It is that time of the year again. The tabling of Malaysia’s Budget 2022 is right around the corner, scheduled for Oct 29. This will be the second consecutive budget during the Covid-19 pandemic. Not surprisingly, it will be another difficult one, primarily because tax revenue is down while expenses are rising as a result of prolonged economic disruptions and fiscal aid due to the outbreak.
At the mid-year mark, total government revenue was only 45% of the full-year forecast that was made in Budget 2021. Meanwhile, it had already spent half of its budgeted operating expenses in the first six months of the year. The Covid-19 Fund, in particular, is rising rapidly — with total payment commitment currently at RM91.8 billion ($29.8 billion). Excluding the RM38 billion spent last year, this suggests the tab for 2021 could hit RM54 billion, compared with the budgeted RM17 billion — with RM18.4 billion already spent in 1H2021 (exceeding the fullyear budget). The government is proposing to lift the ceiling for this expense item to RM110 billion, from RM65 billion at present.
As a result, both public debt (estimated at 65% to 66% of GDP by end-2021) and fiscal deficit (6.5% to 7% of GDP) are running higher than previously forecast — and would have a spillover impact on Budget 2022. We do not buy the irresponsible arguments by some that Malaysia should just ignore any fiscal restraint, spend as you wish, borrow relentlessly and not worry about the consequences to the exchange rate, interest rate, credit rating and other long-term repercussions. Clearly, the government needs to reduce its deficit and slow the rise in borrowings. The question is how best to do so?
The best option is to grow out of our indebtedness — by expanding GDP (the denominator in both ratios), which would also create jobs and boost tax revenue. We expect the economy to register a more sustainable recovery in 2022, with full reopening and a high vaccination rate, where Covid-19 becomes endemic. GDP growth could reach 6%, up from the estimated 3% to 4% in the current year. But there are greater uncertainties about growth beyond the immediate future.
As we have written before, Malaysia has run out of demand levers for economic growth. Remember, GDP = C + G + I + (X – M, or net exports).
We can no longer depend on consumption-driven growth (C) — no thanks to policies that actively encouraged unconstrained consumption, for a whole decade since 2008, without corresponding real wage improvements. The savings rate fell sharply. The result is severely strained household balance sheets today, which will take many years to deleverage. The average Malaysian household debt-to-GDP stood at a record high of 93.3%, as at end-2020.
The government too went on a spending binge (G), dare we say irresponsibly so, including in mega infrastructure projects — and racking up debts. The resulting high public borrowings will limit Malaysia’s fiscal spending capacity for years to come. Granted, countries are given some leverage during the pandemic to expand fiscal stimulus aid and undertake unconventional funding such as quantitative easing, but only for so long.
Meanwhile, given the impact from nearly two years of a pandemic-stricken economy, it is difficult to see a strong pickup in investments (I) in the immediate term. And even if it does, these investments will generate returns and tax revenue only many years down the road.
Ensuring sustainable long-term growth will require tackling the underlying structural issues (that have long plagued our economy) and a strategic shift towards a knowledge-based economy, including initiatives to promote faster digital transformation, which will also create new and higher-paying jobs. This is why rolling out 5G as quickly and cheaply as possible is so critical to catalysing the digitalisation process (for a more in-depth discussion, see “Pivoting from consumption to production”, The Edge Singapore, Issue 943, July 27, 2020)
In the near-medium term, the government needs to reduce its budget deficit, by raising revenue and/or cutting operating and development expenditures. To soften the impact of the pandemic, Malaysia has so far spent some RM80 billion for fiscal measures in nine stimulus packages. More will need to be spent on recovery efforts, including for segments of the population and sectors worst hit by the pandemic as well as to further strengthen the public healthcare system and for vaccine procurement.
Plugging leakages (such as corruption and wastage) would go a long way towards lowering expenses, but is easier said than done. What is achievable, from a more practical point of view, is the full embrace of the sharing economy. The government budget is based on cash accounting — thus, we can lower expenses by cutting back on outright purchases (ownership) of assets. For instance, instead of high upfront capex for on-premise IT infrastructure, we can lower costs by migrating to subscription-based cloud services, which is also more efficient and can be optimised to usage. Development expenditures can be reduced through private-public partnerships, through the transparent tender process. This will also stimulate private sector investments.
Unfortunately, the reality is that we would also need to broaden the tax revenue base. The country cannot keep running fiscal deficits with borrowings, and not eventually suffer repercussions, including on our credit rating, currency exchange and both foreign and domestic investments. We are certain there will be a lot of speculation in the run-up to Budget 2022. Already, we are reading rumours of tax on windfall profits and capital gains tax (CGT).
The short-lived Goods and Services Tax (GST) was effective, adding RM44.2 billion to government coffers in 2017, before it was abolished in 2018. It was broad-based, levied on every transaction for a wide range of goods and services. It certainly helped fill the shortfall in revenue after oil prices collapsed. Unfortunately, a reintroduction of GST is not politically palatable at the moment. In any case, GST is inflationary and a regressive tax that disproportionately burdens the poor.
