Written by Carmelo Ferlito, CEO of Center for Market Education

First published in Free Malaysia Today on 27 September 2021

Finance minister Tengku Zafrul Aziz announced that the government is considering a windfall tax and a capital gains tax to support federal revenues in times of difficulty.

However, I believe that Putrajaya needs to holistically think about a tax reform that can support government revenues without undermining growth or discouraging private investments.

Any tax reform needs to have little distortion as possible for economic activity. It has to nudge in favour of a saving-oriented mentality, and it has to keep the investment pace from both overheating and depressing.

We at the Center for Market Education (CME) suggest the following pillars for a balanced tax reform.

1. Reducing income tax and shifting toward a consumption tax

CME believes that the key driver for sustainable growth is private investments and therefore, suggests the government spur them by launching a commitment signal in the form of a moderate income tax reduction.

While CME advocates a shift toward indirect taxation (as explained by the GST proposal below), the shift must be accompanied by the higher standards of enforcement – both for direct and indirect taxes – and by the reduction of unnecessary government expenditure.

2. Introducing a targeted goods and services tax (GST)

The reduction of the income tax should be partially replaced by a consumption tax. The case for a consumption tax mainly lies in the possibility of stimulating household saving in a country that is burdened by a very high household debt.

Against potential regressive effects, we suggest a progressive consumption tax.

CME proposes the following:

  • exempted goods – items related to the basic consumption habits of the lower-income population, such as rice;
  • low-rate GST (3%) – key-development items such as culture and education-related goods;
  • middle-rate GST (6%) – all the goods not identifiable with the other three categories;
  • high-rate GST (10%) – luxury goods.

The GST reintroduction can become an occasion to test the possibility of a higher degree of tax devolution, with the local states more involved in tax collection so that they may have more direct access to funds that can be used to support them.

Hence, we also propose the T-GST to be collected by the state, 20% of which is retained by the state, and 80% transferred to the federal government.

3. A special scheme for microbusinesses

Microbusinesses can be supported in exiting the shadow economy with a special accounting and tax system, whereby a flat and low tax is applied on the self-declared turnover, while most of the accounting and reporting burdens are waived.

4. The special purpose tax for Covid-19

Given the fiscal deficit that has increased substantially due to the allocations required for the Covid-19 pandemic, we propose a special purpose tax (SPT) of 5% to be imposed in Malaysia on taxable profits of corporations above a specified threshold.

Such a tax should be imposed for a two-year period for the assessment years 2021 and 2022 and removed after that. The limited temporal framework needs to be clearly defined as part of a sort of new social pact between the government and the people, whereby the former demands special effort from some of its taxpayers, but it commits to fighting Covid-19 with these additional revenues and allowing businesses to operate without additional lockdowns.

The objective would be to channel this SPT to a specific medical fund that would allow hospitals to immediately (within the short term) enhance their medical resources and capacity so that more ICU beds/units can be set up and more medical equipment can be acquired to manage the huge number of cases being reported.

What is absolutely crucial is that the government needs to state the commencement date, the objective, and the end date clearly in its communication narrative. Failure to consistently do so will lead to presumptions of a permanent corporate tax rate increase, and that will have an effect on foreign investors who may become concerned about further changes being made to the general corporate tax regime.

5. A counter-cyclical progressive capital gain tax

CME considers the proposal for a progressive capital gains tax (Hanusch-Wackermann tax) as part of the public sector role in supporting healthy growth of the economy, a role that should be guided by a two-sided countercyclical strategy.

On the one hand, it is to avoid trends of exaggerating or overheating in time and, on the other, it is to overcome a possible period of stagnation as quickly as possible.

A progressive capital gains tax (PCGT) would help the economic system in growing within the boundaries of a sustainable growth corridor.

The idea of such a corridor pre-supposes that the political sphere can take the appropriate measures that can effectively and opportunely tame and dominate those forces in a capitalistic system which continuously tries to go through the roof and risks exiting the corridor towards an excessive growth path.

At the same time, policymakers have to make sure that the economy will not fall out of the corridor, and that it will not have to cope with economic stagnation (like in the situation we are in now).

How can a PCGT help keep the system moving within the boundary of the corridor without limiting the positive effects produced by profit-seeking behaviours?

This tax could be an automatic stabiliser to investment behaviour. As it is easy to realise, the proposed scheme (progressive) will generate a situation where the lower the return the lower the tax rate.

It is well known that, in general, low return investments are the ones linked with low-risk and, therefore, such a tax would favour conservative behaviour. Overall, we would see a shift in the behaviour away from highly speculative investments promising a high rate of return, because some investors will lose interest because of the increased tax burden.

In a situation where the economy finds itself above the corridor (overheating), fewer people will join the bandwagon, and the dangerous bubble formation might evolve at a slower speed.

This would give the system the chance to slow down on its own or integrate the highly dynamic sectors in such a way as to widen bottlenecks before a looming breakdown.

In times when the economy is stagnating and below the neo-Schumpeterian corridor, the low tax rates incite investors to leave their money in the capital market and support a sustainable development.

Furthermore, the government would increase its tax receipts above average in boom times due to the rising tax rates and could, theoretically, use the money to support the economy in times when it nevertheless falls through the corridor.

With this scheme, innovative industries may still attract investors at the beginning of their expansion, when expected returns are low and financial resources are more needed. At the same time, the influx of second-comer speculators may be contained precisely because they tend to enter the game when returns are rising and therefore they could be discouraged, at least to a certain extent, by increasing taxation.

Thus, less money is invested when returns are on the rise and speculation-induced overheating could be prevented. The anti-cyclicality is then built into the scheme.