Budget 2012 reveals Malaysia’s structural problems

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The public sector budget defi nes the role of government. Citizens have to decide how big they want their government to be for it to articulate suffi ciently well what it must do for the people. This, in essence, is what a budget is all about.

Heavy handed or the “invisible hand”?

The main economic purpose of government is to ensure the delivery of public goods –these being goods that would not be equitably accessible if left to the free market to supply. Believers in the free market prefer to leave the economy to Adam Smith’s “invisible hand” and let the economy make its own supply-and-demand adjustments. Others think that policy instruments need to be wielded if a nation’s social goals are to be achieved.

Malaysia’s budget — a quarter of the GDP

Today, just as it was 40 years ago, Malaysia’s public budget is roughly a quarter of the nation’s gross domestic product (GDP). In actual fact, the public budget crept steadily upwards from 1967 through to 1981 when it was nearly half Malaysia’s GDP. By the early 1990s it was back to the quarter mark and has remained roughly there ever since. Dipendra Sinha’s study in 1998 found no statistical link between Malaysia’s GDP and how much the government spends. Th e data also showed no causal links between the rate of economic growth and the rate of increase in Malaysia’s government spending.1

The size of government in economies around the world is shown in Figure 1. It says little about big and small governments being dependent on the stage of development or economic success. Western economies tend to have larger governments, which may help explain why countries like Ireland, Italy, Greece and Spain are currently in trouble. The US appears to have only a small government but the source of this data explains that only the federal budget has been counted. Inclusive of state government budgets, the US would be closer to Japan at around 40% of the GDP. Singapore is also small because much of the government service there is made up of public enterprises, while Hong Kong has long been an example of a free market economy.

How the Malaysian government spends money has become the subject of public debate in recent years. The operating and development expenditures of Malaysia’s public budget from 1976 through 2012 are shown in Figure 2. Over the past 35 years, both the government’s operating expenditure as well as the public wage bill (emoluments) rose on a compounded growth rate of 10% per year, while development expenditures grew slightly slower at 8.8% per year (these rates are not adjusted for inflation).

As can be seen, the government’s operating expenses have increased slightly faster than the development expenditure. This is normal as in the early stages, there were fewer private investments in the economy because both local entrepreneurship and local capital market were lacking. The government invests more when it has better access to external funding than to private investors. As the economy matures, investments can be left to the private sector. Public money then begins to move to the domestic social agenda such as health, education, public amenities and income distribution. At this point the government is not building infrastructure for these but is concerned with ensuring quality public delivery and standards.

Patients waiting for their turn at Adventist Hospital.

The collective choice

Even though the proposed 2012 public budget is roughly divided between operating expenditure and development expenditure on an 8:2 ratio, it is more convenient to see the individual components of public allocation as part of the whole RM231bil budget, so that financial obligations and social priorities can be better compared, as shown in Figure 3.

Development expenditures are allocated to education, transport and public utilities (three per cent to four per cent share each), which are given slightly more emphasis compared to trade, industries, agriculture and rural development, housing and communications (less than one per cent to two per cent share each). Only very small amounts go to domestic security and national defence (two per cent of the total budget) and to general administration of government (one per cent share).

The government’s wage bill – a quarter of Budget 2012

Salaries of government employees, on the operating expenditure side, constitute almost a quarter of the entire public budget. Pensions and gratuities of retired government employees add another five per cent to the budget. There has been talk about the bloated civil service and the additional strain that pension payments make on the operating expenditure. Emoluments of government employees have become more compared to the development budget. However, compared to the total operating expenditure, the proportion made up by emoluments plus pensions and gratuities has remained about the same over the past 35 years, averaging 36%.

Today, Malaysia has 1.2 million public servants making up about 10% of the country’s labour force. Th rough the 1990s, the number of government employees increased on average about 1.5% a year but over the past decade the size of the civil service has grown by 2.7% a year, which is much higher than the current rate of population growth of only 1.3% a year. Malaysia’s civil servants make up four per cent of the population which is about twice the proportion that of Thailand, Philippines, Indonesia and South Korea.

It is actually the number of civil servants and NOT the wage bill of public employees that merits concern. The structure of Malaysia’s civil service is very hierarchical, as Table 1 shows. Worse still, the median salary level (half of all those employed above this salary level and half below) – pay grade D – is a monthly salary that is barely RM1,000 a month! Civil servants on average are thus not at all well paid; the wage bill is high only because there are so many civil servants.

