This article first appeared in The Edge Malaysia Weekly on October 28, 2024 - November 3, 2024

LIVING up to his reputation as a skilled orator, Prime Minister Datuk Seri Anwar Ibrahim not only cited from the Quran when tabling Budget 2025 in Malay on Oct 18 but also used words of wisdom in Chinese (¤@¦A [yi cuo zai cuo] to refer to the fatal mistake of continuing down the wrong path) and a classic Tamil verse from the Thirukkural (‘Iyatralum Eettalum Kaatthalum Kaattha Vaguthalum Vallathu Arasu’) on the need to manage the country’s coffers well to elevate the people’s well-being.

Yet, not everyone is impressed with another record-sized third Budget tabled under the Madani government, deeming reforms to be “not as bold as they should be” on the back of enviable GDP growth, a stronger ringgit and global oil prices coming off their peaks.

“Yes, many see this as an opportunity to do more subsidy rationalisation and broadening the revenue base, for the most part,” says Dr Nungsari Ahmad Radhi, a seasoned economist and chairman of the Khazanah Research Institute.

“The government stayed true to decreasing the [fiscal] deficits and slowing down the growth of debt. [It’s] just that some people want more done,” adds the former member of parliament who is familiar with how the political economy works.

Acknowledging the need for more reforms before the window for it closes “by mid to third quarter next year” for the current cycle, Nungsari gave a one-word reply when asked for his greatest concern when looking at the government’s fiscal balance: “revenue”. That basically refers to the federal government’s narrow revenue base and lack of tax buoyancy. The latter indicates the inability to collect the appropriate level of taxes relative to the country’s level of economic growth.

“For me professionally, I would like to see things done to rebalance the tax system and, in doing so, broaden the revenue base. We are too dependent on direct taxes and have little room there. We cannot do anything with corporate tax. We have little room on personal income tax, except for perhaps increasing the highest bracket tax rate. The government has introduced some wealth-based taxes [on] income not from labour or wages, such as [tax on] dividends [in excess of RM100,000 per year] … But most of all, we should look at indirect taxes, which is the value-added tax (VAT),” Nungsari elaborates, choosing to speak on a broad-based consumption tax that is similar to the goods and services tax (GST) but has not been demonised like it.

In favour of a more efficient indirect tax that does not have a cascading tax problem, unlike the sales and service tax (SST), Nungsari says “Malaysia’s consumption-based taxes should be simplified to just the VAT”.

“Remove all other consumption-based taxes and just have VAT, even at a 4% rate. This has the effect of formalising the whole economy and capturing everyone and every entity and will raise reasonable revenues over time. It has buoyancy in that it will grow faster than GDP growth,” he adds, noting that the question of household income — be it the low median or unequal distribution — are a separate issue from the need to broaden the government’s revenues.

“The former is about productivity and competitiveness while the latter is tied to existing levels of commitments and forward contingent liabilities. Both must be done. [The need to raise income levels and broaden the government’s revenue base are] not an ‘either or’ or a sequential thing,” Nungsari says, without mentioning recent news reports that Malaysia would consider implementing GST/VAT only when the minimum wage rises to between RM3,000 and RM4,000.

Critics familiar with the state of government finances point out that a country that does not manage its finances well could end up with a situation in which nominal wages are high without the desired purchasing power.

Most people understand the need to sequence reforms so that the positive changes would not come undone at the next political cycle.

To borrow the words of Professor Yeah Kim Leng, president of the Malaysian Economic Association (MEA), when kicking off its post-Budget 2025 debate on Oct 21, there is a need to “understand the nuances and balancing act that go into crafting a budget that not only enables the economy to thrive but also for every segment of society to not only feel that they are better off but are actually better off based on statistical data and empirical awareness”.

At the same time, there also needs to be constant awareness of whether enough is being done to advance Malaysia’s strategic capabilities and far away from the path to bankruptcy, lest those accustomed to kicking the can down the road are lulled into thinking problems would not come home to roost.

