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Letter to Donald Tsang  Submission on 98/99 Budget

30 October, 1997

BY FAX & BY POST
(Fax No. 28400569)

Lower Albert Road, Hong Kong

Mr. Donald Tsang, JP, The Hon  
The Financial Secretary  
Government Secretariat  
Lower Albert Road, Hong Kong  
  
Dear Mr. Tsang,

We understand that you are gathering input for the 1998/99 Hong Kong Budget, and we would like to submit our proposals for your consideration.

Our main concern, as we have stressed in submissions for a number of years, is that the fiscal reserves are far too high. The main priority of your forthcoming Budget should be to set out a strategy for returning this money to the citizens of Hong Kong from whom it was taken and to whom it belongs.

In more detail, our proposals are as follows.

1.    Excessive reserves

Your 1997/98 Budget forecast a surplus of HK$31 billion for 1997/98 and fiscal reserves of HK$418 billion by the year 2001. This will be equivalent to 21 months Government expenditure at that time. And in the months since your Budget, further influxes of funds, especially from burgeoning property and stock markets, will have boosted these figures to higher levels. Such levels of reserves are simply excessive. The Government is raising much more revenue than it can meaningfully spend.

Excessive revenue raising on this scale has negative effects. In principle, Government should raise revenues to spend on the provision of public goods and services that citizens cannot arrange for themselves. Where the Government raises and retains surplus revenues, accumulating savings of its own, it duplicates the savings function that citizens can perform for themselves, so straying outside its proper function.

Moreover, the Government is an inefficient saver. The fiscal reserves, deposited with the Exchange Fund, have earned an annual average return of just over 5% over the last decade, considerably less than the rate of inflation and less than most citizens could have managed on their own. Government-controlled funds are also subject to political appropriation. We are seeing many self-interested calls for the reserves to be invested in areas that would benefit only narrow sectors of the community.

We urge that the problem of excessive reserves is addressed in your coming budget. A strategy for returning these reserves to the citizens of Hong Kong, whether by dividend, tax holiday, or substantial tax reductions, is urgently needed. If nothing is done, we fear that resentment will mount against the Government, and against special interest groups who are seen to benefit form the reserves, to the detriment of Hong Kong’s social stability.

2.    Land tax

For a number of years we have drawn attention to the problem of the concentration of Government revenues on land-related taxes. Such taxes include premium on initial allocation of land, rezoning premium, rent on Government-owned land, the 3% rent on New Territories leases, stamp duty on land transactions, and rates. These revenues typically amount to 30% or more of total Government revenues.

We have two concerns. Firstly, the scale of the various land taxes undermines the claim that Hong Kong is a low tax jurisdiction. If the land-related taxes, which many other territories do not have, were abolished, Hong Kong’s profits tax rate would have to more than double to compensate. The overall tax take of the Hong Kong Government is not lower than that of some of its Asian neighbours, but merely allocated differently.

Secondly, its reliance on land-related taxes gives the Government an incentive to keep land prices high. This it is in a position to do because it is the monopoly supplier of Hong Kong’s land. The current extremely high land prices and housing crisis strongly suggest that the Government has preferred to maximise its revenue rather than provide adequate land for Hong Kong people. Such policy is highly detrimental to social stability.

The Government’s conflict of interest can only be overcome if the function of determining supply is clearly separated from the function of enjoying the revenue. We propose the creation of an independent commission to determine the supply of land based on objective analysis of social and commercial need. The land should then be released as soon as possible and without regard to the revenue impact.

3.    Fees and charges

As we have noted in prior submissions, we are concerned at the continuing rise in fees and charges. These are widely perceived in the community as a form of "double" taxation. In addition to paying taxes to enable the government to provide services taxpayers find themselves having to pay directly for the services as well. If not addressed, this tendency will deepen resentment against the Government and weaken social stability.

We believe that a complete review of the rationale for Government charging is needed.

