The Online Citizen

US tax rule changes and implications for Singapore: the Prisoner’s Dilemma

May 15
15:22 2009

Breaking News: Malaysia confirms its first H1N1 flu case, says top health official Ismail Merican.

Announcement: Stay tuned for TOC’s very special feature on Monday, 18 May. You shouldn’t miss it.

Kenneth Jeyaretnam / Senior Writer

On May 06th I posted a link on my Facebook page in response to a speech by  Obama *- where he announced that the US was going to end the tax deferral for US corporations on income earned abroad but not repatriated to the US. – and added that, “Whilst one might criticize the folly of doing this without simultaneously targeting foreign corporations’ global profits based on the proportion of their sales in the US, it does represent another threat to Singapore’s tax-arbitrage based export-driven foreign investment model. The government has yet to acknowledge this threat or explain what steps it intends to take to counteract it.” 

There followed a lively string of comments and messages, mostly disagreeing and saying that this was never going to happen.   I felt it would, particularly because the Obama administration has already pencilled in US$210 billion of revenue from this source between 2011 and 2019** and is desperate for revenue to reduce the mounting budget deficit projections. Since then there has been a flurry of articles in both the local and foreign press on this issue. So the threat does appear to be real.  

The US taxes the worldwide income of US corporations, whereas most other countries tax companies only on the income earned in that country. As a result, non-US companies are able to engage in global tax arbitrage by moving the base of their operations to countries with low corporate tax rates such as Eire, Hong Kong or Singapore. US companies are able to do this to the extent that they do not repatriate their earnings, i.e. remit them to the US rather than depositing them offshore. Over the years this has led to the kind of non-zero-sum game akin to what in economic theory is known as the Prisoner’s Dilemma+, where all countries would be better off in terms of tax revenues if they set the same tax rate. However there is a short-term incentive for individual countries to set a lower tax rate than the others but this is largely illusory since it only works if other countries do not retaliate. If they do, which fits with experience, then everyone ends up poorer. 

This new US proposal may stop that game, at least for US corporations, though in the longer term it is likely to accelerate the process, which is already underway, of US companies being acquired by foreign ones (unless the US reduces its own corporate tax rate.) As such, it is a logical extension of the moves by the EU and the US to stop their citizens evading income taxes on interest earned on money deposited in tax havens. It is unlikely to be the end of the process however, as other major economies are likely to retaliate by moving to a global basis for corporate taxation as well.  

Implications for Singapore

Given that the US is desperate to raise revenue in a manner that will not have a contractionary effect on its own economy there is every chance that these proposals will become law. In which case there are likely to be grave implications for Singapore as this will definitely lead to some, probably significant, loss of jobs and investment in Singapore. The situation becomes more serious particularly if the other major economies follow suit. Unfortunately, Singapore is not in a position to retaliate. Neither are the other Asian economies to which US corporations have relocated their manufacturing and which now run large trade surpluses with the US. This will obviously be mitigated by how much the decision to set up operations in Singapore was driven by tax considerations in the first place. If other countries take the same approach as the US then the implications could become extremely serious. What is worrying about the US proposals is that they have the explicit objective of repatriating jobs and investment that have moved offshore. As Obama said, “And it’s a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.”** 

Considerable room to expand S’pore’s economy

These new moves by the US only serve to reinforce the points I have made previously. Namely, that Singapore needs to develop alternative sources of growth. It may no longer be able to rely to the same extent on foreign investment by MNCs if one of the primary motivators, a low corporate tax rate, is negated.  

Obviously Singapore’s small home market means that there are limits on how much domestically generated growth can replace exports. However, Singapore has a very large trade surplus in relation to GDP and near 50% of that GDP that was saved in 2008. So there is considerable room to expand the economy by increasing domestic consumption and investment. The lead here needs to be taken by the government sector through tax or service fee cuts (principally targeting the lower income groups) or increased infrastructure or education and health spending. My preference would be to encourage private sector involvement rather than further growth of the GLC sector. As long as other countries do not follow the US lead then low corporate tax rates still have a role in attracting investment by non-US companies.  

Given the  relative lack of indigenous world-class exporters (partly dictated by the small domestic market and partly the fault of the Government which has concentrated on boosting net savings and investing the surplus abroad)  Singapore should also consider attracting more foreign (particularly US) companies to move their domicile to Singapore. A good example of this is Flextronics, a major contract manufacturer for the leading electronics companies, which is domiciled in Singapore but listed in the US. Again, the US may later take steps to prevent its companies moving offshore. 

To conclude, Singapore is facing a potentially major challenge in the form of US proposals to eliminate the tax deferral for US corporations. If other countries retaliate and change the basis of their corporate tax regimes from territorial to global, then the problem is much more serious. Low corporate tax rates may be largely self-defeating. While there are no magic solutions, this is merely another straw on the camel’s back of a broken economic model. I have proposed that Singapore needs to rely less on net exports and more on domestic consumption and investment.   Given the high savings rate there is considerable room to expand both these without the external impact causing problems. Only today the Financial Times reported that Stephen Roach, the Asia chairman of Morgan Stanley, had argued that the Chinese government was “clinging to antiquated policy and economic growth strategies that presuppose a classic snapback in global demand.”*** I believe Singapore can be substituted for China in that sentence quite easily. In the longer run Singapore needs to do more to encourage the growth of domestically owned companies that can replace the foreign investors who may relocate. 


