This chapter examines the first phase of Malaysian telecommunications reform. Three main arguments are presented. First, Prime Minister Mahathir played a central role in the adoption of privatisation in Malaysia. Second, while the Malaysian state is strong and determinedly adopted privatisation as an economic policy, its implementation was greatly influenced by the active lobbying of Malay businessmen. This points to the fact that, a strong state that is able to formulate policies independently is not necessarily insulated from lobbying that shapes implementation. Third, the implementation of telecommunications privatisation mainly benefited politicians, their political allies, and those within the Barisan Nasional patronage network.

The discussion is divided into three parts. The first looks into how and why privatisation was adopted as a state policy. The second focuses on the privatisation of the telecommunications sector by analysing its stages, its implementation, and the roles of major actors. A final section synthesises the chapter's evidence and main arguments.

PRIVATISATION IN MALAYSIA

Malaysia was one of the first among developing countries to adopt privatisation as part of its economic reform program. In the early 1980s, the total or partial sale of state enterprises to the private sector was viewed as the solution to numerous problems confronting the state including inefficient state enterprises, high levels of public debt, and poor economic performance. In March 1983, Prime Minister Mahathir Mohamed spoke of privatisation as a cornerstone of his economic policy. He said:

This chapter describes the condition of the telecommunications industry in Malaysia and the Philippines before market reform by examining the condition of the telecommunications sector and the roles played by the state and private actors. The patterns of political patronage, the types of rents, the way they were obtained, who acquired them, and how they were used will also be analysed. Finally, the question why the Malaysian telecommunications sector was more efficient than that of the Philippines will be addressed.

Immediately after independence, Malaysia was left with a fairly efficient communications infrastructure. Telecommunications were originally the responsibility of a state department that had monopoly control of service delivery. The private sector's role was limited to equipment supply. With the introduction of the New Economic Policy (NEP), the state's monopoly over the telecommunications sector was used to allocate patronage to Malays through the award of licenses for some services and equipment supply contracts. The NEP goal of rapid economic development led to massive state investment for the expansion of the communications sector in the 1980s. The modernisation of the communications infrastructure, however, was also used to create business opportunities for Malays. State patronage of these businessmen resulted in increased costs and inefficiencies in the infrastructure expansion programme. Yet, the economic impact was generally expansionary and growth-enhancing.

Under American occupation, foreign-owned companies under state regulation provided telecommunications services in the Philippines. In 1967, a group of Filipino businessmen close to then President Ferdinand Marcos took over ownership of the Philippine Long Distance Telephone Company (PLDT). PLDT had sole authority to operate a national communications network. During the 1970s, PLDT consolidated its monopoly status, and was under very little state pressure to expand its network and improve its services. A few other businessmen were granted exclusive privileges by the Marcos regime to operate various communications services, and small provincial telephone companies proliferated due to unmet demand. Yet, the state protected the monopoly profit of PLDT, whose services were inefficient. Monopoly rent was captured for private profit, and was growth-hindering.

In this chapter we now turn our attention to the telecommunication industry's liberalisation and the ensuing outcomes. The narrative identifies the market entry beneficiaries, discusses how they obtained their licenses, and identifies their political linkages. The section also assesses the types of rent outcomes and their impact on the industry and economy.

Although the privatisation policy was well planned and deliberations with various stakeholders were held during a series of conferences and seminars, the liberalisation of the sector was largely unplanned. Decisions to allow the entry of competition were made in an ad-hoc and secretive manner. The way in which licenses were issued suggests that the government favoured politically well-connected businessmen. Senior UMNO leaders presided over the distribution of the much sought after market entry licenses.

The opening of the industry commenced in the early 1980s, with the liberalisation of customer equipment terminals and the award of turnkey contracts. As was discussed in Chapter 4, these contracts were exclusively conferred to bumiputera-owned firms. Other methods used for liberalisation were public pay phones and radio paging licensing. However, the most profitable sectors of the industry were basic network, mobile telephony, and international gateway services. The liberalisation of these segments marked the introduction of real competition in telecommunication services.

