PETALING JAYA: Accounting for 21% of the country’s gross domestic product (GDP), the shadow economy, if left unchecked, has the potential to impact the country’s economic growth and increase inflationary risk, according to economists.
Besides affecting the nation’s tax ecosystem, they said the menace can distort economic policies and have an adverse effect on the economy.
Measures to shrink its growth would result in the collection of higher tax revenues and stimulate relevant spending in the infrastructure and services sectors, said the economists.
Finance Minister Lim Guan Eng has recently raised his concern about the shadow economy.
Among others, he noted that the loss in tax revenue from the hidden economy could threaten the stability of the nation’s tax ecosystem, particularly in terms of fair taxation and voluntary tax compliance.
After a slower growth of 4.4% in the third quarter of 2019 (Q319), economists have projected last year’s final quarter GDP growth to 4%-4.5%.
For 2020, the forecast is 4.5%-4.6%, in line with moderate global economic expansion. Bank Negara is expected to release the Q419 GDP figure by next month.
As for inflation, the consumer price index (CPI) rose 1% in December 2019 compared with the same period a year ago. The CPI for the whole of last year increased 0.7% compared with 2018.
AmBank Group chief economist Anthony Dass said the impact of the shadow economy could either be harmful or helpful.
“It’s harmful if the economy sits on a large shadow economy. The money is not collected in the form of tax by the government and this will hurt government efforts to drive economic growth and public programmes.
“But this economy can be positive if they pay taxes. The money collected can be used to stimulate demand. Due to its masked nature, it is difficult to determine the amount of money that changes hands as their transactions are not reported nor subject to governmental oversight, ” he added.
Dass noted that as business activities from the shadow economy do not generate tax returns or appear in official statistical reports, it distorts the accuracy of the key economic measurements and cause policies to go wrong.
This, he said is true especially if the focus is to lower fiscal deficit by raising taxes and cutting expenditure while ignoring the shadow economy.
Shadow economy comprises of economic and business activities that are deemed illegal, as the goods or services traded are unlawful or if the transactions fail to comply with governmental reporting requirements.
Bank Islam Malaysia Bhd
chief economist Mohd Afzanizam Abdul Rashid said money obtained from corrupt practices, for instance, are not productive since there are no additional output being produced although there was an exchange of money.
“Irrespective of the amount, the corrupt monies will flow back into system and since there is no productivity, it could lead to inflation as there is too much money chasing a few products.
“In that sense, the scenario will make it difficult to address the high cost of living issue. Curbing corruption is also part and parcel of the solution since the corrupters will spend the unproductive money thereby, causing inflation.
“Corrupt businesses who pay bribes would charged them as part of the product costing. This could also lead to inflation. It’s a vicious cycle, ” he noted.
Meanwhile, based on an IMF research working paper in January 2018, Malaysia’s estimated size of shadow economy has been trending lower from 37.5% of GDP in 1991 to 31.1% in 2000,30.2% in 2010 and 26.1% in 2015. The average ratio for the period 1991-2015 was 31.5%.
Executive director of the Socio-Economic Research Centre Lee Heng Guie said the reported 21% of GDP figure was higher than the 6% to 15% of GDP in less developed as well as some rich countries.
He noted that a large shadow economy would deter the development of an inclusive economic growth as it deprives potential high tax revenue to fund development projects such as healthcare, education and transportation.
As the informal sector does not contribute by paying taxes, it will create an unfair playing field for the registered tax-paying businesses, he said.
“The shadow economy’s adverse economic and social implications are an erosion of tax base, price and competition distortions in the market place. The influx of lower quality goods will pose a health hazard to consumers, ” Lee stressed.
Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias said with better governance and institutional reforms, the size of Malaysia’s shadow economy could be reduced although the pace would depend of several factors.
“One factor that could slow down the pace of the reduction in shadow economy is the rising trend of e-commerce. This is because economic crimes like tax offences and payment frauds are not uncommon.
“In the case of Malaysia, online businesses that fail to register with the Companies Commission of Malaysia could get away from being under the watchful eye of the Inland Revenue Board by underreporting income and tax liability if not properly monitored, ” he said.
The economic menace could be curtailed by raising awareness on the laws that govern the collection of direct taxes.
The information on taxation of e-commerce should be widely circulated upon the registration of new online business entities, he said.
“The fines and penalties imposed on tax offences should also be highlighted to business owners.
“To monitor cyber activities within the e-commerce sphere, the government will need to invest more in human capital and technology, ” Zahidi said.
Dass said complex tax laws, weak tax enforcement and the lack of incentives to make payments through formal banking channels were among the factors that should be addressed.
“Greater tax complexity imposes heavier compliance burden on taxpayers, It disincentivises tax compliance and encourages taxpayers to move into the shadows.
“Receipt-free cash transactions for goods and services increase the risk of tax evasion. So, a simpler and flatter tax structure will be desirable, ” he said.
Besides reducing the complexity of the tax system, the usage of information and communications technology solutions will improve tax enforcement and prevent tax evasion, according to Lee.
“Issues facing some informal sectors can be addressed with measures such as increasing labour inspections at building sites and business centres, introducing more restrictive penalty sanctions for counterfeiting of excise products, ” he said.
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