MALAYSIA INTERGOVERNMENTAL FISCAL TRANSFERS (Federal Constitutional Monarchy)

FORM OF GOVERNMENT

Malaysia’s form of government is FEDERAL CONSTITUTIONAL MONARCHY. It is nominally headed by paramount ruler (commonly referred to as the king) and a bicameral Parliament consisting of a nonelected upper house and an elected lower house. All Peninsular Malaysian states have hereditary rulers (commonly referred to as sultans) except Melaka (Malacca) and Pulau Pinang (Penang). These two states along with Sabah and Sarawak in East Malaysia have governors appointed by government.

The powers of state governments are limited by federal constitution[1]. Under the terms of the federation, Sabah and Sarawak retain certain constitutional prerogatives (e.g., right to maintain their own immigration controls).[2]

Malaysian sub-units collect a total of 17% of Malaysia’s total revenue while the federal government’s revenue amounts to over 80% as can be gleaned from table 1 below. The operating expenditure tells us almost the same amounts.

The federal government’s operating expenditures by object is showed in table 2. Here grants and transfers to states and statutory bodies amounts on average to around 10% share of the total operating expenditures of the the federal government of Malaysia from 2014-2016.

TABLE 1: 2014-2015 Revenue and Expenditure by Government Level

MALAYSIA REVENUES 2014 2015 Ratio Ratio  
Federal Government 162,291 177,327 79% 82%  
State Government 17,223 12,553 8% 6%  
Statutory Body 17,962 17,799 9% 8%  
Local Government 7,465 7,510 4% 3%  
Total Revenue (in RM Million) 204,941 215,188 100% 100%  
           
MALAYSIA OP. EXPENDITURES          
Federal Government 193,395 187,328 79% 79%  
State Government 11,646 11,972 5% 5%  
Statutory Body 31,416 31,534 13% 13%  
Local Government 6,936 7,768 3% 3%  
Total Operating Expenditure 243,393 238,602 100% 100%  
           
MALAYSIA DEVT. EXPENDITURES          
General Government                                     48,884                      56,075 100% 100%  
Federal Government                                     31,885                      37,474 65% 67%  
State Government                                       7,693                      10,167 16% 18%  
Statutory Body                                       7,373                        6,390 15% 11%  
Local Government                                       1,933                        2,044 4% 4%  
PABK/NFPE’s                                  105,683                    111,380      
           
Total Public Sector Net Development Expenditure                                  154,567                    167,455      
Source: Ministry of Finance Malaysia (http://www.treasury.gov.my/index.php/en/economy/economic-data.html)  

 

 TABLE 2: Federal Government Operating Expenditure by Object

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Source: http://www.treasury.gov.my/pdf/ekonomi/er/1516/chapter4.pdf

 TYPES OF REVENUE TRANSFERS IN MALAYSIA

Article 110 of the constitution delineates the sources of revenue available to the state governments. Part III[3] of the tenth schedule of the Malaysian constitution enumerates in detail these taxes, fees and other sources of revenue. Part V[4] of the tenth schedule lists those additional revenue-sources assigned to Sabah and Sarawak.[5]

Article 109 enshrines two sets of federal to state grants – the Capitation Grant and the State Road Grant – and also makes provision for the possibility of other grants being introduced. This provision has allowed for, for example, the Revenue Growth Grant and grants to local governments. The constitution thus explicitly recognized that there was a “fiscal gap” between the expenditure responsibilities and the taxing powers of the states. The Capitation Grant as well reflects recognition of a need for some equalization of revenues across states.[6]

There are essentially three forms of revenue transfers in Malaysia:

  1. Tax Sharing Grants
  2. General Purpose Grants
  3. Specific Purpose Grants.

 

  1. TAX SHARING GRANTS

 These grants are established under the Article 110(3)[7] of the Federal Constitution. The Malaysian Constitution provides that 10% of the revenues collected by the Federal government from export duties on tin, iron[8] and minerals ores[9] must be allocated to the producing states.

TABLE 3: Tax Sharing Grants

  Formula
Tax Sharing Grants 10% of the revenues collected from export duties on tin, iron and minerals ores

(Source: Malaysian Constitution and Acts)

 

  1. GENERAL PURPOSE GRANTS

 A. Capitation grant

The grant is established under the Article 109(1)a of the Federal Constitution which provides that “The Federation shall make to each State in respect of each financial year-

(a) a grant, to be known as a capitation grant, which shall be calculated in accordance with the provisions of Part I of the Tenth Schedule.”

