Budget 2023: Fiscal headwinds call for hard choices
As surpluses dry up, raising tax revenues and productivity will be key to fiscal sustainability
In the run-up to budgets in the 1990s, it was common for economists to be asked: “Will there be more tax cuts?” It was a fair question because cutting taxes was then in vogue, and the answer was usually yes.
Singapore’s top personal income tax rate came down steadily from 33 per cent in 1991 to 20 per cent in 2016. Corporate income taxes were reduced as well, more or less in lock-step. With the goods and services tax (GST), introduced in 1994, Singapore was able to run regular budget surpluses as well as add to its reserves.
Rapid economic growth helped. From 1990 to 1997 – the year of the Asian financial crisis – GDP growth averaged around 9 per cent, which kept tax revenues buoyant.
After the 1990s, it was a different world. Since 2001, the Government’s expenditure often exceeded its operating revenue, leading to frequent primary deficits. As the economy matured, gross domestic product (GDP) growth also declined. For example, from 2011 to 2022, it averaged below 4 per cent.
Looking ahead, Singapore’s fiscal challenges will be even greater.
Last week, the Ministry of Finance (MOF) released an important White Paper containing its medium-term fiscal projections up to 2030. Its conclusions are sobering. “Overall, our fiscal space is now much tighter compared to the past few decades,” it points out.
There are several reasons for this. The external economic environment has become less growth-friendly because of geopolitical tensions, a trend towards de-globalisation and higher inflation.
There are also mounting pressures on both revenue and expenditure.
On the revenue side, lower GDP growth – which is projected at an average of 3.5 per cent over the medium term – will eat into tax collections, both direct and indirect, and operating revenues are forecast to grow by slightly less than GDP.
While keeping pace with GDP growth, investment returns, which account for around 20 per cent of revenue, are expected to grow more slowly than in the past, because of a slowdown in global growth in the face of anti-inflationary policies and trade tensions.
Pressures on expenditure will come from multiple sources, especially healthcare, infrastructure and social needs. Healthcare spending will be driven by an ageing population; more usage of facilities because of the greater prevalence of chronic diseases, higher incomes and more accessible high-quality healthcare services; and increases in manpower expenses for healthcare workers.
Although the Government has tried to moderate healthcare cost increases through more community-based care, greater emphasis on preventive care and reducing procurement prices for drugs and therapies, total healthcare costs as a percentage of GDP are still expected to rise from 2.3 per cent at present to around 2.9 per cent to 3.5 per cent during FY2026 to FY2030.
Infrastructure spending, driven by major long-term projects, may also increase because of higher borrowing costs, and there will also be more social spending in the form of wage subsidies, income supplements and training to uplift lower-wage workers – which will cost more than US$9 billion (S$12 billion) over FY2022 to FY2026 – as well as more outlays on early childhood education.
Overall, the Ministry of Finance (MOF) expects that government spending will increase to around 19 per cent to 20 per cent of GDP during FY2026 to FY2030, from 18 per cent at present. This will exceed operating revenue, which is projected at 15.7 per cent of GDP over the same period.
It would have been about 0.7 per cent of GDP lower, if not for the revenue-raising measures in Budget 2022, which included the GST hike, and increases in top marginal income tax rates and residential property taxes.
Investment income – projected around 3.5 per cent of GDP – will just about bridge the gap between expenditure and operating revenue during FY2026 to FY2030.
Fewer fiscal surpluses
The overall picture suggests the repeated fiscal surpluses that Singapore enjoyed during the 1990s are unlikely, at least for the rest of this decade. Moreover, MOF’s projections do not take into account the impact of potential revenue losses arising from the ending of tax breaks and other changes under the so-called “base erosion and profit shifting” (BEPS 2.0) initiative of the Organisation for Economic Co-operation and Development (OECD).
With multinational corporations (MNCs) required to pay more of their taxes to countries where their consumers are located under the first pillar of BEPS 2.0, Singapore stands to lose revenue because of its small market size.
Nor do the projections factor in the costs of further policy measures that may be needed between now and 2030 to boost economic competitiveness and strengthen the social compact – not to mention emergency spending as during Covid-19, which led to a record fiscal deficit in FY 2020/2021.
