(Reprinted from HKCER Letters, Vol. 65, May/June 2001)
Goods and Services Tax in Singapore
As noted by Adam Smith, government "is but a necessary evil" that should be kept small and should produce or provide social or public goods only when the market cannot. Market failure arises for pure public goods such as defense, security, law, and public environmental health and safety because these goods and services cannot be priced and sold. Their consumption cannot be excluded by price and because the goods are jointly consumed, unlike private goods like books and hamburgers. The private sector and the market remain the most efficient mechanism by which to distribute all private goods and services, so long as market barriers are low and competition is as close to perfect as possible. For the government, financing for public goods and service and for other general, regulatory functions must come from taxation in the main and as well as from other forms of non-tax revenue. Traditional public finance literature advises governments to maintain a balanced budget, that is, to ensure, to the extent possible, that the level of expenditure does not exceed the level of taxation. This is to avoid allowing the state to become too big and inefficient, and, most important, so that the private sector is not "rowded out."
The two traditional principles of taxation are (1) the benefit approach and (2) the ability-to-pay approach. The former is largely regressive, whereas the latter is more progressive. The lower-income group is the largest beneficiary of government expenditure or public goods and, on a benefit principle, they bear the burden of the taxes financing these goods and expenditures. A "Robin Hood" principle based on ability to pay is not as perverse as it sounds because overall income distribution and social equity are important prerequisites for economic growth and development. Thus, a mix of benefit and ability-to-pay taxes exist in most tax systems. Road tolls are determined on the basis of use or benefit, while income tax is progressive or based on ability to pay, allowing for across-the-board government financing and subsidies where warranted. For instance, education and health services for low-income segments of society are subsidized by higher taxes paid by the middle- and upper-income groups. Regardless of income class, all citizens enjoy public defense law and order, which is produced and consumed jointly and severally and financed by progressive taxes, as these services cannot be sold and charged piecemeal.
Another way of looking at taxes is by focusing on the distinction between direct and indirect taxes. Income tax is a direct tax impinging directly on the tax unit; the individual or the firm on which the tax is levied pays the tax as legislated. An indirect tax is one for which the tax burden can be shifted to another tax unit. A tax on goods and services can be passed from seller to buyer. The more inelastic (i.e., less price-responsive) are consumers, the more the tax burden is shifted to consumers because they are "addicted" to the products they want, (e.g., cigarettes, cars). While direct taxes appear to more neatly avoid shifting the tax burden, they may create disincentive effects in earnings or in the work effort. For example, if individuals perceive that the income tax is too steep or progressive and that they are working more for the state and the public at large than for themselves, they respond by working less. To create a strong work incentive, any tax reform necessary for keeping up with changes in the nature and the structure of the economy should be equitable and fair.
An effective tax must thus do much more than generate the revenue needed for government expenditure. An effective tax should have the following characteristics: (1) equity in income distribution (2) fairness, (3) simplicity and clarity in nature and scope, (4) low administrative costs, (5) low compliance costs for taxpayers, and (6) most important, minimal distortionary effects. Any tax on a commodity forms a wedge in raising the price of the commodity, affecting demand and supply. In the strictest sense of resource allocation, an optimal situation becomes a disrupted, possibly non-optimal situation after a tax is introduced, as the tax causes consumers to change their consumption behavior, affecting suppliers as well. Some of these distortionary effects are intended; for example, high taxes on cigarettes are specifically intended to deter smoking for health reasons. But if market choice and freedom are upheld as the best principles in a capitalist economy, distortionary effects have to be minimized or strongly justified by the sociopolitical objectives of the tax.
