Don’t cut spending or raise taxes

 

I’m not sure who put the match to the burning deck but apparently we have an urgent need for fiscal consolidation.

Fortunately the World Bank is running to our rescue, recommending that “consideration should be given to streamlining relief and broadening the tax base of personal income tax and by enhancing the consumption tax framework”.

This of course means tax hikes and by the way they also offer tax reform consultancy services — but I digress.

The same World Bank said the Malaysian economy would grow by 4.5% in 2020 when it shrank by 5.6%. Their forecast rebound of 6.7% in 2021 became a recession and their modest recovery of 5.5% for 2022 will actually be a boom of 8%. But I digress again.

Contrary to the spinning panic of international experts, fiscal consolidation simply means reducing the deficit and the accumulation of debt. We should not presume this necessarily means cutting spending or increasing taxes.

Debt and deficit are usually measured as a percentage of GDP but are also evaluated against the sustainability and stability of the overall fiscal position.

No one has a particular view of what the debt and deficit ratios should be in Malaysia but if GDP rises faster than the deficit and debt levels then these ratios will fall and provided the financing costs can be paid there is no particular risk to fiscal stability.

Malaysia’s debt ratio is relatively low and although the deficit ratio has risen recently it is still manageable and will fall as the economy continues to grow. With prudent fiscal management in Budget 2023 it could be below 4%.

Financing costs are a concern, not so much because they cannot remain affordable but because the RM45 billion spent servicing debt is more than the welfare and higher education budgets combined.

More efficient procurement can cut costs and release funds for priority areas without cutting overall spending. Changes in spending priorities can also improve impact without cuts. Funding with public-private partnerships also makes spending go further without cuts.

Similarly efficient tax collection and system reforms can improve revenue without raising taxes. Lower taxes are a positive incentive to economic activity and can increase revenue even if tax rates are lower.

Government revenue does not rely on taxes alone and in Malaysia oil royalties provide a significant non-tax income as a dividend from public assets.

Responsible privatisation can monetise non-essential assets for income and even profits on the original development expenditure. This can be used to pay down debt.

It can also reduce crowding out which opens up economic activity, promotes growth and drives government revenue without increasing taxes.

Prudent retirement of debt and monetisation of contingent liabilities can also be used as part of the debt management process to reduce debt and lessen default risk.

Of course crucial to the Malaysian context is the constant insistence on anti-corruption measures to cut out waste and theft from government spending.

If the system is as efficient as could reasonably be expected and revenue was sufficient as a result there is no need to increase taxes. If the system is corrupted and inefficient then raising taxes will simply throw good money after bad.

It is also virtually impossible to calculate what the correct rate of tax should be or what the balance should be between different types of taxes when the system itself is dysfunctional.

So before we talk about cutting spending or raising taxes we need to improve the efficiency of the system.

This is the first stage of reform that we are already seeing and that we hope will be reinforced in Budget 2023. - FMT

 The views expressed are those of the writer and do not necessarily reflect those of MMKtT.