Thus, the MOF realistically acknowledges that in future the Government will “either require more resources, or have to cut back in some existing areas and re-allocate funds to these new priority areas”.
Taxing challenges
Raising new resources may not be easy. On the tax front, a strong case can be made that Singapore has room to do more. Its tax-to-GDP ratio, which has been declining since the 1990s, is around 13 per cent of GDP, compared with more than 33 per cent for OECD countries on average, and lower even than the Asia-Pacific average, which is around 19 per cent.
As many observers have pointed out, there is limited scope for higher direct tax rates. Personal income taxes, which were already increased at the top end in Budget 2022, could be raised some more, but the impact on revenue would not be substantial and would diminish with ageing.
There may be room for raising corporate income taxes slightly but that would run the risk of losing tax competitiveness. There is more scope for higher wealth taxes, particularly on high-end properties – although more revenues could also come from higher stamp duties on such properties, the market for which is booming.
That leaves GST, which even at 9 per cent from 2024, is far below the OECD average of 19.2 per cent. While a 9 per cent rate would be sufficient to meet near-term spending needs, raising GST into the double digits should be an option beyond the medium term, even if politically difficult.
Meanwhile, the Government could consider reducing the turnover threshold for GST eligibility, which, at $1 million is abnormally low by international standards and excludes around 90 per cent of businesses. By comparison, in Britain, the threshold is £85,000 (S$136,000), while in Australia it is A$75,000 (S$69,000). In some countries, no businesses are exempt from GST. While Singapore should not go to that extreme, gradually broadening the tax base for GST could make a significant difference to revenue.
Can’t have it both ways
So far, it has been possible to build infrastructure and strengthen the social compact with low taxes. But given the mounting pressures on spending, including in new areas such as climate adaptation, having it both ways will be harder to achieve in the future.
Singapore will have to face the fact that to sustain a social compact and infrastructure standards comparable to other advanced economies in the face of slower economic growth, its tax revenues need to be higher than they are.
It should also think twice about replacing corporate tax breaks to MNCs with grants. Many of them have been paying effective tax rates in the single digits.
Whereas under the first pillar of BEPS 2.0, Singapore stands to lose revenue, under the second pillar, it will be able to tax MNCs at the minimum rate of 15 per cent – otherwise, they would have to top up their taxes to that level in their home countries.
Singapore should use the additional revenue for social and infrastructural spending or, at a minimum, be extremely selective with any non-tax incentives.
It needs to trust in the fact that it has a sufficiently enabling environment for business to attract investments from MNCs without having to give them financial handouts, even if other countries are doing that.
Productivity key to growth
Finally, and probably most importantly, Singapore must put productivity growth at the front and centre of its economic strategy. Absent higher immigration and with a below-replacement fertility rate, Singapore’s workforce will grow slowly, if at all. It will therefore have to depend almost entirely on productivity for its GDP growth. This will also be important for its social compact. For example, without higher productivity, wage increases for low-income workers under the Progressive Wage Model will not be sustainable.
The Government has taken big steps to boost productivity in recent years, through its productivity solutions grants, initiatives to speed up digitalisation, automation and upskilling. Nevertheless, outside the manufacturing sector, productivity growth has been lacklustre. The International Monetary Fund points out, for instance, that from 2015 to 2019, most service sectors, except for financial services and infocomms, have experienced limited to no growth in labour productivity. It is particularly weak in domestic-facing sectors such as construction, retail and food services.
A key problem in many such sectors, which are dominated by SMEs, is a lack of scale that limits their ability to reduce unit costs, deploy technologies, attract talent and venture overseas.
Apart from providing the usual productivity incentives, the Government needs to encourage scaling initiatives. One way would be to limit at least some of its business subsidies to companies above a minimum size to encourage mergers – otherwise it would be subsidising inefficiencies.
Private equity firms can also help accelerate consolidation among SMEs. Once they achieve scale, some of Singapore’s service-oriented industries, including those providing education, healthcare and environmental services, can be significant players at least regionally, if not globally, producing not only more jobs but also revenues.
So, despite the challenges ahead, there are pathways for Singapore to achieve fiscal sustainability over the medium term, while building a more advanced economy and continuing to strengthen its social compact. But it will take some hard, and politically difficult, choices to get from here to there.
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