II. Rationale of Singapore's Goods and Services Tax
Singapore's government has been accumulating budget surpluses since the late 1970s, even in recession years (e.g., 1985). The arguments in favor of such a conservative budgetary policy have to do, first, with the nature of the small city state, which lacks resources other than human and financial resources. Second, such arguments consider the nature and political economy philosophy of the state, where the People's Action Party (PAP), which has been in power since 1959 is highly influential. Despite the fact that Hong Kong and Singapore share many similarities, Hong Kong is the epitome of a laissez-faire economy, whereas in Singapore the state wields a heavy hand. The large role of the state in Singapore explains not so much the size of the government budget in terms of expenditure and taxation but the spinoffs in statutory boards and government-linked companies (GLCs) that make up Singapore, Inc. So long as the PAP government is clean, honest, and efficient, and so long as economic policy results in successful industrial restructuring, high-quality residences, jobs, and a high standard of living, Singapore will remain a "nation of followers" rather than one of creative entrepreneurs and innovators.
Ensuring international competitiveness by managing human resource, infrastructure, and the business environment (including costs) is always imperative. Fiscal reform, especially taxation, both as a means to woo direct foreign investment, on which the economy is reliant, and as a way to enhance competitiveness, becomes important as the economy restructures. Table 1 shows that income tax as a direct tax has traditionally been the largest contributor to tax revenue and that the share of the goods and services tax (GST), which stood at 8.2% of total tax revenue in 1999, is still low. At the outset, it has to be clear that the GST is not revenue oriented. Its main objective is to make Singapore competitive. This involves the need to shift from direct to indirect taxation and to lower income tax at the same time. Direct income tax reduces people's willingness to work, save, and invest while the GST is more neutral in these effect. As exports as final goods are not taxed, unlike imports as inputs, competitiveness is enhanced. Any GST paid by tourists is refunded to them to alleviate any perverse effect of the GST on tourism.
Table 1: Government Revenue (S$million)
Source: Yearbook of Statistics, 2000
Singapore's tax-collection process, which is efficiently administered with a self-policing monitoring system via firms and suppliers, minimizes avoidance and evasion. The result through shift to indirect GST taxation is a more equitable in income distribution than when the main is borne by salaried workers via income taxes. The top 10% of households, approximately, consume six times more than the bottom 10%, following the empirical evidence that household consumption rises as incomes grow, according to Engel's law. The GST also taps the self-employed, who previously avoided income tax. Unlike the income tax, which has cyclical effects, the GST is a more stable revenue source; it minimizes economic distortions and provides more comprehensive coverage. It increases export competitiveness and improves the business environment. As corporate tax is borne by small, medium-sized enterprises (SMEs), which are largely local firms, lowering that helps them to be competitive with lower tax.
III. Mechanics, Rate, and Coverage
Table 2 shows how the GST has been levied since April 1, 1994. On a value-added basis, the GST has no cascading effect. Only enterprises with a turnover above S$1million are subject to the GST. This spares small retailers, (e.g., hawkers) for the purpose of keeping the cost of living down, as much as anything else, because otherwise it is too unproductive to maintain surveillance over so many SMEs. A large number of SMEs, which are family owned, do not conform to the requisite accounting and billing processes of GST collection depicted in Table 2. Some, like the Singapore Bus System, Singapore Mass Rapid Transit, and the supermarkets owned by the National Trades Union Congress have absorbed the GST.
Table 2: GST (w.e.f. 1 April 1994)
Sales Price before GST
Payment to Government
Supplier price = $10
Raw materials supplier
Sales price = $10.30 (+GST)
GST collected = $0.30
Less GST paid = nil
GST payable = $ 0.30
Manufacturer price =$50
Sales price = $51.50 (+GST)
GST collected = $1.50
Less GST paid = $0.30
GST payable = $1.20
Wholesaler price =$70
Sales price = $72.10 (+GST)
GST collected = $2.10
Less GST paid = $1.50
GST payable = $0.60
Retailer price = $100
Sales price = $103 (+GST)
GST collected = $3.00
Less GST paid = $2.10
GST payable = $0.90
Payment to retailer $103
Total GST paid = $ 3.00
As for rate and coverage, it was decided that there would be a single low rate of 3% with few exemptions, that is, the rate would be across-the-board even on basic goods and services rather than being higher for a few items for the same revenue. Revenue is the product of rate and base (e.g. 3% tax on a base of $10 yields 30 cents tax), low rate-wide base or high rate-narrow base for the revenue the government wishes to generate. When the GST was introduced in 1994, the government promised that the 3% rate would not change in the next five years, and it remains 3% today. As noted, the turnover limit of S$1 million as the exemption threshold was determined as much in consideration of the high costs of compliance for SMEs as to keep costs of living down for provision, retail, neighborhood shops, taxis, and the like. A tourism refund is provided.
