Here’s How Scrapping Malaysian Consumption Tax Will Play Out

(Bloomberg) -- Malaysia’s intention to scrap a 6 percent goods-and-services tax within 100 days of Prime Minister Mahathir Mohamad taking office has economists and budget analysts on edge about the ripple effects.

Critics of the tax, including Mahathir, say it has raised living costs and that a more modest sales-and-services levy would provide enough government revenue alongside efforts to cut wasteful spending and root out costly corruption.

Supporters of the goods-and-services tax point to how much more income it gave the government than the previous system, helping to underpin Malaysia’s credit rating and its reputation with foreign investors.

A goods-and-services tax differs to a sales tax because it’s levied at all stages of the supply chain -- meaning manufacturers and their suppliers also pay tax on the goods produced, not just the consumer. It’s also charged at a flat rate compared to variable rates for a sales tax, so is simpler to manage and considered more efficient.

Here’s a look, in charts, at what the removal of the tax would mean for Malaysia’s economy and its fiscal position:

1. Oil Revenue Share

As a net oil producer, Malaysia is set to benefit from the upswing in global crude prices, which should partly offset any loss in revenue from scrapping the tax. But it also means the economy’s sizable reliance on petroleum-related revenue will rise again, making the budget more vulnerable to swings in oil prices. Since the implementation of the tax in 2015, revenue has proven much more balanced.

2. Revenue Intake

The biggest challenge for the new government would be plugging the hole that scrapping the goods-and-services tax would leave. The finance ministry’s pre-election estimate of the tax’s share of overall revenue this year was 18.3 percent, the biggest proportion after corporate income tax.

Mohamed Faiz Nagutha, an economist at Bank of America Merrill Lynch, estimates that bringing back the old sales-and-services tax would yield just about half the revenue coming from GST. The intake from the latter amounts to about 3 percent of Malaysia’s gross domestic product, versus an average of 1.6 percent from 2004 through 2014 from the sales-and-services tax, he said.

3. Government Debt

Malaysia’s debt-to-GDP ratio of 50.8 percent is higher than that of its peers also carrying an A credit rating, according to Moody’s Investors Service, and that ratio is set to remain elevated without a steady stream of cash from the goods-and-services tax.

“Given the government’s limited ability to trim spending further, we expect the deficit and the debt burden to hover around current levels,” Anushka Shah, a senior analyst at Moody’s, said in a research note. “However, a reversal of some past reforms without other adjustments risks widening the deficit,” including the “credit-negative” risks of scrapping the tax and re-introducing fuel subsidies.

The former administration had a debt limit of 55 percent of GDP and had forecast a budget deficit of 2.8 percent of GDP for this year.

4. Inflation, Consumption

Removing the tax could limit any upside risks to inflation, which has been fairly benign this year, and allow the central bank to remain on hold after an early interest-rate hike in January.

Scrapping it could also give a boost to consumer spending, supporting an economy that the central bank forecasts will grow 5.5 percent to 6 percent this year.

The introduction of the goods-and-services tax in April 2015 caused a spike in inflation to 4.2 percent early the next year, even though the government provided some handouts for low- and middle-income residents to help offset the bigger tax bills.

To contact the reporter on this story: Michelle Jamrisko in Singapore at mjamrisko@bloomberg.net.

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Henry Hoenig

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