Before raising GST, consider scrapping tax relief for retirement savings that benefit high earners more
Prime Minister Lee Hsien Loong and Finance Minister Heng Swee Keat have warned that the Government needs to raise revenue to fund increasing social expenditure.
Actually, this begs the question of whether the Government should fund the expenditure from financial reserves accumulated by past governments or by raising taxes from earners today.
Both options involve real costs. Society must pay today or in the future. But leaving aside this issue for another day and assuming that the preference is to raise tax revenue today, let's consider how additional revenue should be raised.
Various experts have suggested increasing the goods and services tax (GST). GST is levied on the purchase of goods and services. Poorer families spend a larger proportion of their income on consumption than do richer families. Hence, the burden of higher GST would fall disproportionately on poorer families. In that sense, an increase in GST would be regressive. Typically, the government offsets the regressivity of GST through GST vouchers.
Nevertheless, we suggest first exploring other tax options that are more progressive and directly raise revenue from better-off people.
SCRAP TAX RELIEF FOR SRS
Our first suggestion is to rescind the tax relief on contributions to the Supplementary Retirement Scheme (SRS). Introduced in 2001 and progressively expanded, SRS contributions of up to $15,300 for Singapore citizens and permanent residents and $35,700 for foreigners are exempt from tax.
If the contributor uses his SRS for investment, those returns on investment accumulate tax-free, and, when the contributor retires, only 50 per cent of the withdrawal amount is subject to tax.
All sounds good, except that the loss of revenue means the Government is effectively subsidising retirement savings of those contributing to the SRS.
Eliminating retirement tax reliefs could generate revenue equal to increasing GST by 0.6 percentage points. Importantly, it would do so in a way that is progressive, and does not require additional GST vouchers to offset the burden on lower-income households.
In the 2016 year of assessment, SRS contributions totalled $788 million. This could be worth more than $100 million annually in foregone tax revenue, assuming the typical SRS contributor pays a marginal tax rate above the 11.5 per cent tax bracket. Relatively rich people probably contribute more than the less well-off.
People earning the median income of $4,056 a month, which amounts to less than $49,000 a year, are not likely to have $15,300 to put into the SRS. So, the SRS is a regressive scheme in the sense of providing larger benefits to better-off people.
Conversely, this means that removing the tax relief for SRS would be progressive.
Would the removal of tax relief on SRS reduce savings and hurt preparedness for retirement? Actually, we do not even know whether schemes such as SRS effectively promote savings for retirement.
Research by economist Raj Chetty and co-authors shows that for most people, such tax incentives do not increase savings. Some lack the disposable income, while others are too short-sighted.
Many respond to the tax incentives by simply shifting their savings from taxable to tax-exempt accounts. Instead of saving $15,300 in the bank, they may put $15,300 in their SRS account. To this extent, the tax relief for SRS just reduces taxes on the rich.
TAX CPF CONTRIBUTIONS
Our second suggestion is: Rescind the tax relief on contributions to the Central Provident Fund (CPF). CPF contributions up to specified limits are exempt from income tax, and the returns on CPF investments accumulate tax-free.
Again, like the SRS, this sounds helpful for retirement. But there is a cost - in foregone revenue to the Government.
Although all employed Singaporeans are subject to CPF contributions, the tax relief benefits high-income earners relatively more. Those earning more than $320,000 a year pay the highest marginal rate of 22 per cent. For every thousand dollars of CPF contributions, their taxes are reduced by $220. By contrast, those earning just over $40,000 a year pay a marginal rate of 7 per cent. For every thousand dollars of CPF contributions, their taxes are reduced by $70.
For the 2016 year of assessment, retirement-related reliefs totalled nearly $12.7 billion, with 92 per cent from mandatory CPF contributions.
Based on the distribution of taxable incomes of resident taxpayers, we estimate that tax relief on mandatory CPF contributions costs about $1 billion in foregone tax revenue.
Our model estimates that the top decile of income-earning households receives about 30 per cent of all retirement tax relief benefits and the upper half, about 85 per cent of all benefits. Thus, the upper half of Singaporeans by income receives perhaps $850 million in retirement benefits annually.
To put these numbers in perspective, the Silver Support Scheme provides the bottom 20 per cent of elderly Singaporeans with more than $300 million in retirement benefits annually. But CPF tax relief now gives a much larger estimated benefit to the richest Singaporeans.
There is room to improve progressivity in retirement policy.
Rescinding tax relief on SRS and CPF contributions could raise more than $1 billion in revenue, which is equivalent to about 9 per cent of GST revenue.
Hence, eliminating retirement tax reliefs could generate revenue equal to increasing GST by 0.6 percentage points. Importantly, it would do so in a way that is progressive and does not require additional GST vouchers to offset the burden on lower-income households.
Any effective tax increase on lower-income CPF contributors could be offset through a modest flat tax credit for CPF contributions.
There is precedent elsewhere for eliminating tax reliefs for mandatory retirement contributions. Social security taxes in the United States are not tax deductible. Contributions to the Australian Superannuation retirement scheme are taxed, but at a concessionary rate. In some countries, general taxes fund pensions, so there is no tax deduction possible.
Many Organisation for Economic Cooperation and Development and European Union countries do provide tax advantages to encourage voluntary retirement contributions under schemes similar to Singapore's SRS. But these tax incentive schemes were based on untested assumptions that the broad middle class would respond to incentives to save for retirement.
Now that evidence is gradually accumulating to the contrary, it may be time to revise tax incentive policies that tend to benefit the rich more than the rest of society. We strongly recommend following our approach before raising GST.
•Walter Theseira is Senior Lecturer of Economics in the School of Business, Singapore University of Social Sciences, and Ivan Png is Distinguished Professor in the National University of Singapore Business School and Department of Economics.
A version of this article appeared in the print edition of The Straits Times on January 12, 2018, with the headline 'Taxing CPF,SRS savings could raise $1b'. Print Edition | Subscribe
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