Economics Model Essay 18
Discuss whether a shift from direct taxes to indirect taxes would improve the current and future standards of living in Singapore. [25]
Introduction
A direct tax is a tax imposed on income or wealth. An indirect tax is a tax imposed on a good or service. The standard of living refers to the material and non-material welfare of the people. The effect of a shift from direct taxes to indirect taxes in Singapore on the current and future standards of living can be discussed with reference to aggregate demand, aggregate supply, the amount of goods and services available for consumption, the mental health of workers, the size of the multiplier, the size of the population, income equity, negative externalities and the amount of leisure time.
Body
A shift from direct taxes to indirect taxes in Singapore may lead to a rise in the current standard of living. Aggregate demand is the total demand for the goods and services produced in the economy over a period of time and is comprised of consumption expenditure, investment expenditure, government expenditure on goods and services and net exports. If the Singapore government decreases personal income tax and corporate income tax, disposable income will increase which will lead to an increase in consumption expenditure. For example, the decrease in the marginal tax rate in Singapore in the top personal income tax bracket from 40 per cent in 1986 to 22 per cent currently, with the corresponding reductions in the marginal tax rates in other personal income tax brackets, has led to an increase in consumption expenditure. In addition to an increase in consumption expenditure, a decrease in corporate income tax will lead to higher expected after-tax returns on planned investments resulting in an increase in investment expenditure. For example, the decrease in the corporate income tax rate in Singapore from 40 per cent in 1986 to 17 per cent currently has led to an increase in investment expenditure. An increase in consumption expenditure and investment expenditure will lead to an increase in aggregate demand which will induce firms to increase production resulting in an increase in national output. When firms increase production, they will employ more factor inputs from households and hence will pay them more factor income which will lead to an increase in national income. Furthermore, due to the multiplier effect, the initial increase in aggregate demand due to the increase in consumption expenditure and investment expenditure will lead to a larger increase in national output and hence national income. An increase in national output may lead to an increase in the amount of goods and services available for consumption. If this happens, the material standard of living will rise. Furthermore, when national output rises, the demand for labour in the economy will rise which will lead to a fall in unemployment. When this happens, the morale and self-confidence of the workers who were previously unemployed but have found a job may rise which may improve their mental health and this may lead to a rise in their non-material standards of living. In addition, the mental health of the workers who were previously employed and have remained employed may improve as they may experience a higher sense of job security and this may lead to a rise in their non-material standards of living.
Diagram
A shift from direct taxes to indirect taxes in Singapore may not lead to a rise in the current standard of living, at least not significantly. As Singapore is a small economy that is more dependent on external demand with the domestic exports accounting for a large proportion of the aggregate demand, an increase in consumption expenditure and investment expenditure may not lead to a significant increase in aggregate demand resulting in an insignificant increase in national output and hence national income. Singapore has a small multiplier due to the high savings and the high imports. The savings rate in Singapore is high due to the culture of thrift, the compulsory savings scheme and the absence of a generous welfare system. The level of imports in Singapore is high due to lack of factor endowments and the embracement of free trade. Therefore, the initial increase in aggregate demand due to the increase in consumption expenditure and investment expenditure may not lead to a significant increase in national output and hence national income. An increase in national output and hence national income in Singapore may not lead to a rise in the standard of living due to several reasons. First, the amount of goods and services available to the average person for consumption may not increase because the population is generally increasing. In the event that the population increases by a larger proportion, the amount of goods and services available to the average person for consumption will fall. Second, an increase in national income may worsen income inequity. When national income rises, the incomes of high income individuals may rise by a larger proportion than those of low income individuals and this is particularly true in view of the fact that the government is lowering direct taxes which are progressive and raising indirect taxes which are regressive. If this happens, although low income individuals will be better off in absolute terms, the larger income gap will make them worse off in relative terms which will lead to a fall in their non-material standards of living. Third, an increase in national output and hence production of goods and services may lead to an increase in the amount of negative externalities such as carbon emissions which will result in a more polluted environment and hence a fall in the non-material standard of living. Fourth, an increase in national output and hence the demand for labour in the economy may result in people working longer hours which will cause them to have a smaller amount of leisure time and hence experience a fall in their non-material standards of living. Aggregate supply is the total supply of goods and services in the economy over a period of time and is determined by the production capacity and the cost of production in the economy. An increase in goods and services tax in Singapore will lead to a rise in the cost of production in the economy. When this happens, aggregate supply will fall which will lead to a decrease in national output and hence national income. A decrease in national output may lead to a decrease in the amount of goods and services available for consumption. If this happens, the material standard of living will fall. Furthermore, when national output falls, the demand for labour in the economy will fall which will lead to a rise in unemployment. When this happens, the morale and self-confidence of the workers who have lost their jobs may fall which may worsen their mental health and this may lead to a fall in their non-material standards of living. In addition, the mental health of the workers who have not lost their jobs may worsen as they may experience a lower sense of job security and this may lead to a fall in their non-material standards of living. An increase in aggregate demand and a decrease in aggregate supply in Singapore will lead to a rise in the general price level resulting in higher inflation. Higher inflation may reduce the real value of savings. When inflation rises, nominal interest rates on savings may not fully compensate for the rise in the general price level. If this happens, the same amount of savings will allow individuals to buy only a smaller amount of goods and services which will reduce the real value of savings. This will lead to a fall in the material standards of living for individuals who live on their savings such as retirees.
