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Wednesday, 2 December 2009

Further thoughts on VAT/GST

There are several ways of looking at GST that can create some reservations about this form of indirect taxation. If the term 'indirect' suggests that the tax is not foreboding, we are clearly deceived. There's nothing that doesn't evoke unhappiness about having to pay taxes. The people are veiled from the intricacies that go behind the VAT- they just know they have to pay higher price for the goods and services they buy. They can't juggle between input and output VATs. They just take it to them. Suppliers and retailers and business intermediaries just play along appearing to pay their portion of valued added taxes. Their costs and profits remain untouched.

That's why we citizens have a sneaky feeling that there are countless ways businesses can avoid paying higher amount of taxes by employing all sorts of accounting. When they classify all sorts of spending as business expenditure, the taxable amount becomes lower and they pay lower income tax. Hence business people can drive in their Bentleys, Porsches and so forth and count them as expenses to acquire capital good.

I always hear of the same justification- rather than pay the government; we'd rather splash on ourselves. At the end of the amortization period, high end vehicles are sold to directors for a song.

So we complain, this is not fair. Those people must also pay taxes. From the taxes we can supply public goods which society can benefit. By introducing VAT, each of this group will pay tax on the value they add to the product. And so we thought.

What the VAT does is to give an illusion that producers and retailers also pay VAT but as we show in our examples, the position of the manufacturer or the retailer do not change at all. They still make the same profit. The cost to the manufacturer is still RM1 and the cost to the retailer is still RM 1.50. What the VAT does is to juggle the input VATs and the output VATs.

The supplier of raw materials adds his output VAT of 10% i.e. 10 sen to the cost of raw materials to the manufacturer. The manufacturer treats this as his own input VAT and sells to the retailers incorporating his own output VAT to the retailer. The difference between his output VAT of 10% i.e. 12 sen and the input VAT of 10 sen is 2 sen. This is his VAT payable to the government. The retailer sells to the end user adding his output VAT in turn of 10% which is 15 sen. But remember his previous input VAT is 12 sen. The difference between the retailers input and pout put VAT is 15-12= 3 sen.

The total amount of VAT payable by the customer is 10 sen + 2 sen + 3 sen= 15 sen. The end user pays 15 sen additional. He cares not about what happens from supplier to retailer.

So what does VAT do actually? It improves the recovery rate of tax from existing economic resources. It doesn't create new sources. It's a way government improves its tax collecting efficiency. Now, when efficiency is spoken of, that's another matter which hopefully we can talk in another forum. It's good to increase government revenue.

It's just plugging loose ends. Through plugging the holes in businesses, the government gets how much? RM1 billion says the FM2. Why don't we compare the earnings gained from plugging holes through VAT with the earnings we can get by plugging holes in the sale of government land or from having open tenders?

People have the extra accounting to do so that they correctly pass on to the government the difference between what they collect in VAT (output VAT) and what they spend in VAT (input VAT). Note that in each case the VAT paid is equal to 10% of the profit, or 'value added'.

The final price the consumer pays, gives the impression that the tax burden has been distributed between the manufacturer, retailer and him as consumer. If he ignores the distribution niceties, he comes to the realization, that it is he who bears the burden.

But here is the disturbing element. Through VAT, the government does NOT increase its revenue out of a productive activity. What it does is improve its recovery rate on tax revenue which they would have lost without netting in the business intermediaries.

But as the net widens, it also catches those who are not taxable previously because their yearly income does not reach taxable level, will also have to pay. Everyone has to pay VAT now as long as they consume product or service.

Now, this is what a responsible government must do. Weigh the benefits of ensuring different economic actors pay against the money issues faced by a bigger majority.

Remember, the ordinary Joe doesn't think of the devilishly detailed calculations BEHIND the VAT. All they know; now they have to pay VAT in the form of higher prices of goods and services. In my earlier post on this subject, there is a valid observation from a commentator who calls himself Donplaypuks. This is his observation.

