the gst and you - penang monthly

2/4/14, 11:03 AMThe GST and you | Penang Monthly

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The GST and you

Photograph: Haifeez/Flickr

The GST is on the way, stirring up a lot of controversies. Penang Monthly offers an understanding of what it will mean to the common man.

By Lim Kim-Hwa and Ooi Pei Qi

The likelihood is very high that the National Budget being tabled on October 25 will introduce the country to a Goods and Services Tax (GST).This move is driven by a combination of several external macroeconomic and domestic factors.

First, several international ratings agencies have voiced concerns about Malaysias mounting fiscal debt, meaning that the country is at risk of adrop in its credit rating [1]. As we know, Malaysias fiscal budget has been in deficit since 1998 (see Figure 1). That makes 15 years in a row,showing that the fiscal deficit is now structural rather than cyclical in nature.



FIGURE 1: MALAYSIAS FISCAL SURPLUS/DEFICIT AS A PERCENT OF GDP

Source: Economic Planning Unit, Malaysia; Bloomberg.

Second, the loose monetary policy adopted in the US since the financial crisis in 2008 may soon be reversed. The normalisation of long-terminterest rates in the US, which are currently at a historic low (see Figure 2), is already resulting in an outflow of capital from emerging markets.Since a significant amount of Malaysian debt securities is held by foreigners (see Figure 3), this leaves the country highly vulnerable. As the USFederal Reserve hinted on a reversal in monetary policy in June 2013, the yield in Malaysian Government Securities has increased (see Figure4). This means that as US interest rates revert to its long-term rate, borrowing to fund the deficit will cost more in years to come.

FIGURE 2: US GOVERNMENT 10-YEAR TREASURY YIELD



Source: Bloomberg.

FIGURE 3: FOREIGN HOLDING OF MALAYSIAN DEBT SECURITIES

Source: Bank Negara; Bloomberg.

FIGURE 4: MALAYSIAN GOVERNMENT 10-YEAR BOND YIELD



Source: Bloomberg.

Third, the above two external factors will increase the cost of raising new finances, thereby negatively affecting Malaysias economy and thesustainability of the current fiscal condition [2]. Since Malaysian sovereign notes act as the benchmark in the pricing of Malaysian corporatebonds, the increase in yield will filter down to corporations and households, making the cost of financing higher in Malaysia.

Fourth, the federal government has issued strong responses and indicated that it is committed to reforming the subsidy structure and broadeningthe tax base. Therefore, to be credible in financial markets, the government will have to follow up with concrete actual measures.

Finally, raising taxes is never a popular government policy. Hence, the government is very likely to introduce the GST in the first budget after therecently concluded 13th General Election, and in that way, minimise the political fallout.

All in all, if the government does not introduce the GST under the given circumstances, Malaysias credit ratings will be cut. A credit ratings cut,when combined with the withdrawal of loose monetary policy in the US, will result in a significant withdrawal of foreign capital from Malaysiaand an increase in the cost of financing. This will severely impact several infrastructure projects that have been underpinning the growth ofMalaysias economy. Additionally, the increased debt servicing costs and loss of credibility in the eyes of the financial markets will affectMalaysias fiscal situation for years to come. Hence, the costs of not introducing the GST now are significantly high.

We have five objectives in our analysis. First, we discuss what the impact of the GST will be on households in Malaysia. Which segments ofMalaysian households will feel the pinch harder than others? Second, given that the government has indicated that basic essential items are notgoing to be subject to GST, will the GST be a progressive or regressive tax [3]? Third, given that the budget is in deficit, what will the expectedamount to be raised via GST be in perfect conditions vs. in realistic situations where there are leakages in tax collection? Fourth, what is theexpected impact of the GST on inflation? And finally, what are the implications of implementing the GST on Malaysias economy in general, theRinggit, and the offset welfare packages as indicated by the government?

According to data from the Household Expenditure Survey 2009/10 (HES), each item was determined to be either zero rated, exempt or subjectto a standard GST rate of seven per cent. Unfortunately, in the Goods and Services Tax Bill 2009, the Ministry of Finance and the RoyalMalaysian Customs Department did not provide a list of GST-chargeable items.

