This article first appeared in The Edge Malaysia Weekly
MALAYSIA has travelled far on the road to economic growth and shared prosperity. Using its natural resources, the country not only eliminated absolute poverty from 49% in 1970 to less than 1% in 2014, but also lifted the incomes of households at the bottom 40% of the income bracket. The Gini Coefficient — a measure of income inequality in an economy — dropped from 55.7 to 42.1 over the same period, implying that gaps in incomes were narrowing. This road is now leading towards a developed country, with a vibrant and growing middle class where aspirational households have access to relevant education and training, higher income opportunities, more savings for retirement and a safety net to protect the vulnerable from shocks.
Underlying this journey to developed country status is a series of structural reforms that have formed the bulk of the national development plans, most recently the 11th Malaysia Plan. The quest moving forward is therefore to sustain and finance this process. The 11th Malaysia Plan is budgeted to cost RM246 million between now and 2020. Taxation choices will matter a great deal for Malaysia’s prospects in this journey, more so in an environment of low or volatile oil and commodity prices and a global and regional economic slowdown.
Most developed and high income countries collect taxes primarily through the income tax and/or value-added tax. By contrast, Malaysia’s tax system consists of two large sources: corporate income tax and petroleum-related revenue. While both of these sources of revenue have helped fund Malaysia’s growth into a middle-income economy, other more solid bases will be needed moving forward. Oil-related revenue has dropped due to the decline in commodity prices, from 6% of GDP in 2014 to 3.7% of GDP in 2015.
Yes, it is possible that commodity prices may rise again, but history has shown that it is unwise to predict future oil prices, or pin any country’s fiscal fate on them. Countries such as Norway or Chile use these commodity revenues for public investments, fiscal stabilization and for future generation funds, rather than for recurrent expenditure. Instruments such as Malaysia’s KWAN (Kumpulan Wang Amanah Negara) Fund may fill the role of a future generation fund if their structure and mandate allow for it.
At the same time, revenue from corporate income taxes in Malaysia was 5.9% of GDP in 2013, while the OECD average stood at 3%. So, the potential for substantial additional funds from this source is also limited.
The Malaysian authorities have been introducing new tax policies and administration in recent years. One example is the Goods and Services Tax (GST) introduced this year, which is widely used by governments given its effectiveness as a broad-based tax. In Malaysia, the GST has partially offset the drop in oil prices and helped maintain the momentum of the 2015 budget.
Budget 2016 also relies on the GST, but with tax exemptions and zero rates for specific products. Insofar as these exempted products represent a high share of the goods and services used by Malaysia’s most vulnerable, all the better. Nonetheless, exemptions imply lower revenue and higher administrative costs, and it will be important for Malaysia to quantify these GST exemptions, and reflect their true costs in the budget.
What about personal income tax? Can it play a greater role in raising revenue and reducing inequalities in Malaysia than in the past? Malaysia’s top marginal income tax rate is much lower than that of most countries. The 2016 budget raised top earners’ tax rates to 26% for those earning between RM600,000 and RM1 million, and to 28% for those earning above RM1 million. This is another step in the right direction.
However, while this increase will make the income tax slightly more progressive, its redistributive impact may be limited due to the very narrow tax base. International best practice suggests that, for an aspiring high-income nation, there may be room for further broadening of this base. In Malaysia, only around 20% of income earners pay personal income taxes. While developed countries attribute 7% of their GDP to personal income tax, in Malaysia, it was around 2.3% of GDP in 2014.
Also, personal income tax revenue tends to be around three to four times corporate tax revenue in developed countries, allowing them to exploit the broad tax base to raise more, and to redistribute better. The time is right to explore further reform.
Taxes are never popular, but they are necessary to provide a better life and better opportunities for the rakyat.
MALAYSIA has travelled far on the road to economic growth and shared prosperity. Using its natural resources, the country not only eliminated absolute poverty from 49% in 1970 to less than 1% in 2014, but also lifted the incomes of households at the bottom 40% of the income bracket. The Gini Coefficient — a measure of income inequality in an economy — dropped from 55.7 to 42.1 over the same period, implying that gaps in incomes were narrowing. This road is now leading towards a developed country, with a vibrant and growing middle class where aspirational households have access to relevant education and training, higher income opportunities, more savings for retirement and a safety net to protect the vulnerable from shocks.
Underlying this journey to developed country status is a series of structural reforms that have formed the bulk of the national development plans, most recently the 11th Malaysia Plan. The quest moving forward is therefore to sustain and finance this process. The 11th Malaysia Plan is budgeted to cost RM246 million between now and 2020. Taxation choices will matter a great deal for Malaysia’s prospects in this journey, more so in an environment of low or volatile oil and commodity prices and a global and regional economic slowdown.
Most developed and high income countries collect taxes primarily through the income tax and/or value-added tax. By contrast, Malaysia’s tax system consists of two large sources: corporate income tax and petroleum-related revenue. While both of these sources of revenue have helped fund Malaysia’s growth into a middle-income economy, other more solid bases will be needed moving forward. Oil-related revenue has dropped due to the decline in commodity prices, from 6% of GDP in 2014 to 3.7% of GDP in 2015.
Yes, it is possible that commodity prices may rise again, but history has shown that it is unwise to predict future oil prices, or pin any country’s fiscal fate on them. Countries such as Norway or Chile use these commodity revenues for public investments, fiscal stabilization and for future generation funds, rather than for recurrent expenditure. Instruments such as Malaysia’s KWAN (Kumpulan Wang Amanah Negara) Fund may fill the role of a future generation fund if their structure and mandate allow for it.
At the same time, revenue from corporate income taxes in Malaysia was 5.9% of GDP in 2013, while the OECD average stood at 3%. So, the potential for substantial additional funds from this source is also limited.
The Malaysian authorities have been introducing new tax policies and administration in recent years. One example is the Goods and Services Tax (GST) introduced this year, which is widely used by governments given its effectiveness as a broad-based tax. In Malaysia, the GST has partially offset the drop in oil prices and helped maintain the momentum of the 2015 budget.
Budget 2016 also relies on the GST, but with tax exemptions and zero rates for specific products. Insofar as these exempted products represent a high share of the goods and services used by Malaysia’s most vulnerable, all the better. Nonetheless, exemptions imply lower revenue and higher administrative costs, and it will be important for Malaysia to quantify these GST exemptions, and reflect their true costs in the budget.
What about personal income tax? Can it play a greater role in raising revenue and reducing inequalities in Malaysia than in the past? Malaysia’s top marginal income tax rate is much lower than that of most countries. The 2016 budget raised top earners’ tax rates to 26% for those earning between RM600,000 and RM1 million, and to 28% for those earning above RM1 million. This is another step in the right direction.
However, while this increase will make the income tax slightly more progressive, its redistributive impact may be limited due to the very narrow tax base. International best practice suggests that, for an aspiring high-income nation, there may be room for further broadening of this base. In Malaysia, only around 20% of income earners pay personal income taxes. While developed countries attribute 7% of their GDP to personal income tax, in Malaysia, it was around 2.3% of GDP in 2014.
Also, personal income tax revenue tends to be around three to four times corporate tax revenue in developed countries, allowing them to exploit the broad tax base to raise more, and to redistribute better. The time is right to explore further reform.
Taxes are never popular, but they are necessary to provide a better life and better opportunities for the rakyat.
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