This article first appeared in The Edge Malaysia Weekly on April 23, 2018 - April 29, 2018

CHANGES to the country’s tax regime are on the cards, whoever wins the upcoming 14th general election (GE14). In its GE14 manifesto, the ruling Barisan Nasional coalition mentions a revision of individual and corporate income taxes to ensure Malaysia remains competitive regionally while the opposition Pakatan Harapan wants a holistic review of the national tax system. Both sides speak of putting more money into the hands of the people, who should live better as Malaysia progresses towards high-income developed nation status.

Yet the biggest headache for policymakers is that most Malaysians earn too little wages.

Half of Malaysians earn less than RM1,703 a month, according to 2016 data from the Department of Statistics (DoSM) — barely enough to live from day to day, let alone squirrel away enough money for retirement.

Even among degree holders, half earn less than RM4,810 a month — the equivalent of US$1,235 or S$1,623 (not enough to be a taxpayer in Singapore where the median income is S$4,232 a month).

In Malaysia, however, a monthly income of RM4,810 is considered to be “on the high side”.  If you earn RM4,810, you will be among the 2.27 million people or 15% of the labour force paying individual income tax. Even some of their retirement savings with the Employees Provident Fund (EPF) is taxed! (See accompanying story)

“The labour income share to gross domestic product (GDP) is still quite low at about 35%, which also proves wages are low in Malaysia even though labour is an important factor to production,” says Dr Zakariah Abdul Rashid, executive director of Malaysian Institute of Economic Research (MIER).

The Economic Planning Unit (EPU) wants 40% labour share to GDP by 2020 but meeting that deadline would be tough with only two years left. “The 40% is already seen in other developed countries,” laments Zakariah, weighing in on the importance of achieving the target in the coming years.

He also points out that the minimum salary for the over 1.6 million government servants, at RM1,200 a month, is already higher than the minimum wage for the private sector of RM1,000 in Peninsular Malaysia and RM920 in Sabah and Sarawak. Unlike civil servants, most private wage earners do not have a pension.

“Malaysians generally earn too little to have a minimum acceptable standard of living as income is barely sufficient to cover the rising cost of living,” says Lee Heng Guie, executive director of Socio-Economic Research Centre (SERC).

“Between 2014 and 2016, while the average monthly income of the bottom households increased 6% per year to RM2,848 from RM2,527, after adjusting for the increase in the cost of living, the real average monthly income grew 3.8%. This goes to show that the rise in income is hardly enough to keep pace with the basic necessities and living expenses, leaving them with little savings for contingency and emergency expenses.”

Half of the individuals with tertiary education earned less than RM3,274 a month in 2016 — double the median income of RM1,600 for those with only secondary school education and RM1,200 for wage earners who only finished primary school. Wages are even more dire among those without a formal education, at only RM1,000 a month, way below the national median income of RM1,703 a month, DoSM data shows.

Most local graduates are not able to command high salaries either. Some 62.7% of graduates with a bachelor’s degree earn a monthly salary of between RM1,000 and RM2,500 while 88.6% of diploma students earn between RM1,000 and RM2,000 a month, Lee says, citing data from the Higher Education Ministry’s 2016 graduate tracer report.

For the majority, income is not that much higher in the Klang Valley or the major cities. Half of wage earners earn less than RM2,500 in Kuala Lumpur and less than RM2,362 in Selangor. The median income is RM1,950 in Johor and RM1,800 in Penang.

This means many would fall short of Bank Negara Malaysia’s “living wage” guide of RM2,700 for individuals and RM6,500 for couples with two children to attain a minimum acceptable living standard — figures for Kuala Lumpur, which central bank governor Tan Sri Muhammad Ibrahim said can be applied to major cities like Penang and Johor.

While the median individual income in Malaysia has risen an average of 4.6% a year from RM1,300 in 2010 to RM1,703 in 2016, the generally low wages relegate the income tax burden to even those who are not rich.

Even though individual income tax kicks in when one’s monthly income is more than RM3,100 (or RM4,000 with enough exemptions), only 15% of the labour force — a small group of just over two million individual taxpayers — is the source of 13.4% of government revenue (RM32.23 billion) for this year.

In Singapore, about 30% of the workforce pays taxes while in Thailand, it is 10%, says Lee.

So while policymakers may want to exempt more low and middle-income people from paying individual income taxes, the general low wage situation limits their options.

Changes in tax brackets

To be sure, the government has in recent years exempted the lower income group from paying individual taxes. The tabling of Budget 2013 came with an announcement of 170,000 people being exempted from paying income taxes. The headline number of people exempted from paying individual income taxes was 300,000 for Budget 2015 and 260,000 for Budget 2018.

In conjunction with the introduction of the Goods and Services Tax (GST) in April 2015, new tax brackets have also been introduced for assessment year 2015 (YA2015) and YA2016 to lower the tax burden of the lower income group while increasing that for the (relatively) higher income earners.

In YA2018, everyone but those in the lowest income tax brackets saw a RM300 to RM1,000 reduction in payable taxes with a 2% cut in three of four of the lowest tax brackets (see table on Page 70).

More can be done. A knowledge worker residing in Iskandar Malaysia and individuals under the returning expert programme are given a preferential tax rate of 15%.