+The Prisoner’s Dilemma

In its classical form, the Prisoner’s Dilemma has nothing to do with which flotation device to choose but is more often presented as follows:

Two suspects are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal. If one testifies (betrays the other) against the other and the other remains silent (cooperates with the other), the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both remain silent, both prisoners are sentenced to only six months in jail for a minor charge as there is insufficient evidence. If each betrays the other, each receives a five-year sentence. Each prisoner must choose either to betray the other or to remain silent. Each one is assured that the other would not know about the betrayal before the end of the investigation. How should the prisoners act?

The Prisoner’s Dilemma forms a non-zero-sum game in which two players may either cooperate with or betray each other. In this game, as in all game theory, the only concern of each individual player is maximizing his/her own payoff, without any concern for the other’s payoff. Assuming each player wants a shorter sentence, rational choice leads the two players to both betray even though each player’s individual reward would be greater if they both played cooperatively.

In the classic form of this game the only possible equilibrium for the game is for both prisoners to betray each other. No matter what the other prisoner does, one prisoner will always gain a greater payoff through betraying the other. Since in any situation betraying is more beneficial than cooperating, all rational players will betray, all things being equal 

* Obama Targets Corporate Offshore Tax Avoidance, Wall Street Journal, May 6th 2009

** Titans Vow Overseas Tax Fight, Wall Street Journal, April 22nd 2009

*** Chinese Exports Tumble Sharply Again, Financial Times, May 13th 2009 

Headline picture from Wikimedia Commons.


  • http://nil Rajiv Chaudhry

    Kenneth, presumably, the tax payable by US Corporations abroad is the difference between the local tax paid and the US rate, so as to avoid double taxation?

    In practice how can the US prevent an exodus of companies (and therefore jobs) from the US, if the tax arbitrage opportunities continue to exist? Isn’t this proposal likely to run into a lot of domestic opposition in the US?

  • David

    If Singapore can create our water source without relying on Malaysia, I see no reason why we cannot create our own entrepreneur, MNCs, without having to rely soley on American MNCs to create job for us. Afterall, local employers created the bulk of jobs here and if our govt can help these organisations expand further (without having PAP GLCs to take the cake in every damned businesses), and if we can also stopped the influx of foreigners to steal our jobs, all Singaporean will definitely have no problem finding job even if some American MNCs were to pull out of this country. As long as we can continue to achieve growth even at lower rate it is still growth, rather than banging our head to earn (or lost) so much money that doesn’t translate into peasants pocket money and cause so much social problems and divide in our society.

    With careful tax planning & business strategy, I am sure MNCs can get around with complicated tax regime and still make good profit after tax.

    On the other hand, jobless Amercians should be proud that they have a new president who constantly think of his own citizens’ hardship, and tried all ways to create jobs and protect its own people and their money. Singapore govt? I still cannot forget GKY message “I will NEVER BOW TO SINGAPOREAN!”.

  • Rurehe

    If sing gets poorer because US companies pull then there is one alternative and one of many that she can do.

    She can lease vast tracts of land in other countries to plant crops or to grow timber.

    Sing can grow rice and send it to sing.

    Sing can grow sugar cane and turn it to sugar or ethanol and sell them to the world or send a portion of it to sing.

    Where to get the money from? Ask Ho Ching to get back the 51 billion she lost in the equity market. Then there will be a lot of money.

    If she cannot win it back but at least a portion of it then we can still that amount for our farming in foreign lands.

  • How?

    “I have proposed that Singapore needs to rely less on net exports and more on domestic consumption and investment.”

    How? Only 4.5 million people and with a huge income and wealth gap. Maybe 20% of the people has 80% of the wealth. Maybe even most of these 20% are foreigners who can easily move elsewhere if things are not to their favour.

    So how to stimulate domestic consumption? Ask people to eat more? Buy more? Already most ordinary Joes are financially strapped. Or ask the super rich to buy more Lamborginis? Or multimillion $ pigeonholes?

  • Dingfeng

    The fallacy of this Prisoner’s Dillema:
    “Over the years this has led to the kind of non-zero-sum game akin to what in economic theory is known as the Prisoner’s Dilemma+, where all countries would be better off in terms of tax revenues if they set the same tax rate.”

    Countries are not the only players of this game. If all countries set a lower tax rate, companies benefit. A country’s wealth belongs to its people, and a corporate’s wealth belongs to its shareholders. Either way, the wealth goes back to people (although different people).

  • RW

    thank you for the well-written article. I think regardless whether Congress passes the amendments, we should be anticipate the issue and plan for it.

    I have two questions, hopefully you can help clarify.

