How tax policies can help governments achieve balanced and sustainable economic growth

How tax policies can help governments achieve balanced and sustainable economic growth.

In brief

• In the absence of a broad-based consumption tax, the Government must look at new or under-utilized sources of revenue.
• There should be adequate income support to enhance economic opportunities.
• A digitalized tax administration will curb leakages and increase compliance.

Malaysia’s 2023 Budget will be re-tabled on 24 February.  Last October, just before the tabling of the original 2023 Budget, I had shared my views on how governments can use fiscal policy tools to support long term sustainable economic growth while still generating higher tax revenue, which is much needed to fund increasing expenditure and reduce debt.  I had outlined four considerations to gradually increase tax revenue for sustainable development:

1. Implementation of a more broad-based consumption tax, or expansion of the scope and coverage of the current indirect tax regime
2. Strengthening tax administration, through better use of information and communications technology and enhancing the taxpayer experience.
3. Further simplifying the tax system through the introduction of presumptive taxes for small businesses.  A presumptive tax system is a simplified tax regime aimed at simplifying tax compliance and reducing compliance costs, potentially with lower tax rates than the “standard” tax system.  
4. Introduction of green and health taxes that can raise revenue and contribute directly to meeting the United Nations’ Sustainable Development Goals, while encouraging the right behavior. 

The re-tabled Budget will be based on the Honorable Prime Minister’s new national development theme, ““Membangun Negara Madani” (Developing a Madani Nation).  The Madani concept comprises six core values, namely sustainability, prosperity, innovation, respect, trust and compassion.

The Prime Minister stated, “Madani means we must have good values and prioritize good governance and ethics. This will be crucial as we face 2023. Madani will be the approach we take where we disregard race, religion and political affiliations, so that everyone can have a fair chance”.

The above is aligned with several studies conducted, and recommendations made, by global institutions such as the Organisation for Economic Co-operation and Development (OECD).  These institutions have observed that in developing and implementing measures for economic recovery post the COVID-19 pandemic, governments have the opportunity to set their nations on a recovery path that places growth, equity and sustainability on an equal footing.

To this end, outlined below are some fiscal policy measures advocated in these studies, which our policy makers may be evaluating as they formulate the upcoming Budget:

1. Re-visiting the tax burden of the wealthy, reducing inequality: The COVID-19 pandemic has resulted in a higher budget deficit and a significant increase in our debt levels. The pandemic has also exacerbated existing inequalities and hit vulnerable households the hardest.  The Prime Minister has committed to addressing the rising cost of living and correspondingly, has stated that a Goods & Services Tax (GST) will not be re-introduced until the income levels of Malaysians increase.  In the absence of a broad-based consumption tax in the immediate future, there is the need to look at new or under-utilized sources of government revenue. Considerations could include taxes on the wealthy, through increasing personal income tax at higher income bands, introducing wealth taxes or increasing taxes on property disposal, given their potential to reduce inequality.  These measures however should be carefully studied, with a focus on identifying whether they will be effective in achieving their desired objectives and whether they will result in a meaningful and worthwhile increase in tax revenue.  There is always the risk of capital flight and tax planning opportunities that will continue to allow the wealthy to shield their income from these tax measures.
2. Provide adequate income support and enhance economic opportunities for the B40:  This could be in the form of tax incentives that encourage employment and upskilling, which will help contribute to reducing unemployment and addressing mismatches between skills availability and market needs. However, these need to be targeted, such that they focus on those who are currently in the lower levels of the labor market and the lower income group.
3. Support economic growth: Aside from the need to continue to improve the investment environment generally, incentives (both fiscal and non-fiscal) will continue to play an important part in attracting and retaining investments to support economic growth and increase high-quality employment opportunities. With the proposed introduction of a global minimum tax of 15% for large multinationals, which will be effective in many countries in the year 2024, incentive offerings have to be more flexible and agile, as they will need to be tailored to the needs of the individual investor.  This is to ensure that Malaysia does not provide an incentive which will simply result in a top-up tax elsewhere and that the investor still benefits from the incentives. Further, to ensure positive spillovers, incentives should continue to be targeted and tied to the creation of high value jobs, development of local SMEs, boosting demand for local services and goods and strengthening Malaysia’s reputation as an investment destination of choice. There is a need to review the existing incentive offerings in Malaysia, to ensure that we are providing the right incentives to attract high-quality investors in the targeted industries and geographical areas. There should also be a balanced approach between attracting new investors and retaining and expanding existing investments in the country – we must make sure that the latter is not neglected.
4. Tax policy in the furtherance of environmental, social and governance (ESG) goals:  This needs to be a “carrot and stick” approach, with targeted incentives to reduce greenhouse gas emissions and encourage the use of environmentally friendly technologies combined with taxes on emission activities, such as carbon taxes, and studying the gradual reduction or elimination of fuel subsidies.  Nevertheless, there must be balance in the context of what works for Malaysia.  For example, there are studies that show that reducing subsidies for fuel can increase poverty risk.  
5. Digitalization of the tax administration: The introduction of e-invoicing and e-reporting in many countries has curbed tax leakages and increased compliance, thereby improving tax revenue collections. Tax administration digitalization also has the potential to support the growth of Malaysia’s digital economy. In addition, there are new studies that show reducing business registration and compliance costs, which can be made possible through digitalization, can reduce the share of the economy occupied by the informal sector and significantly boost tax revenue.

Some of the above tax policy measures were evident in the 2023 Singapore Budget tabled on 14 February.  Singapore increased Buyer Stamp Duty on higher value properties and additional registration fee on luxury cars, essentially measures to tax the wealthy.  To promote economic growth and continue to encourage investments, Singapore further enhanced the Enterprise Innovation Scheme, a scheme for businesses to obtain larger tax deductions for activities such as conducting research and development in Singapore, and also extended selected incentives.  On the ESG front, the Energy Efficiency Grant was extended for another year.  There were also measures for employers who hire senior workers, lower-wage workers, people with disabilities and ex-offenders.

While tax policy is a powerful tool to motivate behavior that supports the overall objectives of sustainable and equitable growth, it cannot be considered in isolation.  Prudent government spending, accountability and stronger public institutions that deliver quality services and value are equally crucial.  These factors are crucial to strengthening tax morale among Malaysians, which will in turn increase compliance rates, and bolster investor confidence and trust in the country.