Tuesday, November 7, 2017

Thoughts on Alternative Budget 2018

So, I’ve finally sat down to read through Pakatan Harapan’s alternative budget for 2018. There are some good ideas here, and a fair share of bad ones, but no more than expected. The numbers are bonkers, but I expected that since this is more a political manifesto than a real fiscal document. I’ll give most of it a pass except the more egregious ones, and like many, I note that some of the policy objectives and prescriptions are contradictory. At least one proposal has me upset, but I’ll leave that for the very last.

Can the (overall) numbers be achieved? I’d say yes. If the government really wanted to, they could go with a balanced budget tomorrow. But I think it would involve as much cutting the provision of public goods and services, as it would be some putative “savings'” from reducing corruption and improving governance. I’m sceptical that there’s that much savings to be had from that source.

In any case, I really question the need for balancing the budget when there are good arguments for maintaining a deficit. Sustainable fiscal policy neither calls for nor needs a balanced budget approach, and really should be seen in the context of all institutional sectors, and not the benefit of the government alone.

But first, on to the good bits:

  1. Reinstate spending on health and education – absolutely needed and welcome. But I don’t think Pakatan is aware of just how much is needed here long term, and I note that there is zero mention of managing the issue of pension entitlements here.
  2. Setup of heritage fund from oil & gas revenues – as noted, the fund already exists, but funding should certainly be boosted. The fixed formula sounds nice, but if you want to be true to the principle of investing all gains from non-renewable resources, ALL oil & gas revenues should go to the fund (including corporate tax revenue from LNG, which does NOT fall under PITA). That is after all, how Norway actually does it. More importantly, both the Alaska and Norway funds directly underwrite pension and other transfers to citizens, not “finance government deficits”. Returns from Singapore’s Temasek for example are channeled to endowment funds used for specific social purposes (such as health insurance for those outside of the CPF system), which the government can’t touch. Can we have some really serious consideration of this please?
  3. State finance – I’m becoming more interested in this topic, since it’s becoming clearer to me that the entire system badly needs reform. Revenue sharing is one option, but there’s also the possibility of states being allowed to levy certain forms of indirect taxation themselves (e.g. state level sales tax/GST as in India or the US). For example, you can have sharing of GST revenues, based on the amount that was raised in each state. The current reliance on property taxes and land conversion premiums means that state revenue raising is partly culpable for rising housing unaffordability.
  4. Fiscal reporting – some really nice points here, though I think MOF is continuing to work on implementing accrual accounting. I believe one of the sticking points is asset valuations (accrual accounting also includes publishing the government’s balance sheet, hence the importance of tabulating asset values, i.e. property, under each Ministry). I’m disappointed however that there’s no mention of a fiscal council.

The I-don’t-know-where-to-put-it category:

  1. Raising minimum wage to RM1,500 – It seems to me that the minimum wage forms a critical linchpin in Pakatan’s strategy to raise household incomes. The co-pay idea makes the proposal viable because it’ll mitigate the disemployment and business cost effects, but at a ridiculously high cost. At RM2.6b, you’re spending the equivalent of half of BR1M on a very small segment of the labour force. Second, there’s the presumption that the minimum wage forms the bottom of the income distribution. It doesn’t – it only forms the bottom for the salaried worker distribution and an imperfect bottom at that (see the last point at the end of this post for more on this). Then there’s the issue of people who earn the minimum wage on an hourly basis, but don’t work enough hours to reach the monthly minimum. Third, as others have pointed out, there’s all the people who earn between the current minimum wage and the RM1,500 target. By my count, there’s roughly 3 million people with salaries at RM1,500 and below, and roughly about the same with equivalent incomes in the informal sector. That’s significantly more than the 361,000 this budget assumes will need compensation. So on the one hand, there’s the issue of fairness in compensating perhaps just half the workforce at those income levels, and on the other the far bigger cost than is assumed.

The Bad:

  1. Abolishing GST – this has me totally confused. The clunky compromise that Pakatan came up with is to zero-rate GST for all goods and services, and reinstitute the Sales and Services Tax. Um, what’s the point? Wouldn’t it be simpler to just restrict the GST list to those goods and services under SST? At least this way, consumers are clear on what goods and services are being taxed, unlike the completely opaque and hidden Sales tax. In any case, bringing back SST will bring back all its old problems – leakages, cascading effects, and the de facto taxation of exports. Lastly, despite all the rhetoric about GST (and SST) being regressive, the tax incidence is actually highest on the upper middle income group. Abolishing GST is actually a tax cut for the urban elite.
  2. 20% consumption boost from abolishing GST – I can’t make head or tail of the assumptions here. One is that the effective corporate tax rate is about 19%-20%, versus the headline rate of 24% i.e. the government collects fully 1/6th less from corporate profits than implied by the headline rate. Second, MPC of households is about 0.5, so roughly half of any tax cut wouldn’t be spent, especially since most of the tax relief would be on middle and upper income households. Third is that 20% higher transactions in both the property and car markets isn’t exactly an economic positive. The property market looks depressed because the past decade has seen an unsustainable boom – I don’t think anyone (outside of property flippers) wants to see those kinds of speculative price increases again. Plus, this directly contradicts the stated policy objective of reducing household debt to 75% of GDP over the next five years. The car market looks depressed because we’ve seen an expansion in public transport and ride sharing. Also, the idea that removing GST will boost the car market ignores the fact that one of the biggest contributors to the sales tax was the auto industry – car prices might actually rise under SST. Lastly, any kind of consumption “boom”, especially the double-digit variety, is likely to elicit an immediate and vigorous monetary policy response from BNM.
  3. Backing Management Buyouts of GLCs – uh no. We just spent a whole generation getting away from individual ownership of corporates to institutional ownership, with all that implies in terms of improvement in corporate governance. Then there’s the issue of debt loads affecting corporate strategic decision-making (i.e. emphasising short term gains to service debts), as well as increasing corporate vulnerability to economic shocks. Let’s not go down that route again. The biggest issue with GLIC ownership of corporate Malaysia is really the lack of viable domestic investment alternatives, something wholesale MBOs will not solve, since the proceeds of buyouts will need to be redeployed into a now smaller investment universe.