Therefore, two principles were used to determine if the item is subject to GST:1) According to the Ministry of Finance, basic food items such as rice, sugar, flour, cooking oil, vegetables, fish and meat, eggs and essentialservices such as health and private education, public transportation, residential property and agricultural land are exempted; and 2) any item thathas been value-added is subject to GST. For example, meat and food served at restaurants have undergone a value-adding process and aretherefore subject to GST.



[1] In July 2013, Fitch Ratings cut Malaysias sovereign outlook to negative. This is usually a precursor to an actual credit rating downgradeunless substantive positive measures are undertaken. Although Moodys reiterated Malaysias rating as stable in August 2013, it warned that theratings could be at risk given Malaysias debt situation.

[2] For example, a one per cent increase in yield on a RM1bil debt will mean an additional RM10mil in interest payments. Since the centralgovernments debt amounts to RM519bil (Bank Negara Q2 2013; which excludes any off balance sheet financing), interest payments willincrease significantly as the debts are rolled over.

[3] A tax is deemed regressive if the tax payable is proportionately higher for lower income groups than it is for higher income groups. In ourstudy, as we were unable to match household expenditures to household income, we assumed that their income and expenditure levels directlycorrelate.

FINDINGSThe underlying data from the HES comes from March 2010, the month the survey was concluded. To take into account inflation, we have alsore-indexed our results to July 2013 using the official Consumer Price Index (CPI). Table 1 thus shows that the government could have collectedRM7bil in March 2010 (equivalent to RM7.5bil in July 2013 values) annually from Malaysian households. GST payable by businesses andcorporations are excluded from our analysis.

Basic food items such as vegetables are exempted from GST.Photograph: Daniel Lee

Regional analysisContrary to expectations, urban and rural households in Peninsular Malaysia pay similar GST rates, although their monthly expenditure differsby approximately RM800. This is because both urban and rural people spend equal proportions on items that are subject to GST. Urban peoplespend more on food and beverages away from home, whereas rural people spend more on transport. Peninsular Malaysia foots a slightly higherproportion and percentage of the GST bill as compared to Sabah and Sarawak (see Table 1), due to higher spending in restaurants and cafes.

TABLE 1: GST RAISED FROM MALAYSIAN HOUSEHOLDS BY REGION



Photograph: Kwong Wah Yit Poh

Source: 10th Malaysia Plan, Household Expenditure Survey 2009/10, Penang Institute.Note: Total GST raised for Peninsular Malaysia, Sabah and Sarawak does not sum up to total GST raised for Malaysia as each location isanalysed individually and have different averages in total GST

Impact on the typical Malaysian householdThe HES reports that the average household spends RM2,190 a month. We find that after applying a seven per cent GST rate and assigningcertain basic food and services as zero rated or exempt, an average household will pay RM96.70 per month in March 2010 value (July 2013:RM104 per month) equivalent to 4.4% GST rate based on the households expenditure.

The average household size is 4.13 persons, and typically consists of parents and children and/or elderlypeople to care for. With this profile, the income recipients, and hence the heads of the household, arelikely to be in the age range of 35 to 64. This is substantiated by the HES findings which showed thatthe expenditure of a four to five-person household virtually matches the expenditure of those in the 35 to64-year-old age range with similar GST rate imposed on the demography (see Tables 2 and 3).

Households in the 35 to 64 age range have the highest monthly household expenditure (approximatelyRM2,350). This is likely due to support for children and the elderly. These households pay the highestGST amount at RM103 per month (RM111 in July 2013 values) among all age groups in Malaysia. Theeffective GST rate is between 4.37% and 4.47%.

GST as a progressive taxThe number of living quarters in the HES differs from those in the Household Income and BasicAmenities Survey 2009/2010, and so the two surveys cannot be easily matched. Comparing the GSTpayable by lower expenditure deciles and higher expenditure deciles, we find the rate generallyincreases with higher expenditure (see Figure 5). Adopting expenditure as a proxy for income, theincreasing rate shows GST as a progressive tax meaning that higher income earners pay a highereffective GST rate. GST becomes a progressive tax because lower income deciles spend more on items not subjected to GST, such as basic food(1.66% effective GST rate) vs. food consumed away from home at restaurants (seven per cent effective GST rate).