What is often not understood is that all VAT registered businesses will be mere collecting and remitting agents for the Govt. They will net off the VAT on their sales (output) against the VAT on their expenses (input tax), and remit the difference to the Govt, or claim a refund from the Govt is there is a deficit. Neither the VAT on expenses nor that on sales will be included in their P&L or in their product costing. Businesses can also claim back VAT on capital expenditure such as plant & equipment, f&f etc. Thus a manufacture who buys raw materials for $1 and who is subject to VAT at 10%, will continue to treat his cost as $1. The VAT of 10 cents (10% input tax) will be accounted in his balance sheet as owing by the Govt to him. If he sells his product for $2.50 he will charge VAT of 25c and invoice for $2.75. The manufacturer will pay 15c being the difference to Customs & Excise on the due date. In his P&L, the manufacture will show sales of $2.50, cost of sales of $1 and profit before tax of $1.50.Therefore, the reality is that it is always the end user who will bear the brunt of VAT which becomes the Govt's revenue. But since VAT is charged at every stage of a sale to someone, the Govt's cash flow improves tremendously as there will always be a time lag between collection and refund.

The first parliamentarian to raise concern about the introduction of GST is Khairy Jamaludin. When he spoke on this matter, there was hardly any response to it. As usual the mainstream newspapers shied away from this heavy stuff.

The main concern involves the amount of taxes that will have to be paid by the lower and middle income groups. Essentially the VAT is a regressive tax in the sense that lower income groups will spend a higher proportion of their income in the goods and services they consume. That being the case, to compensate for the higher provisions from their incomes which they have to make, will the government consider reducing income tax?

The VAT was invented initially to counter cheating and smuggling because businesses wanted to avoid paying taxes and tariffs. Later it was extended to cover all consumers and became, for some countries a principal means of getting revenue. In France for example, up to 50% of the state revenue comes from VAT.

Needless to say, this revenue aspect is being looked at by the Malaysian government. The question is from whom? From businesses or from ordinary consumers? Maybe business consumers have been evading taxes. Maybe those by cash-transaction businesses such as mamak stalls selling kepala ikan have scrooged in paying taxes to the government. They make more money, they should pay taxes.

Let's tackle that expected revenue part the government advances as justification for this VAT/GST. It says (finance minister 2) the government will stand to collect RM 1 billion. We are certainly comforted by this confident expectation.

I hope the minister realise that his optimism has taken into account that VAT is difficult and costly to administer and collect. Accordingly revenues from a value added tax are frequently lower than expected.

5 comments:

Hamba,  2 December 2009 at 12:24  

An extra gain of RM 1 Billion against the loss of RM 28 Billions through misappropriation, leakages and "whatnot" doesn't really make sense, doesn't it?

It's like taking money from someone else and putting it in the already "holey" wallet. That's a pretty stupid thing to do but of course if the "hole" in the wallet is somehow connected to another pocket (where the money is then channeled to)...that's a different matter altogether. In fact that is very smart indeed, convincing someone (rakyat)to part more with their money and leaving them oblivious to the fact that the monies will end up the same way (into another pocket through misappropriation, leakages and "whatnot").

GST= "Govt Siphoning Tool".

donplaypuks® 2 December 2009 at 12:56  

Bro

Make no mistake. Wherever VAT has been introduced, revenues have surpassed expectations. That is certainly Singapore's experience and the very reason it is popular in UK and Europe!!

My point is that the Govt must research the cost of collecting RM1 of VAT revenue. There are international cost-benefit benchmarks models which can be used to determine if in the M'sian context, VAT can be justified.

UK/Europe and Singapore introduced VAT at a time when their economies were advanced and per capita incomes were in the 1st tier of world economies. Are we quite there yet?

More than that, if the Govt tightens the so-called annual $28 billion leakage due to corruption and stops free APs and negotiated contracts in favour of open tenders, massive subsidies to croney Highway Toll, IPP and Water operators and unnecessary purchase of submarines and jets and "commissions" to bogus agents, we can bury VAT for another rainy day!!

dpp
We are all of 1 race, the Human Race

walla 2 December 2009 at 16:26  

A question for the govt. What is the point of improving the recovery rate if it is applied on an income base that will in the end be shrunk by the very process of trying to make the recovery?

With that as something to ponder further, the following may provide new discussion points going forward:

http://is.gd/59Jek
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http://is.gd/59Jjj
http://is.gd/59Jk7
http://is.gd/59Jlk
http://is.gd/59Jml
http://is.gd/59Jnz

There is another factor. Let's say GST is applied in 2011. Inflationary pressures may spike.

