By Teck Chi Wong
This article was originally published on Policy Forum.
The scandals that engulfed Najib Razak in Malaysia reminded voters that they were paying a heavy price for bad government, Teck Chi Wong writes.
Malaysia’s recent change of government brings with it a major tax policy shift as the Goods and Services Tax (GST), introduced in 2015 by the former Prime Minister Najib Razak, is set to be abolished. The country will, instead, revert back to the old (but less efficient) Sales and Service Tax regime.
As a first step towards abolition, the new Pakatan Harapan (Hope Alliance) government announced that the GST will be zero-rated from 6 per cent on 1 June.
This change will, in effect, create a tax holiday for several months, before the Sales and Service Tax is revived. The new government hopes that this will be passed down as lower consumer prices, easing the burden of the cost of living on Malaysian households.
While a spike in domestic consumption is expected, the move will worsen Malaysia’s fiscal position, which has been in deficit since the 1997 Asian Financial Crisis.
A think tank recently predicted that this year’s deficit might widen to 4 per cent of GDP from 2.8 per cent if the gap is not filled quickly. It is also revealed that public debt would reach 80.3 per cent of GDP, higher than the headline figure announced by the previous government, if it includes government guarantees and lease payments for public-private partnerships.
In order to fix its fiscal woes, the new government led by 92-year-old Mahathir Mohamad has promised to introduce a comprehensive fiscal reform package in the first 100 days of taking office. It remains unclear what measures will be included, although some in the new government have previously indicated that they are looking at options such as a capital gains tax or an inheritance tax.
Tax revolts have been common with broad-based consumption tax reforms, largely because of the inflationary effect of increasing consumer prices and the regressive effect of burden in lower-income households. However, it is rare that countries would abolish a GST system already in place.
Though a late adopter, Malaysia’s GST reform had been seen as a success story from both fiscal and public acceptance perspective.
The GST had helped diversify government revenue and reduced Malaysia’s dependence on oil, which once contributed 35.8 per cent of its public revenue.
The initial backlash against the GST in Malaysia was not as severe as expected. Although inflation went up, the then ruling coalition still managed to comfortably win three out of four by elections held within the 15 months after the GST was implemented.
The tax collected from consumption more than doubled from RM17 billion in 2014 (under the Sales and Service Tax) to RM41.2 billion in 2016 (under the GST).
The results led many to praise Najib Razak as a bold leader who was willing to take risks to undertake difficult structural reforms for the benefits of the country.
The GST, together with other pro-market reforms, were dubbed as ‘Najibnomics’, and were seen as his flagship economic achievements.
However, although initially muted, public grievance against the GST did not dissipate and it finally turned into a tax revolt in the lead up to the general election on 9 May 2018.
Najib lost his premiership in that election and a once successful tax reform story turned into a failed one.
Najib has only himself to blame for the tax revolt. Around the same time as the GST was introduced in 2015, allegations emerged that billions were siphoned out of a state-owned company named 1Malaysia Development Berhad (1MDB) and some of the money went into Najib’s personal accounts.
It was further revealed that these public funds were used to support the extravagant lifestyle of Najib’s family. By 2017, the scandal had morphed into the biggest ever kleptocracy case pursued by the US’s Department of Justice, although Najib has long denied any wrongdoing.
While it is difficult for many Malaysians to fully comprehend the 1MDB scandal as it involved complicated multinational financial deals to hide the money trail, the GST is an issue close to their hearts. Under the country’s GST regime, the tax base was effectively extended to the whole population as they now have to pay tax when they consume (before this, only 10 per cent of the working population paid income tax).
The GST is also a salient tax because it is printed on every bill and every receipt. It reminded the public who foots the bill when there is corruption in the government.
In the election campaign, the GST was often painted as a money grab by Najib and his administration at the expense of the public. For many, the GST became ‘haram’, the Islamic word for illegitimate.
Najib tried to fend off opposition attacks during the campaign by offering sweeteners such as increasing cash transfers for households and individuals at the bottom 40 per cent and exempting youths aged 26 and below from paying income tax, but the measures failed to turn the tide.
Malaysia’s GST failure offers some important lessons. Political legitimacy is essential for successful tax reform, even in the context of countries where the democracy system is dubious.
So-called strongman leaders in these countries tend to overestimate the durability of their regimes, and assume they can rule by coercive force. Corruption scandals, however, paint them as politically untrustworthy and unable to negotiate a stable fiscal bargain, particularly when there are far-reaching distributional effects.
Any effort to push through tax reform in these circumstances will thus be seen as oppressive or illegitimate, and vulnerable to a revolt. Malaysia’s experience is a good reminder.
From the beginning, GST reform in Malaysia was on shaky ground. It was introduced in the aftermath of the 2013 general election, where Najib lost the popular vote, only clinging to power due to gerrymandering and electoral malapportionment, and thus was weak in political legitimacy.
And since the GST is a regressive tax affecting everybody, it was important that the revenue raised be seen to be spent in a fair and just manner bringing long term benefits to the country. Najib, though, was tainted by the 1MDB scandal and no longer had the confidence of the public. This is why he was voted out by the voters.
Regardless of the voter backlash, Malaysia requires a comprehensive fiscal reform plan. In many countries, a broad-based consumption tax like the GST is used because of the stable and sustainable revenues it generates for government.
By committing to abolish the GST the new government has painted itself into a fiscal corner. Malaysia will have to seek for other sustainable revenue sources to fix its fiscal woes.
This piece is published in partnership with Austaxpolicy Blog, Australia’s leading site for the analysis of tax and transfer policy, based at Crawford School of Public Policy.
Image credit: Firdaus Latif on Flickr