WHY THE GST FAILED

It was implemented hastily as a fire-fighting measure without adequate thought, or preparation

THE argument that the Goods and Services Tax (GST) was a major factor in price increases found receptive ears among Malaysians.

The promise to abolish GST was a powerful card played successfully by then opposition Pakatan Harapan to wrest power from Barisan Nasional. The question that begs to be answered is why GST proved to be so unpopular in Malaysia.

GST is a tax on the value added at each stage of the production distribution chain and is generically known worldwide as Value Added Tax (VAT). GST has been prescribed as a panacea for all economies facing revenue shortfalls by the World Bank and the International Monetary Fund (IMF). About 160 countries have adopted the GST or some variation of it.

As a revenue generator, GST’s performance is unrivalled because of its broad consumption base. Since consumption cannot be hidden, even people who evade or avoid taxes on income are forced to pay taxes when they consume. Furthermore, because the tax is collected at multiple points in the production distribution chain, revenue loss is minimised. And in theory, an invoice trail is created by the invoices that have to be obtained and produced in order to subtract the taxes paid on inputs from the taxes owed on outputs. This enables the tax authorities to check on the tax revenue collected and forwarded by businesses and their claims for credit on taxes paid on inputs and minimise the scope for cheating. This is why economists describe GST as being “efficient”. Since the customer knows exactly how much he is being taxed on each purchase, GST is “transparent” as well.

GST will protect revenues when we become an aging society and the revenue from income taxes decline as more people drop out of the workforce. Being a tax on consumption, and because even the aged must consume, revenue from GST will continue to flow into government coffers. These features make it attractive to governments, especially ones that are strapped for funds.

There are, of course, downsides to the GST that are largely ignored. And it is when these concerns are sidelined that a groundswell develops against it.

First and foremost, GST can turn out to be a major liability in the hands of fiscally irresponsible governments; the ease with which it generates revenue does not provide a strong incentive for governments to be frugal. Since virtually every individual is hit by the tax, there is greater interest on how the revenue is spent. Unless it is clearly seen to be spent for the welfare of the populace, discontent will build up.

Second, the GST is a complicated tax to administer and a considerable amount of preparation is necessary before it can be implemented smoothly. Although many developing countries have implemented variations of the GST, not many have done it efficiently and the complications and difficulties they faced or are still facing receive no publicity from international agencies that try to sell GST to cash-strapped governments. Sri Lanka and India are examples of countries struggling with poorly conceived and implemented GST regimes. There are many more.

Third, it is commonly held that businesses do not bear the burden of GST as they can pass the tax forward to consumers. However, businesses are in fact affected from two angles. On one side, passing the tax forward means raising prices and so long as goods have negatively sloped demand curves, this will reduce sales and revenues of businesses. On the other side, and this is frequently ignored by governments, is the compliance cost borne by businesses, with the compliance burden falling more on small rather than large businesses.

The compliance cost includes not only the expenditure necessary to prepare businesses to be GST compliant, but also the continuous cost of acting as a tax collector for the government without any compensation for the time and effort involved. Not surprisingly, many small establishments and family-run businesses ceased operations when the GST was introduced.

Fourth, GST burdens the consumer (taxpayer). However, because it is a broad-based tax, the burden is felt more under the GST than the Sales and Service Tax (SST) that it replaced because virtually no one escapes its effect. The impact on the consumer arises from two sources. One, the GST will raise prices and this lowers the purchasing power of consumers. Two, being a tax on consumption, it is likely to be regressive; that is, it will extract a large proportion of income by way of taxes from low-income groups compared with higher-income groups. If efforts are not made to ameliorate these effects, the GST will impose a heavy burden on consumers.

Finally, it is important to bear in mind that the GST evolved in a developed country context where income taxes are securely in place. The GST is a tax on consumption. If both taxes remained, the taxpayer would be hit both on the income and consumption sides. Therefore, when GST was introduced in developed countries, income tax rates were reduced to afford some relief on the income side. Since a large proportion of the working population pay income tax in developed countries, the reductions in tax rates to offset the effect of the GST on the consumption side benefited a large section of the working population, and this helped to mute protests against GST.

This experiment could not be replicated in Malaysia. With the bulk of the population spending a higher proportion of their income on consumption and only 15 per cent of the 14.6 million workers paying income tax (in 2016), a GST accompanied by a reduction in personal income tax hit poorer consumers with a “double whammy”. They paid more taxes via consumption (thanks to the broader base of the GST relative to the limited base of the then prevailing SST), but enjoyed no benefits from the lowered income taxation since they were outside the income tax net to begin with.

On the other hand, richer consumers probably enjoyed a “double dividend” — lower consumption taxes as a proportion of total income (since consumption expenditure as a proportion of in-

A more detailed look at the experiences of 10 countries that put in place measures to minimise the price effects of the GST is revealing. Unfortunately, it focused entirely on European countries with the exception of South Korea, which was one of the few Asian countries to adopt the GST at the time of the study.