TAX revenue is key in supporting a nation's developmental needs and delivering public services. A tax system design should fit the country's domestic requirements, encourage economic growth, support its citizens and be responsive to international developments.
Strengthening the tax system is not just about raising revenue. It is also about having one that promotes sustainable growth, builds inclusiveness, encourages good governance and provides better outcomes for society.
Spurring economic activity
Higher economic activity can generate tax revenue growth, which engenders income and wealth creation. Policies to encourage growth in economic sectors that are key to the country's development will create more jobs and build a skilled labour force, resulting in higher incomes and growth in the nation's tax revenue.
Targeted fiscal incentives are key to boosting economic activity. Offering tax reliefs and incentives to attract foreign investments and support industry sectors will promote the entire industry ecosystem's growth.
When tailoring incentive packages, Malaysia must consider the preferences and needs of relevant investors, especially since large multinational companies may be subject to a global minimum tax rate of 15 per cent from 2023, pursuant to an initiative by the Organisation for Economic Cooperation and Development and the Group of 20 intergovernmental forum.
Reducing marginal tax rates on business income may encourage local companies to invest domestically, especially in the current competitive landscape where countries in the region are leveraging fiscal policy tools to attract foreign investments.
Tax breaks for research and development (R&D) activities will encourage innovation and the creation of new ideas, which will boost the knowledge and skills of Malaysians and catalyse economic growth. As announced in the 12th Malaysia Plan, there is expected to be an increase in R&D spending from one per cent of the gross domestic product last year to 2.5 per cent in 2025.
This signals a greater emphasis on innovation-led growth and building the nation's capability and talent towards this objective. It is equally crucial to measure outcomes and track the growth of businesses that have been granted the incentives.
Building trust in tax administration
Taxpayers and the public want to know how the country's tax collections are being used, and if the funds are being directed to the right areas.
Good public service delivery will boost the people's trust. It can result in the reduction of tax evasion, an increase in compliance and the prevention of tax leakages. The cost for the government to ensure tax compliance will reduce, which will enable it to channel its focus and resources towards developing more effective policies to support socio-economic growth.
Taxation as a form of influencing behaviour to drive sector growth
Reasonable tax rates encourage the private sector development and formalisation of businesses. It is especially crucial for small and medium enterprises (SMEs).
A higher tax on SMEs may be counter-productive as it may not add much to government tax revenue, but may instead cause these businesses to stop re-investing and innovating. It may lead to reduced tax compliance and payment obligations. Some SMEs may cease operations.
Ensuring compliance with the tax rules and regulations is crucial. One way to achieve this is to simplify the rules by making them transparent and easy to adopt. A good tax system can influence business activity that generates economic growth.
A study by the World Bank on 118 economies over six years found that a 10 per cent reduction in tax administrative burdens (based on the number of tax payments per year and the time required to pay taxes), led to a 3.0 per cent increase in annual business entry rates.
Finding new sources of revenue
Introducing new taxes will influence business decision-making, incentivise behavioural changes, and stimulate or
discourage investments by companies.
There should be careful and holistic evaluation when considering new taxes so that the intended outcome for the nation can be achieved.
There needs to be careful consideration and balance between increasing tax revenue through higher or new taxes and achieving sustainable economic growth that prioritises public welfare and drives the right behaviour.
Tax cuts may increase the budget deficit. Taxation can be an effective tool, not just for revenue collection, but also to influence the desired growth for the economy by incentivising businesses, encouraging people to invest, work and develop their skills, promoting innovation, attracting domestic and foreign direct investments and creating the much-needed spillover sector growth, without driving up deficits in the long run.
The writer is a Partner and the Malaysia Tax Markets Leader in Ernst & Young Tax Consultants Sdn Bhd. The views reflected above are the views of the author and do not necessarily reflect the views of the global EY organisation or its member firms.