^ Back

A Taxing Strategy for the 21st Century

In concluding my response to the 1999/2000 Budget's motion debate, I predicted that this year's Budget will be a most trying one. Few would disagree with me today.

The reunification with China and the implementation of our new mini-constitution (the Basic Law) have resulted in significant political reforms of historic proportion. The sweeping financial turmoil has also wakened us to the fact that we have actually fallen far behind other economies in the development and application of new technology. It has also aroused the call for the third economic restructuring since the Second World War.

In the midst of these major political and economic changes, government departments and private sector organisations are all repositioning their corporate strategies to adapt to the changing environment - a new trend for Hong Kong is now emerging.

In stark contrast, our taxation system and revenue policies have remained fundamentally passive. They still depend heavily on land prices and a profits tax base designed primarily to net local manufacturing, services and trading businesses. But can these outmoded systems survive major changes to the Government's land policy, the stormy emergence of e-commerce or the globalisation of business organisations?

Under the present revenue collection system, land sales and premium payments probably yield between HK$40 billion and HK$70 billion (total annual revenue being just above HK$200 Billion). In the Inland Revenue Department's latest Annual Report, the real estate sector is cited as contributing 62% and 31.7% of stamp duty and profits tax respectively for 1998/1999.

In addition, the real estate sector directly and indirectly employs countless professionals, namely contractors, architects, engineers, etc. When these gigantic corporations raise capital in the financial markets, they also become major clients for merchant bankers and accountants. So, although it has been necessary to try and stabilise land and property prices, the Government's coffers will suffer as a direct consequence.

Most people would rather blissfully assume that tax revenue will rise proportionally to the rate of economic recovery and that the lingering budget deficit will disappear quickly. However, I ask accountants to think twice about this superficial presumption.

Of course, there will be a natural increase in the revenue as the economy gradually recovers. However, the process is likely to be slow and there will be a time gap of about two years before profits are captured in the accounts; reported to the Inland Revenue; assessed after deducting possible recent tax losses; and tax paid on the balance.

If we look closer at what is leading the present economic recovery, we can easily see that it is predominantly international trade and e-commerce.

This means that these activities are not going to yield much immediate tax revenue. And even if the profitability of these activities does eventually grow, Hong Kong's source of taxation rule will impact on whether tax can be collected on related business transaction.

Personally speaking, I am still strongly in favour of the Government not taxing cross-border transactions. This will help us maintain our competitive edge as an international financial and services centre. But if we are to stand back and tolerate a continuous erosion of our traditional tax base, something else will have to be done to replace the revenue.

History has taught us that when a government runs short of funds, it can either increase the progressiveness of its direct tax base or widen the tax base with new regressive taxes. Most governments would attempt the former rather than the latter. However, governments have invariably failed because in times of sustained economic depression, progressive direct taxes are an unreliable source of revenue which penalises capital formation.

However, the recent world trend is obvious: governments have started reducing direct tax rates to enhance international competitiveness and prevent a drain on their human resources and capital. Also, when facing daunting political difficulties, governments have managed to shift the burden of financing public services by introducing a widely based indirect tax, such as sales taxes. For those economies, such as Hong Kong's, that have not done this, some would say it is not really a matter of choice, but rather a question of when.

Although Hong Kong's tax systems may be outmoded, there is much beauty in its simplicity. The basic structure easily accommodates reform and with the right political courage and skill, we can avoid many of the mistakes made by other governments.

We are still in a position to leap-frog unnecessary, but traditional, solutions and deal directly with the identified fundamental problems of land dependency, revenue instability and the narrowness of the present tax base, which may not be able to cope with new emerging business activities.

Notwithstanding logical analysis, implementing tax reforms is easier said than done. With sectoral interests deeply entrenched in today's political structure, even a small adjustment to the taxation system will ignite requests for an overall review. The Government's entire monetary policy will also be unavoidably scrutinised.

I believe the Government must now be prepared to take the following step:

  • reaffirm that it has contained public expenditure such as possible
  • establish clear revenue targets with quantitative analysis and numerical evidence
  • provide possible mixed-bag revenue raising measures upon which the public can focus its debate
  • balance political interests by demonstrating that the principle of vertical equity is still being observed and that the more affluent groups are still contributing more, and
  • begin reform by taking smaller steps first, namely increasing fees, charges and rates, and scaling down personal allowances. If the recurring deficit still persists in a year or two, the time will be ripe for more permanent reforms and to put our legislator's political wisdom and moral courage to the test.

^ Back