Economic stimulus – tax cuts or spending?

Tax Insights - By Kang Beng Hoe

But narrow taxpayers’ role in Malaysia makes cuts ineffective

THE current frightful state of the world economy has given rise to a phenomenon which is unprecedented: countries are all reacting in precisely the same way i.e. via the infusion of massive stimulus packages to pump prime their economies. This is because everyone is suffering from the same ailment - falling demand across all borders bringing in its wake wealth erosion, escalating unemployment and a widening loss of confidence verging on fear.

The scale of the stimulus packages of the 11 advanced and emerging economies “are worth an average of 3.6% of GDP, though spread over several years,” according to the Economist magazine. The IMF expects tax cuts and spending to reach some 15% of global GDP.

The nature of the stimulus packages announced by these countries, the G7 plus Brazil, Russia, China and India all have similarities – they include infrastructure spending, non-bank bailouts and tax cuts. Tax cuts are featured in all the packages without exception. Such measures are seen as essential to spurring economic activities by putting money in people’s hands so that they can start spending again. However, many economists do not see it that way. They argue about the degree when human economic decisions are rational or emotional.

Put simply, if a taxpayer gets a tax cut and ends up having additional disposable income, will he spend it or save it? If he saves it, then the tax cut will not have achieved its objective of stimulating economic activity. Then again, it is asked whether the inclination to spend will be greater among those in the lower income group compared with those in the higher income group.

President Barack Obama thinks so as his proposed tax policy will result in the greatest number of low-income taxpayers receiving a tax credit of US$500 each. The effect of this in boosting consumer demand remains questionable by some.

What are tax cuts? If you receive a tax credit, the size of the cheque you write to the tax department/office is reduced. Most people understand this as a tax cut. Of course the more direct way of a tax cut is to reduce the tax rate. For example, Jactim (the Japanese business group in Malaysia) has asked for a reduction of the Malaysian corporate tax rate from 27% to 20% to be more in line with the Singapore rate.

Tax cuts can work in two ways - to either provide relief to the economic pains of the lower income group or to spur spending. This works if most people pay taxes.

In Malaysia, the taxpayers’ role is a small proportion of the total labour force, which thus means that it will not function well as a distributive tool. Here we differ from all the major economies, all of which see some tax cuts, particularly for individuals.

As for corporate tax cuts only a few, including Canada and Japan, plan to do so. As with individuals, there is still the question whether tax cuts for firms will result in the money being spent rather than saved. Empirical studies are not conclusive as to the “multiplier” effect of tax cuts.

A focused approach in helping firms in trouble through appropriate tax measures may be prudent. For example, firms which are incurring losses could claw back the tax paid in prior years by being allowed to set these losses against profits of the past one or two years. Many jurisdictions adopt this practice as part of their regular tax measure but Malaysia could introduce this to put cash in the hands of ailing businesses, particularly SMEs.

Cash flow problems remain a crucial business concern under the current economic environment. This explains why Jactim has also called for greater flexibility in working out the estimated tax payment arrangements by companies with the tax department/office.

The UK Revenue has been bold enough to take a calculated gamble in agreeing to a deferred schedule of tax payments provided full disclosure is made to the authority. This “time to pay” agreement is driven by the desire to ensure the long-term survival of the business and thus secure more tax revenue in the long term. Would this not constitute a valuable source of finance for distressed businesses in Malaysia too? Should it not be adopted here?

It would seem that in structuring stimulus packages, most economies would consider a broad strategy involving both tax cuts and spending. Malaysia’s narrow taxpayers’ role does not permit tax cuts to be used as an effective distributive tool.

As such, Malaysia’s strategy would be heavily skewed towards spending, particularly infrastructure spending.

● Kang Beng Hoe is an executive director of Taxand Malaysia Sdn Bhd, a member firm of the Taxand network of independent tax firms worldwide. The views expressed do not necessarily represent those of the firm. Readers should seek specific professional advice before acting on the views. Readers’ feedback to this article is welcome. Please email to starbiz@thestar.com.my