An examination of the introduction of competition in these three segments indicates the political nature of awarding licenses. The Minister of Energy, Telecommunications, and Posts had the authority to award licenses. Yet, Samy Vellu, who held the portfolio from 1989 to 1995, and under whom the proliferation of licensees took place, declared in 1993 that it was the Cabinet that decided on these matters. This statement confirmed the widely held belief that the power to allocate licenses or contracts lay not with the Minister, but with someone higher than him.

From 1993 to 1995, the liberalisation of mobile telephony, international gateway, and basic network facilities took place rapidly. By 1995 there were seven basic network providers, seven cellular mobile phone systems, and five international gateway facilities. The lack of planning and the absence of a policy for liberalisation were made obvious when a National Telecommunications Plan (NTP) was released in 1994, after all but one of the licenses had been awarded.

Almost every country now has a VAT. But is the VAT now in place in most developing and transitional countries as good as it could be? Must ‘good’ VATs always follow the same pattern? Can every country administer VAT sufficiently well to make the introduction of the tax worthwhile? Is VAT always the best way to respond to the revenue problems arising from trade liberalization? Can VAT be adapted to cope with the rising demands in some countries, especially federal countries, for more access to revenues by local and regional governments? Can VAT deal with such new problems as those arising from changes in business practices with financial innovations and digital commerce? The answers to such questions are critical in many emerging economies. VAT is too important for them not to get the answers right – or at least as right as possible.

VAT remains the best form of general consumption tax available. If a developing or transitional country needs such a tax, as most of them do, then, as we suggested in Chapter 3, VAT is the one to have in almost all cases. Of course, this does not mean that the VAT most such countries already have has been either designed or implemented in the best possible way, as we discuss in Chapters 6 through 10. In addition, some serious criticisms have recently been leveled against VAT as a source of revenue for emerging economies. We consider many of these criticisms in this and the next chapter.

Once the base of a VAT is determined, several key design issues such as the level and structure of rates must be resolved. Many lessons for VAT design suggested by experience in developed countries are relevant everywhere, but some need to be reconsidered in developing and transitional countries, in which tax reality is even more dominated by administrative capacity and political necessity. As Laffont (2004) remarked in surveying another important policy issue (public utility regulation), not only do we have surprisingly little solid empirical knowledge about the critical factors determining what policy design is best for any particular country, but even the relevant economic theory remains rather sketchy. Moreover, outside experts often know even less about the relevant political economy context. In this chapter we consider some of the important aspects of VAT design that require close analysis of the country in question: rates, thresholds, exemptions, zero-rating, and excises.

RATES

Expert advice on VAT rates is simple: there should be only one rate. (Actually, this means that there should be two rates, since a zero rate should be imposed on exports.) The uniformity of this ‘uniform’ rate advice rests on the assumption that the administrative and compliance costs of rate differentiation outweigh efficiency and equity arguments that might be made for such differentiation. Administratively, more rates seem clearly to be associated with higher administrative and compliance costs and hence reduced VAT ‘efficiency’ in the terms discussed in Chapter 4 (Cnossen 2004).

As anti-VAT protests and demonstrations around the world show, there has always been considerable popular concern about the equity aspects of VATs (Botes 2001). Equity is always and everywhere a central issue in taxation. Indeed, from one perspective the principal rationale for taxes in the first place may be thought of as an attempt to secure equity. Governments do not need taxes to secure money: they print the money. The role of the tax system is to take money away from the private sector in the most efficient, equitable, and administratively least costly fashion possible. One person's conception of what is equitable or fair may differ from those of others. In the end, views of what constitutes an equitable tax system are defined and implemented only through the political institutions within which countries reconcile (if they do) such conflicting views and interests. The result may diverge widely from what an outside analyst may consider to be fair or equitable in terms of some normative standard.

