The government has announced more than RM300 billion in stimulus packages to address the effects of the Covid-19 pandemic. Governments across the globe have adopted a similar approach, with the overall objectives of protecting livelihoods and saving lives. Some reports indicate that US$17 trillion (RM70.7 trillion) of Covid-19-related stimulus packages have been announced by governments globally. This equals to a whopping 20% of global gross domestic product (GDP).
Malaysia’s stimulus packages will naturally cause a larger budget deficit and increased national debt, leading to the immediate questions of how best to close the fiscal gap and reduce rising debt levels.
One obvious way to close the fiscal gap is by increasing the nation’s tax revenues. The challenge though is how best to increase tax revenues while ensuring that our country is still business-friendly, can continue to encourage investments both domestic and foreign, is able to alleviate the challenges faced by the rakyat, particularly the B40, and at the same time, pave the way for sustainable and inclusive economic growth. Is achieving all these objectives at the same time even possible?
Various case studies show that comprehensive and well-thought-out tax reforms can help nations boost their economy while growing their tax revenue in the long run. Improving a country’s tax system can help attract business and investment, encourage entrepreneurship, creativity and job creation, and eliminate deadweight costs and red tape that hold back growth. Some countries that have successfully implemented tax reforms have had their tax-to-GDP ratios increase by at least an average of 0.5% of GDP per year over a minimum of three years, coupled with economic growth.
Yet, tax reform is not a straightforward task. We need to identify the areas of the tax system that need the most attention and decide which reforms will do the most to encourage growth in a reasonable amount of time.
There are many options and views. For sure, there is a need for a careful study of all available options and an assessment of the options that will work for Malaysia. There is no one-size-fits-all answer. We need to look at many aspects, for example:
- The size of our population and the ratio of the T20, M40 and B40. Are the numbers in the T20 group large enough such that increased taxes on this group will close the gaps and leave enough left over for us to support the needy? Or do we need to widen the net to collect taxes from all groups through broader consumption taxes, and redistribute the tax collected to targeted groups that require support through other means?
- How reliant do we want to be on domestic investments versus foreign direct investments? If our reliance is on the latter, then widening the direct tax net or introducing additional taxes could backfire as it would made us less competitive compared with our neighbours. In fact, even local businesses may prefer to invest abroad if domestic taxes are overly burdensome. Introducing a new tax will come with additional compliance and administrative costs to businesses, which many businesses can ill afford at a time when they are struggling for survival. Introducing and administering a new tax may also result in significant implementation costs and time taken for the government.
Some of the common themes gathered from studies of countries that have been successful in instituting tax reforms and growing their economic pie include:
- Broadening the consumption tax base. By broadening the consumption tax base (in the context of Malaysia, this would mean the Sales and Service Tax), there would be a higher chance of increasing tax revenue with the least impact on consumption and correspondingly, the economy. No doubt, consumption taxes can be regressive, meaning that such taxes impact the lower-income group proportionately harder than the wealthy. This is because the lower-income group will spend most, if not almost all, of their income on necessities, while the higher-income group is able to save and invest. Therefore, in parallel with any broadening of consumption taxes, the government will need to consider providing targeted support or subsidies to the B40.
- Reducing corporate tax rates. Lowering corporate tax rates can lead to particularly large productivity gains in organisations that are dynamic and profitable, that is, those that can make the largest contribution to GDP growth. Lower corporate taxes are likely to also encourage inbound foreign direct investments, which have been found to drive increased opportunities and productivity among local/domestic organisations. Studies have shown that countries that reduced corporate tax rates to stimulate growth still increased their corporate tax collections.
- Removing ineffective tax incentives and exemptions. There is a sizable loss of revenue when it comes to tax holidays and other incentives that either fail to attract the right investments or are provided to companies that would have made the investments even in the absence of such incentives. Ineffective or outdated incentives should be identified and withdrawn.
- Simplifying the tax system. A simpler and more transparent tax system can help facilitate and enhance compliance as well as reduce tax leakages. Simplicity should be the mantra across the board, from the legislation and guidance, to the compliance procedures, to the time and effort required for compliance.
- Having political will and buy-in from all stakeholders. Political will at the highest level and broad buy-in are needed. Engagement and dialogue among stakeholders enhance the likelihood of reforms being implemented effectively and sustained. Effective communication with stakeholders that highlights the intended benefits of the reforms can help overcome resistance.
- Pursuing tax administration, tax policy and technological reforms simultaneously. Longer-term impact requires action on multiple fronts. Most of the countries in the studies took advantage of technology, digitising their tax systems and tax administration functions to reinforce their tax reform initiatives. Automation, data sharing among tax authorities, taxpayers and financial institutions, and the use of big data and artificial intelligence go a long way to improving compliance and reducing corruption or loss of tax revenue through the shadow economy, while allowing tax administrators to collaborate on an international level. The studies also show that countries that pursue tax administration reform measures and tax policy reforms in tandem tend to see much larger gains.
- Thinking long term. We need to give tax reforms time to bear fruit. Studies have shown that between two and seven years may be required to fully realise the benefits of reforms. Sustained success requires institutional change, which happens only gradually.
There is no short cut. Malaysia needs a comprehensive reform of its tax framework if we want to be in a better fiscal position and at the same time, ensure we achieve sustainable and inclusive economic growth. The government needs to look at these goals, together with the country’s economic agenda and its engines of growth and formulate a holistic tax reform plan.
In formulating its plans, the government should consult and engage with stakeholders, particularly the business community and foreign investors. Our courage to act today can help build a tax system that will support the country’s growth for generations to come.
Amarjeet Singh is EY Asean tax leader nd Malaysia tax leader at Ernst & Young Tax Consultants Sdn Bhd. The views reflected above are the views of the author and do not necessarily reflect the views of the global EY organisation or its member firms.