The Role of Tax System, Tax Reform in Hong Kong

Introduction

Currently, Hong Kong primarily derives its tax revenue from the Salaries Tax and the Profits Tax, this makes up approximately two-thirds of the total revenue from tax collection in Hong Kong (Arnold & McIntyre, 2002). The existing tax base of Hong Kong is extremely contracted, only 35 percent of the working population, which is approximately 1.2 million, contributes to the Salaries Tax. In addition, only the top 100,000 supply 60 percent of the total amount of the Salaries Tax. With regard to the Profits Tax, the top 800 out of the 750,000 registered business entities contribute 60 percent of the profits tax (Ayesha & Smith, 2008). The significant problem with having a tax base that is contracted is that it results in a lack of stable government revenue. In addition, the major revenue for Hong Kong has been extremely volatile as indicated in the following table with the amounts approximated to the nearest billion.

Table 1: Revenue for Hong Kong

Revenue items Lowest amount received Highest amount received Rate of volatility
Land premium USD 5 billion USD 35 billion 600 percent
Profits Tax USD 38 billion USD 71 billion 87 percent
Stamp Duty USD 7 billion USD 18 billion 157 percent
Salaries Tax USD 25 billion USD 37 billion 48 percent

The need for reforms in the Hong Kong Tax system

High rates of volatility as depicted in the table increase the difficulty of adopting medium and long-term strategies for offering public services and infrastructural developments. The situation is worsened by the fact that Hong Kong is currently facing an aging trend; it is estimated that the percentage of individuals above 65 years will increase from the current 12 percent to 27 percent during the year 2033 (Halkyard, 2010). This demographic trend implies that the contributions by the Salaries Taxes will reduce while resulting in an increase in healthcare costs and the provision of social services. Aging will result in a shrinking in the tax base of Hong Kong. Such estimates resulted in the proposed development of the Goods and Services Tax (GST) model with the principal objective of widening the Hong Kong tax base (Chen, 2011). It is approximated that effective implementation of the GST will result in a revenue collection of USD 24-30 billion, with a volatility of 25 percent. The Hong Tax Reform focuses on the adoption of a low and single GST rate, offering relief measures towards individuals who have low income. The government is also seeking public opinions regarding the implementation of the GST revenue with the objective of reducing the Salaries and Profits Taxes without compromising on the delivery of public services (Halkyard, 2010).

The significant areas of contention with regard to the Hong Kong Tax reform are the approaches that the GST will deploy to address low-income households and its impacts on the retail industry through a reduction of the consumption rates of the public. This will be achieved using cash allowance, offering credit for the charges associated with water and sewerage services, and giving credit for the rates in order to enhance the quality of living for the low-income earners in Hong Kong (Littlewood, 2010). A cross-country analysis reveals that GST has been effectively adopted in at least 135 jurisdictions from a global perspective (Littlewood, 2010). For instance, Australia adopted the GST framework during 2000, after which it initially resulted in increasing inflation and a decline in the consumption of the retail sector. Two years down the line, there was a notable improvement in Australia’s economy. Countries like Canada, Singapore, and New Zealand reported temporary and negligible impacts on the economy. Critics of the tax reform argue that the adoption of the GST contributed significantly to the decline of Japan’s economy (Hong, 2011). However, it should be noted that Japan implemented the GST when the economy was at the peak of its bubble. Proponents of the Hong Kong Tax reform cite its effectiveness in maintaining the competitiveness of Hong Kong through the implementation of a low GST rate. A lower GST rate will facilitate the lowering of the rates of the income tax, which in turn will play an integral role in attracting capital and talent, and enhance the business environment in Hong Kong (Shamdasani, 2010).