Equity issues may be approached at two different levels. One level focuses on the details of how taxes impose burdens on taxpayers who are in the same or different economic circumstances. At a more fundamental level, what matters are not such details but rather the overall effects of the fiscal system on the income and level of well-being of different people. The policy implications of these two approaches to tax equity may be quite different.

This chapter differs from the rest of the book in that issues discussed relate more to the political economy of taxation in general than to the specific economic and administrative aspects of VAT as such. We discuss this broader issue for two reasons. One reason is simply that in many developing and transitional countries controversies about VAT have become one of the central ways in which tax issues arise in the political arena. For better or worse, VAT has often become the ‘poster child’ of tax reform, so VAT reform is inevitably closely related to tax reform in general. The second reason, more directly related to this book, is that the performance of VAT in any country inevitably reflects politics – both short-run factors such as the calculations of particular interest groups and long-run factors such as the nature of political institutions. This critical political dimension of the policy process is often simply taken as given by those directly concerned with VAT design and implementation. Ideally, however, those so engaged should be as aware as possible of the manner in which such factors may impact on (and in turn be affected by) such central elements of VAT design and implementation as exemptions. For instance, being forewarned that a particular sector is politically ‘untouchable’ may enable policy designers to work around the problem in a way that does less damage to the tax as a whole than might otherwise be the case.

Will VAT continue to spread? We think so. One reason we say this is that we think that income taxation offers an increasingly shaky fiscal foundation for many developing and transitional countries. Income taxes are usually more technically complex, more administratively demanding, more vulnerable to erosion and competition, and even less politically popular than consumption taxes (Bird and Zolt 2005). While there is much that can be said in support of income taxes and we think that such taxes continue to have a potentially important role to play in emerging countries, that role is unlikely to be as the mainstay of the fiscal system. General consumption taxes are increasingly likely to rule the fiscal roost, and in most circumstances a VAT is the most sensible form of general consumption tax – both in efficiency terms and, with some qualification, as we discuss later, also in equity, administrative, and revenue terms.

But is VAT always the right answer? Here, we are less certain. For some large subnational jurisdictions (Chapter 8) and some countries, introducing VAT may both make sense and be administratively feasible. However, for some relatively small jurisdictions in which the combination of the ‘border problems’ discussed later and the relatively high cost of administering a consumption VAT may outweigh the economic or revenue gain from doing so, it may not.

In this chapter, we consider four simple questions. First, what exactly is a VAT? Second, which countries have VATs, and how important is VAT in these countries? Third, why has VAT spread around the world so quickly and so broadly? Fourth, is there one ‘VAT world’ or two?

WHAT IS A VAT?

What exactly is a VAT? A recent definitive statement defines a value-added tax as “a broad-based tax levied at multiple stages of production [and distribution] with – crucially – taxes on inputs credited against taxes on output. That is, while sellers are required to charge the tax on all their sales, they can also claim a credit for taxes that they have been charged on their inputs. The advantage is that revenue is secured by being collected throughout the process of production (unlike a retail sales tax) but without distorting production decisions (as a turnover tax does)” (International Tax Dialogue 2005, 8; emphasis omitted). The same name, however – whether value-added tax (VAT) or the more recently favored goods and services tax (GST) – may cover a variety of taxes in different countries. Like the personal income tax, a VAT is not so much a single tax as a set of taxes that share certain characteristics. To put the point in zoological terms, VAT is neither a gorilla nor a chimpanzee but rather a genus like ‘primates.

