The Malaysian government plans to introduce goods and services tax replacing the current sales tax as well as service tax in 2011. I generally prefer consumption tax to income tax because one, it somewhat accounts for externality related to consumption (making it a close cousin to my favorite tax, carbon tax) and two, it is a flat tax. Libertarians typically love flat tax. And probably, three, it is a middle finger to Keynesians and socialists out there.
My position with respect to GST in Malaysia is essentially one of agnosticism at the moment as I try to grasp its merit and demerit, despite my disposition to consumption tax (If there is an abolition of income tax alongside the introduction of GST, I would probably rush to the defense of GST immediately). I am therefore open to argument from both sides.
I do have problem rationalizing opposition to GST based on the argument that GST is regressive however. To the best of my knowledge, sales tax and service tax are flat taxes. That makes them regressive. They are consumption tax too (practically indistinguishable really) because they too can be passed to consumers (though a study of tax incidence suggests passing the tax to consumer is slightly more complicated due to dependency on elasticities).
Given that both types — GST and the current taxes GST is proposed to replace; for the sake of convenience I am lumping sales tax and service tax as ‘the other taxes’ — are regressive, the appropriate question to mount a proper opposition to GST is how more burdensome GST is compared the other taxes to the lower income groups, not whether GST is regressive or not by itself. In order words, what are the marginal effect?
I do not know the answer. Obviously a study has to be done to answer that but my first impression would be that it is less burdensome — less burdensome by meaning of less taxation — because the rate of GST proposed is much lower than the average rates of sales tax and service tax, at least for 2011.
The proposed GST rate is 4%.[1]
According to Malaysian Industrial Development Authority, services tax in Malaysia is 5% while sales tax is typically charged at 10% although there are goods charged as low as 5% to as high as 25%.[2][3][4] There are exemptions where no tax is charged but leave that aside for now.
Clearly, ignoring the anomaly of exemptions, GST is theoretically less burdensome than the other taxes of interest at the proposed and current rates.
Therefore, I am having problem with the basis of opposition to GST as expressed by several politicians from Pakatan Rakyat and possibly Khairy Jamaluddin. The latter spoke earlier in the Parliament, raising his concern about the regressive nature of GST.[5] Like I said, the proper concern should be how much more burdensome is GST against the other taxes, not that GST is regressive.
For Tony Pua’s assertion that the government should postpone the implementation of GST until average citizens earn higher income[6], which I assume GDP per capita is a convenient proxy for that, this is not convincing.
Assuming that rate of GST is the same as the average of rates for the other taxes — ignoring the effect of changing quantity demanded and quantity supplied as well as elasticities that eventually lead to change of tax revenue; those changes would probably bring down aggregate demand given the efficiency of GST but no matter because that is an entirely different issue — tax collection for both should be the same theoretically.
Theoretically because the other taxes are susceptible to tax evasion. Tax evasion is less of a problem to GST because value-adding activities are recorded more diligently across value-chains. That makes it more efficient in terms of tax collection. This advantage that GST has against the other taxes should enhance the appeal of GST, not less, if one is interested in having better taxation system. The opportunity for tax evasion is not a good point to base one’s opposition to GST, again, if one is interested in having better taxation system.
Note however, again, the proposed rate of GST is lower than the current average rates of the other taxes. Any net gain from the switch to GST is likely due to efficiency of GST rather than increase in theoretical taxes.
Nevertheless, Pakatan Rakyat or rather DAP does sound good criticism that weeding out corruption and addressing mismanagement of country’s resources would probably enhance the government’s bottom line compared to expected increase of tax collection of RM1 billion due to GST.[7]
Yet, I think Rajan Rishyakaran makes a good point when he writes, “the need for the GST goes beyond plugging budgetary holes — it serves the need to flatten the tax base.”[8]
I would add further that the function of GST is to diversify sources of revenue for the government rather than raising revenue. Unless all Malaysians suddenly convert to minarchism, which I do not mind of course, given the well-known fact that Malaysia has narrow taxpayer base,[9] diversifying the source and indeed widening the base is a good idea.