A shift from direct taxes to indirect taxes in Singapore may lead to a rise in the future standard of living. Suppose that aggregate demand in Singapore is rising which is the normal state of the economy. Further suppose that the Singapore economy is at the full-employment equilibrium. In the absence of excess production capacity in the economy, an increase in aggregate demand in Singapore will not lead to an increase in national output and hence national income as firms will not be able to increase production in response to the increase in aggregate demand. Therefore, an increase in the production capacity in the economy in the long run will create excess production capacity in the economy which will enable firms to increase production in response to the increase in aggregate demand. When this happens, national output and hence national income will increase in the long run which may lead to an increase in the future standard of living. A shift from direct taxes to indirect taxes in Singapore may lead to an increase in the production capacity in the economy in the long run. As discussed earlier, a decrease in corporate income tax in Singapore will lead to an increase in expected after-tax returns on planned investments resulting in an increase in foreign direct investments. An increase in investment expenditure will lead to a more rapid increase in the quantity of capital in the economy in the long run. Furthermore, foreign direct investments are generally made by multinational corporations which typically have high-end production technologies and substantial financial resources. Therefore, an increase in foreign direct investments will lead to an increase in the quality of capital in the economy in the long run. A decrease in personal income tax in Singapore will lead to an increase in after-tax personal income which will attract foreign high-skilled individuals to migrate to Singapore. When this happens, the quantity and the quality of labour in the economy will both increase in the long run. An increase in the quantity and the quality of capital and labour in the economy will lead to an increase in the production capacity in the economy.
A shift from direct taxes to indirect taxes in Singapore may not lead to a rise in the future standard of living, at least not significantly. Although aggregate demand in Singapore is generally rising, it sometimes falls due to a fall in exports as a result of a very weak external economic environment. For example, aggregate demand in Singapore fell due to a fall in exports in the 2008-2009 Global Financial Crisis. In the event of a fall in aggregate demand in Singapore, an increase in the production capacity in the economy will not lead to an increase in national output and hence national income, at least not significantly. Furthermore, a shift from direct taxes to indirect taxes in Singapore may not lead to a significant increase in the production capacity in the economy. As decreasing corporate income tax has become a global trend, a cut in corporate income tax in Singapore may not lead to an increase in foreign direct investments. Therefore, the quantity and the quality of capital in the economy may not increase. For example, the United States has recently cut its corporate tax from 35 per cent to 21 per cent. Furthermore, as corporate income tax is the largest source of tax revenue in Singapore, the government is unable to cut it by a large extent as it is likely to lead to a large decrease in tax revenue which may result in a persistent budget deficit. A persistent budget deficit will lead to a persistent rise in the public debt which may result in adverse consequences such as a higher tax burden on future generations. As Singapore has a stringent immigration policy, a cut in personal income tax may not lead to a significant increase in the number of high-skilled immigrants. Therefore, the quantity and the quality of labour in the economy may not increase significantly.
Evaluation
In the final analysis, the Singapore government should shift from direct taxes to indirect taxes. Domestic firms in Singapore are small and hence have limited financial resources for investment and research and development and this constrains the growth of the production capacity in the economy and hence economic growth. Therefore, a decrease in corporate income tax in Singapore which will lead to an increase in foreign direct investments is likely to be very beneficial to the economy as it will lead to a more rapid increase in the production capacity in the economy and hence higher economic growth. Singapore has a comparative disadvantage in producing low value-added goods due to its small amount of low-skilled labour which makes it important for the government to increase comparative advantage in the production of high value-added goods through increasing the amount of high-skilled labour in the economy. Therefore, a decrease in personal income tax in Singapore which will lead to an increase in the number of high-skilled immigrants is likely to be very beneficial to the economy as it is crucial for maintaining the good health of the economy. The population of Singapore is aging. It has been estimated that by 2030, one in four Singaporeans will be aged 65 and above. As people exit the labour force, the personal income tax base will decrease which will lead to a fall in personal income tax revenue, other things being equal. In contrast, aging population will not decrease the goods and services tax base as people who exit the labour force will continue to consume goods and services. Therefore, aging population will not lead to a fall in goods and services tax revenue, at least not significantly, other things being equal. It follows that the government should shift from direct taxes to indirect taxes to avoid a fall in tax revenue and hence a budget deficit.
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