[I wrote this article for a mainstream newspaper in August last year. It should be read in conjunction with this post]
It’s almost that time of the year again, when the Federal Government sets about planning its budget for the year ahead. With Malaysia’s sovereign credit rating at risk, it’s also time to take a look at reforming tax policy. One avenue that should be explored but has gotten little public airing is adding a capital gains tax (CGT).
Malaysia like many other East Asian countries does not impose taxes on income derived from capital gains which are defined as profits from the buying and selling of assets, including but not limited to shares on the stock market and on mergers and acquisitions (M&A) activities.
Years ago, the prevailing thinking was that taxing capital gains caused people and businesses to invest less, which reduces long term productive capacity. Taxing capital gains, as opposed to taxes on incomes from wages or dividends, was thus thought to be growth negative. As a result, existing capital gains taxes in advanced economies were cut and in developing economies largely never imposed at all.
But these tax cuts had a perverse effect. Instead of increasing investment and overall income growth, what happened instead was an increasing share of existing income growth went to owners of capital. In other words: where capital gains taxes were cut, the income gap between the rich and the poor increased. This stands to reason, as a higher tax rate on wages would skew the burden of taxation away from the rich to the middle class and the poor.
What would be the impact of imposing CGT? First, it makes things a little harder for entrepreneurs and their investors to exit businesses they’ve built, for example through stock market listing. I’d think this is a really minor portion of the Malaysian business landscape and it’s certainly not a factor in advanced economies like the US.
M&A would also be impacted as share owners selling out would need to pay tax on their capital gains and, very obviously, the same consideration would affect punters on the stock market.
But for most businesses and ordinary Malaysians, CGT would have no impact at all. Wage earners wouldn’t be affected, and companies that grow and invest organically – through productivity, efficiency and profitability – won’t be either.
Consider also that dividends are taxed while capital gains are not. That means long term investors are effectively penalised relative to short term investors and speculators. It’s the same consideration and rationale that gave rise to the real property gains tax (RPGT).
An effective capital gains tax would help redress the inequitable burden of taxation, as well as help to address income and wealth inequality. More than that, it’s also a potential weapon against excessive market speculation.
Concerns over the negative investment effects of a CGT could be addressed by following the RPGT model and levy taxes on a transactions basis, as well as impose a tiered structure to encourage long term investment. And let’s not forget that a CGT would also help refill the Government’s coffers.