General services tax soon?

Tuesday June 9, 2009
Tax Insights - A column by Kang Beng Hoe

With revenue collection substantially reduced, bringing in goods and services tax is likely to be sooner rather than later.

I WAS present when Professor Glen Jenkins, as guest of the Harvard Club, spoke on value-added tax (VAT) some months ago.

This is the consumption tax which the Government had announced some years ago and was to be initially implemented in 2007 but was subsequently deferred.

The title of his talk, Controversies, Heresies and Challenges of a VAT, warned me to expect something different from the usual good things to be said of the tax.

Dr Jenkins is an eminent Canadian economist with a distinguished career, which included advising governments on the design and implementation of the VAT system.

The VAT is also known as the goods and services tax (GST) and the Malaysian Government decided to use this terminology probably because consumers at large, who will be the target of the tax, will find it easier to identify with what the tax is about.

The main question that Dr Jenkins addressed is whether the incidence of a VAT is regressive. The widely held view is that the VAT is regressive since the poor pay tax on a higher proportion of their income than the rich.

Put simply, a person who earns say RM3,000 a month has to spend a greater portion of it on living expenses, leaving less for savings and investments than someone who earns say RM30,000 a month.

Since VAT is imposed on consumer items, the impact of the tax as a proportion of income earned is greater on the low-income earner than the high-income earner.

Dr Jenkins disagrees on two counts. The first is premised on the fact that “high income people live longer in retirement than do poor people, hence they consume more and continue paying VAT after they stop earning income. On a life time basis, the VAT may appear not as regressive as it is measured as a share of current income.”

On the second, Dr Jenkins made the following points:

l The share of consumption subjected to tax as a percentage of wealth for wealthy households is much larger than for poor households.

l Due to the existence of a large informal sector that caters to the poor, the burden of the VAT in developing countries is progressive.

l The types of goods consumed by the poor (basic food, local transportation and housing) are often not cost effective for the tax administration to tax.

l Hence the burden of VAT is reduced.

In the Malaysian context, what he is saying is that the low income earner tends to do marketing at the stalls and pasar tani rather than the super or hypermarkets, to eat at stalls and the various hawker food outlets as well as shop at corner shops selling household wares.

These represent the “informal sector” and are outside or should be made to fall outside the tax net. This could be done by setting a high threshold for the tax i.e. by making only those with annual sales of, say RM1.5mil, being required to collect the tax.

Thus the higher the threshold is set, the larger the informal sector becomes and more poor people will be spared the burden of the tax. Dr Jenkins cites evidence from a survey carried out in the Dominican Republic.

The audience at the talk included senior technocrats charged with designing and bringing on board the GST and one can be sure that this message will be conveyed to the policy makers.

Having been sold on the fact that we need both more tax revenue and better revenue systems and GST is the best form of general consumption tax available, these decision makers remain concerned over the often held view that the poor would suffer most under this tax.

All this is well and good but should we be worrying about tax in these difficult times when there are other priorities? Malaysia’s budget deficit for 2009 was initially projected to reach 4.8% of gross domestic product (GDP), the highest since 2003 when it was at 5%.

With the second stimulus package of RM60bil, the deficit is expected to amount to 7.6% of GDP. The Finance Minister, when he was Deputy Prime Minister, was quoted as saying “a deficit of more than 5% is tolerable as long as it is only one or two years.”

Does this not give us a clue that the GST has to be brought in within such a time frame if we are to reduce our deficit?

The need to enhance the Government’s revenue base has become crucial with the economic slowdown being broad-based and the petroleum and palm oil sectors no longer contributing at past levels – GST is the inevitable choice.

·Kang Beng Hoe is executive director of TAXAND MALAYSIA Sdn Bhd, a member firm of the TAXAND Network of independent tax firms worldwide. The views expressed do not necessarily represent those of the firm.