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Contents

BAB2205 Malaysian Taxation System Taxation and The Modern Economy (Part 1)
Lecture 1

1. Roles of the state and revenue systems 2. Importance of taxes 3. Principles behind the design of an effective tax system 4. Potential bases of taxation 5. Tax terminology 6. Types of taxes 7. Determinants of tax compliance

Roles of the State


Including: Executor Economic and fiscal policies

Source of Funds
It has been said that 'what the government gives it must first take away'. The economic resources available to society are limited, and so an increase in government expenditure normally means a reduction in private spending. (James and Nobes, 2009, p. 7) IMPORTANT : Fund raising to finance government spending
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Provision of public goods:


Education Healthcare Welfare Defense Infrastructure

Source of Funds - Creation of Money


Government simply creates more money and uses it to purchase goods and services Debasement of currency through production of too much money QE1,QE2 - Quantum Easing !!!
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Source of Funds - Creation of Money


Tried many times over the centuries Violently condemned in the 14th century Inflation!!! As the value of money falls, purchasing power is transferred from holders of money to government

Source of Funds - Borrowings


Government can borrow either from:
own citizens; or overseas by issuing national bonds, e.g. MGS Alternative - concessionaire:
Roads Natural resources, e.g. logging, mining
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Source of Funds - Borrowings


Limits to the amounts that people are prepared to lend, even to governments. Bankruptcy risk of a country will increase if government finances its deficits in the balance of account extensively with borrowings.
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Source of Funds - Sale of Public Goods


Charge for goods and services it provides Straightforward! Government operates like a commercial business Charge citizens directly on the basis of the use of many government services
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Source of Funds - Sale of Public Goods


Examples include:
Defense; law enforcement; transport infrastructure.

Very difficult, or even impossible!!! Market failure pricing, free rider Thank you for calling the Police Station; press 1 for bank robbery; press 2 for snatch thieve please key in your credit no. or verification.

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Source of Funds - Taxes


Questions on taxes???
Purpose of tax? Voluntary or compulsory? Who imposes the tax? Is it for a specific right? Is it a penalty?
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Purpose of Tax
Tax revenue most important/ primary source of public revenue Secondary purpose/purposes:
To effect social and economic changes Redistribution - e.g. redistribution of wealth (closing poverty gap) Repricing - e.g. high taxes on cigarettes to discourage smoking (Sin Tax)
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What is Tax?
Compulsory payment levied by government on taxpayers to meet public expenditure. a tax is a compulsory contribution imposed by a public authority, irrespective of the exact amount of service rendered to the taxpayer in return, and not imposed as penalty for any legal offence. (Hugh Dalton, 2003)

Who decides on a countrys tax system?


Government in charge
Democracy Society as a whole (parliament)
Who will pay? How much they will pay? How will the taxes be collected?

Non-democracy Those in power


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Design of an Efficient Tax System


The difference between taxes and thievery is mostly a matter of legality So, design of a tax system is very important How to evaluate a tax system? Adam Smiths Wealth of Nations (1776) provided the common principles of a good tax system.
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Adam Smiths Canons of Taxation


Fair/ equity Based on peoples ability to pay; Certain Easily administered, not subject to sudden changes; Convenience Tax should be collected at a time & in a manner convenient for taxpayer Economy of collection not too expensive to collect and does not hinder economic growth Many others since terminology may change but concepts are the same.

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Canons of Taxation - Application


What is a fair or equitable tax system?
Higher income earners pay a higher rate than those with lower income (progressive tax); or Taxpayers are taxed at the same rate (flat/proportional tax); or A combination of the two.

Progressive, Fixed or Regressive?


Progressive tax
the tax rate increases as the amount to which the rate is applied increases Effect - Upper income families pay a larger share of their income in tax that those with lower income

Flat tax
Tax rate is fixed as the amount to which the rate is applied increases Effect - the same % is taken from everyone regardless of how much or how little they earn

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Progressive, Fixed or Regressive?


Regressive tax
Tax rate decreases as the amount to which rate is applied increases Effect - lower income families pay a larger proportion of income in taxes than the rich

Canons of Taxation - Application


Fairness of tax system should reflect a persons ability to pay (Adam Smith, 1776):
Horizontal equity taxpayers with same ability to pay (i.e. same tax base) pay same amount of tax Vertical equity taxpayers with greater ability to pay owe more tax
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Advocate for Progressive tax system!

