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.