PART 1: CAPITATION GRANT

  1. (1) The capitation grant payable to each State in respect of a financial year shall be at the following rates:

(a) for the first 100,000 persons at the rate of RM72.00 per person;

(b) for the next 500,000 persons at the rate of RM10.20 per person;

(c) for the next 500,000 persons at the rate of RM10.80 per person;

(d) for the remainder at the rate of RM11.40 per person,

and shall be based on the annual population projections of the State as determined by the Federal Government and calculated as of the last population census: Provided that if the last census was taken one year before the beginning of the financial year, the grant for that particular year shall be based on the population as determined by that population census. with an objective of assisting state government in meeting financial requirements. The grants are not subject to any spending restrictions or tax effort requirements. The amount given is based on the population determined by the population census if the last census was taken one year before the beginning the financial year or on the annual population projection calculated as of the population census. One of the rationales behind the introduction of this new rate is to achieve fairer distribution for the poorer states assuming that the less populous states are relatively poor states.

 B. Revenue Growth Grant

The grant is established under the Revenue Growth Grant Act 1977 & Revenue Growth Grant Act (Amended) 1980. The grant was based on the premise that state governments should also benefit from the growth of federal government revenue. The grants are payable to the state governments if the total revenue of the Federal government after deducting tin duties and taxes raised under the Road Traffic Ordinance 1958 increases by more than 10% in a particular year over the previous year. The grants are however subject to a maximum of RM150 million (originally 100 million).[10]

C. Special grants

Under the article 112c(1)(a) of the Federal Constitution, special grants are allocated to the states of Sabah and Sarawak. The objective of these grants is to equalize the standard of services of the two states to that of the other states in Peninsular Malaysia.  Special grants are also allocated to Selangor which amount to RM 18 305 637.66 millions in lieu of revenues losses due to the acquisition of Kuala Lumpur (this is based on the revenue collected in 1974) and to Kedah with an amount of RM10,000 per annum according to 1869 agreement for the lands handed over to Penang.[11]

 D. State Reserve Fund grants

The grants are established under the Article 109(6) of the Federal Constitution. The grants are sourced from the State Reserve Fund on an ad hoc basis. The main purpose of the fund when it was established in 1958 was to supplement the general revenue of state government facing current account deficits.[12]

 E. Contingencies fund grant

Established under Article 103 of the Federal Constitution, the grant was intended to provide advances in order to meet urgent and unforeseen operating expenditures for which no other provisions exist, pending Parliament approval on the required allocation.[13]

F. State Advance Fund grant

The grants were created to provide cash advance to state governments facing cash flow problems. The fund was established in 1981. It renders immediate assistance to state governments, particularly those with limited financial resources in the form of cash advances.[14]

 

TABLE 4: General Purpose Grants

Types of General Purpose grants Formula
Capitation Grant (a)   first 100,000 persons = RM72.00/person

(b)   next 500,000 persons = RM10.20/person;

(c)   next 500,000 persons = RM10.80/person;

(d)   for the remainder = RM11.40/person

Based on the annual population projections of the State as determined by the Federal Government and calculated as of the last population census.

(Source: Malaysian Constitution)

Revenue Growth Grant 2. Whenever there is a growth in the revenue of the Federation in any financial year as compared to the preceding financial year the Minister shall for the following financial year allocate for the purposes of making grants under sections 4 and 4A an amount not exceeding one hundred and fifty million ringgit to be apportioned as follows

(a) a portion of the amount not exceeding fifty million ringgit for the purposes of section 4;

(b) the remainder portion not exceeding one hundred million ringgit for the purposes of section 4A:

Provided that the limit of one hundred and fifty million ringgit, fifty million ringgit in paragraph (a) and one hundred million ringgit in paragraph (b) may be reviewed and varied by the Minister.

Apportionment amongst States equally and on population basis

4. The sum of money allocated under paragraph 2(a) shall be apportioned as grants amongst the States as follows—

(a) one half of the sum shall be apportioned equally amongst the thirteen States; and

(b)  the remaining half shall be apportioned proportionately amongst the States, on the basis of the population of each State as determined at the last census taken before the preceding financial year, at two shares per head for the first five hundred thousand, one share per head for the next five hundred thousand and a half share per head for the remainder of each State’s population.

