Raising Goods and Services Tax

1.45 Lowering corporate and personal income taxes will cost the Government a large amount of revenue. If we reduce the tax rates to 20%, in all, the Government will lose 9% of its annual revenue, or nearly 1.7% of GDP. We cannot afford this loss; we have to make up at least part of it from other sources. That is why we must increase the GST rate from 3% to 5%.

1.46 Some Singaporeans have asked why we cannot simply accept this loss of revenue, and leave the GST rate at 3%. After all, we have been enjoying comfortable surpluses, and should be able to accept smaller, but still large, surpluses in future. The problem is we do not expect large surpluses in future. Growth will be slower and more volatile than before. Revenues will be less buoyant. But demands for the Government to do more and spend more are increasing. Even without any tax cuts, our surpluses are likely to shrink. With the large tax cuts, we face a real risk of ending up with a structural deficit.

1.47 A structural deficit means we will have a deficit in most years, whether the economy is booming or in recession. This will have serious consequences. One key reason the Singapore dollar has been strong, and inflation has been low, is that we have run a prudent fiscal policy. The Government lives within its means, and spends no more than what it receives. If the Government starts spending beyond what it gets, and borrows or prints money to fund its spending, the Singapore dollar would go down. Inflation would go up. Then, Singaporeans' hard-earned savings would be worth less, including their CPF savings.

1.48 Some argue that it is all right for us to run deficits regularly, because we can always draw on the reserves to make up the shortfall. But that is not what the reserves are for. The reserves are to see us through rainy days, to be used only in extremis, because Singapore produces no oil, timber or gold that we can fall back on. Furthermore, we must not be misled by the fact that all our previous recessions have been short-lived. We cannot discount the possibility that future recessions will be prolonged and deep in this new environment. If we draw on our reserves routinely, they will soon be gone. In any case, using the reserves requires the consent of the President, who will very likely say "No", and with good justification.

1.49 This is not to say that we will never run deficits. In difficult years we will end up in deficit, as happened last year. But over the whole business cycle, we must aim to maintain a modest surplus. This is only possible if we accumulate surpluses in good years to cover the deficits of lean years. The Government therefore cannot operate on a tax-to-spend basis. Instead, we should build in a margin of savings, especially given the more volatile and uncertain environment in the years ahead.

1.50 A third argument against raising GST is that the Government should instead cut back on its expenditure. We will certainly do our best to be thrifty, especially when times are hard. But our government expenditure is already very lean at 18% of GDP. In contrast, government expenditure in developed countries is typically much higher - 30% to 40% of GDP. Moreover, hard times are also times when Singaporeans want the Government to respond with generous helping measures. Nevertheless, we will maintain a tight rein on the cost of Government to ensure it stays below 20% of GDP.

1.51 If we examine the Government budget more carefully, we will see how difficult it is to make deep cuts in expenditure. Education is a priority area. It takes up 4% of GDP. If we reduce this, we risk under-investing in our children. Even if we could economise on frills, we would still want to spend more on education. Indeed, MOE has many more worthwhile projects that it is keen to implement, if the money can be found. These include upgrades to schools, polytechnics, the Institutes of Technical Education and the universities. Our health spending will rise as our population ages, and as they demand higher standards of health care. MOT has multi-billion-dollar plans to upgrade our public transport infrastructure, especially the rail network. Public housing is yet another big area where a serious cut-back would adversely affect our quality of life. Finally, defence spending must be maintained if we are to continue to enjoy peace and security. These five critical areas - education, health, transport, housing and defence - together comprise two-thirds of the Government's expenditure. It is therefore not realistic to cover the deficit by cutting government spending without any negative impact on the daily lives of Singaporeans.

1.52 That is why the ERC Sub-Committee recommended, and the Government has decided, to raise the GST to make up for the cuts in direct taxes. Increasing the GST rate to 5% will raise 0.8% of GDP, and make up just half the revenue lost from the corporate and personal income tax cuts. Overall, the Government will still end up revenue negative by 0.9% of GDP, or $1.2 billion per year. This is a not an insubstantial loss, but it should still leave the Government with modest surpluses over the medium term, provided we are careful not to increase expenditures recklessly.

1.53 As for timing, the ERC Sub-Committee has recommended raising the GST in 2003. By then the economy should have recovered further from last year's recession. But whatever the state of the economy next year, the fact that we are coupling a comprehensive offset package to the GST increase means that the increase should not burden Singaporean households, choke off consumer spending, or impact the economy. Our approach is to help Singaporeans adjust to the new realities, so that we can make essential changes to our tax structure without delay, and forge ahead to build a stronger economy.