Where’s the government going to get more money from?

By Khairie Hisyam

In addition to rationalising subsidies, a stronger, broader revenue base is also needed in order to enable Putrajaya to deal with the troubling issues currently facing the Malaysian economy. In this third part of a series on the Malaysian economy we consider Malaysia’s tax structure and what we need to do to reform it.

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In the face of the challenges ahead for the economy which includes the need to cut back on subsidies, the Malaysian government also needs to strengthen its revenue base. And the way forward is to reform the existing tax structure.

This is in-line with the broader need for sweeping reforms across the nation’s economy and finances if we are to realise the dream of becoming a developed nation by 2020 — just seven years down the road.

But can Putrajaya do it? And how? We first look at issues with the current tax structure.

When global ratings agency Fitch Ratings revised Malaysia’s sovereign credit outlook to negative from the previous ‘stable’ rating in July, outcry and protests followed with some even even questioning the credibility of Fitch analysts given their relative youth.

Adding to the fire against Fitch is Moody’s — another international ratings agency — retaining its ‘stable’ outlook on Malaysia more than two weeks later. But what many may have missed is that Fitch merely pointed out facets of a problem that has been there for years.

A broken tax structure?

Among others, Fitch analysts cited the country’s small fiscal revenue base at 24.7% of gross domestic product (GDP) compared to increasing contingent liabilities as well as growth of debt guaranteed from 9.0% of GDP at end of 2008 to 15.2% of GDP as at end-2012. It points to an inefficient tax system — putting things in perspective is the fact that only about 14.2% of the workforce pays tax.

Things are not looking so good corporate-wise either.

In its 2006 report Assessing the Impact and Effectiveness of Fiscal Incentives in Malaysia, the World Bank concluded that Malaysia’s tax and incentive structure is overly generous and complex, and may leave room for tax abuse. In its diagnosis, the global financing body highlighted various issues from ineffective tax holidays; “overly generous” R&D incentives that did not substantially increase R&D spending in the private sector; to unsustainability of current subsidies and incentives.

In another report, Malaysia Economic Monitor: Repositioning for Growth released in 2009, the World Bank points to tax base erosion from the proliferation of incentives and exemptions as a cause for concern.

“Measures that are initially designed to be temporary run the risk of becoming easily entrenched,” said the World Bank in 2009. “The overdependence of the revenue base on oil and gas is a major fiscal risk.”

Years later, this is still a problem. This is one urgent area that needs re-examination in order to enhance the government’s revenue base, says Dr Yeah Kim Leng, Chief Economist of Ram Holdings Bhd Group.

“I think there is a vast scope to streamline our taxation practises so that we can minimise the subsidies and (incentives),” said Yeah when contacted by KiniBiz recently, adding that apart from enhancing the revenue base, this will “provide the correct fiscal signals for firms to pay their taxes full and at the same time enjoy reduced administrative burden for compliance (compared to the current system’s complexity)”.

Also in 2009, prime minister Najib Abdul Razak admitted that various incentives offered by the government had to some extent affected Putrajaya’s revenue. But while he added then that the government had been looking at ways to strengthen the tax base and increase revenue, action in this regard as well as in tackling the fiscal issues facing the country has been slow in coming.

However, slow may not be so bad after all. Speaking to KiniBiz recently, CIMB Chief Economist Lee Heng Guie feels that a comprehensive tax reform would take time. “We have to take one step at a time.”

“You do not want to unload too much reform in one year — they must be staggered,” said Lee. “Subsidy rationalisation is much easier and will probably be followed by looking at the current revenue base, which is too narrow and too dependent on petroleum revenue.”

“Then we will move one step forward to look at the existing tax structure (for businesses). Not just tax compliance but also existing incentives and one-off deductions, whether these should be revamped and eventually replaced by more competitive tax rates,” added Lee.  “I think we will reach a point where the government will re-look (at the entire system).”

Abdul Wahid Omar, minister in the prime minister’s office, was quoted today as saying that the fuel subsidies cut last week is the first step in avoiding a credit rating downgrade and spare serious repercussions on the economy due to higher borrowing costs and slowdown in foreign direct investments.

“We are hopeful of maintaining our credit rating. That will be a priority for the Government,” Abdul Wahid was reported as saying.

The second step, then, would naturally be the much-discussed goods and services tax (GST),which may be included in the upcoming Budget 2014 scheduled for tabling in October.

Making GST work

While the GST system is expected to improve the country’s revenue base, the main hurdle is its implementation.

According to Yeah of RAM Holdings, the accounting profession has been GST-ready operational-wise for some years as they have been waiting for its implementation. Conceding that smaller accounting firms may still need some hand-holding as well as incentives to raise their accounting and record-keeping systems up to mark, Yeah feels that the larger firms would not face any problems.

In addition, he also feels that the Royal Malaysian Customs Department (RMC) would also be ready system-wise to ensure timely GST refunds. The government had earlier announced that RMC would manage and administer GST, which would replace the existing sales and services tax.

“By and large, given the long lead time until now, I don’t foresee any major hiccups: implementation-wise, we are almost there,” said Yeah. “We are now just waiting for the gun to be fired.”