Apportionment amongst States whose per capita gross domestic product is below national average

4A. The sum of money allocated under paragraph 2(b) shall be apportioned as grants amongst States whose per capita gross domestic product is below the national average of the per capita gross domestic product. The per capita gross domestic product of the Federation and all the States of the Federation shall be determined by the Federation. The grant to be given to each eligible State shall be in proportion to the percentage which the difference between the national average and the eligible State’s per capita gross domestic product bears to the sum of all the differences between the national average and each eligible State’s per capita gross domestic product. Allocation after audit

5. The sums specified in paragraphs 2(a) and (b) for allocation under a financial year shall be allocated only after the accounts of all revenue received by the Federation for the preceding financial year have been closed and audited.

Purpose of grants

6. The grants made to a State under section 4 shall be utilized to generally supplement its revenue and the grant made to a State under section 4A shall be utilized for any or all of the following specific development purposes–

(a) water supply;

(b) public housing;

(c) industrial estate development;

(d) minor works; and

(e) such other development projects as may be determined from time to time by the National Finance Council established under Article 108 of the Federal Constitution. Grants charged on Federal Consolidated Fund

7. The grants made to the States under sections 4 and 4A shall be charged on the Federal Consolidated Fund.

(Source: Malaysian Constitution)

Special Grants PART IV SPECIAL GRANTS TO STATES OF SABAH AND SARAWAK

1. (1) Yearly special grant to Sarawak = RM5,800,000 and must be reviewed under Article 112D of the Malaysian Constitution.

2. (1) Yearly special grant to Sabah, 2/5 of the amount by which the net revenue derived by the Federation from Sabah exceeds the net revenue which would have been so derived in the year 1963 if— 189 (a) the Malaysian Act had been in operation in that year as in the year 1964; and (b) the net revenue for the year 1963 were calculated without regard to any alteration of any tax or fee made on or after Malaysia Day, (“net revenue” meaning for this purpose the revenue which accrues to the Federation, less the amount received by the State in respect of assignments of the revenue).

(2) In the case of Sabah, for any year before 1968 in which the State road grant is less than RM5,179,500, a supplement to that grant of an amount equal to the deficiency. 3. In either case, for any year before 1974 and, if at the beginning of 1974 the Legislature of the State has power to make laws with respect to the carriage of passengers and goods by land or to mechanically propelled road vehicles, then during the continuance of that power, a grant equal to the cost to the State in the year of the State road transport department.

(Source: Malaysian Constitution)

State Reserve Fund grants The Federation shall pay into a fund, to be known as the State Reserve Fund-

(b) in respect of every financial year such sum as the Federal Government may, after

consultation with the National Finance Council, determine to be necessary;

and the Federation may from time to time, after consultation with the National Finance Council,

make grants out of the State Reserve Fund to any State for purposes of development or generally

to supplement its revenues.

Contingencies fund grant (1) Parliament may by law provide for the creation of a Contingencies Fund and for authorising the Minister charged with responsibility for finance, if satisfied that there has arisen an urgent and unforeseen need for expenditure for which no other provision exists, to make advances from the Contingencies Fund to meet that need.

(2) Where any advance is made in accordance with Clause (1), a supplementary estimate shall be presented and a Supply Bill introduced as soon as possible for the purpose of replacing the amount so advanced.

(Source: Malaysian Constitution)

State Advance Fund grant  
  1. SPECIFIC PURPOSE GRANTS

 A. State Road grant

The grant is established under the Article 109(1)(b) of the Tenth Schedule, Part two of the Federal Constitution. The objective of the grant is to assist State governments in maintaining state roads, municipal roads, roads to low cost housing areas and back lanes.[15]

B. Economic Development grants

The objective of the grants is to allocate more funds to less developed states to reduce economic and social disparities as well as to promote state development in line with the National Economic Plan. The share of each state is determined by the Federal government with the cooperation of states EPU based on socio-economic indicators.[16]

C. Service Charge grant

It is established under the Article 80(5) of the Federal Constitution.[17]

D. Cost Reimbursement grant

The grant is in support of specific programs in areas of joint responsibility between the federal and state governments. The reimbursement is 100% of the development expenditure for federally approved agriculture, veterinary, works and drainage projects. Meanwhile, for the operating expenditure of the state drainage, veterinary and welfare department the reimbursement rate is only 50% of the expenditure.[18]