The government’s employment structure needs to change

There are two reasons the Malaysian civil service has ended up with such a hierarchical structure. First, public accountability makes it mandatory for public servants to be placed into pay grades on the basis of paper qualifications. Every single government position has a minimum qualification requirement. To upgrade, the government encourages and oft en sponsors public servants to go back to school to earn degrees, in many cases all the way to PhD level. Th e second reason is because the government has been “mopping up” unemployment by creating large numbers of low paying jobs.

In the Malaysian civil service, the pay grade is determined by the size of the “army” one commands. Over the years, many posts have been upgraded to higher pay scales through the creation of additional subordinate departments. However, a move in the right direction has enabled the public service department to sideline such a ruling by upgrading positions without the need to hire more “soldiers”. In critical professional categories like university lecturers and school teachers, staff have been promoted to higher pay grades with the PTH2 or “personal to holder” suffix to his or her pay grade, meaning that the post is an exception for the holder that has no “army” to command.

If Malaysia truly aspires to become a high income society, such archaic concepts of hierarchy and paper qualifications need to be set aside. High income is about productivity output, and in a high income society, the difference between the upper and lower pay scales narrows considerably, flattening the employment structure. Skills can be acquired outside of formal schooling. In the private sector, upward mobility can occur with relevant work experience rather than only with paper qualifications.

To make everyone more productive and earn more would be a useful step in the full employment and labour shortage scenario that we experience in Malaysia. Rather than replace missing workers with cheap foreign labour, it would be better to move more Malaysians into higher end jobs with fewer workers doing more and being paid more.

Grants to states and statutory bodies

Federal financial assistance to state governments is an obligation under the 10th Schedule of the Federal Constitution. The size of state grants depends on the population of the states based on a complicated formula – this much money given for the first 100,000 people and that much for the next 500,000, etc. Th ere is also a road grant based on mileage and maintenance costs. All in all, only three per cent of the public budget is released as grants to states.

Twice as much (six per cent of the budget), however, is paid as grants to statutory bodies. These are semi-autonomous organisations that have income-generating capabilities because they provide a service to the public but at a price set by the government, including public universities, public libraries, state development corporations, port authorities, museums, the national sports council and the academy of science.3 More grants to statutory bodies means that they charge lower fees for public access. Less grants means they become more commercial and would operate like privatised corporations.

Subsidies – the sweeteners

In theory, taxes are paid by one group of citizens (the rich) and subsidies are paid to another group (the poor). The scheme is a redistribution device. In Malaysia, subsidies comprise 16% of the budget (RM33bil). However, it is less clear whether the money has been distributed to the deserving, because in practice, subsidies are more commonly used as a device to moderate prices, such as agricultural subsidies to reduce food prices.

More unique to Malaysia, scholarships, education aid, operating grants to primary and secondary schools and pump prices at petrol stations are forms of subsidies. The rich tend to consume more and are thus in a better position to enjoy the price savings. Malaysia has a population of 28 million and so dividing RM33bil by 28 million, we have RM1,179 per head of subsidies – more than what most households pay in terms of taxes if at all. In Malaysia, the government pays people rather than the other way round!

Federal debt

Malaysia’s public budget has been in deficit for years. Revenues for 2012 are expected to amount to RM187bil leaving a shortfall of RM44bil or about five per cent of the GDP. Textbooks explain that it is impossible for a country to have a current account surplus (especially like Malaysia where this is 15% of the GDP) and yet run a budget deficit. This is because, technically, the government can increase taxes by the amount of the deficit, instantly balancing its budget.

In reality, it is not that simple. Malaysia’s high current account surplus is a result of its high national savings due to compulsory contributions to the Employees Provident Fund (EPF) and is thus no longer available for taxes. The government thus borrows domestically and debt servicing costs nine per cent of the total budget. Debt servicing of foreign loans, on the other hand, is comparably negligible, at less than one per cent of the budget.

The budget deficit that incurs more federal debt has been under scrutiny for years. One argument is that the government has been wasteful. With better financial management and prudence the government would have been able to balance its budget quite easily. The Auditor-General’s Report4 released on October 24, with many references to bills for ordinary items that are unrealistically high, is a case in point.

However, unlike governments with runaway budgets (like Greece as well as the US) Malaysia is not heavily in debt to the world. The national debt (the government’s debt), based on Bank Negara figures, as of June 2011 is RM437bil, which is more than half of the GDP, but RM421bil (96%) of this is domestic debt and only RM16bil (four per cent) is foreign debt.