Those familiar with federal government finances flag the need to raise revenue because operating expenses have been growing much faster than revenue for decades.

In January 2018, The Edge calculated that Malaysia’s direct federal government debt could rise from RM687.43 billion at end-September 2017 to hit RM1 trillion by 2021, RM2 trillion by 2028 and RM3 trillion by 2032 if borrowings continue to grow at an average pace of more than 10% a year, the average rate at which it was growing annually between 1997 and 2017 (see “Debt surge — Should we worry?” in The Edge, Jan 8, 2018). Direct federal government debt was RM980 billion at end-2021, RM1.08 trillion at end-2022, RM1.17 trillion at end-2023 and RM1.23 trillion, or 63.1% of GDP, at end-June 2024.

Our latest back-of-the-envelope calculations, using the trajectory between 2014 and 2024, show that civil service emoluments and retirement charges plus debt service charges could take up 70% of federal government revenue by 2033, 80% of revenue by 2040, 90% of revenue by 2045 and exceed 100% of revenue by 2050 if the trajectory of revenue growth does not pick up fast enough relative to the respective operating expenditure (see Chart 1).

Already, economists say development expenditure is not rising fast enough because almost all of federal government revenue goes towards operating expenditure, leaving no choice but to fund development expenditure with debt (see Chart 2).

While the allocation for development expenditure of RM86 billion in Budget 2025 remains on a par with the RM86 billion revised allocation for 2024, and is above the RM84 billion for 2023 (RM97 billion less RM13 billion to repay 1MDB bonds), some quarters have noted that allocation towards economic services had fallen even as more money goes towards social services (see Chart 3).

Malaysia, which implemented GST between April 1, 2015, and June 30, 2018, saw tax receipts rise to 80% of federal government revenue during the two full years of GST implementation in 2016 and 2017. Total tax receipts had fallen back closer to 70% since the transition to SST, with an increase in reliance on non-tax revenue — which includes dividends from Petroliam Nasional Bhd (Petronas) — and non-revenue receipts, which include transfers from Kumpulan Wang Persaraan (Diperbadankan) (see Chart 4).

Reforms underway

To give credit where it is due, the current administration has managed to reduce blanket subsidies for electricity, water and diesel as well as provided a timeline for RON95 subsidy retargeting. It has also said new recruits for the civil service this year will no longer be offered the civil service defined benefit (DB) pension scheme, where the burden of saving for retirement lies fully on the federal government, or taxpayers’ money. This only puts a stop to future accumulation, however, and does not immediately bring down the public pension burden, which will only grow as the population ages. The general lack of retirement savings among many older private sector wage earners also means there will be a greater burden on the government to expand the social safety net to provide for the aged who no longer have time to save for their retirement.

Treasury Secretary-General Datuk Johan Mahmood Merican, who dropped by the annual MEA post-Budget 2025 debate on Oct 21 after a briefing for parliamentarians, said the government would consider expanding sales tax or input tax bubbles extended for the manufacturing sector and certain professional services to counter the SST’s problem of cascading, or double, tax and that the thinking behind the examples of salmon and avocado mentioned in the Budget 2025 speech with regard to the expansion of SST was that these are not food items commonly consumed by the masses.

Johan assured the audience that Anwar had said GST/VAT was not out the window, but stressed the importance of increasing wages and sequencing reforms. “The prime minister has not ruled out GST. He clearly accepts that GST is a very efficient, transparent form of taxation but he very much struggles with the fact that GST is regressive … and it is more challenging to introduce a regressive tax at a time when the majority is still facing issues with cost of living,” he says, relating how investment incentives are also being reworked to nudge the creation of more higher-paying jobs.

