Suggested answer for 2022 A-Level Paper 2 Question 2

The Singapore government announced in Budget 2018 that the goods and service tax (GST)
would rise from 7% to 9% sometime between 2021 and 2025. The intended consequence of this
change is to raise tax revenue. However, following the coronavirus (Covid-19) outbreak in 2020,
the incomes of many households fell.

a) With the aid of diagrams, explain why an increase in GST and a fall in incomes of many
households are each expected to cause a fall in expenditure on luxury goods. [10]
b) Discuss whether this increase in GST is likely to raise tax revenue and whether it will lead to
unintended consequences. [15]

Part (a) - Question Analysis

Command Word Explain why
Question Type Cause and effect
Approach 1. An increase in GST
Start point
2. A fall in incomes of many households
End Point Fall in expenditure
• Price mechanism
Content • Price elasticity of demand (PED)
Content
and • Income elasticity of demand (YED)
Context • Consumer expenditure (TE)
Context Luxury goods, Singapore

Introduction
State essay approach: An increase in GST is expected to cause a fall in expenditure on luxury
good through a decrease in supply and a price inelastic demand while a fall in incomes of many
households is expected to cause a fall in expenditure on luxury good through a more than
proportionate decrease in demand as demand is income elastic.
Body Point 1: An increase in GST is expected to cause a fall in expenditure on luxury good
• GST is an indirect tax, which is initially borne by the producers. A tax imposed on a good will
raise the unit cost of production, leading to a decrease in supply.
• GST is also an ad-valorem tax, which is a tax imposed as a fixed percentage of the price of
the good. Since the tax is fixed in percentage terms, the amount of tax ($) per unit of output
increases as price increases, resulting in a leftward pivotal shift of the supply curve from
SS0 to SS1 as the vertical distance between SS0 and SS1 is the amount of tax.
• As supply curve shift leftward, there is a shortage at the initial equilibrium price, causing
upward pressure on price, until the shortage is eliminated where quantity demanded equals
quantity supplied again. Hence the increase in GST will result in an increase in equilibrium
price from P0 to P1 and a fall in equilibrium quantity from Q0 to Q1.
• Demand for luxury good is also price elastic. Price elasticity of demand (PED) refers to
the degree of responsiveness of quantity demanded of a good to a change in the price of the
good itself, ceteris paribus. Since household can give up luxury goods easily, they will be more
price sensitive to a change in price of luxury good such as a car or designer bag or clothes.
 Price SS1(9%GST)

E1 SS0 (7%GST)
GST
P1
P0 E0
A
DD0

0 Q1 Q0 Quantity
Figure 1: an increase in GST on luxury goods

• Expenditure is given by price multiply by quantity.

• Since PED for luxury goods is more than 1, the increase in price will lead to a more than
proportionate decrease in quantity demanded. The increase in expenditure due to the
increase in price (area P1E1AP0) is less than the fall in expenditure due to the decrease
in quantity demanded (area AE0Q0Q1). Therefore, an increase in GST is each expected to
cause a fall expenditure on luxury goods.

Body Point 2: A fall in household income is expected to cause a fall in expenditure on

luxury good

• A fall in income for many households would result in a fall in real disposable income, ceteris
paribus. This would lead to a fall in purchasing power and households would have less
ability to consume goods and services.
• The demand for luxury good is also income elastic. Income elasticity of demand (YED)
refers to the degree of responsiveness of demand for a good to a given change in the income
of consumers, ceteris paribus. Since income is falling, household would decrease spending
more significantly on luxury goods since these goods are not essential. This result in YED >1
and demand would decrease more than proportionately to a given decrease in income,
ceteris paribus. This is shown by a large leftward shift in demand curve from DD0 to DD1.

Price SSo

P1 C

P2
B
DD1 DD0

0 Q1 Qo Quantity
Figure 2: Fall in demand of luxury goods due to fall in income
• The fall in demand would result in a surplus at the original equilibrium price, which puts a
downward pressure on price to eliminate the surplus, until quantity demanded equals
quantity supplied again. Hence the fall in income would lead to a fall in equilibrium price
and quantity of luxury goods from P0 to P1 and Q0 to Q1 respectively.
• Since both price and quantity has fallen, expenditure on luxury goods would therefore
decrease from area 0P1CQ0 to area 0P2BQ1.

Conclusion
Therefore, an increase in GST would reduce expenditure on luxury good as the increase in price
would lead a to more than proportionate fall in quantity demanded while a fall in incomes would
cause price and quantity to fall, causing a fall in expenditure of luxury goods.

