Friday, June 14, 2013

How Much Would Car Prices Come Down If Excise Duties Were Abolished?

I’ve made no secret of the fact that I’m leery of the notion that cars in Malaysia should be made cheaper. The negative externalities arising from fossil fuel use, which would be exacerbated by cheaper cars, would be a social and public cost that wouldn’t be accounted for in the retail price of cars.

But leaving that aside for the moment, how much should car prices fall if the currently high rate of excise duty levied on the production and sale of cars be reduced or abolished?

It’s not as much as you think.

On the face of it, excise duties are an onerous addition to the price of Malaysian cars. You can check the current rates from the MAA website – for motor cars (excluding 4WDs and MPVs) the duty ranges from 75% for 1.8 litre cars to 105% for cars with engines larger than 2.5 litres. Sales tax of 10% is added on top of that for the final retail price.

Doing the math, abolishing excise duty would for instance reduce the price of a small sedan (say a Toyota Vios) by about 38.9%; for a full size executive sedan (say an S-class Mercedes Benz), by about 46.6%. Such reductions would be a huge boon for lower and middle income families.

Unfortunately, the numbers don’t quite add up. For one thing, unlike the sales tax, the excise duty on cars is not a flat rate based on manufacturer’s retail prices, but is actually adjusted downward for local content i.e. the published rate is just the maximum rate and won’t apply to all cars equally.Both the nominal and effective rate of excise duty can and would be considerably lower in practice.

Second, from what I’ve been made to understand, excise duty is levied on the ex-factory price and not at the distribution level, which means that it doesn’t take into account the profit margin on distribution.

But rather than take my word for it, let’s look at what the data says:

  1. Sales data on motor cars is available through the Quarterly Survey on Distributive Trade. I excluded sales of parts and motorcycles, as well as revenue from maintenance.
  2. Excise duty collected on motor cars can be gleaned from the Treasury’s detailed estimates of 2012/2013 revenue.

Actual sales of passenger vehicles reached RM74.85 billion in 2012, while excise duty collection on the same reached RM7.14 billion. My calculator says that the average excise duty levied is thus just 9.5% of sales.

That’s a far cry from the 40% implied by a straight line calculation. The idea that cutting out the excise duty for cars alone would see prices drop that much is thus largely wishful thinking.

In fact, for the average Malaysian family car (national or otherwise), the 9.5% estimate would be conservative since excise duty progressively increases for larger cars and for fully imported cars. The tax burden is lower for entry-level and mid-sized sedans, but so too would any reduction in prices from abolishing excise duty.

That still leaves the question of why Malaysian cars are expensive in the first place.

There’s no doubt that industrial policy (AKA protecting Proton) has had a historical and still relevant impact on the structure of car prices in Malaysia. But rather than speculate on causes or effects, I’d rather resort to the data, for which we’ll need to go back a couple of years, to 2010:

  1. Sales data on motor cars again is available through the Quarterly Survey on Distributive Trade.
  2. Excise duty collected on motor cars from the Treasury’s detailed estimates of 2010/2011 revenue.
  3. Ex-factory sales from the 2011 Economic Census for Manufacturing.
  4. Import value of motor cars from DOS’ External Trade Statistics System (HS classification 8703).

You have to make some heroic assumptions here to get plausible estimates, and even then there’s going to be a great deal of uncertainty.

Total sales reached RM67.99 billion, excise duty collection was RM5.2 billion and ex-factory sales reached RM21.46 billion. Import value reached RM8.06 billion and I estimate sales tax collection at RM6.2 billion (which is a gross over-estimate, based on actual overall sales tax collection – there’s unfortunately no breakdown given in the source I used).

Nevertheless, assuming that imports are all CBUs (pretty unreasonable given that they attract the full weight of excise duty, but a conservative assumption), total input value before distribution would be RM29.51 billion (gross ex-factory sales plus imports).

That gives an effective excise duty rate of just 7.6% at retail (based on sales of RM68 billion) and 17.6% at the factory/import level. Again, a far cry from the 40% implied by the top excise duty rate.

More important is the resulting residual – headline sales of RM68 billion less input cost, excise duty and sales tax, suggests that a massive 39.9% of the sales value of a car is captured in the distribution sector.

This is largely corroborated by the slightly earlier 2009 Census of Distributive Trade which implies an even higher “value-added” of 70% on the sale of cars on distribution.

