The recent tax changes mentioned in the title refer to the Singapore government increasing Goods and Service Tax (GST) by 1%, from 3% to 4%, starting from January 1st 2003, as well as reducing personal and corporate income taxes. The effects of these changes vary depending on which view we take when looking at these changes. There are three main perspectives to consider when looking at this. They include that of the Keynesian economists, the Monetarists, and the Supply-side view.
Each of them deal with the aggregate demand and aggregate supply in the Singaporean economy, and how they are structured, as each of these groups have different views regarding the aggregate demand and aggregate supply models of the economy, both in the short and long run. GST is an ad-valorem tax, meaning that it is a percentage of the good or service purchased. The effect of this can be shown in the diagram below:
The change in tax will have an impact on aggregate demand and supply, as they affect prices, which has a major say in deciding the level of both aggregate demand and supply. The other changes announced by the Singapore government regarding taxes are the decreases in both personal and corporate income taxes, (PIT and CIT) to a new low of 20% (eventually), from 26% and 24% respectively. “The aim in proposing these changes is to attract more businesses to Singapore and generate higher growth, more jobs and better incomes for all Singaporeans”.
To help cushion the GST hike, the Singapore Government has also proposed an Economic Restructuring Scheme (ERS), which will see Singaporean households receive between $600 and $1400 in government shares in 3 installments over the next three years. The ERS will ensure an extra $3. 6 billion for Singaporean households. To decide whether the tax changes are justified, it must first be stated that GST is a regressive tax.
That is, that the tax represent a smaller proportion of a person’s income as their income rises, meaning that the average rate of taxation falls. This fact, along with the cuts in personal income tax and corporate income tax, suggests that it will be mainly the higher income earners who benefit more from the tax changes. The Singapore Government would have initiated these changes to increase output and economic growth in the Singaporean economy, which had stagnated somewhat in the preceding few years.
With the Keynesian view, which believes that the aggregate supply curve will be fairly elastic, aggregate demand will go a long way in determining how output will change with respect to price. So, if there is an increase in prices, as there inevitably will be with the increase in GST, aggregate demand will decrease, shown by a movement along the aggregate demand curve to the left, and a shirt of the aggregate supply curve to the left as well, due to the downward sloping nature of the aggregate demand curve.
The aggregate supply curve will shift to the left, as is shown in the following diagram: An actual Keynesian aggregate supply curve would be a lot more elastic, and thus would result in a much more significant decrease in output. It can be seen from the diagram that as prices have risen from the increase in GST (some firms have in fact absorbed this increase, although most have not), aggregate demand has fallen from Q1 to Q2 and thus the economy’s output has decreased, as aggregate demand is indicative of the economy’s output.
This is more commonly known as stagflation, whereby there is cost-push inflation present in the economy, but instead of there being an increase in output as would normally occur with demand-pull inflation, output in this case actually decreases, stagnating the economy. However with the decrease in personal income tax, most people will have a greater disposable income and therefore will not feel the effects of the GST increase as the income tax decrease is larger than the increase in GST.
The Singapore government has even stated that the loss in government revenues will only be partially made up by an increase in GST, which as originally slated to be a 2% increase, rather than the imposed 1% initial increase, with the other 1% to be added next year. However, the decrease in output as a result of the inelastic aggregate supply might be too much for the ERS and income tax decrease to cover, and the Singaporean economy might experience even smaller or negative growth, leading to a recession in the near future.
With a Keynesian point of view, direct government spending might be favoured, and to an extent has already been implemented with the addition of further MRT lines and the extension of the International airport. The Keynesians believe that with extra government spending, the multiplier effect will take place, ensuring perpetual stimulation of the economy through all levels of production and for all individuals, irrespective of income or location, through the trickle down effect. An example of what the multiplier can achieve is shown in the diagram below:
So the reason why the Keynesians prefer to see government expenditure rather than changes to taxes and restructuring schemes is because of the fact that they believe the aggregate supple curve is very elastic, which would negate the effects of tax changes, and would allow for government intervention to work much more effectively. Another reason why Keynesians do not prefer tax changes is because of the stickiness of wages and prices. With the tax changes, wages and prices would have to vary immediately for the effect to take place.
