This article first appeared in Forum, The Edge Malaysia Weekly on May 6, 2024 - May 12, 2024

With a rapid demographic transformation underway, Malaysia stands at the threshold of a pivotal era marked by heightened public spending to effectively address the profound implications of its ageing population. Chief among these challenges is the surging demand for healthcare services, propelled by the intricate and specialised needs of ageing individuals. Concurrently, there is an imperative to fortify the country’s pension system to uphold the dignity of an expanding segment of the population. Additionally, as the proportion of the workforce relative to the total population diminishes, there emerges an urgent call to invest in education and skills development to mitigate the adverse effects of increased dependency, wherein a greater number of seniors rely on a shrinking pool of workers for support.

Therefore, amplifying public spending is not merely a requisite for safeguarding the well-being of the elderly but also a strategic investment in the nation’s future productivity and prosperity. Nonetheless, despite the pressing need for augmented public expenditure, Malaysia’s current level of spending remains comparatively low. In 2023, public expenditure stood at RM397.14 billion, representing only 20.81% of gross domestic product (GDP) for that year, positioning Malaysia among the lowest in terms of public spending relative to its economic development level.

However, Malaysia’s ability to efficiently allocate resources towards public expenditure is severely hampered by its limited revenue generation capacity. This constraint not only undermines the government’s ability to address societal inequities but also impedes the accumulation of the human capital crucial for sustainable development. Without adequate funding, the country risks widening disparities and hindering the upward mobility of its citizens, ultimately jeopardising its long-term economic prospects and social cohesion.

Taxation serves as the cornerstone of modern societies, providing governments with essential revenue to fund public services and investments. Beyond its fiscal role, taxation promotes equity by redistributing wealth, it mobilises domestic resources for development and fosters human capital through investments in education and healthcare.

The potential of a country’s taxation system is influenced by various factors, including the level of per capita real income, degree of income inequality, industrial structure of the economy, social and political context, and administrative competence of tax gathering branches of government. As countries progress along these factors, the tax-to-GDP ratio tends to increase. Nevertheless, Malaysia has been moving in the opposite direction as tax revenue collection weakened over time, falling to less than 12% of GDP in 2023 from 20% of GDP four decades ago (Ministry of Economy, 2024) (IMF, 2023).

Unsurprisingly, Malaysia’s tax-to-GDP ratio significantly lags behind countries of similar developmental status. In fact, Malaysia’s ratio is nearly one-third of the average Organisation for Economic Co-operation and Development ratio (34.2%) and even falls below the average ratio observed in African countries (15.57%) (OECD, 2023).

Malaysia, therefore, possesses significant potential to enhance tax revenue by capitalising on its economic growth, diverse industries and strengthened administrative capabilities. A detailed examination of the tax revenue composition offers valuable insights into potential avenues for expanding fiscal capacity through taxation.

As for the direct taxes, Malaysia’s ratio of direct taxes to GDP is in line with the global average, standing at 8% of GDP (OECD, 2023).

Nevertheless, Malaysia’s tax on goods and services ranks among the world’s lowest as a percentage of GDP, notably falling well below the global average of 9.8% of GDP (OECD, 2023).

Furthermore, it is concerning that the disparity continues to widen over time, as the tax on sales and services grows at a slower pace than GDP growth, diminishing its relative contribution to the economy.

The attempts to address this issue have been limited in impact. The most recent effort has been in Budget 2024, where the government announced the introduction of new measures to broaden the tax base, enhance compliance and streamline administration to effectively mobilise domestic resources. Key initiatives include (Ministry of Finance, 2023):

•    Increasing the excise on sugary drinks from RM0.40 per litre to RM0.50 per litre

•    Raising the service tax by an additional two points, now standing at 8%, excluding food, beverages and telecommunication services

•    Introducing a 5% excise on chewing tobacco, alongside an additional RM27 per kg

•    Implementing a 10% capital gains tax solely on the disposal of unlisted shares of local companies

•    Expressing further intentions to impose new taxes on luxury goods and companies with global income, although specific implementation dates were not provided

While the collective impact of these measures was not reflected in the 2024 budget, their potential to generate tax revenue is assessed to be very limited, contributing only around 0.3 percentage points of GDP (IMF, March 2024).

Value-added tax (VAT) is conspicuously absent from the array of tax options utilised in Malaysia. This largely accounts for the nation’s weakened tax generation capacity, particularly evident in the realm of goods and services.

However, this has not always been the case in Malaysia. The introduction of the goods and services tax (GST), akin to VAT, lasted from April 1, 2015 to September 1, 2018. During this period, it generated substantial tax revenue amounting to 3.23% to 3.3% of GDP for the years in which GST was fully implemented (Ministry of Economy, 2024).This constituted nearly one-fifth of Malaysia’s total revenue during the same years.

VAT stands as a potent revenue tool employed across all OECD countries, except for the US, contributing an average of 20% to total revenues in these nations (OECD, 2023). It is worth highlighting that Malaysia introduced GST at a notably lower rate of 6%, contrasting with the average VAT rates observed in other OECD countries, which stood at 19.3% in 2023 (OECD, 2023).

Therefore, reintroducing VAT in Malaysia has an enormous upside potential to generate a revenue stream that can be channelled for an inclusive growth path. If Malaysia introduces VAT gradually, and to reach the world average rate of 17% the amount generated has the potential to ultimately reach more than 9% of GDP, totalling RM188.4 billion in 2024.

The decision to eliminate the GST in 2018, a pledge made during the 2018 election, stemmed primarily from its regressive nature as a consumption tax, disproportionately affecting the income of the less affluent compared with the wealthy. Reintroducing it without addressing equity concerns poses significant political challenges.

We argue for a phased reintroduction of the GST coupled with a structured system of periodic tax refunds. Given the anonymity of transactions under a VAT system, designing a tax refund mechanism in the form of cash transfer to families with children, senior citizens, persons with disabilities and expecting mothers, can mitigate welfare losses resulting from inflationary pressures and diminished budgets during vulnerable life stages. As shown in the table titled “Proposed system of tax refund to accompany VAT”, a system of tax refund can be introduced at an overall cost of RM15.679 billion. 

Ultimately, the combined impact of VAT and the above system of tax refunds can serve as a progressive social policy tool, while at the same time, generate sizable revenue to increase social investment in the future productivity and prosperity of Malaysia.

Dr Amjad Rabi is a visiting expert and Prof Datuk Norma Mansor is the director of the University of Malaya Social Wellbeing Research Centre

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