Budget 2016: Some Thoughts

The best laid plans of mice and men…

I was going to put up an analysis of Budget 2016 the day after the budget, but as luck would have it, I managed to come down with pneumonia and have spent most of the last two weeks trying to recover. So here’s a very belated, quick overview of what I think of the budget.

Or you can take this is as the confused, feverish ramblings of a diseased brain.

Macroeconomic Projections

Downgrading growth to 4.0%-5.0% for next year is sensible. Chances are growth this year will also probably come in at the lower end of the 4.5%-5.5% range the government is expecting. Inflation is expected to come in at about 2%-3% i.e. more or less where it has been for the last 40 years.

Private consumption has held up pretty well this year despite slowing wage growth and the introduction of GST – too well in fact. My suspicion is that part of this is the bringing forward of consumption pre-GST, but also due to the impact of imputed consumption (rent) from home-ownership. A quick survey of other major economies suggests this forms as much as 20% of private consumption. We don’t have a breakdown for Malaysia, but I don’t think we’re that far out of line. That suggests that despite all the negatives carrying over from this year (slower wage growth, reduced wealth effect from house prices, GST, and low consumer confidence), private consumption might continue to “outperform” next year as well.

Breaking Down the Budget

Both revenue and expenditure will fall to the lowest level (relative to GDP) in a decade and a half. Government revenue is expected to fall 18.7%, and operating expenditure to 17.8%. Meanwhile development expenditure will see the first rise in relative terms since 2013, though it will still be well below historical levels. All told, the fiscal deficit is forecast to hit 3.1% of GDP.

A couple of takeaways here:

1. Fiscal consolidation is still on track, even if the deficit hasn’t been reduced by much
2. It shows just how much of a bind the government is in at the moment

The big factor of course has been the drop in oil & gas related revenue. PITA is down by nearly two thirds to RM9.5b in 2015, and is slated to further decrease to RM9.3b in 2016. That’s on top of the RM10b reduction in the Petronas dividend. Combined, those two items contribute to a nearly 10% drop in overall revenue, which is mostly, but not wholly, covered by the take from GST. The remainder of the revenue gap the government hopes to cover (somewhat optimistically I think) from increased corporate income taxes (+8.9% yoy).

Here, I think the increased transparency from the GST implementation will be a big help here – hard to run away from the corporate tax, when your monthly sales and inputs are reported to Customs. Still, it would be a pleasant surprise if LHDN actually does claw that much in.

GST to the rescue

GST of course is a game changer, and not before time. GST revenue for 2015 is going to be substantially larger than initial estimates, and 2016 is expected to be close to 10% higher. This implies that the economy is much larger than the official statistics show – estimates of Malaysia’s shadow economy suggest that it is as large as a third of the official economy.

More importantly, revenue from GST will be greater and much more stable than the SST it directly replaces, and the oil & gas revenue it indirectly replaces. That’s critical, not just for government funding, but also for the soon-to-come reform of the social security net. Revenue based on commodities that are subject to global price volatility is a pretty shaky basis for welfare spending, especially with the poor outlook for Malaysian LNG.

Of course, we shouldn’t ignore the negative impact GST has had on consumer welfare – it looks like most households will have minimal real income growth this year, though this would be a one time effect. Most of the components of the CPI have already settled down to their pre-GST behaviour, with the notable exceptions of food and furnishings. However, food appears to be the only major consumer category where prices have been affected by the drop in the MYR. The acceleration in furniture prices is harder to explain, and is the only real outlier so far.

Robin Hood?

The addition of two income tax brackets at 26% for incomes above RM600k and 28% for incomes above RM1 million was a big surprise – there was no intimation of it anywhere.

Let me stop here and say that, unlike some have written elsewhere, this measure doesn’t make this a “Robin Hood” budget. For starters, the number of people affected (about 17,000 or about 0.1% of the workforce) and the revenue raised (about RM400m) are too small to have any kind of redistributive impact, or raise government revenue in any significant way. Second, given that optimal tax theory suggests personal income taxes should be 35% or higher (from my vague recollections of the research), there’s no strong disincentive for people to continue to work or invest in Malaysia, especially since corporate taxes were not touched. So much for giving the “wrong” signal. In fact, my only concern here is that the difference between corporate and personal income taxes opens the door to tax arbitrage, for example taking more compensation in the form of share options.

So why bother? From my point of view, this is only worth doing as a way to limit wealth accumulation in the top 0.1% of the income distribution. It’s largely symbolic, since we’re not talking about large sums of money, but still a step in the right direction. On my wish list: Can we have a substantive public discussion on the merits of a capital gains tax please?

Miscellaneous thoughts

1. Tax relief for the middle income group – welcome, but relatively minor
2. Civil service pay revision – after the disaster of the last attempt, this one should be rather innocuous. The minimum pay of RM1200 should be a boost to consumption next year, and incidentally, help ease the debt constraints many civil servants are under.
3. BR1M – as expected, though it remains unconditional and subject to leakage.
4. Announcement of the nationwide minimum wage revision – I’m in two minds about this. One is that it’s well overdue and should be welcome for the bottom 20%, though the increase is above the rate of inflation. On the other hand, this would also put many SMEs under a lot of pressure, and push inflation in the services sector. Eating out will get more expensive, and I would expect a permanent increase in the rate of unemployment going forward.
5. Affordable housing – I’ll believe it when I see it.
6. Lastly – this has got to be the shortest budget speech I’ve ever listened to. “You mean, that’s it?”

Conclusion

On the whole, this budget is pretty neutral. On an aggregate basis, the minor reduction in the deficit is insignificantly negative for the economy. But really, given the circumstances, that’s not a bad policy choice. Growth is expected to still be near potential, as the drop in the Ringgit has borne most of the heavy lifting in terms of adjusting to the terms of trade shock from fallen commodity prices. There’s little call or need for a fiscal stimulus, especially since BNM still has some room to adjust monetary policy, though household debt remains an issue.

It’s an unexciting, steady as she goes, compromise budget; but then, most budgets are.