Posted on 24 October 2013 - 07:21pm
Last updated on 24 October 2013 - 08:16pm
Raja Ahmad Shahrir
The avoidance of taxes is the only intellectual pursuit that carries
any reward. – John Maynard Keynes
PAKATAN presented the shadow budget on Wednesday and Thursday in anticipation of the Federal 2014 Budget. One important area that warrants serious attention is the implementation of GST.
In the last 20 years or so, GST (or in some countries VAT) has been implemented in developed and developing countries to broaden the tax base and increase government revenue. The official website of the Royal Malaysian Customs Department states that as of 2010, a total of 146 countries have implemented GST/VAT.
Malaysia is expected to generate revenue of RM20.5 billion (4% GST with the exemption of basic necessities such as rice, flour, cooking oil, education, public healthcare etc). This is a 36% increase in revenue compared to the existing sales tax and service tax, which the GST is meant to replace. Thus, the GST is expected to account for approximately 13-14% of total tax revenue if implemented, as compared to 9.9% in 2012 with the sales tax and service tax.
However, the key question is what are the risks involved when GST is implemented by a government that is not managed effectively and efficiently?
Historically, two key risks emerge when a country tries to implement GST without first having effective processes and policies in place for better governance. Firstly, the potential for fraudulent practices may arise among businesses and government officials, and secondly, the potential for failure due to lack of proper planning.
Potential for fraudulent practices
In essence, the GST mechanism is such that products and services are taxed at each stage of the supply chain, resulting in an input and output tax. The input tax incurs on business purchases and expenses (relevant to manufacturers or retailers), while the output tax is the tax charged to the buyer. For businesses (consumers generally have no input tax), the difference between the output tax from the input tax, is the amount paid to the government.
However, if the input tax exceeds the output tax, then the business can claim a refund. This creates an opportunity for corruption as the power of tax officials to make refunds may open doors to bribery by business owners. Furthermore, government faced with budget pressures may also delay refunds to businesses. These fraudulent practices are not only evident with the implementation of GST, but also during revisions to the GST.
In India, the GST was revised lower and consumers should have benefited from the reduce tax sales. Unfortunately, due to lack of monitoring businesses were keeping the extra gain by charging consumers at the same price levels.
In Pakistan, government officials are wary of the potential for corruption and under-invoicing as the country is considering increasing the GST from 16% to 17%. Without proper management, it is not surprising for countries to even find that the implementation of GST lowers government revenue, instead of increasing it.
Potential failure due to lack of proper planning
In 1995, Ghana implemented a VAT system that lasted only three and a half months. The main reason for Ghana's failure was due to improper management of public perception, insufficient time to identify the right people, implement procedures and starting taxpayers registration, and an unprepared tax administration. All these factors boiled down to the government's inefficient and ineffective planning prior to implementation.
A similar case was found to occur in Ukraine as during the period from 1998 to 2004, real GDP rose by 49%, but the VAT to GDP ratio decreased by 33% (generally as GDP grows, VAT yield should also rise with at least the same rate as GDP). Study found that the decline in VAT to GDP ratio was caused by the country's ineffective tax administration.
Successful GST implementation is contingent on income equality
The chart above shows the transparency level of a country and its GST/VST rate. 70% of the top four countries have GST/VAT of more than 15% (highest is 25% and that belongs to Norway, Canada and Denmark, the most transparent at number 1).
Coincidentally, Denmark leads the way with regard to distribution of income. Not surprising then, that Denmark has the lowest rate of poverty in Europe. Having a broad based tax system can be socially successful if the income distribution is flatter within the country.
Gini coefficient and GST
The issue of regressive tax will not be as evident as the gap between the rich and poor is not too large. Therefore, a quick look at the top 10 most transparent countries, eight have a GST/VAT that is more than 10%. However the Gini Coefficient of these seven countries are within the 25 – 35 range.
In comparison with countries such as Paraguay, Zimbabwe, Russia, Vietnam, Indonesia, Papua New Guinea and Venezuela (GST/VAT rate of 10%, 15%, 12%, 10%, 10%, 10% and 16.5% respectively), the Gini Coefficient ranges between 36 and 52, with Paraguay, Zimbabwe, Russia, Papua New Guinea and Venezuela all above the 40s mark.
In Malaysia, the Gini coefficient is higher even than Indonesia, Thailand and Philippines. Lower-income groups will have to fork out more of their income to GST.
There are also other factors that should be taken into consideration before implementing GST. Among them are the infrastructure, the people, the processes and policy, and proper planning.
With the on-goings surrounding Malaysia such as the NFC, guns missing in the sea (and possibly toilet), large spending on computers and study trips, the question looms if GST implementation should be carried on. The government should instead focus on the root cause that is causing serious leakages in public funds. From a government management perspective, we have a cost issue, and not revenue.
Raja Ahmad Shahrir is research associate at Institut Rakyat. Comments: firstname.lastname@example.org