Thursday, April 10, 2014

Passing of GST : Sparing the Rod and Spoiling the BN Government by William Leong Jee Keen Member of Parliament Selayang

On 7th April 2014 with time enough for only 10 MPs on each side to debate, the Goods and Services Tax Bill 2014 was pushed through by a vote of 118 to 81. Malaysians, rich, middle class and poor will from 1st April 2015 pay the same rate of 6% add-on tax on their consumption of goods and services.

Straw man Arguments
The Government relying on their 133 majority offered 2 unconvincing arguments for adopting GST. The first argument is GST will not hurt the people because it replaces the Sales and Services Tax (“SST”) which has higher rates of 10% and 6% respectively. It is a straw man argument. Malaysians will soon painfully discover that this argument is a fallacy. GST is a far more burdensome tax than SST. Unlike SST which is a tax paid at the level of the final production or supply of the service, GST is payable at every level of the supply chain and finally borne by the consumer. GST also applies to many more goods and services than SST. The second argument is that 160 countries have adopted GST and therefore GST must be good. This is a jumping on the bandwagon kind of argument appealing to those with a herd mentality. Those who follow this argument will like the lemmings when they fall off the cliff find out, too late, that the rest of the countries who did not adopt GST or abolished it were right.

Now that parliament has passed GST, I wish to point out three reasons Malaysians should press for GST’s abolition. 5 countries have abolished GST: Vietnam (in the 1970s), Grenada (introduced 1986, dismantled shortly thereafter), Ghana (introduced March 1995, removed two months later), Malta (introduced 1995, removed 1997) and Belize (introduced 1996, removed 1999). [Three of these countries have since reintroduced the tax; Ghana in 1998, Malta and Vietnam in 1999].       

The 1st Reason: GST does not solve the real deficit problem but will make it worse
There is an old saying “spare the rod and spoil the child”. We know it does not apply in Sweden and I offer my sympathies to the Malaysian couple, Shawal Norshal and Azizul Raheem Awalluddin who have been convicted. However, for us in Malaysia, discipline is important. It is more important when it comes to public finances. The Federal Government must exercise fiscal discipline to address the deficit problem. If we allow the Federal Government to raise additional revenue through GST this will undermine the discipline needed to address the real cause of the problem. The real cause of the problem is not insufficient revenue. It is the uncontrolled and runaway operating expenditure. The Edge provided a useful analysis: [1]

In 2012, the Federal Government revenues crossed RM200 billion for the first time but expenditure also for the first time crossed RM250 billion. The Federal Government collected RM207.913 billion, an increase of 12.1% from 2011. Income tax revenue increased by 13.9%, customs duties by 6.4%, petroleum income tax by 22.3%. However, the federal operating expenditure for 2012 was RM207.91275 billion and RM46.932 billion for the development budget. The government has since 1999 been on a spending binge and government finances deteriorated. Although revenue was sufficient to cover operating expenditure it was insufficient to meet the development expenditure needs. The Federal Government had to finance the difference through borrowing. This has resulted in 14 consecutive years of budget deficit which by 2012 had ballooned to RM501.617 billion amounting to 53.50% of GDP.

From 1988 to 1997 the surplus of government revenue to operating expenditure grew every year. It peaked at RM21 billion in 1995. During this period, operating costs were kept in check. From 1970 to 1999 total federal operating expenditure increased from RM2.2 billion to RM45 billion. This is over 30 years. In the 13 years after 1999, operating expenditure has shot up to RM207 billion. The biggest single year increase was 2008 when operating expenditure jumped by 29%.  The total operating expenditure last year rose 13%.
The largest component of the operating expenditure is emoluments with pensions and gratuity, it accounts for 36%. From RM18 billion in 1999, it now stands at more than RM74 billion, growing at a compound rate of 11.5%. In 2008 civil servants’ payroll grew 26% and last year by 20%. Salary increases are permanent and will lead to higher pensions and gratuity payments later.