Higher taxes on the rich, on the other hand, are extremely popular with the people. For instance, wealth or inheritance tax is common in many developed countries. Unfortunately, they tend not to be very effective — the super-rich typically structure their trusts in such a way to successfully avoid paying these taxes. So, instead, the provision mainly catches and penalises the upper- and middle-income classes. Critically, such a tax will lead to capital flight — at a time when the country desperately needs private sector capital investments to drive growth.
Similarly, CGT may be popular but carries high risks and is likely to be ineffective to boot. CGT on stocks will almost certainly damage the development and future growth of the Bursa Malaysia, which is already struggling against rising competition for funds in the region. Among our neighbours, Singapore, Hong Kong, Thailand, Indonesia and the Philippines do not have CGT.
It is also risky, as the eventual tax collected is quite likely to fall far short of estimations. Why? Setting a high CGT rate will cause share prices to collapse — indeed, this will happen as soon as the tax is announced — thereby leaving far less “capital gains” to tax. A low tax rate, on the other hand, will result in more damage than any tax revenue that could be collected. In short, it will be a lose-lose situation.
A small tax on all capital markets and property transactions
In principle, it is not a good idea to tax assets. It is more effective to tax income and transactions. GST is a fairly good option but, as we explained, impossible in the current political climate.
Therefore, we propose a small transactional tax on all capital market transactions — for both listed and unlisted equities and bonds as well as properties — as the alternative. It would definitely be less jarring and more acceptable than CGT — transactional taxes are not new, merely extensions of the current tax regime — therefore, far less damaging. And the tax rate need not even be high to generate a big impact.
For instance, in the US, CGT ranges from 0% to 20% (based on income level) and the total collected in 2019 was some US$246 billion. Assuming this amount is raised on just gains on stocks and homes, the equivalent tax rate is less than 1% of the total transacted values (and this rate will be overstated, as the CGT asset base would be larger than just stocks and homes). In the UK, a similar calculation for its CGT collected (£11 billion, or RM62 billion) is equivalent to a transactional tax rate of 0.7%.
The annual value traded on Bursa Malaysia in the past five years has been RM620 billion on average. A tax levy of, say, just 0.4% on both buyers and sellers would raise RM5 billion in revenue for the government. Brokerage fees have been much higher in the past, as high as 0.7%, and have fallen to as low as 0.1% of value traded today. Thus, an additional tax of 0.4% is quite palatable. In fact, Indonesia and the Philippines have a similar levy, of 0.1% and 0.6% respectively, on proceeds from shares sale.
Meanwhile, the total value of bonds transacted was RM2.43 trillion last year and RM2 trillion on average in the past five years. A similar 0.4% transaction tax will raise more than RM16 billion in revenue. As a comparison, bonds-stocks-balanced unit trusts currently take 1.5% to as high as 5% in upfront sales charge from buyers.
Transaction value for properties totalled RM119 billion in 2020 and averaged RM137 billion over the past five years. A 1% transaction tax on both buyers and sellers — on all properties including residential, commercial, industrial and land — will add another RM2.7 billion to government coffers. Residential properties below, say, RM300,000 can be given an exemption, so as not to burden the lower-income class. For comparison, real estate agents typically charge the seller a 2% to 3% commission (and currently even in excess of 5%).
Malaysia has in place the Real Property Gains Tax (RPGT), ranging from 5% to 30%. Perhaps as a trade-off, the government could exempt RPGT for properties held after five years. It creates unnecessary complications when homeowners carry out renovations/ enhancements and, more importantly, hurts them in building equity and the ability to upgrade to larger homes. The aim of the tax is to prevent excessive speculation. A transaction tax will be similarly effective, to reduce excessive trading in properties, which will unduly drive up prices. Home is for living, and owning a home is a basic human right.
In short, implementation of a relatively small transaction tax can, by our estimates, raise RM24 billion in sustainable annual revenue.
One-off excess profit tax
To further boost government cash flow, we think an excess profit tax — in a very limited case — is acceptable, given the current crisis. To be sure, the concept of excess profit is riddled with practical problems. How does one define excess profit? Is it excess returns over assets at current market value, book value or historical value — and above what threshold? Should abnormal profits be based on deviations from historical trend or year-on-year change or on realisable value of assets to generate the returns?
Excess profit is easier to define for mining and agricultural businesses — commodities that come from the ground where extraction costs can be reasonably estimated and abnormal profits are calculated based on price gyrations, owing to exogenous events. At present, Malaysia has a windfall tax for the plantation sector — a 3% levy when CPO prices exceed RM2,500 a tonne in the peninsula and 1.5% when they exceed RM3,000 a tonne in East Malaysia. At the current high prices of CPO, windfall tax this year is estimated to be at least RM1 billion to RM1.2 billion.
