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2000/2001 Budget

21 February 2000

The Honourable Donald Y K Tsang, JP
Financial Secretary
Government Secretariat
Central Government Offices
Lower Albert Road
Hong Kong

Dear Mr Tsang,

We are writing to make our submission to you on the 2000/2001 Budget.

For your convenience, we state our recommendations briefly below. Our major concerns are that,

1. notwithstanding the deficits of the last two years, the level of reserves is still far too high;
2. Government spending is not efficient and value for money is not being obtained;
3. the system is overreliant on land-related taxes, which have distorting effects on the economy, and
4. partly in consequence of (1) and (3), there is a the need for a fundamental review of the tax system.

With regard to (4), we are pleased at your acknowledgement of the need for a review of the system.

1. Excessive reserves

The fiscal reserves, currently in excess of HK$400 million, are much higher than is necessary. Further, the official figure substantially understates the true net worth of Government, which, taking into account the retained earnings of the Exchange Fund and EFIL and the value of the Government's investments and enterprises, would be at least twice as high. The excessive concentration of wealth in the hands of Government represents suboptimal, if not wasteful, use of resources. The greater part of this wealth should be returned to the people of Hong Kong from whom it was taken and to whom it belongs. Means for achieving such return of wealth could be via tax rebates or dividends to all citizens of Hong Kong.

2. A fundamental review needed

We believe that a fundamental review of the system is needed, i.e. including large- scale revision of the Inland Revenue Ordinance which has its roots in early twentieth-century British colonial legislation. Many concepts in the ordinance need fundamental clarification, including the source concept for profits tax. Modern concepts, such as the taxation of the service sector, and of e-commerce, need to be considered. The balance between different revenue sources needs review, especially as concerns land-related taxes.

3. A revenue-neutral review

The review of the tax system should not have as its objective the raising of more revenue; rather, it should be "revenue-neutral", i.e. additional revenues arising from new taxes or increases in taxes should be at least matched by reduction or elimination of other taxes. The existing system has proved capable of raising large surpluses - HK$80 billion as recently as 1997/98 - and the deficits of last year and the current year are relatively small and due largely to cyclical factors. The deficit of HK$36 billion forecast for the current year is likely to be halved as a result of the economic recovery. The objective of the review should be to make the system more economically optimal, especially by reducing the bias towards land-related taxes.

4. Value for money in Government

Concurrently with the review of the revenue-raising system should come a review of the spending system, i.e. the way Government spends the taxpayers' money. We believe that currently Government spending is far too high in relation to the modest level of services it provides. Civil service pay is high, and the pay of many in the Government-linked corporations (GLCs), such as regulatory bodies, is even higher. At the same time, Government and GLCs have at best very rudimentary performance measurement systems, so that not only is accountability low, but it is difficult even to ascertain whether value for money is being obtained. Most developed countries started fundamental reviews of their public sector nature a decade or more ago, embarking for example on large programmes of privatisation, civil service reform, contracting out, performance regimes and private finance initiatives. Often these were initiated as a result of budgetary pressures; it is highly opportune for Hong Kong to take a serious look at this area in the current climate. Hong Kong has made a tentative start with the planned privatisation of the MTRC and the Civil Service performance initiative, but much remains to be done.

5. Reform of land system

As stated above, the tax system needs to be weaned of its reliance on land-related revenues since ultimately these revenues are maximised by restricting the supply of land - to the detriment of the economy and the quality of life of Hong Kong people. However, Hong Kong's land problem is broader than an issue of taxation alone: a review of the entire system is needed. We would like to see consideration of the privatisation of Hong Kong's land in its entirety, i.e. a transition to a freehold system.

6. Fees and charges

Further to point 4 above, Government fees and charges have been raised over the years without the fees necessarily bearing any relationship to the economic cost of providing the service, and without consideration of whether the service needs to continue to be provided by Government at all. We note that fees have been frozen for a period, but freeze is useless if it merely means larger increases once the period is over. There should be a fundamental review of the basis of charging for government services. Many services currently charged for by the Government should not be provided by Government at all but should be provided by the private sector, where necessary under Government supervision to ensure standards. Where services are retained within Government the basis of charging should be reviewed and put on a proper economic footing.

7. Accrual accounting system

It is impossible to ascertain the true financial position of Government, or to account to the people for the use to which their money has been put, or even to determine whether value for money has been obtained or not, without a proper system of accrual accounting. The current cash-based budgeting system, supplemented by departmental resource accounting, is inadequate to capture the net worth of Government, the true rate of expenditure, the cost of services provided, or the true need to raise revenue. We urge the early implementation of a proper system of accrual accounting, ideally along the lines adopted by the New Zealand Government early in the 1990s. See our website for our paper, "Accounting for Government" at http://www.hkdf.org/papers/961208accountg.htm.

8. Increasing complexity

The simplicity of the Hong Kong tax system is a major economic asset. Accordingly, we are concerned at the tendency in recent years to grant tax concessions for special classes of activity, and to engage in double tax treaties. Although complexity is sometimes difficult to avoid in a complex developed economy like Hong Kong's we urge that every effort is made to keep the system as simple as possible. Complexity not only increases costs and diverts energies from productive pursuits to exploitation of tax loopholes, but it also provides a fertile breeding ground for corruption.

9. Tax audits

We appreciate that continuing effort is needed to deter and prosecute tax evasion. However, tax audits need to be balanced by a realistic understanding of the nature of Hong Kong's economic activity, much of which arises from enterprises seeking to avoid heavier taxes in other jurisdictions. It would be highly detrimental if in their zeal to prosecute evaders, the Hong Kong authorities were to deter businesses from operating in Hong Kong. There is also a need for equity in the approach to tax audits, i.e. if audit effort is directed where financial returns are likely to be greatest, the focus will be on the richer and taxpayers who have better quality records, many of whom are foreign companies which contribute much to the Hong Kong economy. Overall, there is a need for articulation of the objectives of tax audits and consideration of whether these objectives are cost-beneficial in the broadest sense for Hong Kong society.

10. Sales tax

We note that you are considering the introduction of a sales tax, and that such tax is opposed by many in the community. A sales tax may be regarded as economically efficient, since it is a tax on consumption. If properly handled, the introduction of a sales tax should not significantly impact Hong Kong's status as a shopping destination, for example, arrangements can be made for non-residents to reclaim the tax on their purchases as they exit the territory. The administrative burden can be great, although this can be mitigated, for example, by charging at the wholesale rather than the retail level.

We are concerned with the regressive nature of a sales tax. While we do not favour trying to achieve social objectives through the tax system, we would expect that if a sales tax were introduced, measures would be taken outside the tax system to deploy more resources to the poorer members of our society. Therefore, the implementation of the proposed sales tax should be considered carefully.

11. Distribution of the tax burden

We believe that the successive narrowing of the salaries tax net, so that that present less than half the workforce pays tax, has been ill-advised, particularly since many non-tax payers enjoy substantial tax-funded benefits such as public housing and hospital care. We recommend that salaries tax be paid by a much larger proportion of the workforce by reducing the allowances. Such move can be made revenue-neutral by widening the progressive tax bands and/or reducing the top rates of tax.

We hope that the above is helpful.

Yours sincerely,

Alan LUNG Ka-lun
Chairman