Wednesday, September 5, 2012

Social spending - where will money come from?

Sep 04, 2012
Eye on the Economy
By Aaron Low Economics Correspondent

THE debate on increasing Singapore's social spending centres on two questions.

The first is: How much more to spend? The next: How to fund it?

On the first, the Government has already started to commit itself to significantly higher spending. This has come about in response to two key trends. Singapore's ageing society and widening income inequality mean the Government will have to spend more on health care for the elderly; and on social spending to level up the playing field and to redistribute income.

As Prime Minister Lee Hsien Loong said in his Aug 26 National Day Rally speech, "nothing falls from heaven". So taxes will have to go up eventually to fund higher social expenditures - "not immediately" but within the next 20 years.

Annual health-care spending will double to $8 billion over the next five years. This year, the Government introduced the permanent GST Voucher, which pays out a combination of cash, conservancy rebates and Medisave top-ups, with more for older and lower-wage Singaporeans, to offset increases in the goods and services tax. This will cost the Government $680 million this year.

Also formalised in 2007 is the Workfare Income Supplement, which supplements low-wage workers' income with cash and Central Provident Fund (CPF) top-ups. This cost the Government $260 million last year.

Plans are also under way to spend $60 billion over the next 10 years to improve the transport system.

All that adds up to rising expenditure for the Singapore Government. In the last financial year, the Government collected $50.5 billion in tax revenues and charges. It spent $47.5 billion, resulting in a primary surplus of about $3 billion.

But the Government also spent $8.58 billion of special transfers on programmes such as Workfare, and top-ups to various endowment funds, such as the Medical Endowment Fund.

To make up the shortfall, the Government tapped $7.91 billion of returns from investment income from its reserves. This is known as Net Investment Returns (NIR).

After deducting and adding all the elements, the Government had an overall net surplus of $2.32 billion last year.

At a time when developed countries in Europe and the United States are drowning in sovereign debt, Singapore's fiscal position is much envied and admired.

But what happens when spending has to go up in the years ahead? Just one item of higher expenditure already promised - raising health spending by $4 billion - would have wiped out last year's $3 billion primary surplus.

So where will the money come from?

Some analysts think the current framework of allowing the use of NIR gives the state access to enough funds for the medium term. NIR now makes up 14 per cent of total government expenditure.

Citigroup economist Kit Wei Zheng notes that it is unclear whether the Government has even drawn down on the full 50 per cent of returns available under the Constitution.

In any case, why should the cap be at 50 per cent? Why not allow a higher portion of the returns to be used?

Mr Kit points out that the NIR contribution is a draw on the flow of new returns on the reserves, not the capital stock itself. In other words, it's only part of the interest that is used, and the principal is untouched.

"Even if the NIR contribution were to be raised to, say 60 per cent, that still leaves 40 per cent of the existing returns to be re-invested to grow the capital stock further," he said.

He adds that "the calculation of the NIR contribution could be subject to some discretion, especially what the projected real rate of return is".

For example, in 2008, the Government changed the Constitution so that the NIR it can use includes returns from capital gains, interest and dividend income. It also takes a longer-term, inflation-adjusted perspective when calculating returns.

Tweaks in either of these will have an impact on the actual amount available to the Government.

But the NIR can at best provide a buffer. Deputy Prime Minister Tharman Shanmugaratnam has previously said that the NIR will go towards education, research and development, and major programmes to expand infrastructure. Although there are no legal limits on its use, that statement imposes a discipline on the Government to fund its operating expenditure out of tax revenues, not from NIR from past reserves.

As the tax base dwindles and social spending pressures increase, the Government will face mounting pressure to use more of its reserves before raising taxes.

Citizens may refuse to accept taxes while the state maintains vast reserves. This leads to the question of how much the state should save for tomorrow, rather than use what it has for the needs of today.

In other words, how much reserves is enough?

No one outside the highest echelons of government knows how much the state has in reserves. The reserves are managed by the Monetary Authority of Singapore (MAS), the Government of Singapore Investment Corporation (GIC) and Temasek Holdings.

MAS, or the central bank, manages Singapore's foreign reserves, which amounted to $304 billion as of April 30.

Temasek, which is wholly owned by the Government and set up in 1972 to hold and manage the Government's investments and assets, reported in July that its portfolio stood at $198 billion as at March 31.

Apart from its deposits with MAS and its stake in Temasek, the rest of the Government's assets are mainly managed by the GIC.

GIC has said in the past that it manages well over US$100 billion (S$125 billion) of Singapore's reserves, but foreign think-tanks such as the Sovereign Wealth Institute have estimated that the figure is closer to US$250 billion.

If you add the three pools of reserves up, you get about $800 billion. A very modest 2 per cent return on that comes up to $16 billion a year.

The NIR contribution last year was $7.91 billion. And even if we assume that the NIR contribution last year had hit the 50 per cent cap, activating the other 50 per cent of NIR would mean an additional $8 billion to the Government.

This is around 14 per cent of last year's total government expenditure and social transfers of $56.12 billion.