Subsidies account for 21% of the total operating expenditure. It grew from RM1.1 billion in 1999 to RM44.1 billion in 2013 at a shocking compound growth rate of 33%. In the 28 years from 1970 to 1997 total subsidies exceeded RM1 billion only on three occasions, 1981 to 1983. In contrast, in 2008 subsidies shot up from RM10.6 billion to RM35.2 billion.

From 1999 to 2012, supplies and services grew from RM6.1 billion to RM32 billion. In 1986, the amount was only 2.6 billion. In other words, for the 13 years before 1999, the amount grew 135%.  For the same period of 13 years after 1999, the amount exploded by 425%.

If the expenditure had been put to good use and provided good returns the rising expenditure could have been justified. However, a look at any of the Auditor-General’s Reports for these past 13 years will show the substantial leakages, wastages and corruption. The leakages and wastages is estimated between RM28 billion to RM40 billion a year. Providing the Federal Government with an additional stream of revenue will not solve the fiscal deficit problem. The estimated net revenue generated from the 6% GST is only RM3.87 billion. The deficit problem can only be resolved by instituting cuts in the operating expenditure and ending the leakages, wastages and corruption. Any gain from GST will be undone if the wastage, leakages and corruption continue unchecked. On the same day that GST was being debated the Auditor-General’s 2013 Report was put on the MPs table. It highlighted weaknesses in improper payment, unreasonable delays in completing contracts, unreasonable prices and made 109 recommendations for correction. These recommendations will now gather dust because there is GST to provide the money to carry on the squandering and profligacy. 

With parliament having allowed GST, there will be no incentive to rein in excessive expenditure and the leakages. A government typically prefers to allow higher spending than making the hard decision to cut expenditure. Those supporting GST would typically acquiesce to higher rates of GST from time to time. There is no more toxic economic potion than the mixture of executive need for increased spending, rubber-stamping parliament acquiescence and the adoption of GST. Greece is an example of what can happen. Access to a powerful revenue raiser like VAT could not protect it from financial crisis when it lacked the discipline to cut expenditure. The situation is like the Government is filling up a bucket of water with a hole in it. Parliament instead of asking the Government to patch up the hole gives it a second pipe. The hole will never be repaired. Parliament in sparing the rod is spoiling the BN Government.  

Further, GST will exacerbate rather than solve the problem of too much government borrowing. Barisan Nasional MPs like Jasin argued that Malaysia should adopt GST because 160 countries have done so. Countries that have to be bailed out, as well as those teetering on the edge of fiscal collapse - including Greece, Spain, Portugal, Ireland and Italy - all have GST. Prior to the 1960s, before the introduction of GST, the European countries had debts on a percentage of GDP below that of the United States of America. Since the introduction of GST, the average debt level of these Western European countries is higher than the US debt level. According to IMF, the public debt of USA is 106% of its GDP, Greece – 158%, Spain – 84%, Portugal – 123%, Ireland – 117%, Italy – 126%, Japan – 208% and Singapore – 111%. For all intents and purpose, the experience in Europe confirms Milton Friedman’s famous warning that:

“In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with.”

Based on the experience of the 160 countries GST will not solve the fiscal problems but in fact will make it worse.

The 2nd Reason: GST will lead to harmful effects on the economy
GST will cause consumption to be reduced, lower the GDP and Malaysians will be worse off. GST being a tax on consumption will reduce consumption and lead to a negative effect on the GDP.

At the initial rate of 6%, the impact will be painful but tolerable. However, IMF in its March 2014 Report said that the 6% GST rate is low because it is only a starting point. At 6% it will not have a significant impact on the Government’s revenue and will have to be increased after the tax is operational. IMF said that in fact many countries have increased the GST rates after its introduction.

Based on the experience of the ten largest countries that adopted GST, the average GST rate has risen from 10.7% at inception to 16%, an increase of more than 50%. The average rate of the Organization of Economic Co-operation and Development (OECD) is 18%. The United Kingdom increased to 20% in January 2011.

