Why I think capital gains tax could be disastrous for Bursa and the country -- Jay


 There are now increasing rumours that capital gains tax will be one of the "new taxes" to be imposed in the coming Budget 2019. For a very long time, shares investment/trading has been seen as "rich people's game" and taxing profit on it could be quite popular with the mass public. Therefore, while it is quite rush to impose a new tax (PH just become government in May) and unlikely any detailed studies have been made, I do not discount the possibility of the new govt to introduce such populist tax.

Personally, I support the idea of capital gains tax. Yes you read it right, I support it. I think fundamentally, taxes represent a redistribution of wealth and so it is not unreasonable to be imposed on any activitites where you make gain/profits. This can then be channelled to the needy/poor or make necessary investments in the country.

But all these are just the concept.

In reality however, I would imagine such tax could be disastrous, not only for investors in Bursa, but also man on the street (they may not realise that yet). I will just summarise a few points below and readers may leave a comment if you agree/disagree with them.



1. Indirect reduction in everyone's wealth (except government)

While many people thought that CGT would not affect their lives since they are "not involved in rich people's game", they fail to realise that a large part of our nation's wealth is in the capital market (equity or bond). Some may not invest directly in the market, but they forgot that they do have money in EPF, Amanah Saham, SOCSO, Tabung Haji, PRS, unit trusts etc. Even Khazanah money is the nation or the people's money. Imposing a tax on their investment activity would reduce the investment worth and everyone's wealth in it.

Imagine your EPF dividend or ASB dividend being reduced because of CGT, now will the public still be happy? To avoid this, govt may put in a counter-measure which I will elaborate in point 2.



2. Limited revenue to be gained

If CGT is to be imposed, It is only fair to tax on the net gains, i.e. if you make RM1,000 and lost RM300 in the same year, you would only be taxed on the RM700 net gain. If you look at the KLCI, last Friday it closed at 1,730. 3 years ago it was 1,745 while 5 years ago it was 1,806. If someone had invested in KLCI for the past 3 or 5 years, he would be staring at a net loss instead of gain. My point is, our market is already lacklustre as it is, how much revenue can the govt reasonably expect to collect, especially once hit by CGT?

There is also a possibility, to avoid the negative publicity associated with point 1 above, the govt may offer exemptions for statutory funds like EPF, PNB etc to be exempted from CGT. But then again, these are among the biggest institutional players in town. And we all know that most of our retail players are on the losing side of the market (some even say as high as 80-90%), so at the end of the day, how much revenue can the govt expect to raise?

And if foreign and retail investors exit our local market (explained in point 3 and 4 below) while GLCs are asked to pare down their stakes, who would be left to invest in our market? Lower demand simply imply prices have to go down and our market could go on a downtrend without recovery. Any hopes of taxing "gains" will also evaporate in smokes.

Bottom line, if CGT is imposed, whatever the figure the govt expect in the budget will most likely be overstated.



3. Death of retail investors and retail brokerage firms

Bursa's retail participation is one of the lowest in the region and this represents an unhealthy market when it is all cornered by institutions. Bursa has been actively tring to rectify that by doing roadshows, education series etc. All these efforts could be wiped out overnight by CGT.

Retail interst is already lacking, imposing a new tax on it will only kill off whatever spark left. Not only the notion of paying tax, but imagine the hassle of filing another tax return. Uncles and aunties who don't understand how CGT works probably will stop investing to avoid paying the wrong amount of tax and get into trouble. This would probably also means the potential death of smaller retail focused brokerage firms such as Kenanga, TA, Jupiter, Malacca etc.



4. Flight of foreign capital and local companies falling into foreigners' hands

When I have the chance to speak with some foreign friends, some are international investors, the most common word I hear when it comes to Malaysia equity or bond market is "boring". This partly could be due to the market lacking vibrancy as it is being cornered by institutions. Our KLCI has been stagnant or decline for the past 3-5 years while our bond market offers neither the higher yields or the higher ratings for lower yields. Add to that the weaker RM, most foreign investors would have lost money in Malaysia for the past few years. Put it simply, our market is not as attractive as what our Prime Minister or Minster of Finance (past or present) or Bursa CEO would like you to believe.

