Sunday, May 15, 2011

Working In The Shadows II

In my recent post on GST, one commentator suggested that it would be a fairer tax simply because it would bring in all those who aren’t part of the “official” economy, the so-called shadow economy. I didn’t realise at the time just how perceptive this comment was – at least in terms of the potential impact.

For looking back, I’d actually made the same point in a post about half a year ago, based on a recent Policy Research Working Paper from the World Bank. I’ve been blogging so much, I can’t keep track of half the posts I’ve made:

Working In The Shadows

So how big is the shadow economy in Malaysia? The authors use 7 different estimation specifications, which yielded broadly similar results – averaging between 30.7% to 31.3% of official nominal GDP, from 1999-2007, with a 15% error rate. That’s a little below the median for the East Asia region as a whole, so we’re par for the course here. But it does imply that the Malaysian economy is 25%-35% bigger than implied by the official GDP statistics.

One obvious reaction here is to look at the potential shortfall in government revenue, though I’m going to resist the temptation to use simplistic mathematics and claim that we could get a 30% boost to government revenue by bringing these activities within the formal economy. Given the smaller scale of these activities, the net increase in taxation should be fairly small.

On the other hand, a more efficient taxation system and more consistent regulation would help bring these activities under the “official” economy, and no doubt help government finances as well as give a boost to “official” growth.

Time to bring on GST?

For comparisons sake, the top three “developing” countries are Singapore, China and Vietnam with shadow economies around 13%-15% in size. All have low levels of direct taxation i.e. income taxes.

So yes, GST might be far more effective in raising fiscal revenue than we realise.

Technical Notes

Schneider, Friedrich; Buehn, Andreas; Montenegro, Claudio E., "Shadow economies all over the world : new estimates for 162 countries from 1999 to 2007", The World Bank, Policy Research working paper no. WPS 5356, June 2010

* There are a number of versions of this paper, dating back to 2005. This version represents the latest estimates and an enlarged sample size.


  1. GST a fairer tax ? bringing everyone not in the official economy ? that means taxing retirees, kids, housewives ... this is an excuse at best to get back money we had squandered away so easily. I would much prefer they put more effort in stopping the public leakages and poor planning public projects. This doesnt need economy knowledge at all, it is common sense 101.

  2. I always wonder why we need to pay income tax globally when those in power can create money as they like to solve problems for bankers and state linked corporates, and flash a M2 chart and said everything is well under control, funny people, and said money can be destroyed (like they are responsible individual to pay down debt). Before 1900, america has no personal income tax at all, that should be the way, government should be small in size, government these days are too big creating menaces worldwide.

  3. GST is more "efficient", in that for a given tax rate the tax yield is higher.

    You also have to factor in that:
    1. Basic essentials (food, petrol) will almost certainly be zero rated i.e. no GST. Every country that uses a GST/VAT tax regime does this;
    2. GST will replace the current sales and service taxes, which are set at higher rates (if you notice, you're currently paying 15% extra on hotel and restaurant bills for example; legal fees get 10% added on);
    3. It will also almost certainly be concurrent with a cut in income tax.

    So yes, I'd say its fairer - you only pay tax if you consume "non-essentials". The more you spend on non-basic items, the more you pay.

    I'd prefer a tax on wealth (e.g. zakat), but that's really hard to quantify, which is why the majority of governments tax income instead. A consumption tax is a second best alternative.

  4. The limit to "printing" money is the output of goods and services that an economy produces. If a government consumes (and finances) more than the excess of output over private consumption, that's the trigger for inflation - but not before.

    It's generally not done because of the impact on the credibility of the issuer of the currency i.e. the central bank.

    BTW, America in the 1900s might have had a small government, but it also had an enormously unequal society dominated by the rich, a financial system that was prone to crashes, and periodic depressions caused by an adherence to a metallic monetary system. There's a reason why countries have left the gold standard behind.

  5. But I do not earn enough to be in the tax bracket.I do need to buy TVs,washing machines,books n magazines.I also subscribe to ASTRO,Streamyx,mobile phones etc.

    Will I be paying more?
    Any tax reduction will not help me.
    I estimate that I need to fork out 560 ringgit extra after GST.I guess govt will be able to reduce taxes on the better offs with the additional income they get from me.

    GST is good if there is more parity in the country.I think Msia with the too big poor/low middle income and the small upper n rich is not ready for GST.

  6. Books, magazines and broadband are likely candidates for zero rating - no GST payable. My guess is you'll pay at worse a minimal amount more.

    Plenty of low income countries actually do impose VAT/GST.

  7. Wrong, no one wants to leave the gold standard, it was president nixon one handedly did it and we just follow because of their military might and us dollar as the reserves currency. Money today is not money, it is paper currency, it is monopoly money, it is the most dangerous thing and we should not put our belief in it. Gold silver do nothing good to the world growth, so be it, what is the good use of growth when it is artificial, it is driven by credit reckless overconsumption, gold silver at least they dont cheat people's wealth.

    I am really worry because if all economists in malaysia think metal is useless, then we are in trouble. Look at our gold reserves, 30 tons of gold ... loaded with tons of papers with different heads with no significant meaning.

    dont forget the economy almost went into cardiac arrest just as recent as 2008, next time we wont be so lucky anymore.

  8. metal standard doesnt solve rich poor inequality, so does fiat monetary system. at least people were able to save money that has purchasing power intact and houses speculation was not widespread. Even worse is fiat money system encourages people to spend on the wants with future money , to generate growth for short term glory.

  9. The system we have today is to reward the corporates and rich because economists are taught that they are the producers of society, cannot be touched. Therefore who suffered, middle class again ! GST is something that will hurt middle class the most !

    GST ... GST ... so how about public project leakages as reported by auditor general's report, why is PEMANDU turning a blind eye on that while suggesting GST ?

    Same thing on fuel subsidies, they can take away, but please remove import taxes on foreign cars and the AP system, national automotive policy.

    as you can see, so much inequality in the social system today, we dont need economists to explain this and that, all you need is common sense and conscience, perhaps someone with a moral compass and do groceries weekly will be a good leader.

  10. @anon 1.18

    You're confusing the gold standard with the Bretton Woods system. Most countries left the gold standard in the 1930s.

    The problem is not that a gold system is bad for growth. If that's all it did, I don't think anyone would mind so much. The problem is that it also directly creates the conditions for depressions.

    Worse, it also creates the conditions for a return to mercantilism, colonialism and imperialism. If the unit of account of the stock of wealth is fixed (or worse, increasing in value), then the only way a people can improve their own wealth is to appropriate, assimilate or annihilate.

    And you're mistaken if you think that a gold/silver standard would create economic stability. Prices of goods are three times more volatile in gold terms than they are in USD terms.

  11. @anon 2.07

    The main reason for inequality in society today is because the prevailing thinking is that markets are always right. That simplistic worldview ignores the asymmetry of bargaining power between labour and employers, an imbalance that has gotten progressively worse since the 1980s globally.

    Railing against GST isn't going to change that dynamic. What we need to do is strengthen labour laws and encourage more collective bargaining.

    Can I also point out that GST will replace the sales tax? At a lower rate no less? How then do you figure that we have to pay more?