Growth and taxation – it seems like a contradiction in terms. Taxation tends to create economic distortions, affecting decisions on consumption, investment and savings. This happens because taxes change the incentives facing economic agents – a consumption tax reduces the propensity to consume, an income tax reduces the incentive to work and invest. Subsidies work in the exact opposite way.
But there are forms of taxation that can promote growth – or at the very least, be less distortionary. That’s a point that’s almost totally absent from the debate surrounding the implementation of GST in Malaysia:
- As a value-added tax, it’s far less distortionary than the SST system that’s currently in place; and
- Because just like in any other country where a VAT has been implemented, exports will be zero-rated. As a result, GST will also actually give a (minor) fillip to growth relative to the SST system
The concerns most people have about GST is that prices of many goods and services will (or might in some cases) go up. But given that GST will be replacing SST, everybody is missing the flip side of that equation – incomes will go up too, and will partially offset the loss in purchasing power from higher retail prices.
The real trick is in the distribution of that income, but that is being partly handled through the mitigation measures the government has put in place as sweeteners, partly by other measures such as the minimum wage. But that’s really a totally separate policy question.
Lest you think I’m blowing smoke, here’s a quote from the European Commission’s Annual Growth Survey 2012 (Annex IV, pg 4; emphasis added):
A high tax burden on labour, especially on vulnerable groups, combined with low indirect and consumption taxation may indicate a need for rethinking the structure of a tax system. Economic literature points to the importance that tax composition plays for economic growth and suggests a ranking of the main categories of taxes with regards to growth, with taxes on immovable property being the least distortive to growth, followed by consumption taxes (including environmentally-related taxes) and, finally, income taxes (on personal and corporate income) being the most harmful….
…The analysis in the 'Tax reforms in EU Member States 2011' report of the potential to make the tax structure more growth-friendly suggests that some Member States might enhance economic growth by shifting their tax structure away from labour (personal income tax and social security contributions). Some Member States have recently shifted to some extent the tax burden towards consumption taxation, mainly by increasing VAT rates and excise duties....Increasing consumption, environmental and/or housing taxation could be a way to alleviate the high tax burden on labour, while enhancing the growth potential of the economy.
And then there’s this very, very interesting proposal:
If I had any real power I would tax you all in the following manner:
First, I’d impose a consumption tax such as a VAT on traded goods and services. The consumption tax will have to be progressive, for example by way of a 0% tax on food and other basic necessities and a rate close to 100% for luxuries. A consumption tax encourages savings and investment and does away with the disincentives of income and payroll taxes which it will replace (disincentives to work, earn and hire)….
…Second: add an inheritance or estate tax because the wealthy, who will save more as a consequence of the consumption tax, will die with larger estates than before. Inheritance is inherently unfair because undeserved. A tax on inheritance not only reduces this unfairness, but does so without distorting incentives….People will not die less when wealth and assets are taxed after death. This tax is therefore sustainable, in addition to being moral….
…Third: add a land value tax. This is a wealth tax, but not really a real estate tax, because the largest part of the value of real estate is the value of the land, not the value of the buildings….A land tax is similar to an inheritance tax: no one built the land, so people will not have less land when it’s taxed. And because no one built it, no one can be said to deserve it….
Fourth: add some pigovian taxes (taxes on carbon and other externalities such as pollution, congestion etc.).
Fifth: abolish all other taxes, including taxes on investment income or normal income, on corporate profits, on labor/employment etc.
It’s an utopian vision, but certainly contains enough sense to provoke some reflection.
And here’s another one, which is highly relevant for Malaysia (excerpt, emphasis added):
Resource-rich countries face a peculiar set of challenges; natural wealth can be both a blessing and a curse. This column looks at links between natural-resource revenues and other taxes. Results suggest that these countries tend to substitute domestic taxes with natural-resource-based revenue; 30 cents in non-resource tax revenue are lost with each dollar of resource revenue. Worryingly, the substitution occurs disproportionately for growth-friendly taxes….
…One could argue that the increasing share of resource revenue has allowed natural-resource-rich countries to reduce their reliance on distortionary taxation. This would help promote private sector activity and thereby encourage economic growth. Recent analysis of OECD economies suggests a growth hierarchy amongst taxes, with property taxes and broad-based consumption taxes – particularly VAT – being the most growth-friendly, with little distortion to savings and investment (OECD 2010, Acosta-Ormaechea and Yoo 2012). At the other end, income taxes (along with corporate income taxes) are seen to have the most adverse effects on growth, as they interfere directly with economic decisions (see also Heady 2011)….
…Our econometric results show that substitution between natural resources and domestic (non-resource) tax revenue has indeed occurred….The largest negative impact is found on taxes on goods and services – in particular VAT – while a more modest impact is found for income and trade taxes….
There are a number of reasons why a well-diversified tax base which comprises taxation of the non-resource sector is a worthwhile policy goal. To start with, natural resources may not last forever, and building a reliable tax base and a culture of tax compliance takes time. Moreover, resource revenues tend to be highly volatile, and in the absence of an appropriate fiscal framework, this volatility is transmitted to the budget. Furthermore, there is ample evidence to suggest that countries with a heavy dependence on resource revenues are less democratic, suffer from the ‘resource curse’, experience higher levels of corruption, and have little incentive to strengthen their tax systems to mobilise revenues from non-resource sectors. Unless the population pays taxes, there is inadequate motivation for them to hold their government accountable.
While resource-rich countries – especially those where resources are expected to last for a long period – could reduce reliance on distortionary taxation, our results suggest the opposite: these countries have in fact reduced reliance on taxes that are considered to be best suited for fostering economic growth.
Have a read, especially of the latter two.