The Ugly:

  1. Bringing back fuel subsidies – fuel subsidies as a whole tend to benefit the better off, so targeting the lower half of the income distribution makes sense. Except this would be a nightmare to administer. Who’s going to check IC and engine size, the station attendants? Most petrol kiosks have shifted to self-service. This kind of scheme is just begging to be abused. Here’s a little secret – the government seriously evaluated such a scheme, but gave up on it because it’s really unworkable. It would be simpler to just boost BR1M, or add a variable component to it that’s linked to oil prices. You hit the right demographic using an existing mechanism that won’t cost you extra to set up, and won’t leak (much). Nevertheless, the whole notion of fuel subsidies directly contradicts all the fine sentiment in pushing the idea of a heritage fund from Petronas. Once again, consuming the proceeds from the extraction of non-renewable resources is a BAD economic idea. If good governance is the real objective, fuel should be taxed instead.
  2. Speaking of BR1M – conditionality is good, especially when it comes to health and schooling. Basing conditionality on continued employment however is paternalistic, elitist, and will automatically disqualify most of the people BR1M is actually targeted at, like retirees, while perpetuating the idea that the poor are poor because they are lazy. This also shows a startling ignorance of what the Malaysian labour market actually looks like. For example, insisting on proof of three months of employed labour via EPF/SOCSO contributions means excluding the bottom 20%-30% of active EPF contributors, some of the very same people BR1M is supposed to help – the median contribution frequency of that segment is just once a year. Also, more than half the labour force are either in informal work, self-employed, or in the type of jobs where pay is variable (which don’t require EPF contributions). Thumbs down.

There’s a few other interesting ideas I won’t comment on (the Bolsa Familia proposal, the proposals for agricultural reform, free tertiary education) – some have merit, some don’t, in my view. The overall impression I get is a budget that speaks directly to Pakatan’s established constituency – essentially the urban elite and middle class.


  1. Hi hishamh, sorry, i thought its ok to go for balance budget if we have significant amount of off-budget expenditure?

    1. @Group 8

      That doesn't necessarily follow. I tend to look at the balance between all the institutional sectors, rather than just the government itself. Context matters.

    2. Equilibrium context of the whole economy?

    3. @anon

      Growth will be slower under the Alternative Budget, unless there is crowding in, i.e. there is a monetary policy response to lower government expenditure, and thus higher private sector consumption and investment. Or in other words, the government reduces its borrowing, by inducing the private sector to increase theirs.

  2. Wouldn’t it be better to begin privatising many of the corporations that are owned by GLICs? This would prevent many problems related to governance, and would also reduce implicit liabilities. It would also give markets more say in allocating resources, reduce systemic risk, and increase liberty and choice.

    1. @anon

      Here's the underlying problem. The truth is that the GLICs have grown so large that selling down is literally not possible. Selling off GLIC corporate stakes sounds nice in theory, but then the GLICs have to buy into something else (as they have to be fully invested), which means that most corporate assets will just circulate among the GLICs - we'll be buying and selling among each other, with no net reduction in ownership.

      The only way a true selldown of GLIC stakes in corporate Malaysia can happen is by increasing their overseas exposure (sell local, buy foreign), which implies that the opposite must happen with foreign investors (buy local, sell foreign).

    2. Hisham,

      What about specifically on Khazanah (which is wholly-owned by federal government, hence taxpayers money)?

      Other GLICs like EPF, PNB, KWAP, etc. are technically "privately"-owned, right? So, if the topic goes back to fiscal policy, it should be confined to only Khazanah.

      And, Khazanah has been selling some stakes in its GLCs portfolio lately.

      Should divestments be part of fiscal strategy in Malaysia?

    3. @Fung

      Technically you're correct (except for KWAP), and in fact that's even acknowledged in the TPPA. However, most people do not see it that way, and Prof Gomez' book doesn't help.

  3. Hi Hisham,

    Happy New Year.

    You noted, " Lastly, despite all the rhetoric about GST (and SST) being regressive, the tax incidence is actually highest on the upper middle income group. Abolishing GST is actually a tax cut for the urban elite."

    Any source for this.


    1. Happy New Year Greg.

      The source is not public. It comes from simulation data from the GST Implementation Unit that was presented to a few local economists before GST was implemented. Highest tax incidence (tax/income) was on households earning between RM4k-RM10k, or roughly from the median to about the top 15% of household income. Since the zero-rated list has been expanded since then, progressivity of GST is likely even higher than initially expected.