Budget 2018 - What’s good and not so good about NIRC

In the past week, much talk has surrounded a term which Singaporeans do not often hear about, the Net Investment Returns Contribution (NIRC), and how these investment returns from the country’s reserves are now the largest contributor to the government’s budget.

In the decade to-date, NIRC is slated to more than double from S$7 billion in FY2009 to an estimated S$15.9 billion in FY2018.

NIRC consists of 50 per cent of the Net Investment Returns (NIR) on the net assets invested by GIC, the Monetary Authority of Singapore and Temasek Holdings and 50 per cent of the Net Investment Income (NII) derived from past reserves from the remaining assets.

In other words, we spend 50 per cent of the estimated gains from investment, and put the remaining 50 per cent back into the reserves to preserve its growth for future use.

Amidst the debate on whether these percentages ought to be changed as government expenditure increases in the coming years, it is important for us to look at the implications of the current government budgetary reliance on the NIRC framework.

The growth of the NIRC contribution to the government budget in recent years can certainly be considered as a mark of the success of the framework, due in no small part to the caution with tweaks that have been made to it over the years.

But it should not be misinterpreted to imply that an increase in the proportion of investment returns that can be allocated to NIRC would automatically serve as an additional stream of budget financing.

This is because the government has made clear that growing the reserves for future generations will remain a priority.

The 50 per cent rule and the use of real rather than nominal returns in order to preserve purchasing power are in place to ensure a reliable stream of contributions is derived from this formula without excessive exposure to market volatility.

They should certainly not be relaxed further in the foreseeable future.

It is also true that without funding from NIRC, the fiscal outlook would be very different.

As it is now, growth in government expenditures continues to outpace that of operating revenues.

In 1997, operating revenues stood at S$29.2 billion, or 19.5 per cent of GDP, comfortably ahead of the S$23 billion of total expenditures. The primary surplus of 4.1 per cent of GDP of 1997 was achieved in the absence of contributions from NIR, which was first introduced in 2008 and expanded in 2015 through constitutional amendments passed by Parliament.

Under this framework, the long term expected real rate of return serves as the basis for determining the contributions from earnings on investments of reserves that the government can tap on for its spending needs.

Depending on the year in question, expenditures may see more or less growth than operating revenues compared to the preceding year. But the overall trend shows that the former is growing faster.

Between 2008 and 2017, total expenditures grew 0.7 per cent per year faster than operating revenues. To make up the difference, NIR has grown 2.3 times between 2008 and 2017, from S$4.3 billion to S$14.6 billion, or an increase of 14 per cent per year.

As a result, the dependence of government finances on NIR contributions has seen a manifold jump in the space of just one decade.

Until very recently, corporate income tax was the main source of revenue. Beginning in FY2016, NIRC has overtaken it to become the main source of budget funding, exceeding all previously conventional sources of revenue from taxes.

ENSURING HEALTHY, SUSTAINABALE TAX REVENUES

The reserves have grown over previous decades through a combination of fiscal prudence and healthy revenue collections.

In the past, revenue collections would have mainly come from the very types of taxes whose contributions have diminished in recent years. It is still early to say that the growth of reserves can be de-linked from tax revenues.

The NIRC clearly affects the growth of the reserves, but it is not clear to what extent the reserves should grow at, and what the sources of the growth will be in future.

Different countries have different needs, and it is difficult to say which one should have more or less reserves.

There is also no reliable evidence on how much a country needs to hold as reserves, and whether different levels of reserves can be directed for different objectives.

All this points to the fact that a heavy dependence on NIRC as the main source of spending increases is still a very insecure arrangement.

For a dynamic economy that is engaged in intense competition with the most advanced economies in the world, there are risks from depending too heavily on sources of revenue that are derived largely from relatively passive streams of income.

One of the main risks of the heavy reliance on NIRC is the failure to take into account fluctuations in returns due to increasing market volatility.

Another important risk is related to what I had mentioned earlier, namely the importance of asset growth in order to produce returns which can fund future expansions in spending.

Obviously, assets of poorer quality carry higher risks. At the same time, the strength of the reserves also enables better quality assets to be pursued and retained.

While the 50 per cent formula reduces the risks to the returns from market volatility, it does not completely eliminate it.

The higher the proportion of investment returns that is assigned as contributions, the smaller the reduction in risk for future returns. This is because the rate at which reserves will grow from year to year would be lower compared to if more of the returns were returned to reserves.

Of the three entities whose investments come under the NIR framework, Temasek’s portfolio has always been widely acknowledged to be more risky.

Most notably, it experienced declines in net portfolio value on more than one occasion, with the most prolonged occurring from 2000 to 2003.

This was, of course, the government’s reason for delaying the inclusion of Temasek in the NIR framework until 2015. Although the other two entities in the NIR framework, namely GIC and MAS, have less exposure to market risk, one can never rule out the possibility that all three entities will be simultaneously affected should another unanticipated global crisis hit.

At the same time, these risks can be managed if we do not deviate from conservative guidelines.

Singapore’s economy is undergoing transformation, but it is not alone in recognising the need to do so.

Although the reserves provide a strong foundation for the change, they need to continue to grow in order to meet the challenges of the future.

Hence, we should be concerned by the extent to which NIR contributions have overtaken tax incomes as the biggest source of funding in the government budget.

So is there anything we can do to address this?

To be clear, running a budget deficit persistently is certainly not in the country’s long-term interest.

For a relatively young and dynamic economy like Singapore, a better answer should be to ensure healthy and sustainable streams of tax revenue.

Taxation is unpleasant for both the government and the ones being taxed. However, it is an inevitable necessity and an intrinsic part of nationhood.

The most important thing is to ensure fairness, which also means removing gaps and implementing new taxes where necessary. NIRC can be used to smoothen the revenue stream to some extent, but should not replace taxation.

ABOUT THE AUTHOR:

Associate Professor Randolph Tan is Director of the Centre for Applied Research at the Singapore University of Social Services, and a Nominated Member of Parliament.