Again, I don’t wish to speculate here – there’re possibilities of inefficiencies at manufacturing level, imperfect competition at the retail level, menu costs at all levels, that could explain Malaysia’s structurally high car prices.

One comment I would make however is that historical protectionism of Malaysia’s national car manufacturers also effectively insulated non-national car brands from competition as well – shades of the US experience of the 1980s (quotas on Japanese imports resulted in these manufacturers making abnormal profits).

What’s clear however is that while excise duty does play a role in higher car prices, it is by no means the only or even the biggest culprit. For that, we’ll have to look elsewhere.

Technical Notes:

All data from the Department of Statistics unless otherwise noted:

  1. Quarterly Survey on Distributive Trade
  2. 2011 Economic Census on Manufacturing (warning: pdf link)
  3. 2009 Census on Distributive Trade
  4. Motor car imports from the External Trade Statistics System (accessed June 14, 2013)
  5. Buku Anggaran Hasil Kerajaan Persekutuan 2013 from the Ministry of Finance
  6. Buku Anggaran Hasil Kerajaan Persekutuan 2011 from the Ministry of Finance

30 comments:

  1. "For one thing, unlike the sales tax, the excise duty on cars is not a flat rate based on manufacturer’s retail prices, but is actually adjusted downward for local content i.e. the published rate is just the maximum rate and won’t apply to all cars equally."

    Isn't this statement only valid for import taxes, and not excise duties?

    Anyway, I've long known that car retailers are just using excise duties as an excuse for obscene profits, although I'm shocked that you calculated that excise duties at 80% of the car's value ends up as just 7.6% of car prices. (I tried, but as a layperson I doubt I'm able to credibly refute your calculations)

    I suspect that the elephant in the room is the AP issue. If there is no free parallel importation of cars, there is no real competition. Futher, the class which controls access to APs gain access to a slice of car sales profits, whether above or below the table.

    Another possibility for the low tax collection is that car sellers charge the car buyers on the basis that tax needs to be paid, but the taxes are just being evaded or avoided (i'm sure you understand the difference) or somehow is being channeled back to the sellers by complex tax rebate schemes.

    At the end of the day, I suspect that abolishing the excise taxes will force prices down more than 7.6%. Excise duties guide public perception, and affects what the public perceives as acceptable pricing. The public outrage if prices do not fall by at least 30-40% when excise duties are abolished will be devastating, as car sellers are no longer able to use excise duties as an excuse for their obscene profits.

    Lastly, I strongly take issue with your objection to the removal of excise duties. The key issue causing air pollution and congestion in Malaysian cities isn't the sales of new cars, but the continual use of old, slow, lousy vehicles on the roads. The negative externalities of our excise duty structure is dirty, polluted air, high rate of car accidents, and thousands of unnecessary deaths every year on our highways due to faulty vehicles and the lack of safety features on substandard deathtraps. What we need is to replace our inelegant excise duty system with a European style carbon-tax on sales and continual ownership. We also need an abolishment of fuel subsidies (start taxing fuel for all I care), and a better redistribution of our petroleum money away from subsidies towards the improvement of public transport (what would RM 40 bil a year buy in terms of buses and trains?). What about an annual cash bonus for every urban household which doesn't own a car?

    Car prices don't necessarily need to be affordable. They just need to make sense in the context of our broader policy goals.

    Anon 86

    ReplyDelete
    Replies
    1. @anon 86

      I'll be honest - I didn't understand the ramifications until someone sat me down and explained the whole thing a couple of weeks ago. That's when I started looking for hard evidence. It's astonishing to me as well.

      AFAIK, tax rebates were phased out in 2006, so we're left with less than perfect competition as the answer - I don't know enough about APs to make up my own mind one way or another how big a factor this is.

      As for mitigating negative externalities, I agree that taxing petrol would be the most efficient way to accomplish this, as I've written about more than a few times before.

      Funnily enough, my rough estimate for the cost of negative externalities is approximately at the same level as the excise duty levied by the government (but not collected) on petrol.

      Delete
  2. Agree abolishing excise duty will not do much in reducing car prices. The most I think is 10%. The largest contributors to retail prices are still import duty on CKD parts and components (30 - 50%) and CBU cars (197 - 297%)from outside Asean, and distribution.

    ReplyDelete
    Replies
    1. @anon 1.39

      Agreed, all good points.

      Delete
  3. 1 question,by imposing AFTA, how much % will be reduce the prices of car??

