Commentary: Hard truths, tough choices ahead after Malaysia’s scrapping of the GST

Malaysia’s move might lead to growth in the long term but it cannot escape a widening fiscal deficit in the short term which has knock-on effects for its competitiveness, says NUS tax expert Simon Poh

Simon Poh, Channel News Asia

Dr Mahathir Mohamad’s shock election win in the 14th general election in Kuala Lumpur in early May caught many observers by surprise.

Many around the world have compared the Pakatan Harapan coalition’s win to Brexit and Donald Trump’s equally dramatic victory.

In Malaysia, since that fateful Wednesday, voters have been watching to see if they will deliver on their election promises, chiefly, the pledge to remove the unpopular goods and services tax (GST) introduced by the Barisan Nasional government three years ago.

Pakatan did not disappoint. Within a week, Malaysia’s finance ministry issued a statement that the 6 per cent GST will be set at zero from Jun 1.

This move to demonstrate a quick win might have been swift but came at no surprise, where it went far to shore up support for the new government, and strengthened Malaysians’ buy-in for future government policies, including tax matters.

The Pakatan government’s ability to immediately effect a concrete implementation of an election promise might have been politically motivated but it was necessary to establish credibility and trust with voters.

A LEAF FROM THE US PLAYBOOK?

The Pakatan coalition may have taken a leaf from a US playbook. In the United States, Donald Trump promised a major tax reform during his 2016 election campaign that will, among other proposals, slash the US corporate tax rate from 35 per cent to 20 per cent.

After being voted into power, Trump relentlessly pursued this goal and eventually scored victory after securing Congress’ agreement to bring the rate down to 21 per cent, but only after clearing many obstacles including countering the challenge that such a drastic cut would lead to a huge fiscal deficit with the expected plunge in tax revenue.

Still, it was a win for the Republican Party and their scores of supporters.

Some have argued that the corporate tax cut boosts the US economy’s competitiveness, aligning rates with the average among OECD countries, and might lead to job creation in new sectors where companies find it more attractive to base out of the US now.

It is still early days – and first quarter headline economic figures for the US look good but growth has slowed compared to the preceding quarter.

LIKELY DROP IN MALAYSIA’S REVENUES

Turning our attention back to Malaysia, the swift action taken by Dr Mahathir to effectively scrap GST will undoubtedly please local consumers and businesses. However, this move has its challenges.

First, the Malaysia government’s coffers will be reduced significantly. As the second top income source for the government after corporate tax, GST contributed revenue of RM44 billion (US$11 billion) or about 18 per cent of total revenue in 2017, and have been projected to remain so for its fiscal year starting 2018.

With economic growth slowing down to 5.4 per cent in the first quarter of 2018 and current debt crossing the RM1 trillion mark, the situation is even more tenuous as the removal of GST without effective offsetting measures will widen the country’s fiscal deficit.

The reintroduction of sales and services tax (SST) and the recovery of oil prices may provide some compensating relief, but the revenue generated by the SST is modest and expected to generate only about RM30 billion or two-thirds of the GST revenue.

Many have said that Malaysia’s oil money will help the country tide over the fiscal gap. Pakatan had outlined a strategy in their political manifesto, pledging to use profits from state-owned oil company Petronas to set up a sovereign wealth fund but uncertainties surrounding this strategy remain, including the sustainability of high oil prices.

While oil prices have recovered substantially from the low levels in 2015 when GST was first introduced, there is no guarantee that it will remain at current levels.

Analysts have said that reducing the GST will spur consumer spending and control inflation. For an economy where household consumption make up almost 60 per cent of GDP, scrapping GST may eventually boost growth and government coffers, the theory goes.

This notwithstanding, the Malaysian Government will still have to find new ways to broaden the tax base or increase current taxes without putting a dent on the country’s competitiveness meanwhile, as time is needed for economic growth to manifest.

Another strategy could be to review government expenditures.  As part of a fiscal reform, the Ministry of Finance may look at ways to reduce government expenditure efficiently and reduce leakages. This is not an easy task as the country has to strike the right balance to prioritise spending on key areas such as defence, education, health and infrastructure – keys to Malaysia’s future growth and security.

This may also have knock-on effects for Malaysia’s cooperative projects with other countries. Of immediate concern to Singapore is the fate of joint projects undertaken by both countries, including the KL-Singapore high-speed rail project and the Johore Bahru-Singapore Rapid Transport System Link.

IMPACT ON COUNTRY’S INTERNATIONAL STANDING

Second, the scrapping of GST when implemented together with other campaign promises that might impact the Malaysian government’s fiscal position, such as a potential move to reintroduce fuel subsidies can adversely affect the country’s sovereign rating as well as inflow of foreign investments.

Whilst GST is unpopular with citizens coping with the rising cost of living, economists, foreign investments and world economic bodies view it positively as a sign of commitment by the country to fiscal reform.

More countries have been turning to GST as a transparent, reliable and sustainable source of revenue for any government, including Singapore.

Reversing this policy by taking the drastic step to effectively abolish GST after its introduction just three years ago without effective alternative plans may affect the country’s overall credit standing and ability to continue attracting foreign investments.

Credit rating house Moody’s highlighted last week that Malaysia’s government debt, which stands at 50.8 per cent of GDP is higher than the median for A-rated peers, and without inflows from GST, will remain elevated, and be negative for its credit rating.

Having taken pains to lay the foundation for the implementation and collection of GST, and as businesses have expended resources to ensure compliance, both government officials and businesses might find it frustrating if there is a future decision to reinstate the collection of GST.

Where the Malaysian government has announced a zero GST rate instead of a complete abolishment of GST, it is not far-fetched to imagine that a more thorough review to fine-tune Malaysia’s taxation system may be in play including consultation with relevant stakeholders.

Options may include reducing the current GST rate to a much lower rate instead of bringing it down to zero, coupled with the measure to mitigate the GST burden borne by lower-income citizens.

The hallmarks of an effective and efficient tax system include a simple, fair, stable, sustainable and competitive tax regime.

In striving for this ultimate goal, governments should refrain from taking short-term populist measures to consolidate or advance its political goals, especially when these are not aligned with the economic goals of the country that include greater competitiveness, progress and fiscal responsibility.

Simon Poh is Associate Professor (Practice) of the Department of Accounting at NUS Business School where he specialises in tax matters.