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Lecture Illustration
A local government has came up with a new property tax. The tax base is the assessed value of the real property and it has a 2 rate structure: 2% for assessed value from 0 RM250k 1% for assessed value > RM250k Is this a fair tax system? The most optimum tax rate system - progressive or a flat tax system?

Other Canons of Taxation in Modern Economy


Neutrality - does the tax system promote or hinder economic efficiency? Simplicity - is the tax system simple to manage and reduce cost of compliance? Sufficiency - does the tax system raise sufficient revenue to finding governments spending?
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Essential Tax Terminology


Taxpayer Jurisdiction Incidence Tax base
Ad valorem versus specific Narrow versus broad

Taxpayer
A taxpayer is :
Any person or organisation required by law to pay tax to the government Person the term refers to both natural persons or corporations separate legal persons

Tax rate
% or other unit of measurement Flat or graduated Statutory v effective

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Jurisdiction
Jurisdiction the right of a government to levy the tax on the person or organisation There must be rational connection between the tax levying government and the taxpayers, e.g.,
residence basis worldwide income source basis domestic income
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Incidence
Incidence refers to the person who bears the ultimate burden of the tax
Formal incidence - person who has the legal liability to pay the tax Economic incidence the actual person who suffers the tax liability

Determinant of the fairness of a tax system


Formal = economic incidence Formal economic incidence must consider the economic incidence of the taxation
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Tax Incidence
Direct tax (e.g. income tax) Taxpayer Tax Office Formal = economic incidence

Lecture Illustration
Adam owns 8 apartments, all rented out. He charges each tenant RM6,000 per annum. Government increases Adams property tax by RM2,400 (total for 8 apartments) Adam plans to increase rental for each tenant by RM300 Tax Office
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Indirect tax (e.g. goods & services) Restaurant Taxpayer Formal economic incidence

Can Adam do so? who bears the incidence of the tax increase?

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Lecture Illustration
Inelastic demand change in price has little effect on demand
Assuming supply of apartments is very limited Tenants will accept the increase, thus are the economic incidence Adam will be the formal incidence Other examples - cigarettes & alcohol
Can shift burden to consumer
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Lecture Illustration
Elastic demand - change in price has significant effect on demand
Assuming apartments are over supplied Tenants may not accept the increase (thus terminate tenancy) Adam will be the economic incidence Other examples - ???
Cannot shift burden to consumer
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Tax Base
Computation of tax involves 2 items: The tax base; and The tax rate: Tax (T) = Base (B) x Rate (R) Tax base all the items, occurrence, transactions or activities subject to a tax
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Tax Base Ad Valorem v Specific


Usually measured as the total dollar amount or the value, Ad valorem higher the value, higher the tax base, e.g.,
Sale & purchase agreement stamp duty based on market value of property

Can be based on specific unit e.g., weight or size,


tobacco kilo or ton liquor liter, alcohol content
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Tax Base - Broad v Narrow


Tax base is often described as having a broad or narrow base: Broad based tax, e.g.,
GST that applies to almost all goods and services

Tax Rate Unit of Measurement


Usually the tax rate is a percentage on taxable income in monetary value, e.g.,
company tax rate is 25% on chargeable income

Narrow based tax, e.g.,


Tax on imported cars

Can be other measurement unit, e.g.,


X cent per kilo of tobacco Y cent per liter/ alcohol unit
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Generally a broader based tax would raise more revenue. The broader the base, the lower the rate can be. Also, a broader base will help achieve the principle of neutrality.

May affect consumption of the taxable goods

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Tax rate - Flat v Graduated


Discussed earlier. A single % that applies to the entire tax base is described as a flat rate. Multiple % that apply at different levels of income is described as a graduated rate
structure.