The implementation of the GST is a perfect instance of transferring the task burden downwards, which results in tax revenue collection through withholding, in the sense that tax is not collected directly from the consumers, rather it is collected from the suppliers. The basic argument is that people who agree with the low tax policy oppose the adoption of the GST; this is due to the viewpoint that the main objective of the GST is to impose taxes on low-income individuals, and that tax revenue collection is done using withholding. Proponents of the GST, who mainly comprise accountants and new generation capitalists, are of the opinion that the GST is the most effective approach for eliminating instances associated with instability and increasing rates of the volatility of government revenue (Hsu, 2001). Opponents cite that if taxes are imposed on poor individuals, there is a likelihood that they will want something in compensation, which is likely to result in a swell in public expenditure. Increased public expenditure can be a good methodology; however, creating its demand using regressive taxes is not justified. GST is usually associated with the need to increase public expenditure (Hong, 2011).

It is arguably evident that the present tax base in Hong Kong is extremely contracted; implying that there is a need to develop strategies aimed at expanding the tax base. The need for tax reforms in Hong Kong extremely relies on few tax classifications and a relatively small group of taxpayers. Presently, most of the tax for the government of Hong Kong is derived from the property market; this translates to the viewpoint that it increases the susceptibility of the government revenue in the fluctuations of the property market. In addition, the economy of Hong Kong is mostly external-oriented, meaning that it is vulnerable to global economic conditions (Halkyard, 2010). A direct effect of this is that the limited tax types are extremely vulnerable to the economic downturns on the globe. The population of Hong Kong is also increasing and there is a need to increase the government expenditure, which can only be achieved by implementing the reforms in the tax system. In addition, the contracted tax base in Hong Kong means that lowering the tax rates is not an alternative if Hong Kong is to maintain its competitive power and the challenges that are inflicted by the onset of globalization (Huizinga, 2007).

The characteristics of the present Hong Kong Tax System

Hong Kong relies on a low rate flat tax, which is usually effective in developed countries that depend on low taxes and small government expenditures. A low-rate flat tax implies that government enjoys the support of the public regarding the adopted public policies. Using Hong Kong as a reference point, it is arguably evident that the effectiveness of the low rate flat tax is effective in scenarios whereby the tax burden is concerted on relatively huge incomes (Slemrod & Bakija, 2004). As such, the tax burden is not distributed to low–income individuals, and that working people should be taxed lightly. In addition, for the low rate flat tax system to be effective, the adopted tax system must have the highest level of visibility, as opposed to withholding, which is a core characteristic of the proposed Hong Kong Tax Reform under the GST approach (Holiday & Ngok, 2002).

The existing Hong Kong tax system makes use of the progressive consumption tax framework. The widely accepted principle of taxation is that an effective approach should impose taxes on consumption rather than income. This is because of the viewpoint that it is only fair to impose taxes on people on what they are taking out of the economy instead of their inputs to the economy (Littlewood, 2010). However, it is also thought that an effective tax system should be progressive; this imposes significant constraints when designing an effective tax system (Huizinga, 2007). This denotes the underlying complexity when designing a progressive tax system that is based on consumption, something which has posed core concerns with regard to the tax theory in the last five decades. It is arguably evident that it is impossible for people to track their consumption rates in order for the government to deploy a progressive tax on them. However, there is a possibility of getting consumption rates directly, on grounds that the rates of consumption are equivalent to the amounts of income less the savings (Jinyan & Elliott, 2003). For instance, if the government has knowledge regarding an individual’s income and savings, there is a possibility that the consumption can be calculated and a corresponding tax is imposed on it. Simply stated, if an income tax is imposed, it facilitates the subtraction of savings and investment, and then the remaining amount denotes the tax on consumption (Halkyard, 2010). An approach like this implies that taxes could be charged progressively and its collection deploys the same methods as income tax. Under the current Hong Kong tax system, this is implemented by the enactment of a legislation that compels tax payers to pay the tax or through the use of withholding requirement on their respective employers using the PAYE scheme (Hong, 2011). The history of Hong Kong tax system faces a heated debate regarding consumption taxes that are progressive due to Inland Revenue Ordinance, which is mostly perceived as a method for imposing taxes on income. The integrated effects of this tax system are similar to facilitating a subtraction for savings, implying that the tax system is based on consumption (Tang, 1997).

