Penang Finance:Strong Roots, Stunted Growth

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The modern history of Penang began when it was acquired by the British East India Company in 1786 to serve its expanding global trade. The island boasted a fine sheltered harbour, and was perfectly located at the northern end of the Straits of Malacca. It served the British well in business and as a military base. Penang’s many geographical advantages allowed it to function for over two centuries as a trading, administrative, travel and educational hub. And since the 1970s, it has also been the industrial centre for the globalising economy of Malaysia. Despite such strong foundations, the island has nevertheless failed to live up to its potential. Its economic hands have been strongly tied by excessive federal control.

Kwong Wah Yit Poh
George Town: The Penang State Government has no option but to persist in convincing the Centre to play fair&hellip

The challenge for Penang

The problem with Penang … is that she, like all states in the country, is permanently dependent on the Federal Government. Malaysia embraces a federal system of government with a “Centre” that is so strong that some have dismissed it as a “flawed federation”. — Holzhausen, 1974

NOWHERE is this more obvious than in the conduct of financial relations. The Centre has retained for itself all major revenue sources, rights of undertaking expenditures and powers of borrowing. The states, on the other hand, have such limited revenue sources and borrowing powers that they are forced to rely on the Centre for development funds.

Prior to the March 8, 2008, general election (where Barisan Nasional lost its two-thirds majority in Parliament and Pakatan Rakyat gained control over five of the 13 states), such reliance was not a big issue because the Centre and the majority of the states were under a single coalition party.

Last year’s political tsunami that saw Penang, Kedah, Perak and Selangor fall to the Opposition led to initial optimism that the old tactics of bullying a state (and thereby, punishing the voters) by cutting down or delaying development allocations would no longer work – these were, after all, developed “key states” and any drop in economic growth would adversely affect the growth and economic performance of the national economy as a whole.

However, an analysis of Penang’s financial records reveals that the optimism is misplaced. This leaves the Penang State Government with no option but to persist in convincing the Centre to play fair, while at the same time improve its revenue management and cash inflow so that it will no longer be heavily dependent on the Federal Government for its economic future.


The financial threat

The Centre’s mantra of “a vote for the Opposition will result in reduced and often delayed federal fund disbursements” is still being chanted and practised, to the detriment of the country’s economy.

A series of measures were announced that appear to be designed to “punish” opposition-held states rather than foster joint development. For instance, the Entrepreneurial and Cooperative Development Ministry replayed a familiar tune from the past by ordering Mara (Majlis Amanah Rakyat), rather than the State Economic Development Corporations (SEDCs), to disburse funds for federal projects under the ministry. This deprived the states of revenue equivalent to five per cent of the value of federal projects implemented in the states.

Opposition states like Penang are powerless to renegotiate the terms of disbursement because innumerable obstacles stand in their way.

Clearly, in Malaysia where a single party has controlled both federal and most state governments since independence, federal-state relations have been akin to intra-party relations. Some time will no doubt elapse before the former is recognised and treated as distinct from the latter. Until then, however, it is prudent for states such as Penang to optimise the internal resources available to her.

Who’s the boss?: Understanding federal and state government responsibilities

The Federal Constitution specifies the division of expenditure, revenue-sharing and borrowing responsibilities between the federal and state governments. The Federal Government controls a wide array of exclusive powers while shared powers are few, with federal law always taking precedence over state laws in cases of inconsistencies.

FEDERAL

• Pays for federal responsibilities;

• In the case of shared responsibilities, pays only if expenditures are related to federal commitments or state commitments undertaken in accord with federal policy and with federal approval; and

• Has exclusive powers to levy and collect all taxes and other forms of revenue except from a few minor sources assigned to the states.

STATE

• Pays for its own responsibilities;

• Revenues are limited to collections from import and excise duties on petroleum products (Terengganu, Sabah and Sarawak), export duties on timber and other forest products (for Sabah and Sarawak) and excise duties on toddy in all states;

• Revenues can be raised from forests, lands (quit rents, fees for Temporary Occupancy Licence, or TOL, grazing permits and conversion) and mines and entertainment taxes;

• Non-tax revenue includes licences and permits, royalties, service fees, profits from commercial undertakings (such as in water, gas, ports and harbours), land sales, rents on state properties; and non-revenue receipts include proceeds, dividends and interests and grants and reimbursements from the Federal Government;

• Is only allowed to borrow from the Federal Government or from a bank or other financial sources approved for that purpose by the Federal Government for a period not exceeding five years;

• Must follow the terms and conditions prescribed by the Federal Government,and these apply even to all loans raised by the state or guaranteed by it;

• Is constrained in its ability to guarantee loans;

• Cannot offer such guarantees except with the approval of the Federal Government, and subject to conditions set by it;

• Revenue is divided into operating revenue (raised mainly within the state) and development revenue (coming primarily from loans and grants from the Federal Government to finance major development projects);

• Expenditures are classified as operating (for maintaining existing infrastructure, services and facilities) and development (for creating new infrastructure, services and facilities).

Kwong Wah Yit Poh
A bar in Upper Penang Road. Collecting entertainment tax remains a state responsibility.