There has been some debate about whether basic goods and services should be taxed. Taxing such goods and services would be perverse for low-income households as low-income households spends more on such basic goods. But education, which is in the main public education in Singapore, is largely state-subsidized, and in fact, to offset the GST, since its introduction, education has been subsidized more heavily. The same is true for public-sector health services. For private health services in public housing estates, the services of general practitioners with turnover below S$1 million are not taxed. For financial and banking services, the GST for charge on service is collected. Services from rentals and sales of residential land and buildings are exempted from the GST, and tax credit claims for those on commercial and industrial transactions are allowed. Statutory boards and ministries supplying goods and services in competition with the private sector do pay the GST.
IV. Pre-GST Offsets
A one-off inflationary impact of the GST is expected, and this could hurt fixed-income earners (e.g., pensioners and creditors). The consumer price index rose marginally in the first year after imposition of the GST, but it did not rise by the full 3%, because of measures taken. Those measures are as follow. (1) The regressive nature of the GST, especially for low-income households and basic commodities, was recognized. Instead of exempting essentials, the government chose to provide direct GST rebates and to reduce other taxes. (2) Many middle- and low-income households were not paying income tax at the time the GST was introduced but thereafter fell under the GST net, which corresponds with the philosophy that all citizens should pay some taxes, no matter how little, to avoid the entitlement, welfare state syndrome.
Among the pre-GST offsets were a reduction of taxes on entertainment, tourism, taxes on utilities, and telephone charges. The separate, high taxation for "social bads" (e.g., betting, tobacco, liquor, gasoline, water) remain, as the objective of imposing them was to reduce demand for these goods. For low-income and elderly groups, public assistance, as well as education and medical subsidies, offset the GST. With over 80% of Singapore's population in owner-occupied pubic housing, lower conservancy charges and property tax rebates were also instituted.
Preparation for the GST included the administration and collection mechanism, preparing the people, and carefully explaining the logic and rationale of the tax. This involved a huge public relations efforts. Governments elsewhere have been toppled because of the inherently unpopular nature of such a regressive tax. This is especially true when consumers generally feel the pinch of an expenditure or consumption tax immediately, whereas with an income tax collected in the year of assessment, they usually do not feel it until a year after the income is earned.
V. Comparative Analysis
Table 3 shows the value-added tax (VAT) prevailing in other countries when Singapore's 3% GST was levied. The GST was not revenue-oriented and was part of tax reform implemented to keep up with the changing nature and structure of the Singapore economy. The GST is probably among those VAT and consumption taxes that are the lowest in the world. Any revenue generated by the GST is offset by income tax reduction, as the shifting of the reliance tax between direct and indirect taxation was an intended one.
Table 3: VAT elsewhere (%)
Indonesia, Korea, Philippines
VI. Consumption Tax for Hong Kong
The logic and rationale behind imposing a consumption tax in Hong Kong may be different from the logic and rationale for introducing one in Singapore. Hong Kong has experience some years of budget deficits, which may be structural (i.e., related to the changing structure and composition of the economy) rather than cyclical (i.e., caused by booms and busts). Like Singapore's, Hong Kong's economy is highly open, that is, international competitiveness and free trade are crucial policy prerequisites. Over time, both city states have become even more service oriented, especially in higher value-added services and in new services in finance and banking, communication, telecommunication, logistics, distribution, and such. Manufacturing activities also have to upgrade along the same high technology and value-added routes, and productivity is the most important element for international competitiveness.
