Written by Dr Stewart Nixon, Director of Research of the Institute for Democracy and Economic Affairs (IDEAS).

For more than a decade, economic policy reform in Malaysia has been dominated by incremental changes that, while largely trending in the right direction, lack the ambition and urgency to noticeably improve livelihoods. Malaysia is no closer to reaching high-income classification than it was in 2014 and income inequality has improved precious little.

That Malaysia’s economic gains and opportunity continue to concentrate among already better-off households, states and cities in no small part reflects persistent distortions in government budgets. The distortions include a chronic inability to raise taxes, insufficient redistribution from rich to poor, and Putrajaya’s overwhelming control of the purse strings.

Space for purposeful tax reform

Tax reform is never easy nor popular, and past politicisation casts a long shadow over policy ambition. The association between Malaysia’s historic change of government in 2018 and the downfall of the goods and services tax (GST) continues to have policymakers walking on eggshells. Swift concessions following backlash against the announced sales and service tax (SST) changes mid-last year highlight the fraught political calculus.

Yet evidence suggests Malaysians are more open to raising taxes than policymakers perceive, at least where the benefits are clearly established. Almost 90% of Malaysian respondents to the Organisation for Economic Co-operation and Development’s (OECD) Public Trust in Tax survey 2025 recognised the link between paying taxes and sustainable development, and two-thirds would pay higher taxes to support meeting sustainable development goals.

Furthermore, Malaysians have comparatively high trust and positive engagement with the tax system. The 2024 edition of the survey found that Malaysians are more trusting of tax systems and institutions than citizens of other large developing economies. An overwhelming majority say they understand tax laws, find them generally efficient and easy to complete tax filings, and trust the tax authorities.

Malaysians are also concerned about inequality and want the government to do more. A September 2025 Ipsos Malaysia survey found 43% of Malaysians want more to be done to address inequality, and two-thirds expect the government to lead with stronger action.

Revenue shortfalls contribute to persistent inequality

The government’s inability to raise and redistribute revenue is intimately linked to persistently high inequality. Analysis by the World Bank last year highlighted Malaysia’s stubbornly high inequality relative to countries that recently achieved high-income status. Malaysia stands out for its pre- and post-tax inequality being little different, with the tax and transfer system preserving income differences between the rich and the poor.

A recent infographic explainer from IDEAS highlights critical distortions that constrain the budget’s role in improving Malaysian livelihoods (see Chart 1).

It illustrates that the space for policymakers to fight inequality through budget policies is closing further under a structural decline in overall revenue collections. At less than 17% of gross domestic product (GDP), overall revenue is half that of the OECD average. Except in years with oil price spikes, federal government budget revenue is growing more slowly than economic growth, meaning revenue is shrinking relative to the size of the economy the budget serves. Fossil fuel dependency will only fall sustainably with growth in other revenue sources, not due to lower dividends from Petronas (see Chart 2).

The explainer also shows how insufficient revenue contributes to inequality through expenditure channels like health, disaster resilience and infrastructure investment (see Chart 3). Malaysia’s underspending on health relative to similarly developed countries affects those with disabilities and who live far from major cities with the best doctors and equipment. Proportionally minimal spending on climate change adaptation leaves poorer, flood-prone states and villages more vulnerable to shocks. Moreover, as the cost of civil service pay and pensions plus servicing government debt command a greater share of a declining budget, development spending on infrastructure in rural areas and poorer states suffers most (see Chart 4).

It additionally highlights how Malaysia’s highly centralised budgets leave states dependent on Putrajaya to address local needs and disadvantages. The federal government controls over 90% of Malaysia’s overall revenue and expenditure, which is unusually high among federated states. It also transfers more money to federal statutory bodies than to all the states and territories combined. While the Madani initiatives to adopt villages and schools are well-intentioned, they exemplify Putrajaya’s extensive reach into areas that local governments would be better empowered to progress.

Many tax levers for policymakers to pull Malaysia’s tax reform needs are extensive, requiring significant design and implementation planning. Policymakers would only worsen matters through further piecemeal reforms that fail to assess expected tax incidence by household income.

To specifically address the abovementioned inequality drivers, reforms could focus on:

A more progressive income tax and transfer system that redistributes from high to low income earners.

More consistently taxing sources of income that are biased towards high income earners:

Capital gains taxes on various assets for both companies and individuals either do not exist or are lower than corporate and income tax rates. For example, gains on individual shareholdings are not taxed, and corporate gains on shares are taxed at a low rate. Many countries align capital gains and marginal income tax rates.

Real property gains taxes are set at rates that reduce with length of ownership, with Malaysian citizens paying no tax on properties sold after the fifth year and non-citizens and companies paying just 10%. Taxes on the profits from property investment are thus very low, advantaging those that can afford to own property.

Considering inheritance or estate taxes that treat the transfer of financial assets and property upon death as taxable income. This is a tax on the transfer of wealth, as distinct from a “wealth tax” that would raise administrative complexity.

Combining consumption taxes with transfers and income supplements. Recent SST reforms highlight the perils of using exemptions to make consumption taxes more progressive. A better approach would be to reduce SST exemptions, raise rates and simultaneously compensate low-income households through other means.

Continuing and expanding efforts to address leakage. Administrative efforts to improve tax collections and compliance were an admirable feature of the 2026 Budget and should continue to be a focus.

Reducing fiscal centralisation through concerted efforts to better align revenue and expenditure policies with federal and state/territory responsibilities, with allocations weighted towards states with lower development levels.

A more equal Malaysia requires deeper and fairer budgets, which in turn demands a political makeover of tax policies. Tax can no longer be a dirty word; it must become a resource for reducing inequality, supporting the most needy and investing in Malaysia’s future.

This article was featured in The Edge Malaysia, 16 February 2026

The views expressed in this article are solely those of the authors and do not necessarily represent the views or positions of IDEAS Malaysia. All opinions are the author’s own.