Sunday, January 17, 2010

Economics @ Home © Volume 2 Issue 2

Tax and Expenditure - Final Part

In the last issue, we saw many examples in which our hard-earned money is taxed from us and how it was wasted via inefficiencies in government spending. In this issue of Economics @ Home, we will examine why there might be a need for a GST.

As mentioned in Part 1, taxes are used as revenue to cover the federal expenditure. It is no doubt easy to criticize the government for misusing the collected revenue. But as we mentioned, solving these structural "inefficiencies" is a long and arduous process. So, it is probably not that constructive to talk about that at this point in time.

First, what exactly is this GST? Anyone who has been to McDonald's should know roughly how this works. We see a government tax of 5% every time we purchase something at McD. That's basically the same idea. In some restaurants, we even see an additional 10% service tax, or service charge. These are called ad valorem taxes, which are fixed rate taxes on the value of the goods or services purchased. So now, you might be thinking, gosh, the next time I eat at Mickey D's, I will be taxed at 10% instead of 5% and Italiannese would be charging me 20% on top of my hefty bill. Well, fortunately for us, that will not be the case as the government has promised to implement the GST in place of the government tax and service tax.

The next question is, how will we be affected? I am no tax lawyer or accountant or anything of that sort. I don't know the exact implications of these new tax structures. But I can tell you what the objective of the GST should be. But first, we should probably ask, why do we even need the GST in the first place?

As mentioned in Volume 2 Issue 1, the personal income tax rate in Malaysia is too high compared to our neighbors. Not only is it unattractive for foreign talents, but high taxes are counterproductive. Imagine that for ever RM1 you earn, 26 sen will go to the government. There is less incentive to work harder or longer than if you were to keep 90 sen out of the RM1 that you earn. Of course, ideally, from a consumer's point of view, we should not be taxed at all, but that is most certainly not feasible due to the expenditure incurred via public goods such as education, utilities, healthcare and more recently, climate control measures. So, we have re-established that the surety of taxes (the other being death).

At an individual level, the high personal income tax may not seem entirely significant. However, at a corporate level, sucking out 25% of a company's profits will significantly reduce its competitive edge. With a quarter of their cake eaten, companies are less likely to engage in research and development or innovative efforts. Without keeping up with the latest technology, how are companies in Malaysia going to stay competitive over the long run?

In a more specific example, petroleum taxes contribute to about 10% of Malaysia's total revenue. As we all know, most of this, if not all, comes from Petronas. With so much money being sucked out of Petronas, it is no wonder that they face difficulties in competing with international oil firms in oil-finds as well as R&D.

These are two examples why the government cannot solely depend on income taxes for revenue, which justifies the widening of the tax base. Of course, to run the government like a profit-generating business to source income is not viable simply because the government is charged with preserving and promoting the well-being of the public, which in most cases, do not align themselves with profit-maximization. Hence, we need a more reliable tax system, which is the GST. Now, we have finally arrived at this juncture: Why is the GST so good?

For starters, let it be clear that the GST is not better than personal income tax. They are supposed to work hand-in-hand with each other. We have been talking about this idea of a broader tax base but not really explaining what it really means. To elaborate, a broader tax base is one that is more consistent and reliable. Personal income taxes (including corporate profit taxes) are more susceptible to changes in business cycles. GST is a tax on consumption, which constitutes two portions, necessary consumption and induced consumption. While induced consumption is dependent on income levels and employment, which are susceptible to business cycles, autonomous consumption, is believed to be stable.

One of the most common arguments against the GST is that it is regressive in nature. This is total junk because the definition of a regressive tax is where the lower income group is taxed at a higher percentage than the higher income group. If a constant percentage of tax is applied on goods and services, it is called a proportionate tax. The rationale that the GST is regressive is based on the argument that it is inequitable it creates a "larger" burden on the poor. How is it unfair if the poor is taxed at 4% and the rich is taxed at 4% as well? The whole idea of a proportionate tax is to incentivize productivity. Those among us who are able to earn more because of their competency and productivity should be allowed to enjoy their income earned. The demand of income equality is a poor man's excuse for being lazy. However, equality in terms of opportunities is another issue altogether and we will leave that discussion for another day.

The reader should also be reminded that I am not arguing for the sole use of the GST as a revenue source. It should work hand-in-hand with the personal income tax, which is already progressive in nature, and is meant to somehow "re-balance" income inequality. A combination of a progressive tax with a proportionate tax still yields a progressive tax where the rich are still being taxed at a higher percentage than the poor.

While common sense clearly points to the fact that the GST is necessary to achieve sustainable growth, implementing it is a whole new ball game. One of the main challenges in implementing the GST include the lack of political mandate. In face of the "silent roar" during the General Election in March 2008, the government has to appear rakyat-friendly (people friendly) in every action that they take. So they have to give all the right excuses and reasons so that the general public does not perceive the implementation of the GST as a heavier burden on the less wealthy.

Guess what, the GST is supposed to cause a heavier burden on the lower income groups. But why? To see the true picture, we need to take a step back and see the sickness that Malaysia is in. We have been running budget deficits for 12 consecutive years because of the white elephant projects that the government has undertaken in the past 20 years or so. Whether we like it or not, we owe people money and we need to pay it back. How do you feel about someone who keeps borrowing money from you for 12 consecutive years and never really paying it back?

In order to reduce this deficit, we need to collect more revenue than our expenditure so that we are able to service our debts. So if we intend to lower our income taxes to attract foreign talent, we NEED to raise taxes somewhere else. The government can pretend all it wants in claiming that the tax is not going to increase the people's burden. It will and it most definitely should. This is the bitter medicine that we must all take.

The other issue is of course, the issue of timing. When do we apply these taxes? Should it be at the turning point of an economic downturn? To be honest, now is as good a time as any. This is more a political issue than an economic issue. It is never really too early to implement something good. From the consumer viewpoint, more taxes are most definitely not even close to the category of "good", but as we all know, Economics @ Home prioritizes the greater good.

Of course, as discussed, the structural inefficiencies still remain. We can only put on our optimistic hats and hope that the people's voice will truly be heard. Hopefully, change is on the way. In the mean time, we need to swallow this bitter medicine, stick it out until our illness is cured.

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