— S.M. Mohamed Idris
The Malaysian Insider
Feb 10, 2012

FEB 10 — The government’s aim is to achieve a high-income economy by 2020 must equally benefit all Malaysians. We cannot have a society where one small elite group is living in luxury, while one big part of the society is struggling to survive.

The income inequality gap

According to Dr Muhammed Abdul Khalid, a research fellow with University Kebangsaan Malaysia, although Malaysia has made great strides in reducing poverty and inequality (especially between ethnic groups) from 1970 to 1990, the inequality remains high post-1990.

It has remained almost at the same level for the past 20 years; in fact, the inequality in Malaysia is among the highest in the region.

Before the 1990s, the inequality improved tremendously, due to commendable government policies that include the promotion of export-oriented industrialisation, education, and training, and the restructuring of equity ownership and assistance in asset accumulation.

However, post-1990s, there is little change in inequality due to the difference in the growth rates of incomes of the rural and urban areas, return on assets against wages, inflows of migrant workers, and impediments to the process of internal migration.

Although there was huge improvement in the rural-urban gap, it also has stopped improving since the ‘90s, the income gap ratio between urban and rural in 2009 is almost at the same level as in the year 1989. But in absolute terms, the income gap has in fact widen considerably, it has jumped three times during the same period. The gap between the rich and the poor also remains wide and equally high across all ethnic groups in absolute terms.

Of course, the socio-economic conditions of the rural population and the poor have improved substantially, but despite the huge resources allocated by the government towards rural development and for the poor, the income ratio between the rich and the poor, and of the rural population and their urban counterparts, has not changed much post-1990s. Unless corrective measures are taken, inequality will widen in the future.

Narrowing the gap

Below are the two areas, namely taxation and subsidies, where changes have to be implemented in order to narrow the income inequality gap:

a) Taxation

i) Capital and property gains tax

In Malaysia, all sources of earnings are not treated equally — most notably, net asset incomes (e.g. financial capital and property gains) get more favourable treatment than salaried income. In other words, capitalists are favoured over the working class in this country.

For many working Malaysians, the top marginal tax rate of 26 per cent is applied to their hard-earned wages and salaries, while for the small group of wealthy Malaysian whose income are earned from the capital gains derived from the stock market and financial transactions, the tax rate applied is zero. In comparison, the United States imposes a top rate of 15 per cent on the capital gain.

The Real Property Gains Tax (RPGT) as announced in the 2012 budget is 10 per cent for the first and second years, 5 per cent for third, fourth and fifth years. However, the 10 per cent rate is not high enough to act as a deterrent to speculation by the rich and will continue to widen the income gap between the two classes.

We may need to consider introducing a similar tax for financial capital gains in Malaysia and perhaps at the same time increase the RPGT for the first five years.

ii) Income tax

The top marginal tax rate is set at a quite low bracket, for instance, a hard-working middle-class household that earns a taxable income of RM100,000 annually is taxed at the same rate of those who earns millions, both are taxed at the marginal top rate of 26 per cent.

Perhaps the income tax brackets can be increased so that the millionaires do not end up paying the same tax as those who earn RM100,000.

iii) Inheritance tax

The absence of an inheritance or estate tax has also contributed in widening the wealth disparity gap between generations. Such a tax is not new — Malaysia used to have it until it was repealed in 1991

Maybe we can reintroduce the inheritance tax.

iv) Luxury goods

Taxes that affect the high-income groups such as taxes on luxury goods have been abolished or reduced.

Reinstate the taxes on luxury items.

b) Subsidies

Another way to reduce the inequalities is to revamp the subsidies regime so that only the target groups reap its benefits. “Blanket” subsidies (given irrespective of the household income level) are unlikely to improve inequality. For instance, the rich person driving a luxurious car reaps more subsidy benefit in absolute amount than a motorcyclist.

A study by IMF has shown that poor households benefit least from subsidies; in Malaysia, only 25 per cent of social assistance goes to the poorest 20 per cent.

However, social subsidies (e.g. for health, welfare, education) will have to be continued as there is need to ensure that they reach the targeted group. Subsidies for fuel should be phased out, and its withdrawal will raise government revenue that can be used to provide social safety net to the vulnerable groups

The government should remain focus on reducing inequality because concentrating on growth alone is not enough: how it is distributed is equally important. Importantly, wide inequalities, if left unchecked, can not only harm long-term growth and impede social mobility, but will also breed social resentment and generate political instability, which will also fuel populist policies. Last year’s Arab Spring and the current discontent with Wall Street are partly due to the unequal distribution of economic growth. It is better if Malaysia can learn and remember these lessons, rather than experience it.

* S.M. Mohamed Idris is president of the Consumers Association of Penang. (The above is based on Dr Muhammed’s paper that was presented at CAP on February 9, 2012.)