Then in 2012 we find that we turn net oil importer.

This seems to mean there will be a new net energy cost to the economy.

Whatever the price of oil then, it will still be net revenue lost on top of new energy cost from importing oil we need which we cannot supply.

The new cost will have to be covered somewhere.

If we remember, the last time petrol price went up, prices of most goods that people in the middle and lower incomes use regularly went up and stayed up. Looking around, most are still up.

So, if to GST-generated inflationary pressure we add net-oil-importer inflationary pressure, wouldn't that compound the rakyats' suffering besides damping economic growth?

And if economic growth be dampened, wouldn't that make the case for better recovery rate through GST less attractive, considering that its introduction will also add new administrative, operational and monitoring costs (as reflected in some of the above reports) that will ultimately have to be borne somewhere?

So far, we hear of the govt saying the poor will be insulated from the inflationary effects of GST application. But it is an indirect tax applied on consumption. Does it then mean subsidies will continue?

Will it also mean petrol will be exempted from GST? But the govt has also recently said petrol subsidies will be reduced by some fifteen percent under some package. Some clarification is needed.

Before the govt implements GST, please also show some omnibus data of what middle-income and low-income rakyat actually consume price-wise on daily, monthly and yearly basis pegged what they make on a daily, monthly and yearly basis. What i hope will result from that is an indication that people who have to hawk for a living, just as an example, should not have their earnings taxed at all, directly or indirectly. Neither should manual workers, drivers, shop assistants, students, policemen, teachers, and so on. Many barely make ends meet in urban settings. Most are not good at saying so.

Anonymous,  2 December 2009 at 17:46  

This is pretty heavy going...but some basic questions>

1>Will i be paying the same for my roti canai and teh tarik at my mamaq bistro pre/post GST?
2>Will Naza owners be paying the same price as me for that same roti canai/teh tarik?
3>Will the govt be able to collect more money and thus can have more events in 5 star hotels,overseas trips for the Ministers,salary/allowance increases.
4>will the value of APs be reduced by 4%?And will the government reimburse Naza for the 4% that they will lose out on their 628 million contract?
5>will China Railway,China Harbour,Indian Railway,etc etc..who got direct negotiated worth Rm 15 billion be compensated if the GST increases their cost.

DingDong,  2 December 2009 at 20:08  

Salam Dato,

My wife asked me why I’m so stressed up. I said Msia is going 2 have GST which is quite similar 2 VAT and I hate to see the hard earned money I’m sending back home shrink in value.

I spoke to the Malaysian Ambassador in Ireland Raja Dato Nazrin. He said the current deficit in trade is E500mil = RM2.5Bil. Growing deficit since Dollah era.

Why Cabinet not giving more attention on all trade deficits inc Ireland instead of Chin Peng nak balik kampung? Even Obama is paying a lot of attention and energy on trade deficits. Everybody knows that a trade deficit will cause a lose-lose situation in the long run.

Ireland is in a bad shape. They need fresh investments. Malaysia needs fresh investment too. The only time I remember Dr M coming to Ireland was way back in the 90s. Ireland is totally different now. Same like Malaysia.

There are plenty of business opportunities for G2G and P2P. I hope you could somehow pass a msg to the person in charge of planning & org business delegation for DSNTR. Why not pay a visit for one of our long good trading partners. Something good might come out from the meetings.

I’m sad to see this big issue GST is not getting front page coverage in all mainstream media. Instead issues such as doa Nik Aziz, kes liwat DSAI etc. Who cares? These are petty issues.It will not put more nasi or ayam on my parents plate back in Malaysia.

I cry when I know some of my relative will have to cut down their expenses on food for their family since that is the only way to trim a middle and lower class budget. Most of us don’t have investment portfolio, annual holiday, family trips etc. The money we earn is just for basic items and all extra is for parents, relative in needs(sekolah nak bukak dah,kampong banjir,fees nak masuk U,bil ubat & hospital), sadaqa and zakat.

I wish everyday I can know what is the Gomen doing to increase the GDP of Malaysia and improve the gini. Other issues are just mere politics and stories 2 sell paper.

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