He also explained that the 2% tax on dividend income above RM100,000 annually is not double taxation but another example of progressive taxation. “We accept, for example, that an individual pays a higher income tax rate when we earn more … So, effectively, this is extending that… If you assume a dividend yield of 5%, that means someone probably has shares worth about RM2 million. We think that is a category that can afford to contribute a little bit more to the government’s tax base. And like it or not, there are some entrepreneurs who are not taking any salaries and are paying themselves through dividends … Why should we have our individual income tax base predominantly reliant on just wage earners?” says Johan, who declined to say how much additional revenue the government expected to collect from the 2% tax on dividend income above RM100,000.

He told the audience that factors such as Malaysia’s robust GDP growth this year, the ringgit’s outperformance against regional currencies in the third quarter, the bellwether FBM KLCI exceeding the psychological 1,600-point mark and improved investment flows show there are already “some early fruits of labour” from some of the macroeconomic reforms under the Madani economy framework.

Malaysia revised higher its GDP growth estimate for 2024 to between 4.8% and 5.3% (from 4% to 5%) after GDP growth averaged more than 5.1% in the first half of this year. This is likely also true for the first nine months of the year, going by advance estimates of 5.3% year on year for the third quarter of 2024, having grown 5.9% y-o-y in 2Q2024 and 4.2% y-o-y in 1Q2024.

Malaysia also kept open the possibility of economic expansion being stronger next year, should growth come in at the higher end of its 2025 GDP growth forecast of 4.5% to 5.5%.

Rather than a budget of compromises, Johan says Budget 2025 “balances fiscal responsibility with an expansionary stance”.

“On the one hand, we are committed in wanting to reduce our fiscal deficit … To some who said, should [the fiscal deficit reduction be] sharper, our response is that we are still on track at a reasonable pace towards the 3% while ensuring we are still spending enough, investing enough in the economy [to] also meet our development needs — and that covers not just supporting industry requirements [supporting energy transition] but also in terms of ensuring we also invest in infrastructure, particularly some of our less developed areas, which includes building highways … These are commitments that we still think are necessary.

“Thus, we retain an expansionary stance in fiscal policy despite our gradual reduction in [fiscal] deficit. We remain committed to reforms and targeted subsidies … It is very unpopular for politicians to speak about RON95 [subsidy rationalisation], but the prime minister speaks about it and has given a commitment to implement targeted RON95 subsidy by the middle of next year. Yes, it raises many questions, but it is one of the things that are consistent with what we’ve done with electricity, diesel and water … The approach to RON95, in looking at the debate of what exactly T15 is, the concept is that the government remains committed to providing subsidies for the overwhelming masses … The intention of the government is to still provide that assistance but we want to remove or reduce the leakages [to] foreigners, corporates, the wealthy, who really shouldn’t be benefiting from subsidies. We estimate that these groups, which account for less than 15% of consumers, currently consume more than 40% of RON95, hence a similar situation for electricity,” Johan says, also reminding the audience that Anwar when tabling Budget 2025 acknowledged the need to not be complacent with past successes and “the importance of staying the course in some of these reforms, which may not necessarily be popular but are important for the long-term prosperity of Malaysia”.

Having flagged the retargeting of RON95 fuel subsidy from mid-2025 for the top 15% of the population, inflation is forecast at 2% to 3.5% compared to the revised estimate of 1.5% to 2.5% for 2024 (originally 2.1% to 3.6%).

Nungsari is in favour of a “simple and gradual” approach to RON95 subsidy rationalisation.

“The government can decide on a fixed amount of RON95 subsidy … let’s say, 80% of the current amount. The 20% savings in subsidies can then be distributed to targeted households. In the subsequent year, reduce the subsidy by another 20% and plough that back to households. [This way, RON95 subsidy removal] can be done over five years using a simple implementation mechanism and [it should be] done concurrently with provision of public transport,” Nungsari says, noting that the government should target the reduction of the number of vehicles on the road as the ultimate measure of this greener policy.

