Splitting the 'P' and 'I' in the PIC scheme

To drive investments in innovation and productivity, the Singapore Government has implemented a number of fiscal incentives over the last five years. These include the broad-based Productivity and Innovation Credit (PIC) scheme, as well as other targeted schemes such as the Research Incentive Scheme for Companies and Innovation and Capability Voucher.

Yet, productivity growth in Singapore has been lacklustre: The multifactor productivity growth rate year on year was 1.5 per cent in 2011, -1.5 per cent in 2012, -0.3 per cent in 2013 and -1.2 per cent in 2014. That is a far cry from the target of 2 per cent to 3 per cent annual growth announced in Budget 2010.

Why the multitude of fiscal and non-fiscal policies has not produced the desired results remains a question that Singapore struggles with.

One important distinction that needs to be made is that of productivity versus innovation. Dr Robert Atkinson, president of the Information Technology and Innovation Foundation, is of the view that "while innovation is related to productivity, and for that matter competitiveness, it is not synonymous". That was a point he emphasised in a report aptly titled Competitiveness, Innovation and Productivity: Clearing Up The Confusion. He observed that "nations tend to meld these together, assuming that success in one will lead to success in another. But this is a recipe for underperformance."

Let's take a look at how productivity and innovation are defined.

The Organisation for Economic Co-operation and Development defines productivity as a ratio between the volume of output and the volume of inputs. The Oslo Manual for measuring innovation defines product innovation as a good or service that is new or significantly improved, which includes significant improvements in technical specifications, components and materials, software in the product, user-friendliness or other functional characteristics. Process innovation is explained as new or significantly improved production or delivery method, which includes significant changes in techniques, equipment and software.

Clearly, productivity and innovation are very different concepts, though arguably two sides of the same coin. Here lies a possible explanation for the inherent weakness of the PIC scheme, which attempts to address two distinct issues with a single approach.

According to Parliament reports in February last year, the take-up rate for the PIC scheme had increased from 33 per cent in Year of Assessment 2011 to 46 per cent in 2014. However, 97 per cent of the claims were made in automation equipment and training categories, while only 1 per cent was for research and development activities. This suggests that the PIC scheme has not been effective in driving R&D, a key component to driving innovation.

If we accept that innovation and productivity are distinct, then it may be timely for policymakers to consider carving the PIC scheme into two separate incentives: one to promote innovation and the other to drive productivity.

The new incentive for innovative activities should address some of the current implementation issues associated with the PIC scheme, by broadening the definition of R&D to include innovative activities; increasing or removing the cap on qualifying expenditure applicable for R&D or innovative activities; and putting in place a more consistent review process in assessing qualifying innovative activities.

Although there is a high take-up rate for the PIC categories of automation equipment and training, which are targeted at driving productivity, the key drawback is that the scheme awards tax deductions based on "inputs", that is, level of expenditure incurred, without regard to the level of "output" generated.

This could lead to incentivising activities that do not result in any productivity improvement. For instance, a company's purchase of laptops qualifies for the PIC but that may be to replace old equipment and not generate productivity improvements.

Conversely, the current PIC scheme could also inadvertently omit relevant expenditure that influences productivity growth. For example, when companies engage consultants to redesign internal work processes and realign resources to more productive tasks, such consultancy costs may not be supported under the PIC, even though the redesign could have been pivotal in lifting the company's productivity.

With that, we propose that productivity incentives be refined to link inputs to the desired outputs.

One possible way is to introduce a simple and straightforward application process for enhanced tax deductions on expenses incurred in improving productivity, where companies must submit information regarding the claimed expenses, together with an explanation of how such expenses could improve productivity, and the key indicators used to measure the impact of these expenses on productivity. Such indicators may include operating revenue, and the number of local headcount and foreign headcount.

While policymakers need to be mindful not to impose significant administrative and compliance burdens on companies, particularly the small and medium-sized businesses, this process could instill greater accountability. To ensure wider outreach and a manageable load for the administrators, the existing network of SME Centres can be part of the approving agencies.

Indeed, ensuring that initiatives aimed at driving productivity growth and innovation are effective and relevant is an ongoing challenge. The Singapore Government has been diligent on this front. Going forward, refining the PIC scheme based on recognising the necessary difference between innovation and productivity, as well as their interdependencies, will make for a more sophisticated and calibrated approach to driving positive change as a whole.

• The writer is Partner, Business Incentives Advisory at Ernst & Young Solutions LLP.

A version of this article appeared in the print edition of The Straits Times on March 24, 2016, with the headline 'Splitting the 'P' and 'I' in the PIC scheme'. Print Edition | Subscribe