F. Grant to religious schools and institutions

Since 1956 a special grant was created under the purview of the Ministry of Education to assist any registered religious school (with student equal or more than 35) not maintained by the Ministry of Education under the Education Act of 1961 or by the State government.[19]

 

TABLE 5: Specific Purpose Grants

Types of Specific Purpose grants

 

 Formula

State Road grant The State road grant payable to each of the States of Malaya in respect of a financial year shall be calculated by multiplying—

(a) the average cost to a State of maintaining a mile of State road at the minimum standard determined for State roads in those States by the Federal Government after consultation with the National Finance Council; by

(b) so much of the mileage of State roads in the State as qualifies for grant.

3. For the purpose of section 2—

(a) the mileage of State roads in a State shall be taken to be that mileage as on the thirty-first day of December of the preceding financial year, and the 187 average cost mentioned in paragraph (a) of that section shall be taken to be the average cost in that State calculated in the preceding financial year; and

(b) the maintenance of State roads means the preservation, upkeep and restoration of State roads, roadside furniture, bridges, viaducts or culverts forming part thereof or connected therewith as nearly as possible in their original condition as constructed or as subsequently improved.

4. A length of State road if it is actually maintained by the Public Works Department of the State at or above the minimum standard mentioned in section 2(a) and a length of any road within the limit of a local authority if such road is certified by the Public Works Department of the State as coming within the qualifying standard and maintained at or above the minimum standard as mentioned in section 2(a) qualify for grant.

5. In this Part of this Schedule, “State road” means any public road other than a federal road, and any other road other than a federal road to which the public has access.

6. (1) The State road grant payable to Sabah or Sarawak shall, in each of the years 1964 and 1965, be payable at the rate of RM4,500 a mile in respect of a mileage in Sabah of 1,151 miles and in Sarawak of such amount as may be agreed between the Federal and State Governments.

(2) Thereafter sections 2 to 5 shall apply to the State road grant so payable with the following modifications: (a) the minimum standard mentioned in section 2(a) shall be the minimum standard determined for State roads in the State; and (b) any length of road maintained by a local authority at the expense of the State shall be treated as maintained by the Public Works Department of the State.

(Source: Malaysian Constitution)

Economic Development grants The share of each state is determined by the Federal government with the cooperation of states EPU based on socio-economic indicators.
Service Charge grant (5) Subject to any provisions of federal or State law, arrangements may be made between the Federation and a State for the performance of any functions by the authorities of the one on behalf of the authorities of the other and such arrangements may provide for the making of payments in respect of any costs incurred under the arrangements.
Cost Reimbursement grant The reimbursement is 100% of the development expenditure for federally approved agriculture, veterinary, works and drainage projects. Meanwhile, for the operating expenditure of the state drainage, veterinary and welfare department the reimbursement rate is only 50% of the expenditure.[20]
Grant to religious schools and institutions  

 ____________________________

NOTES:

[1] The latest federal constitution of Malaysia was drafted 21 February 1957 and took effect on 27 August 1957. It has been amended many times and the latest amendment was in 2010. (Available at: https://www.cia.gov/library/publications/the-world-factbook/fields/2128.html#my, last accessed 28 September 2016)

[2] See, https://www.cia.gov/library/publications/the-world-factbook/fields/2128.html#my

[3] PART III: SOURCES OF REVENUE ASSIGNED TO STATES

  1. Revenue from toddy shops.
  2. Revenue from lands, mines and forests.
  3. Revenue from licences other than those connected with water supplies and services, mechanically propelled vehicles, electrical installations and registration of businesses.
  4. Entertainments duty.
  5. Fees in courts other than federal courts.
  6. Fees and receipts in respect of specific services rendered by departments of the State Governments.
  7. Revenue of town boards, town councils, rural boards, local councils and similar local authorities other than—

(a) municipalities established under any Municipal Ordinance;

(b) those town boards, town councils, rural boards, local councils and similar local authorities which have power under written law to retain their revenues and control the spending thereof.

  1. Receipts in respect of raw water.
  2. Rents on State property.
  3. Interest on State balances.
  4. Receipts from land sales and sales of State property.
  5. Fines and forfeitures in courts other than federal courts.
  6. Zakat, Fitrah and Baitulmal and similar Islamic religious revenue.