“The other important reason for subsidy rationalisation is the removal of distortions. The price distortions resulting from subsidies have distorted resource allocation, a major cause of our non-competitiveness. It perpetuates this artificial ceiling on prices, which include the price of labour. We cannot address the low wage regime without addressing price distortions that are caused by subsidies and also various imposition of controls. We should move away from price subsidies and move towards income augmentation. But we must sort out our productivity, which means we must sort out our schools and universities,” he adds.

At the post-budget debate, Johan said RON95 subsidy retargeting for individuals could be done using a fleet card or identity card that is linked back to a database or with a combination of an e-wallet that replicates the tiered pricing done for diesel, but he did not say whether the government would use the central database (PADU).

To gain genuine buy-in, or whole-of-nation support, economists say there is a need to recast the narrative surrounding tax reforms and subsidy retargeting.

At the MEF post-budget debate, Maslynnawati Ahmad, head of economics and research at Bank Pembangunan Malaysia Bhd (BPMB), is among those who reckon that more development expenditure needs to be allocated to areas that could bring in more private investments rather than having more money set aside for handouts.

“In behavioural economics, once a consumer is given some handout, they expect more … If their expenditure plan also revolves around this expectation, and the expectation is not being met, [there could be pushbacks] — just like expectations on EPF withdrawals [during and post-pandemic],” she elaborates.

Datuk Dr Nik Maheran Nik Muhammad, professor at the Faculty of Entrepreneurship and Business, Universiti Malaysia Kelantan, says the government needs to ensure that proper thought goes into defining who should be considered “mahakaya”, or ultra rich, when retargeting subsidies because the level of household income for the top 15% (T15) of households of RM13,295 may look relatively high due to generally low wages but is far from wealthy.

Firdaos Rosli, AmBank Group chief economist, points out that all indirect taxes — be it SST, GST or VAT — are all regressive in nature, but the effects can be countered using cash transfers and exemptions on basic essential goods and food items.

Tan Sri Dr Noor Azlan Ghazali, director of the Malaysian Inclusive Development and Management Institute (MINDA-UKM), flagged the need to recast the narrative surrounding taxes.

“No government in the world can survive without collecting taxes … We want the government to tax correctly. The nation must understand that tax is not robbery. The problem is that when we teach our citizens that taxing is like robbery, then you’re afraid of telling the people ‘I need to tax you’. Taxation is when you drive through the streets and there are no bumpy roads and the street lights are on, where the rivers are clean … Everybody wants to have good lighting in their housing areas, everyone wants firefighters to arrive fast with good equipment. [But how will that happen if] no one pays taxes? ... So, we must educate the nation that taxes are okay, but they need to be done right. And once you collect taxes from us, you have to spend it correctly as well,” Noor Azlan says, noting how the government needs to spend tax money better and improve conditions where more than 60% of federal government revenue is stuck on paying just emoluments, retirement charges and debt service charges.

Rather than taking subsidies away from the rich and taxing them in favour of the poor, the government must ensure the narrative is changed in such a way that people are not discouraged from moving up the income ladder and taxes are seen as contributing towards nation building.

Nungsari, who was not present at the MEF debate, says problems surrounding the nation’s finances are well known — basically, they involve “how to consolidate government finances while ensuring both strong growth and better safety nets”.

“Both sides [the government and opposition] should debate about how to solve these problems. If the government proposes a solution and the other side is unhappy, then come up with a better solution. What are these solutions exactly? They have to grow up, be more mature [in providing feedback and comments]. Almost everyone in Malaysian politics today has been on both sides of the aisle and knows what it means to govern.

“If you disagree with subsidy rationalisation, you have to give solutions on how to allocate additional expenditures to other things. Do we borrow more or raise new revenues? How is that better? Will it remove the distortion in the economy? Is it more equitable? I would like to see a higher level of discussion and debates in Parliament. Too many politicians are giving politics a bad name! They should do better.”

Those in agreement would also see the need for politicians to lead by setting a better example. 

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