Future economic outlook

If operating expenditure maintains its rapid growth vis-à-vis operating revenue, the future may well see persistent deficits emerging in the operating budget.

A rule of thumb suggests that operating revenue must at least cover operating expenditures. In the case of Penang, after three years of operating deficits (2000–2002), operating revenue has exceeded operating expenditures since 2003. Although the surplus has averaged RM30mil per year, it has varied considerably in size, and it is unclear whether it is on a downward trend.

In the early period, surpluses were generated because development expenditure growth was declining at a faster pace than the decline of development revenue growth. In the later periods, surpluses were maintained despite the fact that development expenditures were growing at a more rapid rate in the face of declining growth in development revenue. If this trend persists, the development budget of the future will accumulate deficits again.

Kwong Wah Yit Poh
Butterworth Port, Penang. Ports are some of the few remaining sources of revenue for the state.

It is interesting to note that, the share of development expenditure in total shrank from about 50 per cent in 2000 to 26 per cent in 2003. Since then it has shown an overall rising trend, reaching about 37 per cent in 2008. This suggests that the state budget surpluses of later years have been achieved largely by trimming operating expenditure rather than development expenditure – a positive trend.

A federal punishment?

The generally favourable picture of Penang’s budgetary health diminishes considerably when we appreciate how vulnerable it is to fluctuations in federal funding. To illustrate:

• In 2000, federal loans amounted to RM62.8mil. Had these not been forthcoming the overall budgetary deficit of the state would have more than doubled from RM35.8mil to RM98.6mil

• Estimated federal loans for 2008 amounted to RM97mil. If not for this, the estimated surplus of RM4.34mil would have turned into a hefty deficit of RM92.7mil.

• Non-revenue receipts – more specifically, grants and other receipts from the Federal Government, which accounted for the biggest chunk of the state’s operating revenue in the past – appear to be on the decline.

Kwong Wah Yit Poh
Revenue from land sales – the only significant state resource – is dwindling both in terms of growth and contribution.

Clearly, Penang was not receiving big grants from the Federal Government even when it was under Barisan control. This is evident from the fact that well before 2008, federal funds as a proportion of operating revenue had been on the decline – from 35.4 per cent in 1980 to 29.6 per cent in 2000. Tellingly, it fell further to a mere 21.9 per cent with the Opposition takeover of Penang in 2008.

The contribution of federal funds to the state’s revenues is likely to fall further in the immediate future. First, while Federal Government payments to local authorities (MPPP and MPSP) were channelled through the state in 2000, the amounts allocated for both in 2008 were not only reduced but were paid, again tellingly, by bypassing the state.

Another component of receipts from federal agencies is the five per cent service charge for federal projects implemented in Penang using state personnel. Although receipts from this source were projected to increase from RM7.31mil to RM10mil between 2000 and 2008, they are likely to fall in the future because the Federal Government is likely to channel the implementation and monitoring of federal projects in the state through federal agencies.

Sources: Report of the Auditor-General on the Accounts of the State of Penang, 1980 and 1990; Penang Financial Statement, 2001 and Penang State Budget, 2008.
Notes: * Estimated

The share of development revenue in total revenue fell from 41.4 per cent in 2000 to 38.5 per cent in 2008. The main source of development revenue was federal loans, hardly what one would call “revenue”! Federal loans (rather than grants) and funds reassigned from the operating budget financed most of the state’s development in 2008.

It is disconcerting that revenue from land sales – the only significant state resource – is dwindling both in terms of growth and its contribution to operating revenue. This suggests an urgent need to review how this resource is being managed.

Penang’s tax base is narrower than those of resource-rich states like Sabah, Sarawak and Selangor, where taxes on natural resources generate substantial state revenues. Given that land is limited in Penang and that the publicly held land bank is only around 12 per cent of total land, the state is likely to face a serious shortfall in tax receipts in future if serious attention is not paid to how land is managed.

Kwong Wah Yit Poh

What now?

State finance is constrained by the asymmetry of power between state and federal governments in Malaysia, with the latter controlling most revenue sources and using it to hold the Opposition-led states to ransom. Despite the fact that the state managed to maintain small surpluses in most years after 1980, the fact remains that Federal Government funding, either by way of grants or loans, has been one of the important sources of funding. So, what now?

All is not lost. Penang MUST:

• Become as self-reliant as possible by maximising the state’s sources of receipts and decreasing unnecessary expenditures or leakages;

• Work with other Opposition-held states to seek a review of the federalstate financial arrangements to reduce dependency on the Centre and gain access to more sources of self-funding;

• Review quit rent rates (the largest component of tax revenue) regularly to keep pace with inflation or rise in property prices. There must be emphasis on efficiency in the collection of quit rents;

• Appropriate a substantial, if not the entire proportion, of the increase in land (including reclaimed land) value from one use to another (appropriation is currently by the land owner). The state can enact a policy whereby the rise in land value from conversion reverts to the state. This will form a huge source of revenue for the state.