How much to save and set aside for the future without compromising the present is a delicate and important decision.

The Government for now understandably prefers to tilt the balance towards preserving more for the future, mindful that Singapore's ageing demographics portend a slower growing, and slower revenue-generating economy, at a time when Asian tigers leap ahead.

But it will have to contend with demands from those who want the state to lighten its coffers first, before tapping taxpayers.

After all, today's taxpayers will argue, the reserves were accumulated from the hard work of this and previous generations.

It is thus equitable to use at least the returns or the interest from those savings, to pay for the social and health expenses of the same generations who built up the reserves.

Some will go further and say it is justified to not only use the returns, but also to draw down a small portion of the capital.

The trouble with such arguments is that they may seem reasonable in isolation, but will spell big trouble down the road. If the country spends all its tax revenue, plus all the interest from past reserves, the reserves will never grow. If the country dips into the capital, the reserves will dwindle.

And when Singapore's economy slows - and it will, due to ageing demographics and limits to returns on productivity - the Budget will go into structural deficit, which means the country will spend more than it can collect (in taxes and interest from past savings) every year.

At some point, the inevitable result will be the state having to borrow to fund its operations. That's like a worker spending more than he earns every year, and borrowing to cover the shortfall.

Unless he gets a huge pay rise; a windfall; or his children take over the debt, the only sure outcome is more debt until he declares bankruptcy.

That prospect admittedly sounds remote, given Singapore's healthy annual surpluses and vast reserves today.

But as the troubles in today's euro zone countries and the United States tell us, the slide into fiscal perdition is all too easy - and hard to reverse.


Gintai_昇泰 said...

Thks for the article. It's going to be problem in the long run. What if our economy doesn't grow or perform that well? Where the money going to come from? It EI t drop from heaven right?

Alan Wan said...

Maybe they should also first ask the million$ question whether we are getting our monies worth for paying our useless team of our PM & his Ministers their million dollar salaries ?

Lately our PM & his team of millionaire ministers has demonstrated to us how to set a very good example of how to discriminate against the disabled in setting the amount of rewards that both abled & disabled champions can receive.

Also our PM absolutely sees no problem in spending millions of taxpayers' monies to house & feed a pair of pandas, almost equivalent to 5-star treatment.

Then they warned that taxes will have to be raised in order to sustain these type of excesses.

Now LKY, what kind of PAP Ministers have you mentored to end up where they value animals more than humans and where the disabled are discriminated ?

El Lobo Loco said...

Alan, your one-dimensional questions add nothing to the discussion. Anyone can ask questions. Stupid questions are also questions. Why feed pandas? Then why have a zoo at all? Then why have a bird park? You think cheap to run those? Or Gardens by the Bay? Why spend money on trees when there are people with no homes? And the stupid Merlion, spitting water into the sea! Even if the water is free seawater, the electricity to pump the water is not free!

Not everyone is like you, donate every cent that you don't spend on essentials, to the poor, the disabled, and the elderly.

El Lobo Loco said...


Your question may be rhetorical, so here's my speculative answer.

Firstly, I always thought the govt was very sneaky to move from income tax to GST. As our population ages, there will be more retirees. Retirees have no income. But Retirees still must buy things. So if they have no income to pay income tax, at least the govt can get revenue from them when they spend.

Of course my "sneaky govt" theory was undermined by the GST voucher for the low income elderly. The max a retiree can get is $960, and to pay that much in GST, you would have to spend about $13,700 on GST taxable goods in a year. If you shop at wet markets, neighbourhood shops, eat at hawker centres and coffee shops, you may never pay GST.

So no, the sneaky Govt was not trying to get revenue from retirees. At least not poor retirees.

What if our economy doesn't perform well? This is the question. There are those who ask, why don't we grow slower so we won't be so stressed? So housing costs won't rise so fast, trains and buses won't be so crowded? But it may not be so easy.

For example as our economy falters, we need to find the next rising trend to maintain our growth. Now a stupid govt would say, let's just bet on one sector, say financial services. A more prudent govt would say, let's bet on two or more sector - financial services, pharmaceuticals, and just in case, let's bet on casinos as well. That way if one or even two fail to take off, we will still have one more engine running and that will give our people jobs.

Then all three sectors took off!

And we don't have enough workers and we had to get foreign workers.

But how to grow slowly? What if we just bet on financial sector only (so we don't grow so fast) and there was another global financial crisis and the financial sector fails? What if we say pharmaceuticals and manufacturing is enough. No need Casino and tourism and both Pharm and Mfg failed to take off?

The govt has always hedged its bets. And that means usually at least one thing will be growing. If you check the quarterly growth figures, there were a few quarters when most of the sectors were down but one bright sector kept SG economy going. But it also means that sometimes everything will click and we will have a boom - we grow too fast. This is not always a good thing. Or rather, there are side effects like housing, transport, and crowding issues.

So where will the money come from? Hopefully, and if we plan well, more from economic growth and less reserves.