GST and inflation

ARCHIVES 2013

By admin-g On May 23, 2013

In Malaysia’s case however, GST will be replacing a pre-existing tax and at a rate that is lower than the prevailing rate. Under those circumstances, the impact should be a one-time decrease in the price level, not an increase.

Hisham H.

Here are the facts:

Malaysia is one of the last countries in the world to implement a full fledged value-added tax. The only countries of note that have yet to implement a VAT are the United States, Hong Kong, Brunei, and the countries under the Gulf Cooperation Council (GCC). Everybody else either has it, or are implementing it.
Malaysia currently levies two forms of consumption tax – sales tax and service tax (henceforth SST).
Sales tax is levied on all goods sold or produced in Malaysia, with the exception of petroleum and exports. The current standard rate is 10%, but a lower rate of 5% is applicable to fruits, certain foodstuffs, timber, building materials, cigarettes and tobacco, and liquor and alcohol.
Service tax is applicable to restaurants, hotels, parking lots, golf courses, clubs, discoes, insurance agents, phone companies, professional services like accountants, lawyers and consultants, and many more at a rate of 6%. Some of these services require a minimum corporate income threshold before the tax is levied. Credit cards are also subject to a service tax, but in this case it’s a flat fee levied on principal and supplementary cards.
GST is going to replace both these two taxes (with the possible exception of credit cards), and from which certain essential goods will continue to be excluded i.e. zero-rated (exports, petrol and basic foods for instance).

So, let’s assume that a 7% rate will be implemented:

For food, the tax on basic staples will go from 5% to 0%.
For other foods, the tax rate will go from 10% to 7%.
For the “sin” goods, the tax rate will increase marginally from 5% to 7%.
For everything else, the tax rate falls from 10% to 7%.
Certain other goods, like books and petrol, will continue to attract no tax.
For services, the rate will increase from 6% to 7%.

When the basic tax rates on most goods at point of sale are set to fall, how on earth can this be inflationary?

Both in theory and in practice, the implementation of a VAT or an increase in the VAT rate is almost always accompanied by a one time increase in the price level (cost of living), but not the rate of price increases (inflation). There are umpteenth examples of this over the last couple of decades.

The regressive nature of GST is completely irrelevant in this discussion, because we’re replacing one regressive tax with another, and moreover one that is proven to be more efficient in raising tax revenues.

Almost all the gains in revenue collection from the switch to GST from SST will come from enforcing tax collection across the chain of production and distribution of goods and services, and not an increase in the overall tax burden to consumers.

Again, how can replacing SST with GST be inflationary?