14.Treasure trove. (Available at http://unmis.unmissions.org/Portals/UNMIS/Constitution-making%20Symposium/Federal%20Constitution%20of%20Malaysia.pdf, last accessed 28 September 2016)

 

[4] PART V: ADDITIONAL SOURCES OF REVENUE ASSIGNED TO STATES OF SABAH AND SARAWAK

  1. Import duty and excise duty on petroleum products.
  2. Export duty on timber and other forest produce.
  3. So long as the royalty levied by the State on any mineral chargeable with export duty other than tin (but including mineral oils) does not amount to 10 per cent ad valorem calculated as for export duty, export duty on that mineral or such part of the export duty as makes the total of royalty and duty on exported mineral up to 10 percent ad valorem so calculated.
  4. In the case of Sabah, so long as medicine and health remains an item in the Concurrent List and expenses in respect of that item are borne by the State, 30 per cent of all customs revenue other than that in respect of the duties mentioned in sections 1, 2 and 3.
  5. For any year before 1974 and, if at the beginning of 1974 the Legislature of the State has power to make laws with respect to the carriage of passengers and goods by land or with respect to mechanically propelled road vehicles or licences connected with those vehicles, then during the continuance of that power, fees from such licences.
  6. For any year before 1974, and if at the beginning of 1974 the Legislature of the State has power to make laws with respect to the registration of mechanically propelled vehicles, then during the continuance of that power, fees from the registration of such vehicles.
  7. State sales taxes.
  8. Fees and dues from ports and harbours other than federal ports and harbours.
  9. Receipts in respect of water supplies and services, including water rates.
  10. Revenue from licences connected with water supplies and services. (Available at http://unmis.unmissions.org/Portals/UNMIS/Constitution-making%20Symposium/Federal%20Constitution%20of%20Malaysia.pdf, last accessed 28 September 2016)

[5] http://econ.queensu.ca/pub/jdi/tdri-mier/publications/download/fed_stat.pdf

[6] Ibid.

[7] Assignment of taxes and fees to the States

110 (3) Each State shall receive, on such terms and conditions as may be provided by or under federal law, ten percent [10%] or such greater amount as may be so provided of the export duty on tin produced in the State.

[8] Assignment to States (except Sabah and Sarawak) of whole or part of export duty on iron ore is provided in Sec. 2 (1) of Act 395 known as Export Duty on Iron Ore of 1962. However, this Act applies only to the States of Peninsular Malaysia.

  1. (1) In the case of iron ore produced in any State and exported after the end of the month of September, nineteen hundred and sixty-two (hereinafter referred to as “the relevant date”) there shall be assigned to that State the export duty levied on the ore or so much thereof as does not exceed 10 per cent ad valorem on the value of the ore (as ascertained for the purposes of export duty). (2) In the case of iron ore produced in any State and exported before the relevant date the Minister may assign to the State the whole, or such proportion as he considers equitable, of the export duty levied on the ore. (Available at http://www.commonlii.org/my/legis/consol_act/aordoioa19621989581/ last accessed, 28 September 2016)

 

[9] Assignment to States (except Sabah and Sarawak) of export duty on mineral ores is provided in Sec. 2 of Act 396 known as Mineral Ores Act of 1964. However, this Act applies only to the States of Peninsular Malaysia.

 

  1. (1) There shall be paid to the State Governments specified in the first column in the Schedule a portion of the export duty on the mineral ores (other than iron ore and tin) specified in the second column in the Schedule, produced in those States; and the portion of export duty so payable shall be as specified in the third column in the said Schedule.

 

(2) No royalty or similar charges (whether under a lease or other instrument or under any State enactment, or whether the lease or instrument was made or the enactment passed before or after the 6 Laws of Malaysia ACT 396 making of the payment under subsection (1)) shall as from the date of the making of the payment under that subsection be levied by the State Governments in respect of such mineral ores (other than iron ore and tin), except with the written agreement of the Minister of Finance.

[10] Ahmad Zafarullah Abdul Jalil and Noor Al-Huda Abdul Karim, Understanding Malaysian State Governments Fiscal Behavior: The Role of Intergovernmental Transfers, Universiti Utara Malaysia, 2009, p. 5.

[11] Ibid.

[12] Ibid.

[13] Ibid.

[14] Ibid., p. 6.

[15] Ibid.

[16] Ibid.

[17] Ibid.

[18] Ibid.

[19] Ibid.

[20] Ibid.

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