Where does the money come from?

Direct taxes pay for about half of the budget, while indirect taxes and non-tax revenues contribute another quarter each as shown in Figure 4. Looking only at direct taxes, nearly half (46%) comes from company taxes and a fi ft h from personal income taxes. A quarter comes from petroleum. In the case of indirect taxes, nearly half (43%) is sales and services tax. Th e remainder is import and export as well as excise duties.

Two-thirds of the non-tax revenues are income generated from investments. A quarter are revenues from licenses and permits and the remaining (one-tenth) come from proceeds from the sale of government assets, rental of government properties, bank interests and fi nes.

Malaysia’s tax conundrum

Malaysia has a population of 28 million and a labour force (economically active people falling within the working age population of 15 to 64) of 12.7 million. The Inland Revenue Board says that there are 6.4 million registered tax payers in the country but four million of them are ineligible because they no longer work or fall below the minimum taxable income.5 This means that only one out of two in the labour force has a tax fi le and only one out of five actually pays taxes.

Some RM21bil is to be raised from personal income tax for the 2012 budget. If it is true that 2.4 million people pay income taxes in Malaysia then on average the tax bill a year is RM8,750. This amount does not say much in the light of the progressive tax structure. If one earns RM3,000 monthly or RM36,000 a year, the taxable income might be RM20,000 after allowing for the usual deductions. For this amount of taxable income, the tax bill is only RM475 a year. Th ere is an RM400 rebate (those earning below RM35,000 a year are eligible). Thus the tax due is RM75 (far below the average), that is RM6.25 a month, the cost of a simple meal for one. For this, one gets free education for the kids, petrol subsidy worth hundreds of Ringgit a year, the protection of the police and the armed forces, reasonably high quality public health care, etc.

If the tax incidence is so low, then a smaller proportion of the 2.4 million tax payers must be paying taxes far above the average to make up the RM21bil tax revenues. The government hopes to widen the tax base (the sum of economic activities that can generate tax income for the public budget) with the value added tax (VAT) that was supposed to have come into eff ect in 2007. The VAT would spread out the burden across many more people. Essentially the tax structure becomes regressive (lower income earners paying a larger share of the total tax compared to today).

But how much money would the introduction of the VAT raise? Sales and services tax is meant to raise RM14.3bil which presumably would be abolished if the VAT is imposed instead. Here lies a cost benefit problem. A VAT system that tracks sales along the supply chain of a product all the way to the end consumer and handles collections and refunds in the process is complicated (and also costly) when compared with a sales tax which is a single point tax. Malaysia’s total consumption (in terms of value added) is about RM470bil, and hence a three per cent VAT levy would raise RM14.3bil only to replace the current sales and service tax. The current income tax cannot be reduced if VAT is at three per cent. In other words, if the VAT is to effectively raise revenues and offset income taxes, a rate much higher than three per cent has to be imposed. Few can escape paying the VAT and thus it will be politically difficult and yet offer little scope of raising additional revenues.

Conclusions

Malaysia is half a century old and has been economically progressive. It aspires to join the ranks of rich industrialised nations within the next decade. Yet its employment structure and income distribution reveal the need for the public sector to continue providing public services through a tax and subsidy system between the rich and poor.

Public provisions would better take the form of club goods where public fi nance pools together private funds for good quality education, healthcare, transport systems, infrastructure and amenities. The collective consumption characteristics of such goods offer economies of scale and efficiencies that an “every man for himself ” private consumption way of life would not. For this, government must grow in size in the economy. Even after decades this has not happened.

The credibility and competency gap of Malaysia’s public service has to be bridged first.

1 Dipendra Sinha (1998), “Government spending and economic growth in Malaysia”, Journal of Economic Development, 23:2,71-80.
2 Or “khas untuk penyandang” or KUP.
3 A full list of statutory bodies in Malaysia by states can be found at the Retirement Fund (incorporated) homepage at www. kwap.gov.my/En/ Contributions/ Pages/Listof StatutoryBodies. aspx
4 Available via the Audit Department’s homepage at www. audit.gov.my/index. php?option=com_co ntent&view=articl e&id=451&Itemid= 244&template=uj_ darkworld&lang=ms
5 The Eng Hock and Serean Lau “IRB expects to collect RM89bil in income tax”, The Star, May 1, 2010.

Chan Huan Chiang is a senior research fellow at Penang Institute.



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