Malaysian State Governments Can Do More, and Get More Taxes

The states of Malaysia have been zealously petitioning more money from the federal government. Their grievance is understandable: Malaysia’s Constitution authorises the federal government to collect tax from income, profits, property, trade, and other sources, while states overwhelmingly depend on revenue extracted from the commercial exploitation or sale of land. Putrajaya thus enjoys ten times more revenue than the 13 state governments, and shares precious little. Of the RM8,969 per capita tax collected by the federal government in 2023, only RM90 went back to the states by obligation, based on population. State governments also receive federal grants for roads and development projects.

The states are stratified in terms of receipts from Putrajaya. In per capita terms, Sarawak’s government, reaping oil royalty and petrol sales tax, collects RM4,414 per capita. Residents of East Malaysian neighbour Sabah get RM1,549 on average, much less than Sarawak but still way more than the 11 Peninsular Malaysia states, which on average got a paltry RM550 to dispense per person.

Small wonder that Sabah and a few Peninsular states have been complaining to Prime Minister and First Finance Minister Anwar Ibrahim. The states are becoming more assertive, leveraging their position in Anwar’s sprawling coalition government that relies on the support of its components. The Regent of Johor recently sought the return of 20-30 per cent of taxes paid from the state to federal coffers; Penang’s Chief Minister asked for 20 per cent. Sabah has filed a judicial review pursuing its longstanding claim that the 1963 Malaysia Agreement entitles Sabah to 40 per cent of government revenue sourced from the state.

Sabah’s argument may have legal merits and will wind its way up the courts. The Peninsular states, however, are on flimsier ground. Minister of Communications Fahmi Fadzil parried the states’ appeals by invoking the Constitution, which unambiguously concentrates both governmental functions and revenue at the federal level. Second Finance Minister Amir Hamzah Azizan denied Penang’s request for revenue redistribution and reaffirmed the status quo. But he assured the state that federal grants can be continually negotiated.

Malaysia’s central government constitutionally administers education, health, defence, utilities, transport, and much more; state governments control land management, Islamic law, local government, and other functions. Some matters, such as public health and social welfare, are the joint responsibility of federal and state governments.   

The constriction of state governments’ revenues demands redress. States desire to do more but are mandated to do little. Electorates demand services that state and local governments may be better poised to deliver, but are not empowered to do so. Dependency on land-based revenue — a finite resource and ecological treasure — constrains state coffers and militates against conservation and sustainable development.

Their financial plight deserves sympathy, but their demands for transfer of taxes without the concomitant transfer of tasks would open a fiscal chasm, since the federal government would continue doing the same scope of work but with less funds.

However, the states must make a stronger case, starting with devolution of roles from the federal to state levels. The states, especially on the Peninsula, have appealed primarily on the grounds of moral injustice and sentimental charity. Their financial plight deserves sympathy, but they are seeking a contractual and constant transfer of taxes without a concomitant transfer of tasks. This would be an incomplete settlement that opens a fiscal chasm, since the federal government would continue doing the same scope of work but with less funds.

The reconfiguration can start with the Constitution’s Concurrent List of functions under the jurisdiction of both federal and state governments. This affords wiggle room for state agencies to expand and replace federal counterparts, most notably, in social welfare and public health.

The level of government should be aligned with the demarcation of benefits and coherence of the fiscal system. State and municipal governments, having closer contact with the populace, are distinctly well-placed to provide welfare and health services to a geographically defined, local population. Large-scale infrastructure and industry projects, which state governments understandably want to pursue as tangible legacies, practically require federal funds due to their cost — and also yield wider benefits beyond state borders. There are good reasons for states to receive ad hoc grants for bigger ventures.

Similarly, tax collection from income, profit, and trade, which accrue to the federal government, also substantially derive from services rendered by the federal government: public infrastructure, law enforcement, national education, trade facilitation, and much more. It makes sense for this arrangement to continue. Importantly, there is also fiscal coherence at the third, local level of government, where municipal or city councils collect revenue based on property value to maintain local amenities.

The confinement of state governments to collect land-based revenue lacks a logical basis. The constitutional design arose from historical circumstances — and circumstances have changed.

Consumption tax is a revenue source especially suitable for a federal-state government sharing arrangement. Consumption is a localised activity, hence there is a solid case for a substantial portion of tax proceeds from domestic spending to be recycled back to the state — to deliver, among other things, more health and social services. A further advantage of consumption tax is its resilience against crises — people buy stuff even during economic downturns, whereas investments may be deferred — hence, state governments will be accorded a steady revenue stream. In various advanced economies, notably Australia and Canada, consumption taxes largely or entirely accrue to provincial governments.

The hurdles — both political and practical — remain steep. Peninsular states are prohibited from collecting sales tax; only Sabah and Sarawak are permitted to do so. But only political will hinders the government from instituting a statutory requirement that a share of consumption tax — say, 3 per cent out of 6 per cent — must be channelled back to the source states.

The need to broaden the tax base continues to weigh on Malaysia, but public discourses repeatedly propose the reintroduction of an unreformed goods and services tax (GST). The Pakatan Harapan government abolished the GST to fulfil a 2018 general election promise. At a rate of 6 per cent, GST netted RM44 billion in revenue in 2017; its replacement, the reinstated the narrower sales and services tax (SST), generated RM27 billion in 2019 and RM34 billion in 2023.

It will be a grave wasted opportunity if Malaysia resuscitates a broad-based consumption tax such as GST without concurrently ameliorating the federal-state disparity and enhancing welfare redistribution. The devolution of tasks and sharing of taxes could also pacify disgruntled state governments.

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