However, it is believed that wages and prices do not often change at the same time as other changes such as tax increases, rather they remain the same for a period of time, and only of they believe that the change is likely to be long standing, do prices and wages become altered to reflect other changes within the economy. However, is has been argued that the trickle down effect loses its effectiveness when coupled with government intervention, as the trickle down effect needs to work independently and government spending might interfere with the trickle down effect and stop it working as it should do.
With the Keynesian view in mind, the tax changes proposed by the Singapore Government might not be fully justified as they may not benefit as many people as they would harm, although, to an extent, they could be seen as an improvement over the previous situation. The monetarist view is slightly different. Their view of the aggregate supply curve differs from long term to short term. In the short term, they believe that that aggregate supply curve is fairly normal, sloping upwards, not elastic, not inelastic. However, they believe that the long run aggregate supply curve is perfectly inelastic.
This is due to their belief that in the long run, prices will always settle back to the equilibrium due to the fact that prices will rise at all levels of production. This effect can be seen in the diagram below: With this in mind, when we consider the tax changes, the effect of the GST will not be too great in the long term as a new equilibrium will be reached as prices will rise simultaneously. If the price of bread, for example, rises by 1%, then the price of the suppliers will also increase bye 1%, as will the wages of the labour by 1% so the changes will not have too bad an effect on the economy.
When we take into account the income tax reductions and the ERS scheme, we find that households will have even more of a disposable income and spend more in the economy. This might lead to inflation, however, and with the perfectly inelastic aggregate supply curve, there will be no increase in output to make up for the rise in prices. The effect of the tax changes in terms of inflation can be shown in the diagram below: As can be seen, there is no increase in output but there is a definite increase in price levels which match the increase in aggregate demand.
The only positive side to this is that there is not much chance of output being decreased. So from the monetarist viewpoint, the tax changes are quite good in that most people will not be too badly affected by the increase in GST, and they receive a further boost to their disposable income due to the decreases in personal income tax and the ERS scheme. It will also be good because peoples increase in disposable income may see them work harder and for longer hours, increasing output further and will give the unemployed more incentive to find work.
This appears to be a plan of action even for George Bush, as he has signalled that he wants to lower income tax to boost consumption to try and stimulate American economic growth. The negative side to this tactic would obviously be the invariable inflation that would be equal to whatever the increase in aggregate demand is, thus nullifying any positive influence the tax changes might have had. The final view would be that of the supply-side school of thought. As the name suggests, this group focuses on aggregate supply.
The aim for these economists is to shift the aggregate supply curve to the right, so as to decrease prices as well as increase output in the economy. In this diagram, if we take E1 to be the original equilibrium level of the economy, and the aggregate supply curve were to shift to the right to SRAS2 with the same aggregate demand curve (AD1), then we can see that the price level has decreased and output has also increased and the goal that almost all governments set out to achieve has been reached. The supply side economists aim to influence the labour supply, and thus national output.
They want to increase the total quantity of factors of production to encourage greater production and therefore greater output. In terms of the tax changes introduced by the Singapore Government, the increase in GST which will see prices rise, but is offset by the cuts in income tax and the ERS scheme, means that it is likely that the effect shown in the diagram, may be partially achieved. Prices may still rise in the economy due to the GST hike but with a larger disposable income for most households, they may still end up spending more on goods and services so as to create economic growth in the Singaporean economy.
So it can be seen that the Singapore Government has made certain tax changes with careful consideration and has kept the individuals at mind when introducing these changes. Only after it became apparent that the government would be facing too great a revenue loss from the decrease in income taxes did they decide to increase GST from 3 to 5% (still one of the lowest rates in the world), and then revised that to just 1% this year with a further 1% next year.
It has to be justified, considering that Singapore must boost its flailing economic fortunes in the face of newly found competition from the much bigger market of China, and has done so by reducing corporate and personal income tax as incentive for businesses to set up in Singapore to boost their economic growth through the multiplier effect and the trickle down effect.
There will be a few negative effects of the changes in the short term, such as some people not being aware of and therefore not being able to take advantage of the ERS scheme, but in the long term, the tax changes are vital to Singapore maintaining its status as business hub in Asia and across the world.