It is a good idea because, like the Pulitzer Prize winner Thomas Friedman puts it in his article entitled The First Law of Petropolitics, if he is right, government dependency on tax as revenue encourages accountability. That can further develop democratic culture in Malaysia. Dependency on oil revenue does not do that.[10] Add to that the fact that oil is a finite resources, diversification is a a way forward.
If the rate of GST gets higher than the average of the other taxes, then opposition to it is very proper. That however is an opposition to the rate, not GST per se.
p/s — I realized that I have not defined the meaning of regressive. Consumption tax like GST is a flat tax. By regressive, it does not refer to actual rate increases the lower one’s income is where progressive means the opposite. Rather, it refers to the fact that those with lower disposal income will spend greater fraction of their income on basic items. Since flat tax increases that fraction on the, if I may use the term, poor, it is arguably regressive. The difference between the two ‘regressive’, should be differentiated, even if the effect maybe the same.
[1] — KUALA LUMPUR: The government plans to impose goods and services tax (GST) at 4%, said Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah.
”We are replacing the current sales and services tax, which is currently at 5% to 10%,” he told reporters at the Culture, Ideas and Values Workshop organised by Foundation For the Future at Country Heights Resorts in Kajang. [Govt may impose GST at 4%, says Husni. The Star. November 26 2009]
[2] — See Service Tax. Accessed December 3 2009.
[3] — See Sales Tax. Accessed December 3 2009.
[4] — See Taxation. Accessed December 3 2009.
[5] — The first parliamentarian to raise concern about the introduction of GST is Khairy Jamaludin. When he spoke on this matter, there was hardly any response to it. As usual the mainstream newspapers shied away from this heavy stuff. [Further thoughts on VAT/GST. Mohd Ariff Sabri Abdul Aziz. December 2 2009]
[6] — Today, out of a population of 27 million, there are in effect only 1.8 million tax-payers who pays any income tax, or only 6.7% of the population. Even if we were to take into account only the 12 million working population, it is only 15% of them who have pay any taxes. The 85% who don’t pay are those who actually don’t qualify to pay any taxes because their income is too low. However, with the implementation of GST, every single one of them whether they are earning RM500 a month or RM1,500 a month or even RM2,500 a month, who don’t current pay any taxes, will be forced to bear the heavy burden of the GST.
Therefore, it is only fair that the income levels of the average Malaysian is raised to a level where the overwhelming majority of working Malaysians are already taxable before the switch is made to a GST or indirect taxation system. [GST: First blood. Tony Pua. December 1 2009]
[7] — IPOH, Nov 29 — DAP has urged the Federal Government to reconsider the proposed 4 per cent Goods and Services Tax (GST), claiming it would do nothing to narrow the nation’s current deficit budget and would only further burden the poor and the middle class.
Party secretary-general Lim Guan Eng said that the Government should, instead, concentrate on fighting corruption and realising savings of at least RM28bil annually instead of a mere RM1bil in additional revenue from GST. [DAP: No sense gaining RM1b from GST to lose RM28b to graft. Clara Clooi. The Malaysian Insider. November 29 2009]
[8] — Tony Pua did point out several other ways to raise revenue (auctioning import quotas, for example) and save money. Nevertheless, the need for the GST goes beyond plugging budgetary holes — it serves the need to flatten the tax base. [GST for high-income economies. Only.. Rajan Rishyakaran. December 1 2009]
[9] — International agencies such as the International Monetary Fund (IMF) and World Bank have long pointed to Malaysia’s narrow tax base as being unviable in the longer term, given that only a tenth (or an estimated one million-odd workers) pay income tax and the nation’s overdependence on oil earnings, which contribute more than 40 per cent of federal revenue. [Najib plumps for GST to fill revenue hole. Business Times via The Malaysian Insider. November 25 2009]
[10] — [The First Law of Petropolitics. Thomas Friedman. Foreign Policy. May 2006]