Cutting Waste Key to Spurring Growth

RIGHT BALANCE: Well-targeted spending cuts complemented by structural reform can actually promote private investment growth

PRIME Minister Datuk Seri Najib Razak, who is also finance minister, has been mulling over plans to rein in the Federal Government’s debt-to-Gross Domestic Product ratio before it exceeds the statutory limit of 55 per cent.

After 15 unbroken years of budget deficit, starting from the 1997/98 Asian financial crisis, there is a new-found concern among the public over the sustainability of the fiscal balance sheet.

But, given the negative global outlook and narrowing trade surplus, would not any public spending cut or tax rise (or both) further dampens economic growth? What should the plan for fiscal consolidation entail in order to avoid a self-inflicting wound on the Malaysian economy?

When a government reduces deficits by raising taxes, the economy is more likely to experience prolonged contraction. But when the government arrests the growth of deficits by cutting spending, the outcome is more positive.

Raising revenue from taxation without commensurate spending cut is akin to filling up a bucket of water with holes underneath. Such fiscal consolidation plan is not credible as it does not introduce the right incentives on the part of bureaucrats to spend resources prudently.

On the other hand, if the government curbs spending today, it sends a signal to investors that tax rates will not be raised in future, therefore this certainty of tax policy creates a favourable outlook for investment.

The risk of expropriation of wealth, either through direct taxation or inflationary means, is also lower as the government has a larger room to introduce stimulus spending during an economic downturn.

But this does not mean that any form of spending cut will automatically generate growth. Spending-based adjustment must be supported by structural reforms such as greater liberalisation of economic sectors and good public service delivery. So, well-targeted spending cuts complemented by structural reform can actually promote private investment growth.

The latest Global Competitiveness Report cites “inefficient government bureaucracy” as the most problematic factor for doing business in Malaysia. The civil servant to population ratio, which currently stands at 4.68 per cent, is the highest in the Asia-Pacific region.

This casts some doubts over the efficiency of the public sector to provide services in a timely manner due to redundancies and overlapping of jurisdiction between different government agencies.

To successfully reform the public services, the government has to undertake a two-pronged strategy: 1) reducing the size of the bureaucracy and 2) institutionalising a meritorious reward system.

Instead of a drastic retrenchment policy, the government should consider increasing the number of quasi-agencies like the Performance Management and Delivery Unit (Pemandu) and Education Performance and Delivery Unit (Padu) to exploit the twin advantages of a lower emolument spending as well as making public services more efficient.

The biggest difference between Malaysia and the Eurozone today is that the former is not facing an economic crisis. This means that Malaysia is in a much better position to cushion the immediate impact of lower government expenditure. But, the existing tax system needs to be reviewed as it is inefficient.

The introduction of a Goods and Services Tax (GST) aims to provide the Federal Government with a stable stream of revenue because the tax is anchored to the consumption behaviour which does not fluctuate like corporate profit or prices of commodities.

Besides, the tax net is spread out more widely as most consumers indirectly pay for GST at point of purchase, regardless of whether one is eligible for income tax.

Cascading tax, or the tax-on-tax phenomenon, can be lowered with GST as the tax burden now shifts from producers to consumers, therefore the tax does not constitute as a cost to the firms’ managers.

But if GST is indeed a better solution, then why has it not been introduced much earlier?

The short answer is that GST is not politically palatable. Now that Najib’s administration has received a fresh mandate to govern, it is about time to correct the flaws in the current tax system, and the GST appears to be a good candidate for its predictability as a source of federal income.

But cutting spending is not popular. Therefore, the success of government’s fiscal consolidation programme depends on the ability to juggle between revenue-based and spending-based adjustments, as well as promoting the growth of private investment in order to increase the country’s average income.

Malaysia does not suffer from political fragmentation, a key variable to explain why certain governments were more able to introduce fiscal reforms, which threatens the survival of the government.

The real challenge rather is for the government to demonstrate its political willingness to maintain fiscal sustainability.

As the saying goes, the proof of the pudding is in the eating. Successful spending cuts which are well-targeted will shore up the government’s revenue base as well as investors’ confidence. The five-year term can be challenging to reverse the declining fiscal position and Najib has to make every hour count.

Article published in the New Straits Times.

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