Money at the heart of govt: REFLECTING ON THE LAW

Wednesday March 10, 2010

Money at the heart of govt

REFLECTING ON THE LAW
By SHAD SALEEM FARUQI

The fiscal gap, the difference between the states’ domestic revenue and their expenditure, ranges between 15% and 75% of their total expenditure.

KELANTAN has a long-standing and popularly backed claim for royalty for petroleum extracted off its shores. Some years ago, the then PAS government in Terengganu had made a similar demand.
These persistent assertions highlight the broader question whether the financial resources of the nation are divided equitably between the federal and state governments.

To begin with, let us agree with Prof R.H. Hickling (who drafted the ISA) that “money represents power, and is at the heart of government”. An equitable distribution of financial resources between the federation and the states is the ultimate test of a true federation.

Under the Malaysian Constitution, there is a clear demarcation of financial powers between central and regional governments, though the balance is tilted heavily in favour of the former.

Federal revenues: In Schedules 9 and 10, most of the lucrative sources of revenue like income tax, customs and excise duties on imports and exports, sales tax, licence fees for motor vehicles, and incomes from banking, foreign exchange, capital issues, insurance, passports, visas, newspapers, radio, TV, tourism, foreign pilgrimages, maritime and estuarine fishing, shipping on the high seas, trade, commerce, industry, patents and designs are allocated to the federal exchequer.

Except for state power over licence fees, the development of mineral resources; mines, mining, minerals and mineral ores; oils and oilfields; import and export of minerals and mineral ores; and all petroleum products are within federal jurisdiction.

All foreign and extra-territorial jurisdiction (presumably including offshore prospecting for oil, gas or minerals) is in federal hands. Regrettably, the situation is clouded by clearly illegal contracts between Petronas and all state governments about payment for onshore as well as offshore oil.

Federal expenditure: With such lucrative sources of income to the federation, come the most onerous items of expenditure. Thus, foreign relations, diplomatic and consular representation, international organisations, national defence, internal security, the armed forces, the police, prisons and intelligence services are federal responsibilities.

Criminal and civil courts, elections, education, medicine, health, fire services, federal pensions and gratuities, medicine, health, social security, currency, audit, roads, bridges, ferries, railways, ports and harbours, posts, telegraph, communication, transport, airways and safety in mines and oilfields are entirely a federal burden.

State revenues: Even though there is a heavy preponderance of financial power in the hands of the Federal Government, the Constitution guarantees certain sources of internal and external revenue to the states.
Article 110 and the Tenth Schedule allocate to the states 14 domestic sources of income. The most lucrative are taxes derived from natural resources like land, mines and forests, fees from toddy shops, entertainment places and water supplies, rents on state property, fines and forfeiture in state courts, zakat, fitrah, Baitulmal and other Islamic religious revenue.

Under Article 110(3), each state receives 10% or more of the export duty on tin produced in the state. Likewise, Parliament may provide that each state shall receive, on such terms and conditions as may be laid down, a proportion of the export duty on mineral ores, metal and “mineral oils” (which term includes petroleum) produced within the territorial boundaries of each state.

Under Paragraph 2(c) of the Ninth Schedule, permits and licences for prospecting for mines and mining leases are exclusively within the competence of the states.

In addition to the above domestic sources of revenue, Articles 109 and 110 guarantee some money reimbursements to the states in the following forms:

Capitation Grants: Under Article 109, this is an annual mandatory payment by the Federal Government to each state based on the state’s population.

State Road Grants: Under the Tenth Schedule, the Federation is required to pay to each state a compulsory road grant to cover the average cost of maintaining state roads.

State Reserve Fund: Under Article 109(6), each year, the Federal Government, after consultation with the National Finance Council, deposits into the above fund, certain amounts to be allocated to the states for purposes of development.

Conditional grants: Under Article 109(3) the Federal Government allocates further conditional grants to supplement the states’ own domestic revenue. These grants are discretionary and are as much influenced by fiscal policies as by political considerations.

Kelantan under PAS from 1959 to 1974 and 1982 to now; Terengganu under PAS from 1959 to 1964 and 1998 to 2003; Penang under Gerakan from 1969 to 1974 and under DAP from 2008 to the present; and Sabah under PBS experienced such financial frustrations.

Loans: Under Articles 111 (2) & (3), a state is not allowed to raise or borrow money except from the Federation or a federally approved bank. In Government of Malaysia v Government of Kelantan (1968), the Pan-Malayan Islamic Party, after its victory in the 1959 state elections in Kelantan, sought to fulfil an election pledge to build a bridge over the Kelantan river but it was financially in no position to do so.

In the face of federal objections, it negotiated a clever financial arrangement with a private company which advanced RM2.5mil to it in return for mining and forest concessions. The Federal Government went to court to challenge the deal as an illegal loan. The Federal Court decided in favour of Kelantan.

The Federal Government then retaliated by pushing through a constitutional amendment so that pre-payment of royalties would now constitute lending.

In sum, it can be stated that in the financial field, the central government’s preponderance of power is very evident. The Constitution has been so devised that almost all the important direct and indirect taxes belong to the Centre.

The states are entitled to the proceeds from some taxes, fees and other sources of revenue, but these are insufficient to solve the chronic shortage of funds experienced by some states.

The fiscal gap, the difference between the states’ domestic revenue and their expenditure, ranges between 15% and 75% of their total expenditure. This imbalance has two aspects: vertical imbalances between the centre and the states, and horizontal imbalances between the states inter se.

It must be noted, however, that federal predominance in respect of functions and resources is less pronounced vis-à-vis the East Malaysian states of Sabah and Sarawak, which control a number of additional sources of income along with additional functions under Articles 112B, 112C, 112D.

Datuk Dr Shad Saleem Faruqi is Emeritus Professor at UiTM and Visiting Professor at USM 

http://thestar.com.my/columnists/story.asp?col=reflectingonthelaw&file=/2010/3/10/columnists/reflectingonthelaw/5827905&sec=Reflecting%20On%20The%20Law