Tax rate - Statutory v Effective)


Effective tax rate - total tax / taxable income
Graduated rate schedule Taxable income RM0-RM25,000 RM25,001-RM100,000 Over RM100,000 Tax rate 2% 6% 10%

*For illustration purposes, not real tax rate


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Types of taxes imposed


Corporation tax* - income tax levied on the financial income of corporations
Why tax corporations? What is taxed? Zero tax corporation tax exemption for Lynas

Types of taxes imposed


Capital gains tax* levied on the profit on sale of a capital asset:
Inflationary environment Favorable tax rate based on holding period

Excise tax* levied on the quantity of goods produced, i.e. a specific tax and not an ad valorem tax:
Focuses on a narrow base of products Regressive e.g. excise tax of RM190 per 1,000 sticks of cigarettes is imposed in Malaysia (in addition, 25% of sales tax is levied).

Personal income tax* levied on the financial income of a person

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Types of taxes imposed


Consumption tax* levied on non-investment spending,
e.g. sales tax levied on the value commodity sold (ad valorem tax) Applies to all retail transactions, with exemptions

Types of taxes imposed


State government/ municipal tax* levied per property/ household, e.g.,
Quit rent (Cukai Tanah) land usage, location Assessment (Cukai Pintu) market value, location

Poll tax levied per individual


An example of a fixed tax Previously used as a de facto or implicit precondition of the exercise of the ability to vote in US Introduction led to 1381 Peasants Revolt and 1990 Poll Tax Riot

Inheritance tax death tax Property tax levied on the value of a property
e.g. house ownership tax in China
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Receipt for payment of poll tax, Jefferson Parish, Louisiana, 1917

Types of taxes imposed


Tariffs* - levied on the movement of goods through a political border (also called customs duty) Transfer tax* levied on the transfer transaction (a.k.a. stamp duty) Toll* levied to travel via a road, bridge Wealth tax levied on net worth that exceeds a certain level Super profit tax* levied on windfall profit due to favourable market condition
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e.g. Windfall profit tax on oil palm planters

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Tax Compliance
McBarnet (2001) distinguishes between different forms of compliance: (a) committed compliance is taxpayers willingness to pay their taxes without complaints; (b) (b) capitulative compliance refers to reluctantly giving in and paying taxes; whereas (c) (c) creative compliance is defined as engagement to reduce taxes by taking advantage of possibilities to redefine income and deduct expenditures within the brackets of the law. (Kirchler, E. 2007, p. 22) Critical Success Factor Tax Compliance Behaviour!
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Tax Compliance - Perception of Fairness


Research shows individual's perception of the fairness or equity of a law and regulations can influence his willingness to comply. Fairness in tax rates, bases, relieves, rebates.
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Tax Compliance - Perception of Fairness


In the notion of ability-to-pay
the higher the tax rate, the more one pays for working hard; find ways to avoid tax (make sense)!

Tax Compliance Efficiency of Tax System


Canons of convenience, certainty and simplicity
complexity of tax system could lead to possible non-compliance difficult for individuals to understand it

Progressive v flat rate = high v low income earner.


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Uncertainty in what is taxable or can be claimed as a deduction reduces compliance to the law.

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Tax Compliance - Probability of Detection, Sanction and Penalty


Enforcement policy by the tax agency. The stronger the enforcement initiatives possibility of being detected would be perceived to be high; more likely an individual would comply. Encourage voluntary tax compliance. Severity of the sanction would have coersive effect on compliance

Tax Compliance - Contact with Tax Agency


Individual who has been subjected to a tax audit and thus had personal contact with the tax agency is more likely to comply with the tax law if the contact has been a favourable one. However, in some cases, contact could lead to increased resistance.
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Tax Compliance - Contact with Tax Agency


Tax agency should be service-oriented agency. System to improve contact: Self-assessment system scheduler tax deduction system e-filing

Tax Compliance - Education


Studies reveal that those who were least educated, were more likely to be ignorant about taxation; tend to view taxation only in terms of its burden. Campaigns should be organised to promote compliance and appreciation of benefits and services provided from tax revenue collected.

Tax returns filing and payment become more convenient and favourable.

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Tax Compliance - Attitude Towards Government Policies


More pleased taxpayers (with services provided by government), more likely to comply with the law. State should establish a system,
for taxpayers to voice dissatisfaction; and allowing one to have a say in shaping policy Individuals who felt being treated fairly = more likely to comply.

E.g., public consultation involving business communities and NGOs to discuss GST implementation.

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