Faced with the persistent years of budget deficit, a narrow tax base and rising expenditure, the government has to undertake a tax reform to broaden its revenue base, to be accompanied by expenditure rationalisation to achieve its medium-term fiscal consolidation and deficit reduction target.

Overhauling the tax reform is not a straightforward task. The appropriate, timing and sequencing of tax reform may involve controversial policy choices and difficult political trade-offs. Implementing a tax reform, either a big bang or incremental approach, when the economic and business conditions are unstable and weak, the economic and financial adjustment costs would be disruptive and may undermine the economic growth in the short-and medium-term.

The scope and sequencing of tax reforms need proper planning. We need to identify the parts of the tax system that need the most attention and undertake the reforms; and how the tax reforms can be implemented without imposing significant overall tax burden on the economy, wage earners, businesses and investors.

Improving a simpler, efficient and equitable tax system can encourage long-term economic growth; boost competitiveness to attract business and investment, reward productivity to encourage entrepreneurship and work, and can eliminate deadweight costs that hold back growth.

So, what does a pro-growth and investment tax system look like? As part of a credible and sound fiscal management framework, the tax reform’s central priorities are not only on the efficiency and effectiveness of the tax system to avoid tax avoidance and evasion but also consider the aspects of equity and fairness.

The tax reform must be built on the following features:

1. Fairness and lower overall tax burden to provide more incentives to work, save, invest and compete.

2. Internationally competitive for businesses and encourage more investments in high technology and value-added sectors, create jobs and raise economic growth potential.

3. Effective, simpler and less complex in administration to minimise compliance costs and reduce business costs as well as discourage tax avoidance and evasion. The complexity of the tax system and fiscal incentives/reliefs/allowances in terms of qualifying and reporting requirements increased costs for SMEs and also invited unproductive rent seeking behaviour, especially by more connected companies.

4. Revenue adequacy and sustainability to meet prudent budget spending while maintaining fiscal stability.

In formulating the tax policy in a globalised and complex environment, we have to take into consideration the following implications and externalities:

1. While corporate income taxes can influence the choice of investment location, a conducive business-friendly regime and regulatory environment, supported by stable macroeconomic conditions are equally important.

2. High tax incidence, compliance and business costs can affect the cost of producing goods and services and, hence, erode the relative international competitiveness.

3. Sales and other related taxes would impact on tourism, e-commerce and cross-border shopping as they can influence tourists’ spending on domestic goods and services as well as the hospitality sector.

4. Personal income taxes can influence the mobility of labour, increase the supply of domestic workforce and attract talented workers in the choice of the country in which they work.

5. Input and raw materials taxes cascading through the production process can dampen production and investment as well as penalize exports.

6. Excessive taxation such as imposing excise duties on the legitimate industries (cigarettes and liquors) are intended to discourage smoking and promote a healthy lifestyle whilst raising revenue, it encourages the consumption of illegal products and rampant smuggling activities. This results in billions of ringgit of government revenue lost to smuggling.

Being a small and open economy amid facing highly competitive countries to boost domestic direct investment as well as attract quality and high impact foreign direct investments (FDI), capital resources and talented workforce, Malaysia’s tax system has to be of competitive and dynamic to compete in the global market place.

Besides tax factors, there are non-tax factors (such as conducive and investors’ friendly environment, access to raw materials and markets via Free Trade Agreements (FTAs) and regional trade agreements as well as low compliance and business costs) that influence the location decisions of FDI in the source country.

The appropriate timing and sequencing as well as scope of tax reforms must take into account the current state of economic and business conditions so as to manage the cost of adjustment, leading to undesired and unsustainable distributional consequences. In this regard, a big bang tax reform approach is undesirable at this stage when the economy is still reeling from the COVID-19 pandemic. One should consider undertaking tax reform in a more stable economic and business environment. Another consideration is to look into institutional constraints and possible temporary negative side effects of undertaking comprehensive reforms simultaneously.

-- BERNAMA

Lee Heng Guie is Executive Director of the Socio-Economic Research Centre (SERC).