    Given MNCs are part of the contributing factor to exports, if they leave, won’t it mean exports will shrink, and consequently reduce the trade surplus that we have? In that scenario, how will the financing work?

    You also mentioned govt should lead the way by increasing govt expenditure. I’m not exactly sure abt the numbers but my impression is that the govt runs a pretty balanced budget over a 4(?) year basis, that is they take surplus from good years and spend in bad years. From that perspective, there is not too much ‘slack’ to finance the increased expenditure. Does that mean it will have to be financed thru higher taxes or govt deficit?

    i guess my preferred solution is to work on the enterprise side.. incentives for MNCs, expansion of local companies. But just to be on topic, i’ll leave it aside! :)
    do let me know if i misinterpret you in anyway.

  • TrueBlood Singapore

    Singapore Government just Stupidly use Tax Payer Money’s to Promote MNC’s R&D department without realised that these Foreigner Boss just want their Money.

    Where got Research? is there another Thomas Edison in Foreigner MNC R&D in Singapore?

    Motorola R&D – Dying with reduce Handset invention compare Nokia, Ericisson!
    Philips R&D – Innovation Center can’t even produce LED TV like Samsung
    Infineon R&D – Just use PAP money to promote their expansion in Taiwan.
    Rest of Biopolis – Don’t know what are they doing, can even produce drug to
    cure Aids or Cancer!

    PAP never trust and fund HomeGrown Enterperises rather than MNC.
    Stupid PAP never wake up their Idea their pay Economical Model is a Failure!

  • Ravi Philemon

    How?@4: It is a mere hypothesis that “Given our population size, we do not have the critical mass to increase domestic consumption and to reduce the ratio of export to GDP.” The reality is that the current government, repeatedly fails to implement measures that would fuel more domestic consumerism. My thoughts here:

  • Spirit-centred

    Considering the small size of Singapore, almost every corners of Singapore are infrastructured and almost every possible piece of land designated for housing, commercial and industrial purposes is almost populated to the brim, I cannot see how much the government can do to increase public spending that can have multiplier effects to the economy. What they can do is to increase the frequencies of putting up festivities banners everywhere in Singapore, increase the numbers of family carnivals and blocks parties at constituency level, giving free lunch to minority community and foreigners every now and then, giving more door gifts during block visits by MPs, giving free chips to locals and tourists to visit our upcoming casinos, arranging more free local tours for residents to help local tour urgencies etc.

  • ali

    Hey Mr. J, great article. I have one question though. You wrote: “So there is considerable room to expand the economy by increasing domestic consumption and investment.” PM Lee though, has often retaliated this with the fact that most of the goods purchased in Singapore are imported, so proceedings eventually flow out of our economy anyway.

    Given my limited knowledge of economics, could you enlighten me to what extent this is true? If i buy an X Box for $500, where exactly does the money go? And if the answer is that most of the profits go back to the original producers, and only a portion to our retailers here, should boosting domestic consumption really be on our agenda?

  • K J

    Thanks to Kenneth for keep us informed.

    I think you present a new hope and face for the opposition, not for inheriting bouts of political legacy, but for possessing a niche to provide professional insights for better policies, unlike most other oppositions who resort to popular sentiments. Keep up the good job!

    I agree with you that growing consumption and investment would reduce the dependence on exports, but I think it may not be easy. What I look forward to know is how similar countries have done it, and where others have failed, and what we should or should not do to achieve this goal. This will be invaluable for the future of Singapore!

  • SIN

    Although everyone sees that risk of relying so much on exports, boosting domestic consumption is easier said than done.

    One way to think about it is how feasible is it to get our small population, instead of overseas markets worldwide, to buy what we everything produce? Maybe one can say, why not produce things local people want to consume. But how much can we consume to replace the jobs that the global market is giving us? How often do we want to go to spa or how much are we willing to spend on food? And how easy is it to reduce import by locally producing things that are cheaper and better?

    Opposition like to mentioned Denmark, but they are the exception rather than the norm. It is definitely worthwhile to study them, but in the meanwhile, diversifying export partners and continuing to invest in education is probably the best option. We should build up our SMEs, but they even are likely to depend on exports for survival too…

  • George

    Sorry lah minister cannot think if their pay is not increased again. Million dollar or more a year is peanuts so said somebody sometime ago. So if SinKaporean want real solution, they must be prepared to pay more to ministers if they want top class people.No pay increase cannot think. That the way Singapore work. If you don;t like it, just go somewhere else. One issue Singaporean must bear in mind, even if the opposition is voted into power come the next election, PAP is could still create allot of trouble as they are cash rich. The opposition must be prepared to use ISA to lock a few away to keep the rest docile and or use the legal system like PAP does, bankcurpt them and take all the money back. Then once they are broke, they had to worry like the rest of us, about day to day mandane issues. That will stop them creating trouble. That would be a good start – let them have the same medicine they had been dishing out to the oppositions.

  • Pingback: We must move up the Value Chain rather than give up on Manufacturing. « Reinventing the Rice Bowl