrality of exports and trade at large to the Malaysian economy vis-à-vis domestic demand must be fast asleep.

If the US economy contracts again this year, the political pressure on the Najib administration for yet another fiscal stimulus would be great as Malaysia’s own ongoing fiscal stimulus measures expire. Already there are calls for a third stimulus in Malaysia. Needless to say, further government spending will exacerbate issues associated with the investment and exports components.

This may further discourage investment by the private sector and there may be an urge for the government to take a more active role in the economy.

Granted, at the moment, there is an effort to liberalize the economy. Yet, the reduction and the expansion of government happen in different parts of the economy, bringing about unclear net government intervention in the market as a whole. Economic theory suggests that the government of the economy portion will expand. Further involvement through stimulus spending will tilt the arrow towards the appropriate side.

Critics of this line of reasoning tend to point out that there is excess capacity during an economic downturn and hence, the negative impact of increased government spending is only a theoretical worry to be shrugged off. They forget that, as with most economic policies, there is a lag between implementation and effect. In the very short term, the impact of crowding out caused by government spending is non-existence. Notwithstanding other arguments against fiscal stimulus such as the relative ineffectiveness of fiscal stimulus for a small open economy such as Malaysia, they can hold on to their criticism in the heat of the crisis. In 2010 and farther into the near future however, the lag will catch up to make the issue less theoretical and more real as each day passes.

How the Najib administration will address that lagged impact will be an interesting economic problem. If the global economy — really the US economy — continues to improve, it will give a boost to Malaysia’s exports component. In doing so, it may solve the problem associated with the lagged adverse impact of the economic stimulus measures. Out of prudence, however, that is a bet deserving of hedging.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

First published in The Malaysian Insider on January 1 2010.

Categories
Economics Environment

[2137] Of 40% cut in carbon intensity may not be something to shout about

Bernama wrongfully reported that the Prime Minister of Malaysia, Najib Razak, put up a conditional offer to cut 40% of Malaysia’s 2005 carbon emissions by 2020.[1] The same goes with the New Straits Times, except it did it more badly by not directly quoting the Prime Minister.[2] This is sloppy reporting. The truth is that it is a conditional cut of 40% to Malaysia’s carbon emissions intensity in terms of GDP within the base and time frame mentioned. Regardless of the inaccuracy, is the cut impressive?

The size of the cut seems big but cutting carbon emissions intensity is a lot easier than cutting outright carbon emissions; a cut in emissions is more expensive than a cut in carbon intensity. Achieving 5% cut as demanded by Kyoto is a lot harder than 5% cut in carbon intensity. The difference is clearer when one takes note that emissions itself can increase even under a situation of decreasing carbon intensity.

A demostration is in order. The most convenient way of showing this is by using intensity per capita as a unit rather than per GDP. In order words, this refers to emissions per person.

Assume that the emissions per person is 2 and there are a total of 10 persons in a neighborhood. The total emissions is therefore 20.

Assume further than emissions per person improves to 1.5 and total population increase to 15. Total emissions gets worse: it is now 22.5.

A cut in emissions will address total emissions. A cut in carbon intensity does not guarantee that.

A concrete example is the United Kingdom. According to the National Environmental Technology Centre of the UK, total emissions fell slightly between 1990 and 2005. Carbon intensity? It fell more or less by 40%. [3]

Hence, the act of stressing the difference is not a matter of splitting hair.

Carbon intensity has the tendency to decrease over time due to application of technology. The typical criticism directed at any commitment at reducing carbon intensity is that even without such commitment, carbon intensity will decrease anyway. This is especially true for developing countries where there is a lot of space for technological improvement through by merely copying.

Given this, the Prime Minister’s conditional offer is not something to shout about. China also made an offer to cut carbon intensity and it has been rightly criticized for trumpeting an unremarkable target and then demanding moral authority at the negotiation table in Copenhagen during the 15th Conference of the Parties that ended recently.

(Despite this tendency, Malaysia’s carbon intensity between 1990 and 2004 increased. I suspect a Kuznets curve.[4] The ratio may increase up to a certain level before decreasing. Malaysia after all was industrializing during the 1990s and now, Malaysia is largely done with industrialization.)

It should only be seen as a brilliant diplomatic maneuver and not a big effort at cutting emissions. It is brilliant not just because that the commitment is very likely to be achieved anyway and thus, making the offerers look good, it is brilliant because it makes demand for aid — and making the exercise cheaper than it would — even when the cut in carbon intensity is very likely to be achieved without any binding commitment.

This is not to dismiss the importance of cut in carbon intensity. I myself believe that technology is the answer to climate change but it is important to get the right message across while the Malaysian mass media failed the public miserably.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — COPENHAGEN, Dec 17 (Bernama) — Malaysia has agreed to reduce its carbon dioxide emission to 40 per cent by the year 2020 compared to the 2005 levels subject to assistance from developed countries.

Prime Minister Datuk Seri Najib Tun Razak said the cut was conditional on receiving the transfer of technology and adequate financing from the developed world.

“I would like to announce here in Copenhagen that Malaysia is adopting an indicator of a voluntary reduction of up to 40 per cent in terms of emissions intensity of GDP (gross domestic product) by the year 2020 compared to 2005 levels,” he said in his speech at the United Nations Climate Change Conference 2009 here, on Thursday,

United Nations data shows Malaysia’s carbon emissions in 2006 stood at 187 million tonnes or 7.2 tonnes from each Malaysian. [Malaysia Announces Conditional 40 Per Cent Cut In Emissions. Bernama. December 17 2009]

[2] — PM Najib says Malaysia is committed to do its best in combatting climate change.

MALAYSIA will voluntarily slash by up to 40 per cent her carbon emission by 2020 compared with 2005 levels.

Prime Minister Datuk Seri Najib Razak, who made this commitment yesterday, said the cut was part of Malaysia’s contribution to global efforts to combat climate change. [40 per cent reduction of carbon emission by 2020. Mimi Syed Yusof. New Straits Times. December 18 2009]

[2] — COPENHAGEN: A roadmap towards realising the 40% reduction of carbon emission per capita from the 2005 level by 2020 will be presented to the Cabinet soon. [40 per cent reduction of carbon emission by 2020. Mimi Syed Yusof. New Straits Times. December 18 2009]

[3] — [Page 18 and 19. Carbon dioxide emissions and energy consumption in the UK. The National Environmental Technology Centre]

[4] — See Kuznets Curve at Wikipedia. Accessed on December 25 2009.