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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.


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