For GST to generate higher revenue, a combination of base broadening and rate hikes have to be considered. These measures will in turn mean a higher impact on growth. Once the rate is increased it will have a negative impact on the GDP. The increased rates will increase the consumers’ burden through higher consumer prices. As a result private consumption will fall. By increasing prices GST will reduce real wages.

Ernst & Young in a 2010 study “The Macroeconomic Effects of an Add-on Value Added Tax” prepared for the National Retailers Federation of the United States found that an add-on VAT of 10% enacted to reduce the deficit would result in a loss of 850,000 jobs, a loss of US$260 billion in retail spending and a 2% drop in the GDP in the year of enactment.

Malaysia will not suffer such losses but the risk of a significant negative impact is there. GST will kill the golden goose which is private consumption in Malaysia. According to the 2013/2014 Economic Report consumption or domestic demand is the key driver of growth led by private consumption and investments. The Government is relying on private consumption supported by household spending to lead GDP growth. GST will dampen this growth. This is clear following the effect of structural adjustment measures such as subsidy rationalization. The Nielsen Consumer Confidence Index for the 4th Quarter of 2013 dropped 98 points, the lowest in three years. Over a third of the Malaysian consumers surveyed cited the economy as a concern followed by increased in food prices (24%). MIER also reported its Consumer Sentiments Survey and Business Conditions Survey plunged to the lowest in five years. MIER warned that with the emerging weaknesses in consumer spending domestic demand will be affected. Due to the economy facing serious challenges with the slow recovery from   global recession and the unsettling effects of quantitative easing, the effects of subsidy rationalization and implementation of minimum wages, the adoption of GST will be too much of a shock to our system and may very well be the proverbial “final straw”.    

The 3rd Reason: GST will hurt the Lower and Middle Classes
GST is a highly regressive tax, hitting lower and middle classes much harder than wealthy families. GST will put further financial stress on the 56% of Malaysian households whose monthly income is less than RM3,000. GST will result in an increase in the tax burden of the middle-income families. GST-induced price hikes would compel households to search for cheaper goods and services. However, 60% of the Malaysian households will find it difficult to substitute basic necessities and essential services. The Federal Government in an attempt to reduce the regressivity of GST has provided for exemptions and zero-rating for certain basic goods for the poor. However, the World Bank in a paper entitled “Value Added Taxation: Mechanism, Design and Policy Issues” in acknowledging that VAT (GST) is inherently regressive stated that attempts to reduce it though exemptions and zero rates have proven ineffective. It is indeed impossible to do so because one cannot segregate food, goods and services consumed by the poor from those consumed by the rich.

In any event, it appears the Federal Government has not carried out an in-depth study of the foods and services that would reduce the GST burden of the poor. The Federal Government in the list of zero-rated foods included trout, Pacific salmon, Atlantic salmon and Danube salmon, Norway lobster, rock lobster, crayfish and oysters while canned sardines, baked beans and instant noodles are liable for the full tax.

The apparent mismatch in the zero-rated items reveals the Government’s poor sensitivities and lack of knowledge of the people’s needs. The GST regime reminds one of the saying attributed to Marie Antoinette, Queen of Louis XVI of France. Upon being informed that the citizens of France had no bread to eat she replied with “let them eat cake.” The French revolutionaries didn’t think too much of her idea of “People First Performance Now” and put her to the guillotine. What shall we do with ours?

Subsidy rationalization and GST are the chickens coming back to roost for Malaysians. Malaysians have voted BN to rule for 56 consecutive years ignoring their extravagance, recklessness, wastefulness and corruption. The future generations of Malaysians will have to pay for the sins of their fathers and mothers unless we can win over the 47% who retained BN before the next elections. It is hoped that the pinch in their wallet will wake them up.      

[1] Against the Wind: Fixing the budget deficit is critical and it requires a political consensus by Tong Kooi Ong and Chan Jian Ming The Edge 20 October 2013