“Re-instating Fuel Subsidies and repealing GST: Good politics but bad economics in Malaysia?” by Francis E. Hutchinson

2018/58 11 May 2018

Dr Mahathir Mohamad has begun his first day as Malaysia’s 7th Prime Minister with a bang, ordering in-depth probes of the Attorney-General, the Election Commission, and the Malaysian Anti-Corruption Commission. These ‘stroke-of-the pen’ decrees will deliver quick wins to the new administration and generate momentum for reform.

Measures like these, along with Pakatan Harapan’s pledges of having two-term limits on the prime ministership, separating the offices of prime minister and finance minister, as well as revisiting the power and prerogatives of Sabah and Sarawak within the Malaysian federation, will also greatly restore the public’s faith in their institutions.

Notwithstanding the above, the new administration will soon need to take some hard decisions. The pledge to repeal GST within the first 100 days of coming to power was one of Pakatan Harapan’s campaign pledges, as was the restoration of targeted petrol subsidies. The first promise was reiterated as recently as yesterday by Dr Mahathir.

It is very clear that unhappiness over GST was a major factor behind the swing in votes from Barisan Nasional to Pakatan Harapan. This was compounded by frustration over cost of living issues, driven in part by the phasing out of subsidies on petrol, diesel, sugar, flour, cooking oil, and gas cylinders. The depreciation in the Malaysian Ringgit also drove up the cost of imported items.

However, from a fiscal point of view, the repeal of GST and the elimination of fuel subsidies taken during the Najib Razak administration were necessary measures. Revenue from oil-related sources as a percentage of government revenue has declined from 40% in 2008 to 14% currently – driven by the declining price of oil. Consequently, the government has needed to find new sources of revenue, widen its tax base, and reduce unnecessary expenditure.

Fuel subsidies were a logical choice for savings, as depending on the global price for oil, they could constitute up to 20 percent of government expenditure. Beyond their expense, the effect was not targeted, benefiting owners of gas-guzzling cars most of all. Thus, while it may be tempting to re-instate some, or all of these subsidies, it would be more economically sustainable and environmentally friendly to focus on improving public transport. Indeed, the focus on car ownership and road building has seen the use of public transport in Kuala Lumpur decline in recent decades.

Turning to income issues, GST has proven a viable and stable method of increasing government revenue. Following its introduction in April 2015 as a replacement for the Sales and Service Tax, GST quickly became an important source of revenue, generating RM 43bn in 2017 – about 18% of total government income, surpassing income tax and oil-related earnings in the government’s coffers.

The incoming administration has pledged to replace the GST with the pre-existing Sales and Service Tax. However, this tax is much less effective, generating only RM 17 bn in 2014. Where will the shortfall in revenue come from? Raising corporate tax above its current level would affect Malaysia’s competitiveness, and its low wage levels mean that only 15% of the working population pays income tax. The other option is to increase the fiscal deficit, which will affect the country’s credit ratings.

While it is tempting to look to fuel subsidies and the repeal of GST as a means of delivering quick returns to Malaysia’s electorate, it may be better to retain one or both of these past policies and to look elsewhere for tangible outcomes.

First, much of Malaysian’s frustrations pertaining to GST were that their hard-earned tax contributions were being frittered away due to mismanagement, such as the National Feedlot Corporation, FELDA Global Ventures, and 1MDB. Through strengthening oversight mechanisms, reforming and empowering the Malaysian Anti-Corruption Commission, and increasing overall transparency, this dis-satisfaction may be substantially addressed.

Second, other aspects of Pakatan Harapan’s campaign platform may provide more promising avenues of pursuit. A great deal of the country’s cost of living issues are linked to low wage levels, which have not kept up with inflation. These low wages are, in turn, the result of Malaysia’s large number of foreign workers, which are estimated at some 6 million people. Through a gradual reduction of the number of unskilled foreign workers, increasing supervision of the awarding of work permits, and encouraging greater process improvements in the workplace, productivity and value-added can increase – which will boost wages.

In the weeks ahead, Malaysia faces crucial decisions. The desire for tangible results is understandable, but must not come before reconciling short-term benefits with long-term sustainability.

Dr Francis E. Hutchinson is Senior Fellow and Coordinator of the Regional Economic and Malaysia Studies Programmes at ISEAS – Yusof Ishak Institute.

The facts and views expressed are solely that of the author/authors and do not necessarily reflect that of ISEAS – Yusof Ishak Institute.  No part of this publication may be reproduced in any form without permission.