The main issue then lies in educating the public about GST and the actual implementation as some businesses may use it to justify price increases for goods and services. “We may see a blanket increase although (the increase) may not be justified as their production costs may not go up or may even go down because they are refunded.”

Therefore, a lead time between announcing the GST and when it actually comes into force is necessary, says CIMB’s Lee, with at least 12 months for people to prepare for its implementation.

“You need to have engagement and continue to educate the public on how to satisfy their consumer protection rights when GST is implemented,” said Lee, adding that he is positive the relevant agencies will publish indicative price guides for consumers to refer to.

One good example is Australia, where much preparatory work and activities to educate its public were done before the country’s GST came into force in order to disseminate information on how GST impacts consumers, along with anticipated effects on prices.

“Therefore it is fair to have a lead time for implementation — if it is announced, say, in Budget 2014, implementation will perhaps come one year later,” said Lee. “And I am sure the government will give exemption to some basic goods (from GST) to ensure the low- to middle-income group would not be significantly affected by GST.”

A bigger tax net

In addition to improving efficiency and transparency via GST, the existing taxation base also appears too small as only 14.2% of the country’s workforce pays tax.

That translates into just about 1.7 million of the current workforce — which numbers around 12 million — being taxed for their income. Can the Inland Revenue Board (IRB) broaden its taxation net and shift focus from salaried workers to other components of the workforce?

“There are a lot of things to look at (in this regard),” said Lee of CIMB. “Maybe we have to look at the existing tax structure — I think (the IRB) should widen the taxation band as in a way this would help the middle-income group.”

“In our current tax structure, once you hit a certain level of income, you are immediately put into the highest bracket,” said Lee by way of example, although he added that the specifics on how to accomplish a more efficient tax system would be better addressed by tax experts.

Yeah of Ram Holdings feels that there are already continuous efforts to enhance the efficiency of tax administration. This is important in order to minimise tax avoidance as well as tax evasion.

“Of course you (also) need to simplify the taxation system so that we have less loopholes and less things that are left to subjective interpretation,” added Yeah. “You also need to strengthen enforcement.”

“As for businesses, (some) are able to avoid tax either by underdeclaring or through all kinds of accounting flexibility to minimise their tax returns,” said Yeah, adding that when GST comes into the picture, the government will be better-positioned to detect such activities.

“So one of the advantages of GST is that it results in greater transparency and reporting standards,” concluded Yeah.

Should there be a broader capital gains tax?

In addition to improving the taxation system by first implementing GST and potentially widening the taxation net, should there be a broader capital gains tax mechanism that goes beyond the current real property gains tax (RPGT)?

The current RPGT rates impose a 15% tax on proceeds from disposals within the first two years of ownership, and 10% for disposals within the third to fifth year while property disposals after five years of buying the property would be exempt. It is worth noting that RPGT was temporarily exempted between April 1, 2007 and Dec 31, 2009 before being re-introduced in 2010, and that the current RPGT rates are lower than they were before the exemption.

However, there are no capital gains taxes for other types of monetary gains outside of property transactions.

Yeah of Ram Holdings feels that there may be a case for capital gains tax beyond property transactions, such as proceeds from equities markets and other business activities.

“If other countries are able to impose (such a tax) in order to ensure there is equitable tax burden (in terms of ) gains and profits made, I think this issue has to be carefully studied so that it would not make Malaysia less attractive to foreign investors,” said Yeah.

“At the same time, we know the returns to capital have been much more than returns to labour, so there may be a need to strike a balance,” added Yeah. “I think in some jurisdiction (capital gains tax) have been used to create a level playing field as well as ensure property tax burden is shouldered by all stakeholders.”

Among countries that currently impose capital gains tax include Australia, Canada and the US. Singapore, Thailand and Hong Kong generally do not impose capital gains tax.

CIMB’s Lim, however, feels strongly against such an idea as it would adversely impact the country’s attraction to investors.

“I do not see the rationale of (expanding capital gains tax beyond RPGT) because you are making yourself less competitive,” said Lim.

Moving ahead ― what next?

Apart from implementing GST, widening the tax net and mulling over a broader capital gains tax, what else can we consider to diversify and widen the existing revenue base?

Privatisation and sales of government assets should be considered, says Yeah of Ram Holdings, adding that selling off and in a way privatising these assets would help raise revenue. “The government owns a lot of equities in all sorts of businesses. What the government can do is streamline the privatisation.”

“This would help unleash private sector growth in conjunction with the long-term objective of reducing government’s role in commercial activities,” said Yeah.

But how about government-linked companies?

Yeah feels that these must also be rationalised in-line with the objective of promoting Bumiputra entrepreneurship and at the same time stimulating private sector-led growth of the economy.

As for corporate taxes and the flawed incentives structure, Yeah feels that the government should capitalise on the work that has already been done by the World Bank.

“The World Bank already conducted their studies, so Putrajaya needs to review their recommendations and how best to implement them in a holistic manner.”

 Yesterday: Why subsidies need to be cut.

Tomorrow: Utilising funds for the right projects