Mark Scheme
Level Knowledge, Understanding, Application, Analysis Marks
L3 Full display of AO1, AO2 and AO3 skills: 8-10
For an answer that shows well-developed explanation of why an increase in
GST AND a fall in incomes of many households are each expected to cause
a fall expenditure on luxury goods.
• clear and accurate explanation of how changes in DD and SS lead to a fall
in expenditure using PED and YED concepts
• supported with appropriate diagrammatic analysis
• supported with relevant examples

L2 Uneven display of AO1, AO2 and AO3 skills: 5-7

For an answer that shows under-developed explanation of why an increase in
GST and a fall in incomes of many households are each expected to cause a
fall expenditure on luxury goods.
• lacks depth of analysis (i.e., limited effective use of relevant economic
analysis or gaps in diagrammatic analysis)
• lacks scope in explaining either GST increase or fall in income
• lacks relevant examples

L1 Limited display of AO1 and AO2 skills: 1-4

For an answer that shows limited knowledge of why an increase in GST AND
a fall in incomes of many households are each expected to cause a fall
expenditure on luxury goods.
• listing of points, unexplained statements, or descriptive response
• many conceptual errors (i.e., using AD/AS analysis, use PED with shift in
demand, use XED etc)
• irrelevant response such as on economic growth or expenditure on
necessity
• smattering of points
Part (b) - Question Analysis

Command Word Discuss whether → balanced answer + evaluation

Question Type Cause and effect
Approach
Start point Raise in GST
End Point tax revenue, unintended consequences
Content Content Price mechanism, PED, equity
and
Context Singapore
Context

Introduction
State essay approach: The intended outcome of the increase in GST from 7% to 9% is to raise
tax revenue in a sustainable manner to fund the increase in recurring healthcare expenditure due
to an ageing population. However, this depends on whether the good is a luxury good or necessity.
GST revenue collected from necessity will likely increase while GST revenue from luxury goods
will likely decrease. The increase in GST might also lead to inequity as an unintended
consequence without further government supports.

Body Point 1: Explain how raising GST might increase tax revenue
• As explained in part a, a raise in GST would result in a pivotal leftward shift of the supply curve,
resulting in a fall in equilibrium quantity and increase in equilibrium price.

Price SS2 (9% GST)

P2
E2 SS1 (7% GST)

E1 SS0
P1
P0
E0
P3
C
P4 D
DD0

0 Q2 Q1 Q0 Quantity

Figure 3: impact of GST on tax revenue collected from necessities

• A 7% GST is currently being levied in Singapore, resulting in equilibrium quantity Q1 and P1.
Hence the original tax revenue collected from necessity, such as rice and healthcare services
is area P1E1CP3, as the total tax revenue equals to the amount of GST (vertical distance CE1)
multiply by quantity of goods and service sold (Q1).
• With GST raising to 9%, the equilibrium price will increase further to P2 while equilibrium
quantity falls to Q2. The new tax revenue collected would be area P2E2DP4, as the new tax
revenue equals to the amount of GST (vertical distance DE2) multiply by quantity of goods
and service sold (Q2).
• Area P2E2DP4 is likely bigger than area P1E1CP3, indicating an increase in tax revenue
collected, as the demand for necessity is price inelastic. Households are price insensitive to
the increase in price as they would still need these essential items. Hence the increase in
 price due to the increase in GST will lead to a less than proportionate decrease in quantity
demanded, leading to the tax revenue gained from the 2% increase in tax rate to be larger
than the tax revenue loss from the fall in consumption of these goods and services.

Body Point 2: Explain how raising GST might reduce tax revenue
• A raise in GST on luxury goods would also result in a pivotal leftward shift of the supply curve,
resulting in a fall in equilibrium quantity and increase in equilibrium price.

SS2 (9% GST)

Price
SS1 (7% GST)

P2 E2
SS0
P1 E1
P0 E0
P4 B
P3 A DD0

0 Q2 Q1 Q0 Quantity
Figure 4: impact of GST on tax revenue collected from luxury goods

• The original tax revenue collected from luxury good is area P1E1AP3, as the total tax revenue
equals to the amount of GST (vertical distance AE1) multiply by quantity of goods and service
sold (Q1).
• With GST raising to 9%, the equilibrium price will increase further to P2 while equilibrium
quantity falls to Q2. The new tax revenue collected would be area P2E2BP4, as the new tax
revenue equals to the amount of GST (vertical distance BE2) multiply by quantity of goods
and service sold (Q2).
• Area P2E2BP4 is likely smaller than area P1E1AP3, indicating a fall in tax revenue collected, as
the demand for luxury good is price elastic. This is because the increase in price due to the
increase in GST will lead to a more than proportionate decrease in quantity demanded,
leading to the tax revenue gained from the 2% increase in tax rate to be smaller than the tax
revenue loss from the fall in consumption of these goods and services.