For all other manufacturing and services sectors, however, accurately defining excess profits would be practically impossible. Different industries — indeed, each business — will have different risks and, therefore, what can be defined as “normal” returns. Whatever the definition adopted, it will undoubtedly lead to manipulations. Worse still, excess profit tax will penalise the most efficiently run businesses and, therefore, discourages productivity, stifles innovation and, ultimately, will be counter-productive.
That said, a case could be made for excess profit tax on businesses that unduly benefited from the effects of the pandemic — that is not due to their own efficiency gains — and to redistribute part of these gains to those who suffered. It is equitable.
We concede that excess profit tax is not “fair”. But there is no ideal solution. And the additional tax payments should have a limited long-term impact on their underlying fundamentals.
Raise withholding tax for non-resident companies
Currently, non-resident companies and individuals pay withholding taxes on revenue earned in the country. The total withholding tax collected amounted to RM3.6 billion in 2019, the bulk of which is derived from fees due through contract payments, interests, royalties, technical fees as well as for services and rent/payment for use of moveable property. These would include payments to global tech giants such as Google and Facebook Inc, service providers such as Bloomberg and Reuters, foreign-based consultancy firms and so on.
The average withholding tax rate is 10%, calculated on sales, which (in theory) is equivalent to our corporate tax rate of 25%, assuming a margin of 40% (after deducting cost of goods sold). But we disagree with this maths. Why?
For many of these foreign-based companies, the local cost of providing the services is in fact very, very low. Think of it this way: Facebook’s platform and business machinery are developed and based, primarily, in the US. Bloomberg’s database and news are collated for the terminal product, the same one also offered to the rest of the world. The additional costs involved in deploying the same business model and services in Malaysia (or anywhere else, for that matter) are minimal. Essentially, their marginal costs approach zero.
What we are trying to say is that the bulk of the costs goes towards creating employment in their home countries. In effect, we are subsidising the employment and wages in these developed economies!
Here is what we propose. Raise the withholding tax on non-resident companies to 25% on sales, less whatever losses reported by their local subsidiaries, which are typically very small outfits, if any. This will result in one of two scenarios:
• Government tax revenue will increase from an estimated RM3 billion currently to RM7.5 billion; or
• These foreign companies will divert more resources to build up their local subsidiaries — and pay the corporate tax rate of 25% (on pre-tax profits, not sales). This will create more jobs locally as well as generate tax revenue for the government.
Clearly, whether the end-result is Scenario 1 or 2, it is a win-win for Malaysia. Though, we suspect this will raise the ire of these (rich) foreign companies (and, perhaps, their governments). But the additional tax revenue will help alleviate some of the burden currently being asked of the people. We think this is equitable, don’t you?
Malaysia entered the pandemic on an already-substantially weakened financial footing — no thanks to profligate spending through the better part of the 2010s and policies that have failed to move the manufacturing sector up the value chain, make a shift towards a knowledge-based economy and create higher paying jobs.
Ideally, we should grow out of the current high indebtedness. And we could, over time. Digital transformation can boost future productivity, wages and growth in the longer term. However, we have run out of levers for growth in the short run. We can improve the efficiency of spending — for instance, by embracing the sharing economy (everything as a service) and, of course, cutting wastage and corruption. All these will take time. Unfortunately, years of cumulative budget deficits and rising public debt are unsustainable and need to be addressed today. In addition, more fiscal spending is needed to aid the economic recovery and especially for the hardest-hit, lower-income groups.
Nobody likes taxes, but it is a necessary evil. And we believe people would be more accepting if they were assured of transparency in how the tax money is to be spent, fairly and equitably.
GST is a viable option but not politically palatable at this point. Wealth taxes and CGT are progressive and popular but damaging to the future development of our capital market and quite likely will induce capital flight and turn out to be far less effective than one would expect. There is good reason that they are not implemented in most developing economies.
A small tax levied on all stock and bond markets as well as property transactions, we think, is the best option to generate sustainable revenue stream, and has limited longterm repercussions. It is easier to accept and, in fact, various types of transaction-based taxes are already being levied — for instance, sales tax, service tax and stamp duties.
In addition, a one-off excess profit tax on companies that benefited from the circumstances during the pandemic can boost government revenue in the immediate term, to tide the country over the current crisis.
Last but not least, we believe it is equitable to share this growing burden with foreign-based companies, by raising withholding taxes on their locally generated revenue.
All in, our proposals can raise RM28.5 billion every year — and, together with the Sales and Service Tax imposed, more than make up for the loss of revenue from the abolishment of the GST.
The Global Portfolio fell 1.1% for the week ended Sept 29. Tech companies were the biggest losers as rising yields hit growth stocks, including Adobe Inc (-7.7%), ServiceNow Inc (-6.7%) and Microsoft Corp (-4.9%). On the other hand, Bank of America (+7.3%), General Motors Co (+4.2%) and Singapore Airlines Ltd (+0.8%) were the top gainers in the Global Portfolio. Total returns since inception now stand at 60%, outperforming the benchmark MSCI World Net Return Index, which is up 53.8% over the same period.
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