Basic tax principles under the Hong Kong Tax reform

In the proposal of the Hong Kong tax reform using the GST approach, the basic guidelines on tax were deployed. Simple and certain implies that the adopted tax system had to be compatible with the existing tax system, which is low rate. Fair and equitable meant that the taxation approach on the government and individuals should be same (Littlewood, 2010). The principal of economic neutrality implies that the taxation cannot impose cases associated with market distortions and market decisions that are likely to affect the allocation of resources. The adopted tax system must also be efficient and effective in the sense that it should reduce the administrative expenses on the side of the government and also reduce compliance costs for the case of the business entities (Kaur, 2011). It is also important that the tax system should be purpose generating, in the sense that it must have the ability to generate constant revenue for the government that can cover comprehensively for the demands of public expenditure (Huizinga, 2007).

The role of a unified tax system in Hong Kong in the light of globalization

The era of globalization implies that economic activities are being undertaken on a global platform. This requires the implementation of efforts aimed at enhancing the taxation policies that are imposed on multinational corporations and the adoption of a regulatory framework regarding the flow of global capital and encouraging foreign direct investments in Hong Kong (Ngok, 2007). This also implies that effective strategies will be implemented to ensure that cases associated with international tax evasion are avoided at all costs (Tang, 1997). Therefore, the adoption of a unified tax system in Hong Kong in the light of globalization will play an integral role in the development of an improved tax system aimed at addressing trade at the international level, which also includes business transactions that exist between financial institutions, security investments at international level and telecommunication services across countries (Slemrod & Bakija, 2004). A unified tax system is thus a possibility in the context of Hong Kong. The underlying benefit of such an approach is that it will serve to increase the competitive power of Hong Kong at an international level (Hong, 2011).

It is important for the SAR government to be continually moving forward in terms of economic growth and to have the capabilities to address the global financial changes effectively; this is important in guaranteeing the competitiveness of Hong Kong from a global perspective, which in turn will further improve internal cooperation between Hong Kong and mainlandland China (Noronha & Vinten, 2003). This will ensure that the government of Hong Kong is effectively responding to the demands of its people, adopting frameworks for public expenditure aimed at increasing the living standards of its people and establishing social stability in Hong Kong. It is arguably evident that the implementation of the 12th Five-Year Plan in Hong Kong will impose significant benefits to the business enterprises found in the city (Shamdasani, 2010). The 12th Five-Year plan in Hong Kong will also play an integral role in eliminating the economic bottlenecks that the city is currently facing, thereby creating strategic opportunities and advantages that the city can make use of to establish sustainable development (Keen & Ligthart, 2003). This will be achieved through the elimination of critical social problems and reducing the income inconsistency that exists among the poor and rich in the city. In addition, the 12th Five Year Plan will play an important role in the establishment of a solid economic establishment in the city (Shafer & Simmons, 2008). This implies that effective implementation of the 12th Five-Year plan requires a strong collaboration at the regional level, which offers an opportunity for economic evolution and expansion in Hong Kong. All these strategies will play an integral role in ensuring the competitive power of Hong Kong (Pheny, 2009).

Conclusion

The primary issue of concern in the debate of the Hong Tax System is whether the existing tax system is efficient in meeting the demands of present day Hong Kong. The government is of the opinion that the existing tax system is inefficient, which is one of the core reasons why it tried to adopt the GST. On the contrary, most of the residents of Hong Kong are of a different opinion. The solution to the debate does not rely solely on a technical answer, rather the adoption of a tax system that is politically acceptable and technically efficient. It is arguably evident that the present tax system used in Hong Kong is not adequate in comparison with the tax systems used in the rest of the globe. The only framework that can be used to evaluate the Hong Kong tax system should base on what the people of Hong Kong actually want. This can be achieved by engaging them in the development of the tax system through a system of the governance that is based on democracy. When compared to other parts of the globe, it is arguably evident that existing Hong Tax system denotes the successes that can be accrued from a low rate flat system that is simple.

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