In 2007, the Singapore government increased the Goods and Services Tax rate to 7% and decreased the corporate tax rate to 18%.

(a) Explain how the above tax changes can help Singapore achieve higher economic growth. [10]

Introduction

• Define taxes
• Distinguish between direct and indirect taxes via definition and examples

Main Body

1. Define economic growth + determinants of economic growth (Briefly)
2. Tax changes to achieve higher economic growth:

a. Effect on Investment
Through cut in corporate income tax, it increases/enhances investments (local or foreign direct investment) and encourages entrepreneurial spirit as post-tax profits are increased. Comment also on importance on providing good investment climate.

Essential for S’pore to decrease direct taxes ie. corporate income tax lo offset the rising land and labour cost. Also to win in the global beauty contest of attracting direct foreign investment → increases increases productive capacity → higher economic growth. This is especially important for a small and open economy like S’pore with regional competitors eg. Hong Kong, China, India.

b. Effect on corporate savings
A fall in corporate income taxes → increases the source of funding for capital formation (investment) or spending on R & D for biz profits → encourages production and hence economic growth.

c. Broadens tax-base
Indirect taxes can help widen tax base and is a more stable source of revenue.

Especially good for S’pore because of declining working population due to its rapidly ageing economy → smaller tax base for income taxes.

Also, she is small, very open and hence very vulnerable to world’s cyclical changes. Hence indirect tax provides a good alternative to increase tax revenue → increased tax revenue raised can help to finance increased govt expenditure on infrastructure, training and development → promotes investment climate and increases productivity → encourages economic growth.

d. Effect on price levels
Increasing indirect taxes levied on goods and services increase the prices of goods and services and hence the cost of living.

May also lead to cost-push inflation → loss of competitiveness → fall in production and hence hinders economic growth. However, if the increase in productivity (due to lower direct taxes) outweighs the wage increase → economics growth

Conclusion

Fall in direct taxes is more useful in promoting economic growth relative to increasing indirect taxes as the latter’s aim is mainly to provide an alternative source of tax revenue for the government.

To read part (b) of this question, visit Consider whether economic growth should be the top priority goal of a government. [15] to find out more.

Economics Tuition: Explain how tax changes can help Singapore achieve higher economic growth. [10]