If there is one thing that sets Singapore apart from any other country in the world, it is the way it is funded. No other nation has achieved so much and so little.
The tiny city-state is known for its tax and business friendly environment, but few people ask how exactly this is possible.
The common idea advocated by free market enthusiasts is that a friendly tax environment will stimulate business activity and result in increased budget inflows even at lower tax rates, which in this case is only partially true.
Indeed, Singapore does very well for businesses, but the country is surprisingly generous to the public as well. It subsidizes all important areas of human life: housing, healthcare, education, public transport, and at the same time has an advanced military.
The only reason it can afford so much is because of its decades of prudent policy of not spending beyond its means and investing budget surpluses in national reserves that are continually invested.
Today, half of the projected long-term returns on these reserves can be returned to the budget annually.
Photo credit: Ministry of Finance
The Net Investment Returns Contribution (NIRC), introduced in 2008, has grown so rapidly that it will be the largest source of household income in 2021.
It accounts for a whopping 20 percent of all inflows – or S $ 19.56 billion – of the S $ 96.16 billion available to the government this year.
In other words, it's bigger than any single tax source.
If the NIRC didn't exist, the government would have to more than double corporate tax rates, or triple income tax rates, or triple the GST rate to 20 percent or more – that is, no one would try to dodge these increased obligations (which is likely if taxes were to get high).
Thanks to its solid financial management, Singapore does not need to think about raising the GST to 20 percent, which would be similar to VAT rates in Europe.
Instead, it will be increased from the current seven percent to a modest nine percent.
But why doesn't the government have to increase the GST at all?
Singapore can be governed very well, but it is not immune to demographic changes.
Society is aging and the proportion of older people will only increase, adding to the pressure on the provision of health services and financial assistance in retirement.
In the coming decades, there will also be significant demands on infrastructure investments such as new MRT lines, the continuous expansion of the port, Changi Airport, the development of new housing developments and the rehabilitation of aging HDB cities – as the working-age population gradually shrinks in the 21st century .
In order for Singapore to stay as rich as it is, it needs to find more money. This can be done either by increasing taxes or by dipping into reserves. However, the latter is far more expensive.
The Covid-19 pandemic has only accelerated this need, tearing about a S $ 50 billion hole in the reserves that now needs to be repaired.
This is because a sharp drop would hurt future NIRC returns and in the already uncertain future would lose billions in the country's annual revenue.
Photo credit: Joshua Lee via mothership
Let's put things into perspective. The increase in GST from seven to nine percent is expected to initially provide an additional S $ 3.2 billion for the budget.
If Singapore were to pull more of its reserves (as some have suggested) instead of raising the tax, it would gradually erode the base of its future investment returns.
We know that GIC has an annual return of roughly 5.5 percent over a 20 year period, which means the money it manages almost triples every two decades.
On this basis, we can calculate that for every S $ 3.2 billion removed from reserves to prevent a GST increase, the country would lose nearly S $ 10 billion after 20 years and $ 16 billion after 30 years. Might cost S $. That's for every single year.
* $ 3.2 billion invested at an annual rate of 5.5% will become $ 9.33 billion and $ 15.98 billion after 20 and 30 years, respectively
The cumulative loss of reserves after 30 years could reach almost S $ 400 billion if we take economic growth into account. This is how much lower the national reserves would be by 2050 if the GST were not increased (how compound interest affects the Singapore reserves holdings).
As a reference, building a single MRI line costs around S $ 20 to 25 billion.
Isn't GST repressive and hurting the poor more?
At this point, some people may raise a common problem: GST is regressive in nature. This means that the rich pay a proportionally smaller part of their income than the poor.
This is true, but it is also very misleading as most of the money is still paid by the rich, who spend far more than any single average citizen.
Yes, the percentage would be lower in relation to their income. However, this is not an income tax, but a consumption.
Every time they buy a new car, luxury handbag, or book a suite in a five-star hotel, they put thousands of dollars into the budget with a single purchase – more than any single average resident over the course of a year.
Photo credit: Gov.sg.
At the same time, the government has the means to grant tax breaks in the form of GST vouchers, which are used to specifically reduce the burden on the poorest.
Pay less today to stop paying in the future
Nobody likes it when taxes go up, but in the exceptional case of Singapore, the sales tax hike should actually have widespread public support.
There are two reasons:
- It's still quite small compared to rates around the world.
- The sooner it is increased, the faster the country's reserves can grow (or recover in the post-Covid reality), protecting everyone from a much larger tax hike later. There's a reason VAT rates in Europe and most OECD countries are at or above 20 percent (and have continued to rise in recent years), and I don't think anyone would want to be in a similar position in Singapore.
Canada levies additional taxes at the state level / Source: OECD
The priority is to protect and even expand the reserves as the NIRC should continue to provide an increasing share of the revenue for the state budget.
As long as this pace is maintained, taxation should remain stable in the future, even as society ages.
This is very unlike any other country in the world, where taxes are usually collected in desperate attempts to fill gaps caused by budget deficits and are used to fund current expenses.
In Singapore, a higher GST helps protect national reserves and enables faster accumulation and profitable investment over the long term so that they can continue to generate ever higher returns – and the country continues to enjoy its low-tax environment regardless of demographic change and future economic and political challenges .
Selected image source: Paul Wan & Co.