Noting the differences between Hong Kong's laissez-faire system and Singapore's dirigisme, both academics and the private sector in Hong Kong have understandably called for a smaller government and prefer to let private-sector efficiency provide the conditions for global competitiveness. This is easier to do in Hong Kong than in Singapore, given the latter's political economy of a "government-made," state-led model of growth. So, if the purpose of a consumption tax in Hong Kong would be to generate more revenue in view of expected government deficits, the dissent is understandable if the state insists on continuing with what it considers its legitimate functions in the economy and in society. Management of the public sector budget, efficiency, and productivity are the standard arguments the private sector throws back at the state in the debate over revenue-oriented taxes.
Does the state really need more revenue, or can it reduce spending without cutting back on expenditure? Is the government inherently and necessarily less efficient than the private sector? It has to be noted that government ministries and departments are not profit-oriented like commercial firms. Without the profit-maximization principle guiding productivity and efficiency and without the social functions related to many government services that have a redistributive effect (e.g., education, health services), the public sector is usually deemed less efficient in resource allocation than the private sector.
It is difficult to generalize about the wisdom of whether imposing a GST in another economy like Hong Kong without a deeper understanding of and insight into government budgetary policies and economic, sociopolitical philosophy. In Hong Kong's case, as long as the private sector thinks it can do better than the public sector and has done so, a smaller rather than a larger government and budget are, of course, more desirable. On the other hand, with greater social expenditure and an ageing population, whether the state should assume a larger role in instituting more directed policy-induced economic restructuring to meet the challenges of the new knowledge-based economy (KBE), which is based on information communication technology (ICT) and propelled by new globalization, is ultimately a political question. New globalization is defined as the democratization of finance, information, and technology as capital markets have globalized and the new technology and information have given the market more power and increased access to resources and at the same time intensified competition globally.
Be all this as it may, should Hong Kong seriously consider levying a consumption tax, Singapore's experiences may be useful. These experiences include starting with a low rate and making the tax base comprehensive rather than selective in terms of the nature and scope of the tax. On administration and implementation of tax including compliance costs, mount the necessary and important campaigns on publicity and public education, as was done when the Mandatory Provident Fund was introduced in Hong Kong, explaining the reasons and objectives for instituting the tax. It is worth paying attention to details of possible regressive effects on the poor and lower income groups and making appropriate adjustments suitable to Hong Kong's context. The political backlash of such a tax which hurts immediately is there. One-off inflation and possible profiteering by suppliers and firms have to be monitored as well. As a tourist hub, averting the burden of a GST on tourists has to be considered.
Singapore's GST is part of a structural tax reform intended to shift the tax burden to indirect taxation. It is not a revenue-oriented tax meant to ensure growth incentives and international competitiveness. The sociopolitical dynamics of possible perverse effects of the GST have been carefully taken into account and were dealt with through more subsidies and offsets before the tax was imposed. Implementation of the tax has been smooth thanks to advance public education. The government has been cautious in not raising the GST more progressively to lower direct taxation as intended; the GST has remained at 3% since its imposition. With Singapore's economic prospects remaining uncertain in the face of the continued regional downturn and a possible recession in the United States, the Singaporean government has been reducing business taxes like corporate and property taxes and offering other fiscal incentives to improve the business environment. The government is able to do this because it has accumulated budget surpluses.
A remaining and pertinent question in Singapore is what is the long-term desired effect of reducing the role of the government and letting the private sector with its characteristic efficiency in resource allocation be the engine of growth. Singapore, Inc., may suit the old economy better than the new KBE, with ICT and globalization as the drivers essentially pointing to market forces rather than to state intervention. So far, crowding-out effects appear to have been averted, as the public sector has spent heavily on physical infrastructure, human resources development, other social service (e.g., housing, medical services, defense, security). Even Singapore's GLCs run on strict commercial, profitability-based criteria have assisted in the economic restructuring, although their role and image have to change as they regionalize or venture abroad. Like Hong Kong, Singapore has to be more private-sector led and driven, necessitating a scaling down of government, including its budgetary surpluses and official reserves. Still, it is important to remember that introducing tax reforms in the way the GST was introduced is easier to do with a comfortable state coffer that is not pressed by revenue shortfalls and can afford to provide offsets.