    ReplyDelete
    Replies
    1. @Living Seed,

      The reduction in import duties through AFTA has already been in effect since 2005, IRIC.

      Delete
  4. But PKR Rafizi promises to abolish car duties and we can all drive to work. How does your figure tally with his?

    ReplyDelete
    Replies
    1. @Morty,

      His figures approximate that which I tabulated in the fifth paragraph in the blog post above i.e. the assumption that excise duty is levied at the full rate, and there is no margin on distribution.

      Delete
  5. Interesting. But doesnt the average car sales data u have used here include proton which i assume wud enjoy lower rates? Shouldnt u exclude the proton cars to estimate the average excise duty for importes cars? I have yet to look at the data u hv used in detail and so my comment here might be irrelevant and in which case i apologise.

    ReplyDelete
    Replies
    1. @Mac

      Don't apologise! We're all trying to figure out the truth, and any constructive criticism is welcome.

      Proton (and Perodua and Naza) all pay the same excise duties as everybody else, where the rate is subject to the source of the parts they put into their cars. If the national car brands pay lower duties, it's only because they have slightly higher local content. I vaguely remember seeing some figures on excise duties on Proton cars which suggest that excise duty paid is in line with the average I've calculated i.e. around 10%.

      Delete
  6. i think Diseconomies of Scale also contribute to the highest car price

    ReplyDelete
    Replies
    1. @Living Seed,

      Agreed; production volumes and fragmentation of production would certainly play a role in embedding inefficiency in car pricing. However, the sales figures on manufacturing output suggest this is at worse a minor caontributing factor.

      Delete
  7. Hi Hisham, you may have forgotten that the hybrid tax rebates in the past few years allows an interesting UNSCIENTIFIC case study which may disprove your theory in relation to the effect of taxes on imported CBU cars.

    Taking UK prices into consideration:-

    HYBRID CARS

    1. Toyota Prius
    UK Price = ~ RM 107000; Msia price = RM 140000
    Verdict: Msia 30% more expensive

    2. Lexus CT 200h (luxury)
    UK price = ~ RM 140000; Msia price = RM 200000
    Verdict: Msia 42% more expensive

    3. Audi A6
    UK price = ~ RM 220000; Msia price = RM 300000
    Verdict: Msia 36% more expensive

    NON HYBRID

    1. Toyota GT 86 (auto)
    UK price = ~ RM 140,000; Msia price = RM 250,000
    Verdict: Msia 80% more expensive

    2. Lexus GS 250
    UK price = ~ RM 171,000; Msia price = RM 365,000
    Verdict: Msia 113% more expensive

    3. Audi A6 (330 bhp quattro)
    UK price = ~ RM 255,000; Msia price = RM 515,000
    Note: UK version is diesel, Msia is petrol.
    Verdict: Msia 100% more expensive

    Conclusion? Assuming no excise duties, import duties or sales duties, cars in Malaysia are around 35% more expensive than in the UK. With the taxes however, cars in the same range will be around 100% more expensive. Ergo, if taxes are removed for all cars, prices will drop by around 32.5% (200% -> 135%). If only excise duties were removed, we would be looking at around a 25% fall in prices.

    Comments/disclaimers:
    a) UK prices have 20% VAT included.
    b) Conversion at current rate of 1 GBP = 4.9 MYR
    c) Specs are as close as I can make them, but there are still differences due to non-availability of particular options
    d) I suspect that the only reason hybrid vehicles in Malaysia can be sold at higher margins (~35% higher than UK) in Malaysia notwithstanding the tax rebates, is because non-hybrids are so expensive (~100% higher than UK). Consumers numb to high prices and car sellers do not want to cannibalize sales of their other models. If all cars were subject to the same tax, it is reasonable that prices will fall by more than 32.5%.
    e) Car companies have different price and branding strategies in different markets, and this affects prices.
    f) UK has a much larger volume for higher spec cars, whereas the car market in Malaysia is dominated by P1 and P2. US prices are not taken as for comparison they have ridiculously high volume.

    Anon 86

    ReplyDelete
    Replies
    1. @anon 86

      1. Import and excise duty exemption only applies to hybrids below 2000cc, and they still attract sales tax of 10%.

      2. Non-hybrid CBUs (and especially those from outside ASEAN) attract the full weight of import (30%) and excise duty (80%-105%), especially for cars above 1800cc. I don't think you can generalise from these examples to the entire market.

