Final notes on GST/VAT

VAT is intended to increase government's revenue. The increased revenue doesn't come from new sources of economic activity. It comes through a more intense accounting. The business intermediaries from producers to retailers are made to pay VAT. Government retraces it steps to ensure it milks more.

Now the government must register all eligible businesses. Then, each registered trader sells his outputs at a price plus the additional VAT. He will pay the VAT to the treasury (excise and Customs department). Make sure, here the people can count ok?

He can claim a refund for any input VATs on purchases he bought from suppliers. His customer can do likewise until it reaches the final customer. At each point of exchange, the tax is passed on in the form of higher prices. The final consumer, being at the end of the food chain, bears the whole tax. The traders act as collecting agencies.

VAT can be regarded as a burden on end-consumers of products and is therefore a regressive
tax the poor pay more, as a percentage of their income, than the rich. One main concern involves the fear that lower income groups may have to spend even larger portion of their income on basic necessities.

The government can do the following. Identify the lower income groups and exempt the basic necessities from VAT. The lower income earners don't pay taxes in the first place and if basic necessities are exempted from VAT, their real incomes remains the same or becomes better. Except, the higher income people consume the same products and services and get to enjoy the exemption benefits. In practice therefore, the VAT is a flat rate covering a homogenous group of consumers. That being the case, the position of the lower income groups relative to that of the higher income groups, worsens.

The chief virtue of VAT is therefore, it remains a good revenue raiser to the government. But ultimately the lower income earners who form the majority of the population will bear the burden of VAT. Also, their position vis-a-vis higher income earners is made worse off thus creating sources of divisiveness further.

Then there's a problem of which businesses need to be registered? The kepala ikan stalls in Kg. Atap, Raju's at Section 5 PJ, Kg Pandan kepala ikan, Taman Wahyu Ipoh Road- will these register? What about the mushrooming foot reflexology shops? (Many KL folks have foot related ailments). These industries tend to have more VAT avoidance, particularly where cash transactions predominate, and VAT may be encouraging this avoidance.

VAT, to be successful, relies on voluntary tax compliance. Since VAT believes in self-assessments, dealers are required to maintain proper records, issue tax invoices, file correct tax returns etc. The opposite can happen as is the case in India for example. There, businesses are still run on traditional lines where cash transactions are the order of the day. The same thing can happen here in Malaysia.

We are banking collecting tax revenues by hoping that tax returns are conscientious. As the experience in India shows (because India is less developed like us also and is therefore a good example) there is a high percentage of return defaulters high credit returns and equally high nil returns. What do these imply? This implies that where possible, people will want to cheat the government. How will the government overcome this? Obviously, through closer monitoring and vigilant tracking of businesses which add to the cost of collecting. So when Minister Husni Hanazliah speaks of getting RM 1 billion in revenue he is silent on the cost of getting that RM 1 billion.

As the experience in India shows, roughly 70% of VAT dealers are presently not paying any tax. Filing of credit returns is rampant traders especially in businesses dealing with consumer Durables, Drugs and Medicines and Fertilizers. The margins are low in this sector (ranging between 2 to 5%). The value addition is not enough to yield the revenue expected.

The question is, in a typical purchases and sales scenario; can there be more output tax than input tax? When purchases consistently exceed sales, can output tax exceed input tax? If a VAT dealer can balance his/her purchases and sales, can there be a net tax to the State? Is there a mathematical model or paradigm which can give value added tax and which can reduce the percentage of credit returns? There are no ready answers for these queries. The only remedy seems to be the restriction of input tax to the corresponding purchase value of goods put to sales.

So on what basis is Minister Husni's optimism based on?

Then there's the question of what will the government be spending the tax revenue on?

A VAT, as in the case of most taxes, distorts what would have happened in cases where there is no tax. Because the price for someone rises, the quantity of goods traded decreases. The demand for goods may fall and supply correspondingly adjusts itself by contracting. When these happen, some people are worse off by more than the government is made better off by the tax income . That is, more is lost due to supply and demand shifts than is gained in tax. This is known as a deadweight loss.

When the income lost by the economy is greater than the government's income; the tax is inefficient. How can the government improve the situation such as this? The entire amount of the government's the tax revenue may not be a deadweight loss entirely if the tax revenue is used for productive spending or has positive externalities. Meaning, we can offset the magnitude of deadweight loss provided governments may do more than simply consume the tax income.

The problem is the government hasn't shown prudence in stopping leakages.