By Hafiz Noor Shams
JAN 28 – While the economic outlook around the world gets gloomier by the day, the second fiscal stimulus package seems imminent even as the federal government struggles to spend RM7 billion allocated under the first package.
Even though there is widespread belief that the extra adrenalin jab is urgently needed, reports suggest that the outline of the second stimulus has not yet been written. The evidence? The Finance Minister is asking the public for ideas on how to spend lots of money. If that is so, then this is an opportune time to argue why, for Stimulus Version 2.0, a regime of tax cuts is a better solution than government spending. If the purpose of an economic stimulus is to reduce the impact of an economic downturn, then the package has to satisfy at least two criteria.
First, the lag between the administration, the execution and the effect of the stimulus has to be short. This is to ensure that the stimulus comes at the times when it is most beneficial. That is when the economy is deep in crisis and not when it is already nearing reasonable levels of recovery. Any later, a stimulus will be useless.
Secondly, it has to be widely distributed to the participants of the local economy. An unevenly distributed stimulus will be meaningless in terms of alleviating the sufferings of individuals adversely affected by the downturn. While the economy could, theoretically, show signs of recovery even with an uneven stimulus, it may do little to improve key figures like, for instance, the unemployment rate.
The previous RM5 billion injection by the government into ValueCap – a fund management company active in the equity market – is a case in point where the stimulus is extraordinarily focused.
While the massive injection into ValueCap may save the fund managers, investors and shareholders, it does nothing for the real economy.
The very nature of government spending is such that it is unlikely to achieve both criteria at the same time simply because there is a trade-off between the two.
For a stimulus to act fast, it has to be simply administered on small items without complex distribution methods. Any effort to distribute the spending and, hence, the money, widely will necessarily bog down the execution of the stimulus. A distributed stimulus has to be planned for policymakers have to know where to spend. This information, unfortunately, does not come quickly. Any investigation requires time and an investigation of countrywide magnitude demands a reasonable amount of time for it to be completed.
It is possible that efforts by the Finance Minister to harness the wisdom of the masses is partly to cut short the process of information gathering.
Independent of the quality of information is the question of execution. A widely distributed stimulus, by definition, requires a considerable number of transactions at various levels in the government as well as the economy.
Each transaction itself takes time, especially so when transparent processes, which include open tenders, are applied.
While government spending suffers from the trade-off, tax cuts do not. Tax cuts can be done relatively quicker and are, by nature, more distributed than government spending.
Cuts, especially on transactional taxes on consumer goods like sales tax, can be administered quickly simply because the information required is not a massive as the data required for government spending.
The government could simply announce that sales tax has been reduced to a certain level in a matter of weeks, if not days.
Secondly, a tax cut, especially on sales tax, is more distributed in its effects than any practical government spending. Just imagine how many times a week do each of us make a transaction with sales tax appended to it? How many people do you know pay sales tax on goods and services they consume? Compare that to the number of people you know who may immediately benefit financially from government spending on, say, highways or schools?
The reduction or even total – albeit temporary – removal of sales tax could increase the quantity of goods bought and sold, simply because these become cheaper. There are other taxes that could be cut, like corporate and personal income taxes but these will not take effect as quickly as a sales tax cut. The fastest way to use such cuts is to implement a backdated cut and return the money paid as taxes in 2008 within the next several few weeks or months. This puts the money in the taxpayers’ pockets.
Announcing future cut on those taxes soon is likely to be a game of expectation management. Any reduction of non-transactional taxes on consumer goods must be directed at the lower and middle classes. It has been demonstrated time and again that these groups are the ones most likely to spend instead of save the extra cash they receive.
A large tax cut will, of course, hurt government revenue in times when revenue from petroleum and its by-products may fall short of projections made last year.
This will increase the fiscal deficit. Concerns about deficit, however, are immaterial if the alternative is greater government spending. Whether government revenue shrinks or its expenditure grows, the end result will likely be the same in direction if not in magnitude.
Besides, while RM7 billion pales in comparison with the size of the drop in Malaysian exports of late and is therefore unlikely to counter the full effect of weakened external demand, the path of government spending has been explored.
The first stimulus attacked the demand curve in its first wave. Perhaps it is wise to attack the supply side in its first wave now. Thus, when the first and the second stimuli are combined, a more holistic view is taken.
Finally, for Barisan Nasional, tax cuts would be better for public relations than government spending. The BN-led federal government has been accused of cronyism with government contracts circulating mostly among BN party members. Even in a system that favours the Malays, the general feeling is that only Umno members are benefiting from it while other Malays are left out.
Consider government spending as fiscal stimulus: with its requirement to be executed fast, large spending is likely to bypass many transparent processes, if there is any at all. With an already bad reputation for corruption and waste, the haste of commissioning various stimulus-conscious projects is likely to encourage the public and political rivals of BN to question the methods of awarding contracts and the beneficiaries.
With tax cuts, especially on sales tax on consumer goods, there is no basis for any accusation of cronyism or corruption since the action benefits all consumers.
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