      Delete
  8. Salam Hisham,

    With due respect, I think the averaging out of the excise duty reduction creates a skewed picture. The reduction would lead to significant falls in foreign car prices, as you have pointed out, and I think this would by extension lead to more customer choice and competition in the market.

    ReplyDelete
    Replies
    1. @anon 5.45

      Absolutely, calculating the average certainly obscures the different tax burdens on specific cars. On the other hand, the average I've calculated is a lot more informative than assuming car prices could be cut by 40% just by abolishing excise duty.

      Delete
  9. The latest Proton Saga SV shows some good move by Proton when comparing the price between SV vs FLX Standard which is estimate 5K different but have more accessories in it.

    But I'm hoping for non-national cars to join the price drop as well.

    ReplyDelete
  10. My economics is really outdated but I do work in the automotive sector, but there are countries with higher level of vehicle pricing (like Australia) even without tariffs or taxes, it's purely demand side - high wages mean that the same car costs about 30% more than it does in the US. It's the lack of competition (and general collusion among manufacturers) and large disposable income that's to blame, I think. The AP issue is a bit of a red herring, it's true that's one bottleneck that restricts competition (what with all the accusations of "who" generally gets those APs) but the bigger bottleneck is that there's only 5-10 major automotive manufacturers anyway and they get to set prices before the cars reach the wholesale level anyway.

    Anyway, as an illustrative example, when the AUD went up in value by 30-40%, the "cost" of importing all these cars went down, but their prices didn't drop dramatically... the price points stayed similar, maybe dropping 10% on some models, but they all just upped the content level on the models to sweeten the deal... from a marketing perspective, it's a better branding exercise to announce to the press that your cars are now equipped with Sat Nav and Automatic Parking as standard, rather than announcing a $2000 price drop, even though the "value for money" proposition is identical.

    I suspect car prices in Malaysia will be sticky that way too to "some" extent. What's happened is that society is habituated to prices at a certain level (small car at XXX, medium car at YYY, large car at ZZZ, etc) and prices outside those ranges make consumers feel uncomfortable, even if the value for money is "right". Currently I believe (from the models I've seen and compared) Malaysia gets slightly downspecced variants of international vehicles, if the costs of importing them go down (either by rise in MYR or reduction in import taxes) most manufacturers will try to keep their prices the same but add content to their vehicles, similar to the situation in Australia.

    ReplyDelete
    Replies
    1. aetherfox,

      Absolutely agree - if the market was really competitive, prices wouldn't stick so high for so long. Even without Proton, there's just too few players and even fewer distributors locally, to think that market forces will move any faster than a snail's pace.

      Delete
  11. Instead of explaining it in such a macro way, why don't we explained it in a simple way where layman can understand it and useful for them to make decision. Example, if we buy a Toyota Camry 2.0 today in Thai, it is about RM110,000 and in Malaysia is about RM140,000. Then go line by line, what have cause the difference. And conclude, how much excise duty do we actually paid for Toyota Camry. Use 2 or 3 more example, like Honda city, VW, etc. Appreciate it.

    ReplyDelete
    Replies
    1. @yauwenchin

      I wish I could - But the reason why I can't and why there is so much confusion over the level of excise duties is because the specific numbers for each model under each brand is not publicly available.

      Delete
  12. Isn't this an asymmetric information problem? i.e. consumers don't really know how much of the cost they are paying for their cars really go into paying taxes thus manufacturers/distributors have an incentive to put a premium on branding? Apparently EBIT margin for automotive segments in UMW is at abt 17% while proton's EBIT margin is below 5%. So they are essentially riding the protectionist policies meant for proton/perodua to jack up car prices and profits in general.

    Could you then argue that car prices can be made cheaper not through a cut in the excise duties but with a more transparent pricing mechanism? I mean, i don't generally agree with having cheaper cars in KL for many reasons but shouldn't the debate on prices then be shifted from the excise duty issue?

    ReplyDelete
  13. Hi Hishamh

    My name is Yang and I am an analyst covering the automotive industry. i am given a task to conduct an analysis of the 2014 NAP. would be great if i could buy you coffee and meet up. thanks

    ReplyDelete
    Replies
    1. Hi Yang,

      I'm not sure what I can contribute, as I'm not a microeconomics specialist. But email me if you're still interested econsmalaysia@gmail.com

      Delete
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