2Q 2011 Federal Government Finance

In today’s the Star (excerpt):

Govt should cut expenditure

IN just over two weeks, the Budget will again be presented to the people and like always, Malaysians will be wondering what goodies the Finance Minister will have in his briefcase for them…

…Realism, however, dictates that the giving will be hamstrung by the state of finances.

Dishing out more tax cuts, waivers or rebates could mean less tax collection in the future and with the Federal deficit expected to hit 5.4% this year and at around the 5% range for Budget 2012, the realism of public finance is that more money will need to come in before money is lavished elsewhere.

GST On The Cards Again?

From yesterday’s Star:

PM: Income tax may be reduced once GST is in place

PUTRAJAYA: Corporate and personal income tax may be reduced with the implementation of the goods and services tax (GST), Prime Minister Datuk Seri Najib Tun Razak announced Tuesday.

He, however, said the government was still engaging with the Public Awareness Education Programme to educate the people on the advantage of the GST.

"As far as the people are concerned, there is a growing acceptance that the GST is good," said Najib, who is also Finance Minister, to reporters after attending the Budget 2012 Consultation here Tuesday.

GST Postponed

Of all the news that’s come out over the last couple of days, the news over the postponement of GST (Goods and Services Tax) implementation has got to be the most disappointing (read the original press release here, reasonable English translation via The Star).

The reaction (and underlying explanations) to the postponement are more disappointing still (emphasis added):

GST acceptance easier if reductions known upfront

PETALING JAYA: The goods and services tax (GST) may have found easier acceptance if the Government had made known a reduction in corporate and personal tax rates upfront.

Observers said due to the politically sensitive nature of imposing new taxes, even indirect ones, the move to implement the GST necessitated a more transparent communication over how and when personal and corporate taxes would be restructured...

Why Individual Income Tax Cuts Won't Boost The Malaysian Economy

Now that the mini-budget has a date (March 10), speculation is increasing regarding what's going to be part of the stimulus plan. One idea that continues to be popular is the personal income tax cut - but as this article argues, the effect might be very small relative to the revenue loss to the government. In other words, there are better uses of the money that might have a greater impact on the economy. I find the line of argument a little confusing though - what the heck does "taxpayers’ role is a small proportion of the total labour force" mean?

Leaving aside the Laffer curve controversy (see:Reagonomics or Bushinomics), there's a very strong argument against using tax cuts to support economic growth. If, as the case should be here, the tax cuts (or rebates as the case may be) are expected to be temporary and will be lifted after the crisis, then rational economic agents would treat any such income as a windfall and save it rather than spend it. This means there would not be any boost in aggregate demand.

In real life, people aren't always fully "rational" in the economic sense - some of it will be spent, even if such spending is not logical and does not maximise utility. This was clear from the first Bush fiscal initiative just after the onset of the crisis, where there was a mini-boost to the economy in mid-2008. Nevertheless the boost was very short-lived, indicating possibly weak multiplier effects and reflecting the fact that the stimulus didn't resolve the underlying structural problems in the financial system.

Another issue with tax cuts is that it will only affect those who actually pay taxes. While I don't have the figures with me, my personal tax experience suggests that the lower-income group will receive little if any benefit from a cut in marginal rates. Unfortunately, this would be the group that would be most effected by the slowdown in growth, and need the most help. I'm thinking this effect is what the article meant by "narrow role of the taxpayer".

More to the point, a 1%-2% cut in personal income taxes won't actually release much money into the economy - at least relative to the stimulus required. Individual income tax only amounted to around RM12 billion in 2007, and under RM16 billion in 2008 for the first three quarters (much less than half of the take from companies). A 2% cut might put in RM1 billion into the economy, most of which would likely be saved. Remember that a cut in the rate effects mainly the top marginal rate, not the tax brackets necessarily. I'm doubtful whether a change in the tax brackets themselves might be effective either.

I'm more of the view that fiscal expenditure would probably be more effective, but that's a post for another day.