Supporters of CGT would always point to US as an example that people never stop investing there. This is plain stupidity on display. It's not even comparing apple with orange, more like rambutan and durian. They could not have been more different.

US is the largest developed financial market in the world and majority of global assets are denominated in USD. Like it or not, if you are managing large enough of gloabl assets, you can't run away from the US market. But other than US, only a handful of developed countries have CGT. Even Singapore and Hong Kong does not have it, not to mention all our emerging market peers such as China, Indonesia, Thailand, Vietnam etc.

In a globalisation era, imposing CGT would only reduce Malaysia's relative competitiveness. There would be little incentive for foreign investors to stick around especially in an already lacklustre market and a weak currency.

In an uncompetitive capital market, aspiring local companies would also probably choose to list themselves overseas rather than in Bursa, which means highly likely that these future local champions would end up being owned by foreign investors rather than locals. It's just sad to think about that.



5. Double whammy on RM

Another point I think most fail to realise is what foreign outflow would mean to our currency. Our Prime Minister himself has repeatedly stress that we are a trading nation and so our door will always be open to foreign investments. Unfortunately as a smaller emerging country reliant on trades, we are more vulnerable to external shocks than other developed countries.

If one were to pay attention to financial news, they would know that US Fed is gradually increasing their interest rates. To explain the impact in layman's terms, imagine past few years investing in US Treasuries only give you 0.5% return a year while investing in Malayisa/emerging country gives you 4%. Some would choose to invest in Malaysia because the 3.5% is sufficient to compensate for the additional risk. Fast forward to today, US Treasuries touched 3.25% recently, do you really think Malaysia at 4.2% or other emerging countries are still attractive?

That is exactly what happen to Indonesia and Philipines this year. If you think RM has been weak, FYI RM has depreciated ONLY by 1.7% in 2018 while Rupiah and Peso has depreciated 12% and 8.5% respectively in 2018. There is an emerging market carnage happening around the world in case our new govt fail to realise that. The foreign investment outflow associated with CGT will only worsen the situation.

Think I'm exaggerating? Foreign investors turned bearish on Malaysia back in around Sept 2014 when crude oil prices started free falling. When they exited our market in droves, USD/RM depreciated from 3.15 in Sept-14 to 4.43 in Jan-16, 40% in around 15 months. It's a downward spiral, a weak RM cause high imported inflation, lower spending power and weaker economy which in turn cause more weakness in the currency. I don't think any Malaysians (except exporters) enjoy that ride very much. Another 40% depreciation would bring USD/RM to 5.80. Impossible? Cannot imagine that? Few people can also imagine RM to break below 3.80 (1997 level) a few years back.

It may not be that severe but question is, do we really want to risk it?





Summary

Now, you would understand that why, depsite me supporting the CGT conceptually, I still think it is unrealistic and potentially very damaging to our country to impose it, especially in this volatile and vulnerable times. Being idealistic is good, but being unrealistic is dangerous. The nation's economy and people's lives are at stake.This is not a social experiment or simulation and there is no simple undo button. Whatever the govt does can potentially cause irreversible damage.

I implore the govt to think through not just CGT but any of the new taxes to be imposed thouroughly. The country may be in bad shape because of mismanagement in the past but rushing into rash decisions is unwise. Even as a person, we know that you can't cure a sick individual by pumping 10 different medicine at one time (it would just kill him). Proper discussions and consultation is necessary before any new taxes are to be imposed to evaluate the potential impact and it's not necessary to have them rushed in Budget 2019 if there's insufficient time.

People voted for not just a clean but also wise government. Sometimes, doing the wrong things with the right intention is simply not good enough...

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