Tag: taxes

Categories
Economics

[2122] Of the proper question is, is GST more burdensome than sales and service taxes?

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.

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

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.

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

[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]

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.

Categories
Economics Politics & government

[2106] Of thumbs up for MP from Bukit Bendera on GST

With respect to the proposed implementation of the goods and services tax, MP Liew Chin Tong said:

“This is a huge sum for a study. The Finance Ministry should explain what kind of study this is, who is conducting it and which consultancy firm is handling the study.

“The idea of implementing this kind of study needs serious national debate.

“When Australia implemented the GST in 1998, it was decided based on a referendum.

We need to debate whether we need the GST or whether the Government should cut down its spending instead” [Parliament: Why RM22m for GST study? Zulkifli Abd Rahman. The Star. November 3 2009]

Indeed.

Categories
Economics Politics & government

[2013] Of regretfully, fiscal deficit is a non-issue

The consistent fiscal deficit the federal government currently experiences is an issue far removed from everyday life. For many, it is an abstraction without concrete consequences. Hence, it is highly unlikely that the issue will be able to capture public attention and directly become a determinant in any election. This gives the federal government too much free hand in managing its fiscal position.

Despite the lag in effect, the persistent fiscal deficit presents real challenges to the economy and perhaps, more tangibly, to all taxpayers. It is so because the idea of scarcity is not something that is only valid within the theoretical world of economics.

It is because of scarcity that the concept of deficit exists. It is also because of scarcity that any deficit requires financing.

As far as the fiscal deficit of the Malaysian government is concerned, it is being financed through borrowings. The government issues debts in which market participants — be they individuals living within Malaysia or financial firms based abroad — purchase in return for greater payoff in the future.

So far, the federal government is fulfilling its existing debt obligations by issuing more debts. The situation on the ground at the moment allows that to happen but it does not take a leap in imagination to understand how a snowball may cause an avalanche. Argentina in 2001, for instance, defaulted from fulfilling its debt payments; it borrowed to finance its deficit for the longest time until its repayment requirement became too big for it to comply.

Malaysia still has a long way to go before that happens. Nevertheless, eventually, our deficit has to be attended. There are at least three ways to address the deficit: increase revenue, decrease government spending or default.

For any self-respecting government, defaulting is not much of a choice. The Argentine economy was in ruinous state after it defaulted on its payment; capital fled and dried up, bringing the economy to a screeching halt. Regardless of preference, the current local scenario that includes the maintenance of strong foreign reserves by Malaysia makes the likelihood of default very small.

Decreasing government spending is the policy path that libertarians favor because it necessarily reduces the size of government. Unfortunately, this will not occur anytime soon. Even during the Abdullah administration when the fiscal deficit finally saw relaxation, government spending continued to rise. Keynesian thinking meanwhile reigns supreme in the Najib administration; the government has expressed its intention to spend to stimulate the economy. The two factors set the momentum for the federal government’s fiscal position in the near future.

The third way is to increase revenue. This can happen by having enough growth in either non-tax revenue, tax revenue or both. With a healthy economy, those items can help in balancing the fiscal position. Without a sufficiently healthy economy, however, taxes simply have to increase to meet the gap eventually.

A tax increase is the clearest credible solution because it is increasingly clear that the fiscal deficit is structural in nature, and not cyclical. It is structural because it is arguable that we may have seen or are seeing the completion of a business cycle. In that cycle, the federal government has been running on a persistent fiscal deficit. Year 2009 will be the 12th consecutive year that the government has either failed or refused to close the gap and there is no reason to believe why year 2010 will not be registered in red ink.

A tax hike, however, is an unpopular policy, even when it is a potent tool in arresting the runaway fiscal deficit. Under the current political atmosphere where the Barisan Nasional-led federal government faces a considerable number of hostile voters, raising taxes is committing harakiri. The political situation demands spending.

In fact, the pressure is on Barisan Nasional to continue to spend in order to keep the economy going. More importantly, it has to keep voters happy by shoring up the economy in the short term to push its expiry date farther into the future.

Government spending is not necessarily bad or undesirable even in times of deficit. Yet, unless the government spends the money for the purpose of investment, spending for the sake of spending — as the two fiscal stimulus packages are doing — will further widen the difference between revenue and expenditure. For deficit hawks, the situation is gloomy because between investment and spending, the effect of the latter comes quicker than the former. Naturally, political expediency favors quick wins; quick wins mean the deficit will continue to take a hit.

Given the situation of a structural fiscal deficit, weak economic environment and political unpopularity, the only palatable short-term option is to continue to borrow to finance the deficit.

As a result, the present generation will be free from the burden of increased taxes and so too subsequent generations that are lucky enough to live during times when the economic situation allows the government to keep borrowing to finance its deficit. With the problem being out of sight and out of mind among the current generations, regretfully, there is no pressure to address the issue of fiscal deficit.

Somebody, however, eventually will have to pay those debts. By the time that happens, it is likely that the problem will become too big to handle.

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 June 15 2009.

Categories
Economics

[1969] Of Obama’s offshore tax is a protectionist taxation

The Obama administration plans to tax US-based corporations for revenue not originated from the US as part of effort to create more jobs in the US.[1] This will help neither the US economy nor the world economy to recover.

There are of course legitimate concerns with respect to tax havens as money laundering tend to happen there more often than not compared to elsewhere. But Obama administration’s proposed action will punish corporations for operating in countries with low taxes as well. The administration thinks that by doing this, those corporations will relocate its foreign operations to the United States if they are faced with the possibility of being taxed for operating abroad.

Indeed, if passed by the US Congress, the proposal may force corporations to reduce or abandon its operations outside of the US, unless they are willing to pay those taxes. Under a scenario where these corporations do relocated into the US, the corporations will suffer higher operations cost due to  prevailing environment in the US, compared to places like China or India. It is worth noting that these corporations operate parts of their business out of the US to take advantage of low cost environment, especially if industries which those corporations are in are labor-intensive.

With higher production cost, higher prices will have to be charged and consequently, less will be sold.

If the proposal goes through, it will not only punish those corporations. It will also punish low-tax countries. Worse, such tax is likely to hurt trade volume in times when many countries including Malaysia are heavily reliant on trade to recover.

This of course will only happen if the tax actually convince these US corporations — in reality, multinational corporations — to relocate into the US. Given lower operations cost abroad, the other possibility is that these corporations may actually relocate more of its businesses abroad, avoiding being labeled as US corporations to avoid the tax altogether. This will be bad for the US economy.

So, the possibilities here are: one, the US bringing the world down together with it; two, the US bringing itself down. Either way, the US will lose out. The third and better possibility, of course, is for the US to not impose that tax.

The proposed move should not be too surprising to too many people. The Democrats since at least 2004 — the days of John Kerry and John Edwards — have wanted to somehow punish firms that they accuse as shipping American jobs abroad, either through outsourcing or offshoring. That thinking is protectionist and the Obama administration’s proposal should be seen as a follow-up to that protectionist tendency that Democrats are known for.

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[1] — May 4 (Bloomberg) — President Barack Obama proposed raising about $190 billion over the next decade by outlawing three offshore tax-avoidance techniques used by U.S. companies such as Caterpillar Inc. and Procter & Gamble Co.

Obama’s plan also would make it riskier for Americans to stash money in tax-havens. [Obama Seeks End of Corporate Tax Break to Raise $190 Billion. Ryan J. Donmoyer. Bloomberg. May 4 2009]