How GST adds value

Christopher Pang

Goods and Service Tax (GST) is also known as Value Added Tax (VAT) in most European countries and North America. It is a consumption tax that is levied on the value of a product. The irony of the tax being called value added tax is not because it adds value to the product, but it adds a value to the final cost price to the consumer. GST was first introduced in 1994 to shift the reliance from direct tax to indirect tax.

The government alleges that with an aging population, income tax is expected to drop gradually and the introduction of GST would create a tax structure that will support the country’s future expenditure. It has become a dependable source of revenue because consumption is more consistent than income and the reliance on it has been reflected with further rate hikes of 1% in 2004, 2005 and a 2% hike in 2007.

The graph below plots tax revenue for GST and Personal Income Tax, demonstrating the impact of the hike in 2007. The spike from 2006’s 3.98bn to 2007’s 6.17bn was a result of the 2% hike started on 1st July 2007. From a different perspective, a 2% hike should technically result in a 40% increase in tax revenue collected from GST for the government. Given that the actual hike only begun in July, the estimated impact should be about 20% higher than the previous year if consumption stays at similar levels. However, government intervention usually leads to unintended consequences.

In anticipation of rising prices, people started to shift consumption from a future time frame to current time frame. It creates a disincentive to save after the GST hike announcement because everything will become more expensive by 2% just by saving beyond July, especially with the low interest rate. In another perspective, your savings after July 2007 will become about 98.04% of what it used to buy.

Nominal savings / income remains but your real income or purchasing power has been reduced. So was it any surprise that GDP a measure of aggregate spending increased from USD139bn to USD167bn during that period? As ministers’ performance is highly based on the nation’s GDP and its growth rate, forming an incentive to implement policies that encourage consumption, including GST.Constant hikes create expectations of inflation and the induced consumption continues to sustain a house of cards built on a foundation of unproductive service sector industries.

GST has always been one of the controversial topics before, during and right after an election. As the year edges to the World Cup 2010 when the General Elections is expected to be held this year, many Singaporeans have began speculating whether the upcoming budget deficit announced recently would be financed through a GST hike possibly to 10%, especially with the previous GE experience in 2006.

It is expected similar answers to questions raised during Budget2007 would be provided by Ministry of Finance to a future GST hike if any. I provide my opinion on some of the standard answers given by MOF under this link (http://www.mof.gov.sg/budget_2007/gst.html)

Markets can function well if not better when given more self governance as free markets will automatically reward/punish the actions of the participants. It is therefore not necessary to increase GST and the solution is to cut government spending. Deregulation and free markets can bring about innovation, greater efficiencies and lower costs, creating higher purchasing power.

Examples of free(r) markets would be the technology products and mobile phone providers, where innovation of new products creates competition among industry players, driving older technology prices down, creating incentives to innovate, benefiting consumers in terms of cost savings and higher purchasing power. Firms that are unable to compete on innovation will compete on costs and efficient production, passing such savings to consumers, in order to compete with firms which can innovate, e.g. Creative.

One of MOF’s arguments is that it is better to increase GST when the economy is doing well. How about reducing GST last year when the economy is experiencing a downturn late 2007 till now? An increment when the economy is doing well drives up consumption through purchase of property, cars, and any other big imperishable goods expected to be consumed in the near future.

The malinvestments created an illusion of economic health. This optimism of ever rising prices of property and healthy up trending stock markets because of economic activity will come to an end once the credit driven consumption dries up, which it did on a global front when asset prices start falling and all paper wealth vanish into thin air.

The government claims a GST hike would help the lower income group and assumes that the higher income group would consume more of everything in absolute terms. The assumption is valid but ignores the impact in terms of percentage terms where the lower income group spends a larger percentage of their income just on necessities alone, i.e. transportation, food, household bills.

A 2% hike on a person of lower income has a larger impact in percentage terms than a person earning a higher income. The real income gap between the lower income and higher income group potentially increases because of imposing a GST. The maximum GST credits to an individual of $1,000 is barely enough and the only way he can benefit from it is by spending less than $50,000 for the rest of his life, which is highly improbable.

Small businesses were most likely affected by GST hikes as the cost of keeping track and reporting of GST is too high for small businesses. If the small businesses are able to pass the cost to consumers, the small businesses would survive at the consumers’ expense. If the small businesses are unable to pass down the costs and have to absorb the GST, it would reduce the profitability of the business, reducing the ability to expand the business and create more jobs locally. The fallacy that an unregistered firm can charge a lower price is therefore not justified in this case.

In summary, GST hurts the lower income group more than the higher income group and should be abolished if the administration is truly interested in helping the lower income group. The only means leading to a prosperous  future is through savings, better allocation of capital into productive capacity and not through a bigger government budget and higher taxation whether through direct or indirect taxes.