A broad-based tax, such as goods and services tax, is generally considered to be a regressive tax. Before we go further, let us look at what regressive actually means.
In simple terms, a regressive tax imposes a greater burden (relative to resources) on the poor than on the rich — there is an inverse relationship between the tax rate and the taxpayer’s ability to pay as measured by assets, consumption or income.
Any consumption taxes, including the Goods and Services Tax (GST), is generally regarded as regressive because the poorer households spend a greater proportion of their income on consumption compared to higher income households.
The issue of regressive nature of any consumption tax is often a serious concern to policy-makers.
Despite its regressive nature, GST, or better known as VAT (Value-Added Tax), has been introduced in more than 160 countries in the world.
Experience of other countries
Over the years, many developed countries such as the UK, Australia, Germany and Spain have experienced a regressive nature of VAT amongst the lower, middle and higher income groups. The reason for this is the minimal zero rating of basic essentials and exemptions that have been practised by these countries when implementing the VAT.
For example, a study conducted on the distributional impact of the VAT/indirect tax package in Australia showed that the VAT impact was equivalent to a burden of 4.4% of income for the bottom 20% of households compared to 1.4% of income for the top 20% of households.
The result was the same for Japan, Colombia and Peru as the VAT was found to be regressive, with little effect from exemptions.
On the other hand, several developing countries such as Vietnam and Ethiopia have experienced progressive VAT as they adopted the zero rating of basic essentials and exemptions when implementing the VAT.
In Pakistan too, the VAT was found to be progressive owing to exemptions (especially of in-kind consumption)
Is Malaysian GST Really Regressive?
The introduction of a GST often raises the concern that it is a regressive tax, meaning that the tax represents a higher burden for lower-income households.
“A broad-based consumption tax, such as a value added tax or GST, is generally considered to be a regressive tax.
“This conclusion, however, has not taken into account the fact that in developing countries, the commodities on which poor households spend most of their income, is not taxed. When this factor is considered, VAT can be naturally progressive” .
In Malaysia, GST should not be considered in isolation to the taxes that it is replacing which may be equally (or more) regressive. In addition, GST tends to have multiple rates which are justified for equity reasons in developing countries on the grounds that social safety nets are typically not as well-developed as in high income countries.
As a result, “essential” goods such as basic food, piped water and the first 200 units of electricity consumption to domestic consumers are zero-rated under the Malaysia’s GST.
To further lessen the GST impact on the poor, services such as health, housing, public transport and education are treated as GST exempt.
Apart from not taxing necessities, by setting the GST threshold at a level where small businesses are excluded to account for the tax, the low-income households are somewhat free from the burden of GST.
The reason being, low income households tend to purchase a larger proportion of goods and services from the small retail sector in the rural areas where the goods are either not taxed at all, or are more lightly taxed.
However, the higher income households purchase goods and services in retail outlets in the urban areas that are likely to fully comply with the tax rules.
As a result, the share of consumption subject to GST for higher income households tends to be greater than that for the poor.
Lately, we have seen many articles which basically criticised Malaysia’s model of GST as being regressive.
Notably, some critics have made presumptions that the poor will be taxed higher than the rich, an income earner of less than RM2,000 would now have to pay taxes in the form of the GST where it is going to eat into his household debts and the assumption of the gross domestic product (GDP) to fall in 2014.
The question is, is this true?
Many of these articles grossly ignored to discount the effect of SST (sales and services tax) that would be abolished when GST is introduced. Some critics who consider GST to be a regressive tax do not study the expenditure pattern of the various income groups.
Why Malaysian GST is progressive
The Royal Malaysian Customs and the Finance Ministry have done extensive research on the GST. A recent study shows that Malaysia’s model is indeed progressive.
Based on the data compiled from the tables shown above, the tax burden as percentage to expenditure for a household income of RM2,000 is only 2.59% whereas for a household income of RM12,000 is 4.14%.
The tax incidence at GST 6% on expenditure subject to GST for a household income of RM2,000 per month is only RM39.16 but for a household income of RM12,000 is RM345.06/month which is almost nine times greater.
The tax incidence would be much lower if we discount the sales tax and service tax factor for which they are currently already paying.
A household income of RM2,000 spends about 32% of his total expenditure on zero-rated item and 32.63% on items subject to GST where else a household income of RM12,000 spends only about 12.15% of his total expenditure on zero-rated item and 63.90% on items subject to GST.
GST is a consumption tax. It is based on spending. If the spending is higher, then tax charged will be more.
Low- and middle-income earners are unlikely to spend more on non-basic items that are not GST zero rated or exempted. Even if they did, the volume is not as high as wealthy people as their purchasing power is limited.
It is usually the wealthy ones who spend more on luxuries.
Despite the many unfavorable aspects of GST, the Malaysian GST model is designed to be a progressive one. It lessens the impact on the rakyat and at the same time overcome the inherent weakness of SST.
Even though the Malaysian Model is a progressive one, the Government has designed a compensation package to offset any additional tax burden that might affect the low income Rakyat when GST is implemented.
The offset package includes;
1. RM300 one-off cash to BR1M recipients as household assistance.
2. Individual income tax rates reduced by 1% to 3% to increase their disposable income – 300,000 tax payers will no longer pay tax.
3. Families of RM4,000 household income will no longer pay tax.
4. Cash assistance under the BRIM is increased from RM500 to RM650 in 2014 and to increase it further in 2015
5. Chargeable income subject to the maximum rate of exceeding RM100,000 will be increasing to exceeding RM400,000. Current maximum tax rate of 26% will be reduced to 24%, 24.5% and 25%.
In Malaysia’s case, the overriding rationale to introduce the GST is to modernise our tax system and to overcome the inefficiency of the indirect tax system in the country. Moreover, GST also provides the opportunity to enhance fiscal sustainability.
From the studies done by the MoF and Customs, it is evident that zero-rating of basic food, water and electricity(up to a certain level) and exempting the critical sectors such as housing, public transportation, health, education, land and financial services including life insurance, has made the Malaysian model a progressive one rather than a regressive one.
This is due to the fact that the Government is not taxing or taxing very lightly on goods and services on which poor households spend most of their income.
The writer is the Director General of Customs, Malaysia.