The famous Russian author Leo Tolstoy once wrote that all happy families were alike. Most countries with value-added taxes seem relatively happy. But this does not mean that all ‘good’ VATs are alike. And of course not all VATs are equally ‘good.’ By definition, all VATs are value-added taxes in the sense that, as do happy families, they share many important common characteristics. Nonetheless, value-added taxes have a variety of sizes and styles, with different prices attached. No one would expect that a rich person in a cold country looking for the right boots in which to go skiing would buy the same footwear as a poor one in a hot country looking for a little protection for his or her feet. Equally, it seems unlikely that the best VAT for a country like, say, Switzerland – rich, with an excellent tax administration and a solid revenue system – would be the same as that for a country like, say, Liberia – poor, recently emerged from a violent conflict, with few administrative resources and in dreadful fiscal shape. Not only will one size not fit all, but VATs inevitably play different roles in different countries. The right VAT for the moment in any particular country may often be very context-specific.

All this is obvious. Somewhat strangely, however, for decades most developing and transitional countries have been told almost without exception that, so to speak, what is right for Switzerland (or France or Canada) is also right for them.

The value-added tax (VAT) has been around for more than 50 years. A large literature dealing with various aspects of this most important fiscal innovation of the last half-century exists. One aim of this book is to review this literature and suggest some avenues for further research that should prove rewarding and yet more questions that need further examination. A more important aim is to review the extensive practical experience with VAT around the world in recent decades and suggest some ways to improve its design and implementation in developing and transitional countries.

A first version of some of this material was prepared for a project on Fiscal Reform in Support of Trade Liberalization supported by USAID. We are grateful for numerous comments received from participants in several workshops held at USAID and the World Bank during the course of this project. In addition, we are grateful to the many colleagues in governments around the world and in the International Monetary Fund, the World Bank, and the Inter-American Development Bank who have, over the years, contributed so much to our knowledge of VAT both in theory and especially in practice. Duanjie Chen, Sijbren Cnossen, Glenn Jenkins, Michael Keen, David Sewell, Carlos Silvani, Emil Sunley, and several anonymous reviewers were also most helpful in providing comments and materials that have helped us in writing this book.

Even if attention has been paid to all the elements of good VAT administration we discussed in Chapter 9, tax administration remains a difficult task even at the best of times and in the best of places – conditions seldom met in developing or transitional countries. The way a tax system is administered affects its yield, its incidence, and its efficiency. It matters. Good tax administration is both inherently country-specific and surprisingly hard to quantify in terms of both outputs and inputs. The best tax administration is not simply that which collects the most revenues; facilitating tax compliance is not simply a matter of adequately penalizing noncompliance; tax administration depends as much as or more on private as on public actions (and reactions), and there are complex interactions among various environmental factors, the specifics of substantive and procedural tax law, and the outcome of a given administrative effort (Bird 2004a). All this makes the administration of a VAT complex. We discuss in this chapter two particular issues that have proved particularly difficult to deal with in many developing and transitional countries. One issue – the refund problem – relates to keeping those within the VAT system honest; the other – dealing with the small and shadowy – relates more to ensuring that those who should be within the VAT system actually are. As a filling between these two slices of VAT administrative problems, we also discuss some general ways in which VAT administration can be improved.

VAT is often thought of as a relatively simple tax. Admittedly, a VAT is, by definition, simpler than an income tax for reasons of both definition (it is less ‘net’ so its base is easy to determine) and timing (there are almost no intertemporal issues in applying VAT). Nonetheless, designing and implementing a VAT are far from simple tasks. In this and the next two chapters we consider a number of design issues, leaving some important administrative questions for Chapter 9 and 10. In the present chapter, we discuss several issues in defining the base of a VAT – the treatment of real property and land, the treatment of public sector and nonprofit activities, and the treatment of financial services. These three issues have proved troublesome in practice and not easy to resolve in theory.

Of course, many other design issues are also often troublesome in developing and transitional countries – for example, the treatment of agriculture and the treatment of tourism – but are not discussed in this book. Other interesting and sometimes important issues we do not discuss include the treatment of gambling, a number of issues related to VAT and services (especially cross-border services), and many aspects of VAT administration (including penalties, issues related to imports [uplifts, post-import control, etc.], and tax ‘offsets’). It would take a much longer book than this to do justice to all aspects of VAT.