• Introduce a property transfer charge on a sliding scale so that properties that are held for shorter periods are taxed at higher rates. This would be a source of revenue and also discourage excessive speculation on property investments;

• Review the policy of conversion of leasehold to freehold land. All land reclamation should be carried out by the state and the benefits accrue to the state. In the past, the state lost billions in revenue by allowing private companies or individuals to benefit from land reclamation and conversion of reclaimed land to freehold land. This practice should be terminated;

• Review its investment portfolio to consider partial investments in government bonds and securities based on its cash flow needs to enhance yields. Performance of state corporations like the Perbadanan Bekalan Air (PBA) and others should be monitored regularly with a view towards improving their returns;

• Renegotiate tax-sharing arrangements to extend the current revenue sharing mechanism so that all states get a share of the taxes raised in their respective jurisdictions. The revenue obtained will then have a direct relationship with the level of economic activity in the respective states;

• Review the basis on which grants are given. The tax base of the state should be taken into account;

• Set yearly operational targets to control or reduce this category of expenditure and appoint appropriate state organisations, possibly with participation of independent public individuals or organisations, to monitor this process;

• Upgrade and develop the Botanical Gardens and Penang Hill as ecotourism is crucial to Penang’s economy. This will eventually generate a small surplus for the state’s coffers;

• Make audited financial data public to ensure that its finances are transparent and to encourage more research and suggestions from the public.

The message is simple: Penang needs to trim wasteful expenditure, maximise collections from existing revenue sources (especially by improving the management of land matters), look for new sources of revenue, and plug leakages in spending!

“In terms of costs, the performance failure is even more alarming. Only RM1.8bil of the projects out of a total of RM7.6bil are expected to be completed on time.”


“In terms of costs, the performance failure is even more alarming. Only RM1.8bil of the projects out of a total of RM7.6bil are expected to be completed on time.”


‘A shocking failure’ RM5.8bil worth of projects allocated for Penang under the 9th Malaysia Plan (9MP) not completed on time

ON HIS BLOG – cm.penang.gov.my (30.8.2009) – Penang Chief Minister Lim Guan Eng expressed the state’s deep concern about “the shocking failure rate of 76 per cent, where RM5.8bil out of the RM7.6bil worth of projects allocated for Penang under the 9MP could not be completed on time.”

Quoting media reports, Lim said Minister in the Prime Minister’s Department Tan Sri Nor Mohamed Yakcop had revealed that under the 9MP, 1,055 physical development projects involving an allocation of RM7.6bil were approved for Penang, and that 496 of these projects worth RM1.5bil had been completed, 22 were behind schedule and the rest (537) were at various levels of implementation.

Kwong Wah Yit Poh
Incomplete projects: ‘Not getting our rightful share is bad enough with only RM7.6bil but it is wholly unacceptable when RM5.8bil of the RM7.6bil projects under the 9MP cannot be completed on time.’

“In other words, 537 of the 1,055 physical development projects or more than 50 per cent of those planned under the 9MP cannot be completed on time by the end of 2010.

“In terms of costs, the performance failure is even more alarming. Only RM1.8bil of the projects out of a total of RM7.6bil are expected to be completed on time.

“This means that RM5.8bil worth of projects have failed – a shocking failure rate of 76 per cent! This is a great loss to Penang and there should be some explanation of how this could [have] happened and what the projects involved [are],” he said, adding that the sum was significant as Penang contributed some RM20bil to the Federal Government’s coffers during the period of the 9MP.

“Not getting our rightful share is bad enough with only RM7.6bil, but it is wholly unacceptable when RM5.8bil of the RM7.6bil projects under [the] 9MP cannot be completed on time.

“More information [will] be sought from the Federal Government to see what these projects [are] that could not be implemented as scheduled, and whether [or not] both the state and federal governments can work together to resolve this problem in the public interest,” he said.

Kwong Wah Yit Poh
Penang Botanic Gardens: A mere development budget allocation of RM1mil for 2008.

In The Star’s report (31/8/09), Lim’s predecessor Tan Sri Dr Koh Tsu Koon accused the current administration of sending out different kinds of signals and messages to the Federal Government.

“Hence, the Federal Government has to postpone the plans as it does not know what is going on – one minute it’s this and the next minute it’s something else,’’ Dr Koh, who is also a Minister in the Prime Minister’s Department, said.

Greening the gardens

More money for the Penang Botanic Gardens, please!

BESIDE our other recommendations to improve the state’s finances, it is imperative that more funds are pumped into the management and upgrading of the Penang Botanic Gardens. The development expense for this purpose must be seen as a long-term investment that will bring returns to the state.

Flowers at the Gardens: Once the attraction is improved, reasonable entrance fees can be a source of revenue.

The eco-attraction has long been in a state of neglect. A mere development budget allocation of RM1mil for 2008 didn’t help.

Some necessary steps that can be taken include:

• Setting up an advisory committee comprising highly qualified and experienced professionals to provide vision, direction, guidance, and assistance to the gardens’ staff and representative users to provide feedback and input on policies;

• Increasing the gardens’ budget to upgrade staff skills;

• Upgrading/beautifying the gardens in stages/areas;

• Raising funds by appealing for public donations of all amounts – the state can match the smaller sums pledged.

Once the attraction is improved, reasonable entrance fees can be a source of revenue for the maintenance of the gardens.



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