FIGURE 5: MONTHLY EXPENDITURE, GST (RM AND %) PAYABLE BY EXPENDITURE CLASS IN MALAYSIA



Legislators, senior officials, managers and professionals contribute mostHouseholds in these occupations tend to spend on items chargeable to seven per cent GST, making their effective GST rate payable at 4.71%. Ashouseholds with these occupations also have the highest monthly expenditure (RM4,067 and RM3,611 vs. RM1,927 per month for otheroccupations) and pay the highest GST rate among all occupation categories, they contribute the most in GST tax revenue. GST implementationwill affect skilled agricultural and fishery workers the least (3.95% effective GST rate).

How GST affects the young vs. the elderlyAlthough the GST rate increases across expenditure deciles, it decreases with age groups. Although households below the age of 24 have thelowest average expenditure of RM1,623 a month, they pay the highest GST rates among all age groups (4.7%). This is because those below 24spend more on alcohol and tobacco, along with food and drinks away from home, as compared to all other age groups. Both categories of thisexpenditure have a seven per cent GST rate. On the other hand, the elderly (households above 65 years old) have the lowest GST rate at four percent, as they spend more on grocery items and cook at home.

TABLE 2: MONTHLY EXPENDITURE, GST (RM AND %) PAYABLE BY AGE GROUP IN MALAYSIA

TABLE 3: MONTHLY EXPENDITURE, GST (RM AND %) PAYABLE BY HOUSEHOLD SIZE IN MALAYSIA IN RURAL ANDURBAN AREAS



Photograph: Kwong Wah Yit Poh

TABLE 4: MONTHLY EXPENDITURE, GST (RM AND %) PAYABLE BY HOUSEHOLD SIZE IN MALAYSIA IN URBAN AREAS

TABLE 5: MONTHLY EXPENDITURE, GST (RM AND %) PAYABLE BY HOUSEHOLD SIZE IN MALAYSIA IN RURAL AREAS

Single-person urban households pay the highest GST rateTable 3 shows the trend for GST rates payable by household sizes in both urban and rural areas. Single-person households in Malaysia have ahigher GST rate (4.63%) than the average household of four or five individuals (around 4.45%). Single-person households might constitute ofunmarried individuals below 24 years old who might spend on items chargeable at seven per cent, as explained above.

In Malaysia, large urban households of more than 10 individuals pay a higher rate compared to the average household (see Table 4). Large urbanhouseholds tend to spend more on miscellaneous goods and services, which have a GST rate of seven per cent. Conversely, the trend in ruralareas shows that large households pay one of the lowest effective GST rates (see Table 5).

All ethnic groups pay the same effective GST rateGST is colour-blind. All ethnic groups (categorised by the ethnicity of the head of the household), regardless of whether one is Bumiputera,Chinese, Indian or others, pay 4.3%-4.4% effective GST rate in Malaysia. We found that location was a more dominant factor, as the effectiveGST rates are similar among all ethnic groups within the same location, but differ across locations.

Nevertheless, because GST is a consumption tax, the total GST revenue raised from different ethnicgroups differs; as expenditure increases, GST in Ringgit payable increases. In Malaysia, Chinesehouseholds spend 36% more, 27% more and 52% more than Bumiputera, Indian and other householdsrespectively. This reflects a higher GST payment in Ringgit terms.

Equal impact on male/female-led householdsMale and female-led households are subjected to fairly similar rates 4.44% and 4.25% respectively,although the monthly household expenditure for female-led households in Malaysia is on averageRM483 less per month compared to male-led households.

A realistic GST revenue amountThe total GST revenue of RM7bil (RM7.5bil in July 2013 values) is under perfect tax collection andzero leakages. This is certainly unrealistic, and even more so when the Ministry of Finance, in order toavoid excessive administrative burden on small businesses, has proposed that establishments with asales turnover below RM500,000 need not register for GST, hence GST from these small retailers willnot be collected.

