Is trickle-down economics working for Singapore?

The annual Budget is an expression of the Government’s commitment to its policies — put simply, the Budget is when the bucks are put into the bangs.

However, those dollars are sourced from finite revenues, whereas demands for policy attention are often infinite. Even among critical policies, there is a need to prioritise. It is thus appropriate that we ask fundamental questions about the assumptions, motives and directions of our taxation system, which makes public expenditure — and which usually occupies everyone’s attention in the Budget — possible.

For the past 20 years, we have been shifting our tax system into one that reflects the philosophy of trickle-down economics. This reflects the belief that the wealthy create value and jobs in the economy and, thus, should be incentivised and rewarded with a low effective-tax ceiling. To be fair, the entire tax schedule has been influenced by this thinking, to the extent that all levels of income earners today pay much less income tax than ever before. Further, Singaporeans earning less than S$40,000 annually do not pay any income tax at all and are still eligible for — and by policy design, receive disproportionately more of — the share of public benefits each year through subsidies, grants and supplements.

GST AND THE POOR

However, everyone — whether they are income earners or not — pays indirect taxation in the form of Goods and Services Tax. GST, because it is taxed at the point of consumption, is a very efficient tax compared with direct taxation. It is also more stable as a tax flow, given that consumption must occur even during economic downturns.

Nonetheless, GST targets consumption and because it is applied equally regardless of income level, it is highly regressive. For low-income earners, whose major expenditure is on basic goods, the tax affects them disproportionately compared with higher-income earners who have much more disposable income to expend on discretionary items.

As GST has increased, the direct income tax has been reduced at all levels. A further move towards efficiency and a reflection of a bias towards wealth preservation has been the removal of inefficient taxes that targeted capital owners, such as the estate duty and capital gains tax.

If we take it as a tax and benefits system, it could be argued that we have a generous tax system. However, our demands on public expenditure are set to increase over the longer term due to an ageing population, added infrastructure due to population growth and the need to renew existing infrastructure. This will create pressure to raise additional revenues. Thinking rationally, it is an obvious choice that this should be met by an increase in the most efficient tax channel, which is the GST.

WEALTH SKEWS THE PICTURE

The question to ask is, what — beyond the practical and vital purpose of raising revenue — is the object of taxation? I would argue that a tax system also signals social values. It is a practical, hit-in-the-pocket expression of what we believe our responsibilities as citizens are to each other and in relation to the concept of the State.

We need to revisit the philosophy of trickle-down economics. Its influence extends beyond our tax system to inform our policy on immigration — which, in part, targets wealthy foreigners — and on urban planning — which is creating more “wealth zones” such as Sentosa Cove and Marina Bay. This is important because there are social, political and economic externalities.

We are facing high and growing income inequality, which can prove socially divisive. Immigration policies are creating political tensions. The influx of wealthy foreigners and the ability of our own wealthy to keep more of their income create economic activity — such as high-end food and beverage outlets, which compete with other sectors for labour and land share — to suit their consumption patterns.

It may also be promoting rent-seeking behaviour as they invest in property and other passive investments. The upward price pressure raises the general cost of housing consumption.

Wealth also gives those with capital a chance to boost each successive generation’s starting position in life — in the process creating an “arms race’’ in everything from childcare and education to health. When this happens, it can take the principle of meritocracy to absurd levels — does one need to speak three languages, enjoy a cosmopolitan lifestyle and have a perfect International Baccalaureate score to win a scholarship or become a doctor? No, but education competition may mean that, eventually, only the few who can — through a combination of not only ability and effort but also wealth — will “win” at such races.

Furthermore, the ability of the wealthy to pay a premium skews the market to supply them a disproportionate share of scarce services, such as in healthcare.

EFFECTIVENESS OVER EFFICIENCY

Where is the data that shows that trickle-down economics is working? If it is, we should be able to both prove that the wealthy are creating growth and jobs, and that our policies to promote a low-tax environment and pro-wealthy lifestyle are working in our favour.

While we can show that the wealthy boost consumption, which is the largest economic multiplier, it is much more difficult to prove that they promote economic growth, and that such growth benefits the general population to a degree that cancels out the negative externalities. The costs of these externalities are so high that we cannot take it on faith alone.

If we set a social-political agenda for our tax system, then we have to look beyond efficiency to its effectiveness.

If direct taxation were higher and regressive indirect taxation were lowered, would we be worse or better off as a society? Alternatively, what if GST were rescinded and if all income earners had to pay direct tax, on a highly progressive schedule, so that everyone understood that we all have to chip in to finance our collective needs?

Under such a model, low-income earners — who do not now pay income tax but pay the GST — would pay a low direct tax but no tax on their consumption. Would marginally higher direct taxes really make us less attractive as a destination for the talented and ambitious? Would removing policies that overwhelmingly favour the wealthy really put us into an economic tailspin?

OPTIMISE USE OF THE RESERVES

As can be seen from the 2013 Budget statement, yield from personal income tax is falling while that from GST is rising. Tax yield from GST is estimated to exceed that from personal income tax by S$1.75 billion, or about 23 per cent, in FY2013.

Increases in the effective tax rates would not yield much revenue. However, they would not be insignificant either and, more importantly, they would be symbolic of a changed socio-political model of burden sharing.

The shortfall in revenue from a reduction in GST could be made up from increasing the share of Net Investment Returns Contribution. The NIRC is the share of income (50 per cent) from the reserves which can be deployed for current expenditure. The remainder of the income (50 per cent) is returned into the reserves to continue to grow them.

The sharing formula is governed by the Constitution and an amendment, such as that made in 2008, would have to be made to increase the share that can be deployed to current expenditure. This would not be “raiding the reserves”, as the underlying capital is untouched.

It would, however, mean that the reserves would grow at a slower rate. But it is arguable that we should be optimising the use of the reserves for national purposes rather than focusing on their relentless expansion.

QUESTIONS AND ANSWERS

These are important questions we should ask and seek answers to before we continue down a road that has already created considerable externalities. But in this important inquiry, the starting point matters — we must first choose whether to begin by deciding on what kind of society we want, or by deciding on what kind of economy we want. Our answers will vary significantly depending on the focal question.

This is a process that involves all Singaporeans and should be taken up from the community level up to parliamentary politics. This commentary is not advocating which is the right choice — it is advocating that a deliberate choice be made.

For that to happen, questions should be asked and answers need to be sought on not only how we raise revenue, but also why we raise revenue, as well as about the assumptions and economic beliefs underpinning our fiscal system.

ABOUT THE AUTHOR:

Devadas Krishnadas is Managing Director of Future-Moves, a strategic risk consultancy. His new book Sensing Singapore: Reflections in a Time of Change was released last month.

*In Part II tomorrow of a Budget 2014 curtain-raiser: Restructuring and its demons.