Intermediate EV – whether the raise in GST will increase tax revenue

• Therefore, whether the GST increase will raise tax revenue for the Singapore government
depends on whether the increase in tax revenue raised from necessities would be greater
than the decrease in tax revenue collected from luxury goods.
• It is more likely that the GST increase will raise tax revenue for the Singapore government as
Singapore has one of the highest real GDP per capita in the world, hence luxury goods such
as car, might be considered as a necessity in Singapore due to lower proportion of income
spent on such goods. Therefore, even with the increase in GST, consumers in Singapore are
unlikely to cut back on spending significantly as they are generally more price insensitive.
• Singapore is also a tourism hub and tourists are generally less price sensitive when spending
overseas, hence GST collected from tourist will likely increase.
Body Point 3: Explain raising GST will lead to inequity
• GST is a regressive tax in nature. When the GST is raised, the absolute amount of GST paid
by the higher income group will still be a smaller proportion of income than the lower income
group for the same basket of goods and services. Hence the lower income group will bear a
larger burden of the tax, which may worsen income inequity as an unintended consequence.
• Moreover, the increase in GST will raise the price of necessities to a large extent due to PED
<1. Low-income households might not be able to afford these necessities, worsening inequity.

Intermediate EV – explain how the raise in GST might not lead to unintended consequences
• To prevent worsening equity, the Singapore government has introduced the Assurance
package, aimed to cushion the impacts of the hike in GST for Singaporeans, especially the
lower-income groups.
• This is a form of transfer payment, where GST Voucher cash pay-outs will be given to
Singaporean households, with lower-income Singaporeans getting more cash to offset the
increase in GST. This would ensure that Singaporeans who are relatively better off and non-
Singaporeans will bear a greater burden of the GST, preventing inequity.

Summative Evaluation
• An increase in the GST would likely increase the Singapore government’s tax revenue the
most, compared to other types of tax. Expert has estimated that each increase of 1 percentage
point would net an additional S$1.5 billion to S$1.8 billion per year. This is likely due to the
large tax base
• The Singapore government has also put in place complementary policies to minimise the
trade-off between fiscal sustainability and inequity.
• However, the ceteris paribus assumption might not hold in real life. For example, the rise in
global food prices due to the war between Russian and Ukraine has increased the costs of
living for Singaporeans. A GST hike in such circumstances might lead to worsening inequity
even with Singapore support.
• Furthermore, some businesses might absorb the increase in GST instead of passing the tax
increase to consumer in the form of higher prices as these firms might have alternative
objectives. Hence there might not be any unintended consequence of worsening inequity.

Mark Scheme
Level Knowledge, Understanding, Application, Analysis Marks
L3 Full display of AO1, AO2 and AO3 skills: 8-10
For an answer that shows well-developed explanation of the impacts of GST
hike on tax revenue and its unintended consequence
• well-supported with diagrammatic analysis
• well-supported with relevant examples

L2 Uneven display of AO1, AO2 and AO3 skills: 5-7

For an answer that shows under-developed explanation of the impacts of GST
hike on tax revenue and its unintended consequence
• lacks depth of analysis (i.e. limited effective use of relevant economic
analysis or gaps in diagrammatic analysis)
• lacks scope in impact on tax revenue or unintended consequence
• lacks appropriate examples
 L1 Limited display of AO1 and AO2 skills: 1-4
For an answer that shows limited knowledge of the impacts of GST hike on
tax revenue and its unintended consequence
• listing of points, unexplained statements, or descriptive response
• many conceptual errors (explain impact on total revenue instead of tax
revenue, explain why GST increase is ineffective instead of unintended
consequence
• Smattering of points

Evaluation Marks
E3 For an answer that builds on appropriate analysis to evaluate and synthesizes 5
economic arguments to arrive at well-reasoned judgements on whether the
increase in GST is likely to raise tax revenue and whether it will lead to
unintended consequences.
E2 For an answer that makes some attempt at evaluation or a conclusion on 3-4
whether the increase in GST is likely to raise tax revenue and whether it will
lead to unintended consequences but does not explain the judgement or base
it on analysis.
E1 For an answer that gives superficial evaluative statement(s) without 1-2
supporting analysis and elaboration on whether the increase in GST is likely
to raise tax revenue and whether it will lead to unintended consequences.

Additional Reference:

• https://www.todayonline.com/singapore/where-spores-additional-tax-revenue-could-come-
experts

• https://www.straitstimes.com/singapore/budget-2022-assurance-package-increased-to-66-
billion-gst-voucher-scheme-beefed-up-to-offset-gst-hike