According to data from the Preliminary Report Census of Distributive Trade 2009, only 73% of sales turnover will consequently be registeredfor GST. And so, stripping out the GST due from small retailers that are not collected, the total GST collected by the government falls toRM6.52bil (RM7.01bil in July 2013 values), which is 93% of the original amount. However, we believe the actual reduction in the total amountraised may be higher as we have not accounted for GST fraud nor were all items taken into account in this analysis.

Imposing 20% GST on a narrower band of itemsWhat would happen if a high GST rate was imposed on only one or two items, while everything else is exempted from GST? If only twocategories alcoholic beverages and tobacco, and restaurants and hotels were imposed with a 20% GST rate, the government can collectRM4.1bil (or RM4.5bil in July 2013 values) annually. This means that the government can collect a significant amount of GST (59.3% of theoriginal amount) by taxing just these two categories at a high rate. However, this will not broaden tax collection on more industries and willnegatively affect the businesses in these two categories.



WIDER IMPLICATIONSWe have so far focused on the impact of GST on Malaysian households and some possible scenarios. Nevertheless, the impact of implementingGST is wide-ranging.

InflationUsing the official CPI basket weights and ignoring secondary effects, inflation is expected to spike up by an additional 3.84% upon theintroduction of GST [4]. The expected additional inflation is calculated by assuming that the spending pattern of households remains the same.The expected inflation spike is consistent with a study in Canada where each per cent increase in costs induced by taxes leads to approximately aone per cent increase in inflation (or sometimes a bit more) [5].

Nevertheless, households will likely alter their spending patterns due to price increases and the reduction in their spending power. Thegovernment has also indicated that the Sales and Services Tax will be abolished after the implementation of the GST. Therefore, the degree ofhigher inflation is difficult to estimate accurately. Be that as it may, the economy is expected to encounter a period of high inflation as consumersand businesses adapt dynamically to higher prices.

Malaysia has traditionally adopted price controls to keep inflation down, using the Anti-Profiteering Act, enforcing this through the NationalPricing Council and making hypermarkets act as price setters. While these measures are aimed at changing profit-centred attitudes and unethicalbusiness practices, prolonged implementation in an era of high inflation will result in the withdrawal of labour and capital from the production ofthese goods. Unprofitable businesses are unsustainable, after all, and capital and labour may be reallocated to the production of other profitablegoods which are not subject to price controls.

Introducing the GST so soon after the reduction in fuel subsidies in September 2013 will severely impact the spendingpower of households and cause demand destruction in the short term.Photograph: Kwong Wah Yit Poh

Fiscal deficitThe GST is expected to raise RM7bil from households in March 2010 values (equivalent to RM7.5bil in July 2013 values) [6]. Although the



Photograph: Ong Ee Lynn

expected amount raised is lower than the RM20bil-RM27bil that the government expects to raise in total [7], this will go towards plugging thefederal governments fiscal deficit and will help to allay the concerns of international rating agencies.

However, introducing the GST so soon after the reduction in fuel subsidies in September 2013 (which will save in subsidies or cause consumersto pay an additional RM3.3bil in 2014 [8]) will severely impact the spending power of households and cause demand destruction in the shortterm. On the other hand, introducing the GST gradually will not help address the deteriorating fiscal condition and may demonstrate weakresolve from the government in addressing a pressing issue, sending the financial markets exactly the wrong message.

Besides, with the overwhelming wave of foreign capital withdrawal from emerging markets due to the tapering of quantitative easing in the US,it is possible that the introduction of GST will only make a small, marginal impact on investor confidence in Malaysia. The cost of debt financingmay continue to increase with a depreciating Ringgit and with import inflation.

GDP growthBank Negaras second quarterly bulletin in 2013 noted that firm domestic demand has continued to support the GDP amidst weak demand fromeconomies in the West. While introducing the GST will have a negative impact on GDP growth, because of a reduction in disposal income, thenegative impact on domestic consumption may be countered by the improvement in export competitiveness resulting from a depreciated Ringgit.Since it is impossible to predict if implementing the GST will be perceived positively or negatively by foreign exchange markets, the net effectof demand destruction vs. improved export competitiveness is difficult to predict.

