Protecting the poor under GST


BY Dr JEYAPALAN KASIPILLAI AND Dr JONATHAN BALDRY

MAICSA PERSPECTIVE: A monthly series by The Malaysian Assssociation of The Institute of Chartered Secretaries and Administrators 

THE most efficient and effective goods and services tax (GST) is one that covers virtually all goods and services at a single rate. It will, however, allow exemptions on cost-efficiency grounds for small businesses and for certain transactions involving special considerations, but will confine zero-rating – which means zero GST – to exports. 

The result is a broad-based tax that is simple to explain and comply with, easy to administer, and does not distort the pattern of production and consumption. There is also little room for tax avoidance, implying greater efficiency in implementing a new tax system. 

An exempt business is one that is not required to collect the tax on output sold to its clients but is not entitled to claim for the credit of the tax the business had already paid on its output purchase. The effect is that the actual GST on its sales is lower than the full rate. 

On the other hand, purchases of zero-rated commodities from a firm do not include any GST. Effectively, the firm charges a rate of 0% on its sales, yet receives a refund of the GST previously incurred on its input purchases. 

The main argument against a broad-based tax without zero-rating is that such a tax will unfairly affect the poor in society. The argument is that most necessities, such as basic food, clothing, medical care, housing and public transport, have not previously been taxed. A broad-based GST will tax these commodities for the first time, and so raise their prices. Since these necessities account for a significant proportion of the income of the poor, they will be made worse off under the tax. By a similar argument, the price of “luxuries” previously taxed at high rates is expected to fall and the rich will benefit. 

Several steps need to be taken in assessing these arguments and deciding whether to abandon the benefits of a broad-based GST in order to protect the poor. One piece of information needed is how the pattern of prices would change if a broad-based GST were introduced at a specific rate. It would require some sophisticated econometric modelling to answer this question. 

However, it would be unlikely that the prices of necessities would increase by the full extent of the tax. In the first place, most commodities, necessities included, already incorporate a sales tax component, and perhaps even a service tax component. 

For example, the price of food sold incorporates the tax included in the prices of inputs used in the supply chain, such as vehicles and components, cooking equipment, packaging and many others. It may even include a share of the service tax paid on the parking fees and courier charges of the various sales representatives in the supply chain! 

Secondly, exempting small businesses from GST would itself ensure that most commodities bought by the poor, and largely purchased from small retailers, would bear a lower effective rate of tax. 

When the information on price changes is available, it can be used in conjunction with information on spending patterns and incomes, to estimate the actual impact on the real income of the poor. This again would require some sophisticated econometric modelling if it were to be done properly, but only when we have that information will it be possible to develop strategies to protect the poor. 

The obvious strategy to use is to adjust income tax rates and social security payments in order to compensate for the introduction of GST. Unfortunately, while this strategy is available to developed nations such as Australia, New Zealand and Britain, the comparatively small reach of the income tax and low tax rates, and the minimal coverage of social security, means that it is not available to Malaysia. However, there are alternatives. 

The most promising set of alternatives is the use of selective subsidies, or even income tax concessions, either to individuals or to commodities. The poor in Malaysia, however, do not pay income tax, let alone mediocre salaried personnel who escape the net with hefty tax relief and exemptions. 

Malaysians are not strangers to subsidies and tax concessions, but so far they have generally been used for economic development purposes. It is not impossible to use commodity subsidies to limit any price rise in basic foods, and it is comparatively simple to increase subsidies to bus services and other public services used largely by the poor. 

Where this approach is not possible, or where to use it will also give a significant benefit to the rich, it is often possible to subsidise poor people individually. This would be true, for example, for medical prescriptions or dental care, where increased subsides to hospitals or clinics is undesirable. A coupon system to subsidise one-off rising costs in the first year of GST implementation is an option but its implementation may be problematic. 

None of this will be easy, but it is possible; and to follow this path rather than permanently distort a new tax system is the best route. Commodity subsidies can gradually and easily be wound down through time. Personal subsidies gradually and automatically diminish as personal incomes grow with the economy. By contrast, once in place, zero rating, exemptions or multiple tax rates are difficult to change and remain a permanent impediment to tax simplicity and efficiency. 

The revenue will be available to finance a system of subsidies once the GST is introduced. Rough calculations suggest that a broad-based GST at a rate of 5% will probably increase indirect tax revenue above its present level, because of the wider coverage of the tax by comparison with the higher-rate sales tax ranging from 5% to 25% and the 5% service tax. 

The additional revenue would be sufficient to finance a modest system of compensatory subsidies. This would be a far better use of any increased revenues than the corporate and individual tax rate cuts proposed. The Government will be under a great deal of pressure over the next two years, and most of this pressure will come from business, professional and consumer groups lobbying for special treatment (i.e. lower GST rates) for their sectors. 

The Government should resist such pressure. Like the New Zealand Government in 1988, the Barisan Nasional is strong and secure enough to preside over the introduction of a simple and effective GST that will be a massive improvement rather than just a modest improvement over the current tax regime. The poor, nevertheless, will have to be protected; more soul-searching techniques are required for the right mix.  

Numerous developing countries around the world have introduced GST in the hope of raising revenues efficiently with minimal collection cost. The distributional impact of the GST should not be viewed in isolation, but in a broader perspective of the whole fiscal system encompassing both taxes and expenditures. With greater revenue collections, more expenditure can be channelled to assist the poor through social programmes such as improved housing, well-guided education and decent health care.  

  • Dr Jeyapalan Kasipillai is the author of a taxation book entitled A Comprehensive Guide to Malaysian Taxation – Under Self Assessment System (McGraw-Hill) while Dr Jonathan Baldry is an associate professor at the University of New England, Australia. 

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