Will the same consideration be shown to other professionals and middle-income earners who have been working and contributing to the nation’s economy?

Someone earning more than RM7,083 a month or RM85,000 per year (more than RM70,000 taxable income) is already taxed 21% — a big gap with the previous tax bracket of 14%.

While a monthly income of RM7,083 is way above the RM1,703 a month that half of Malaysians earn, translating that into Singapore dollars would render the figure a mere S$2,390 — just over half of Singapore’s median income of S$4,056 in 2016 and S$4,232 in 2017.

After all, tax incentives are not just about attracting talent (from outside Malaysia) but also about making sure that the locals are happy to stay and motivated to move up the income ladder.

Even those earning RM15,000 a month — which is considered high income and is no longer eligible for PR1MA affordable housing — are not all that rich. He or she would be in the 24% to 24.5% tax bracket and incur RM26,500 of taxes — being 14.7% of gross annual income or 1.8 months’ salary, according to YA2018 brackets.

Someone earning S$15,000 a month in Singapore would pay 9.75% of gross annual income in taxes, assuming zero relief (see table above).

No wonder both the ruling party and the opposition have touched on the need to review taxes.

Need for a tax review

“There is a worldwide trend towards lowering income taxes to spur effort and investment while raising revenue from consumption taxes. We will have to seriously relook and lower our income tax rates to remain competitive against our neighbouring countries,” says Dr Yeah Kim Leng, economics professor at Sunway University Business School.

“There is a need to make sure income groups are not burdened by both the direct and indirect tax to ensure that the overall tax system, comprising income tax and indirect taxes such as GST, remains progressive based on the principle that those with higher income shoulder a higher tax burden,” he adds.

SERC’s Lee is all for a review of individual income taxes: “A competitive and lower tax rate will reward performance, boost productivity and raise disposable income to support consumer spending. Besides that, the restructuring of personal income tax bands so that the taxpayers will not hit the higher tax rates immediately will help attract and retain knowledge workers.”

He reckons that the middle-income group would benefit from higher relief for parental/elderly/disabled care, childcare, education (tuition) and healthcare expenses.

As the bottom 40% (B40) do not pay income taxes, any reduction in taxes would favour the middle 40% (M40).

For the middle-income group, Zakariah is in favour of further income tax reduction or giving additional relief rather than more cash transfers, such as BR1M.

“There are many ways of putting more cash in consumers’ pockets… Personal income tax reduction is easier to implement as it is done via the Inland Revenue Board and everything is on record. For income transfer, there are issues such as ensuring payment is properly targeted, meaning only the deserving people get help,” Zakariah says.

Cash transfers and income tax cuts would both come at the expense of government revenue, something that Zakariah says needs to be given due consideration. After all, rating agencies closely track Malaysia’s federal government budget deficit — which is essentially the spending in excess of what is earned that year.

To have more flexibility to cut income taxes, Yeah reckons that the government can look towards local and cross-border entities that are getting revenue from doing business online as well as explore the broadening of its tax base from those who can better afford them.

“E-commerce and ‘platform’ business income derived by tech giants such as Google and Facebook is an area being looked into but its implementation is more difficult as it requires cooperation among all countries. Increasing tax administration efficiency and regional cooperation through initiatives such as reducing base erosion and profit shifting (BEPS) can also enhance revenue. More contentious sources such as capital gains, property and inheritance are the other areas that may need to be looked into more seriously in the future, especially if income inequality keeps widening,” Yeah says.

Another economist says GST may also be raised to partially offset the loss in revenue from a reduction in the income tax rate or higher threshold of tax exemptions: “Given that Singapore is looking at a 2% increase by 2021, there is a window for Malaysia to do the same and still have the lowest consumption tax rate in the region. Reducing zero-rated supply, however, would likely hit the lower-income group more as they tend to consume more of the necessities.”

RM1,500 minimum wage in five years?

Raising the minimum wage is another method to put more money in the hands of the lower-income group but the implementation would be a challenge as long as productivity growth remains sluggish.

“Raising minimum wage is only a small instrument. Malaysia needs to make its labour market more efficient by removing some of the distortions and the most urgent is foreign labour. Official figures are 1.8 million to 1.9 million but the unofficial figures are three times that or 6 million and 90% or more are unskilled or low-skilled. When skills [and productivity] are low, employers cannot pay high wages,” Zakariah says.

Assuming BN retains power in GE14, the targeted RM1,500 minimum wage within five years (by 2023) would imply a RM250 increase in the review this year to RM1,250 and another increase to RM1,500 in 2022, given that the minimum wage is reviewed every two years.

According to the BN manifesto, there would be a need to cut foreign labour to 15% of the workforce. Six million foreign workers would imply 30% of the current workforce.

The removal of these distortions in the labour force should help nudge wages higher, economists say, but equally important are the changes needed to spur the right kind of investments that would create the desired high-income jobs here for Malaysians. Malaysians would also need to upskill to deserve the higher income.

While having a larger pool of higher-income earners would make it easier for policymakers to cut income taxes for the middle-income group as well as reduce the rate for professionals, there is a need to ensure that businesses and the relatively small pool of professionals here are happy to stay on while others climb the skills and income ladder.

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