The government has promised to increase cash handouts to lower income households to help alleviate the burden imposed by the GST. If thismaterialises, the negative impact of the GST will be somewhat reduced. This is especially true since lower income groups have a higherpropensity to spend. For example, households earning less than RM1,000 per month will, on average, spend RM0.81 out of RM1 of additionalincome, whereas households earning more than RM10,000 per month will spend an additional RM0.18 out of any additional RM1 income(Outlook and Policy in 2013 section of Bank Negaras 2012 Annual Report). Therefore, any welfare cash handouts will filter very quickly to theeconomy, providing a temporary boost to consumption.

While distributing cash handouts may alleviate the effect of demand destruction in the short term and address the welfare aspect of implementingGST, its impact will weaken over time especially when inflation erodes the purchasing power of the handouts. Of course, the amount of cashhandouts can be continuously increased, but this is not a sustainable policy as it will accentuate a dependency culture and is certainly notconducive in helping build a knowledge-led economy based on innovation and entrepreneurship.

In addition, cash handouts may be politicised by tying the welfare of a segment of Malaysian households to the political fortune of any politicalparty. Hence, we recommend that any welfare package be channelled through the income tax authorities. This will also encourage more peopleto be registered with the tax system.

Asset (property) prices

The impact of the GST on asset prices is unclear. Here, we will only discuss the case of property, notfinancial assets. Due to the higher costs of building materials and professional services, thereplacement costs of buildings will increase. Although the government has indicated that residentialproperties and land are not subject to GST, higher construction costs may lead to higher propertyprices.

Nevertheless, the influence of the GST on property prices is expected to be marginal as thesupply/demand factor and market sentiment will dominate property prices. However, the impact can beindirect, e.g. any interest rate increase (if it is used to defend a depreciating Ringgit due to a ratingscut) will severely impact property prices since speculative players in the property market may haveoverextended during an era of low interest rates.

CONCLUSIONThe ratings agencies have fired the first warning shots, and the window for fiscal reform is rapidlyclosing. Nevertheless, there is still room to restore stability provided measures are taken expeditiously,and with clarity and credibility.

Any half-hearted fiscal reform and use of creative accounting methods are unlikely to inspire investor confidence and may further spur thedepreciation of the Ringgit. Although the Ringgits depreciation may restore Malaysias current account surplus (which has been shrinkinglately) by making exports more competitive, it will not improve the standard of living in Malaysia since purchasing power will be eroded. This,together with subsidies reduction and a broadening of the tax base via the GST, will negatively impact Malaysian households.

The implementation of a poorly conceived welfare system is also likely to lead to inflation, abuse and wastage, and possibly accentuate adependency culture. Although cash handouts can be a quick fix and may be a politically savvy move, this may not be conducive in spurringeconomic growth.

Adapted from the policy paper Implementing Goods and Service Tax in Malaysia which is available from the Penang Institutes website.

[4] If 20% is imposed on alcohol, tobacco, restaurants and hotels, while all other items are exempt/zero rated, then inflation is expected to spikeup by 1.08%.



[5] M. Smart and R. Bird, 2009, Replacing a Retail Sales Tax with a Value-Added Tax: Evidence from Canadian Experience, Canadian PublicPolicy Vol. XXXV, No. 1

[6] GST raised from corporations and businesses was not included in our analysis.

[7] Idris Jala, Minister in the Prime Ministers Department, has said that the GST could raise RM20bil-RM27bil at maturity(www.nst.com.my/latest/gst-implementation-to-add-up-to-rm27b-to-malaysia-s-income-1.280974).

[8] www.theedgemalaysia.com/in-the-edge-financial-daily-today/253313-moodys-malaysias-fuel-hike-credit-positive.html

Copyright 2014 Penang Monthly. All Rights ReservedPenang Monthly is published by Penang Institute.

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