• Firstly, the job of Government is to provide "public goods", ie goods and services that the community needs but in respect of which the cost is difficult to recover directly form the beneficiaries. By definition, such services are difficult to charge for. It appears likely that many of the services for which the Government charges are services that could be provided by the private sector, eg under franchise or service contract, and need not be provided by Government at all.

• Secondly, in the absence of full accrual accounting (see point 5 below), prices charged for services by the Government are unlikely to be appropriate. For example, the full cost of inputs such as land and internal service support may not be fully costed leading to under pricing.. Alternatively, the effective monopoly many Government charging units enjoy may lead to overpricing and exploitation of the consumer.

We believe that a complete review of the Government’s policy of charging for services is needed. Such review should aim to determine the scope of services to be provided by the Government, by Government-related units, and by the private sector respectively, and in respect of the two former categories, the basis of charging.

4.    Review of the revenue-raising system

In view of the scale of the three problems we mention above - excessive reserves, excessive reliance on land-related revenues, and excessive charging - we believe that a full scale review of the way in which the Hong Kong Government raises revenue is overdue. We have yet to see the result of the review of profits tax that is currently in progress, but such review should be taken as a starting point of review of the entire system of revenue raising, and not as an end in itself. In any case, the review should not be of each revenue stream, such as profits tax, individually, but should be of the system as a whole. The review should also take account of overseas experience. Questions that such review should address would include the following:

1. What is the need, both current and projected, for the Government to raise taxes? Is the current proportion of GDP represented by Government expenditure- around 18% - an optimal figure in view of the services the community expects from the Government, or should it be more or less? Would the optimal percentage change over time, and if so, on what basis?
   
   
2. What are the optimal sources of the revenue that the Government needs to meet the above need? What is the optimal balance of taxation for the community, ie the balance between direct and indirect taxes, the place of land-related taxes, the level of direct tax rates? Study to address this question would over the economic effect of the various forms of taxation, as well as the social effects.
   
   
3. Where the Government over-or undershoots its revenue target on a sustained basis, what is to be done with the excess reserves/deficit? How is this to be invested? At what point would the excess be returned to the citizen, and how would this be done? And how can such under/overshooting be avoided?
   

We believe that some form of Fiscal Responsibility Legislation may be needed.

5.    Inappropriate accounting

In important respects, the Budget presented annually by the Government, and the proposals it embodies, are based on incomplete or inappropriately stated financial information. The Budget is compiled on a cash basis, with no account taken of assets or liabilities that are not realised in cash within the period. We have recommended to you in a separate submission to you dated 12 August 1996 the adoption of full accrual accounting. As stated more fully in that letter, accrual accounting would lead to better-informed policy decisions, and more accountable and efficient government. We urge that full accrual accounting, for example along the lines taken by the New Zealand Government, be adopted without delay.

6.    Increasing complexity

The simplicity and predictability of Hong Kong’s tax system is an economic and social asset that should be maintained. Complexity diverts resources into tax compliance and avoidance, and becomes a breeding ground for corruption; it also gives rise to perceptions of unfairness.

We appreciate your efforts to resist the calls of special interest groups for tax concessions. However, recent developments, such as the negotiation of double tax treaties, the tax deductions for certain classes of debt instrument, give rise to a concern that there will be "complexity creep" that if not addressed will in a few years seriously change the character of the Hong Kong tax system. We urge your continuing attention to this problem.

We recommend that rather than merely resisting increasing complexity, you actually launch an initiative to simplify the tax system. Examples of such simplification could include the abolition of a tax or charge (the 3% New Territories lease rental would be a good case), the simplification of an existing complexity (eg the annual depreciation allowance system - see below), or a procedural simplification. We would suggest that you aim to announce at least one simplication in each category in each annual Budget.

7. Other points

1. On salaries tax, we believe that the allowances should not be increased by more than the rate of inflation, and should ideally be increased by less than this rate, if at all. They have been raised too much in recent years, to the extent that less than half the workforce pays salaries tax. We believe that this is not a healthy development, as it tends to encourage a large sector of the population to demand more services in the expectation that someone else will pay for them, and so may weaken social stability.
   
   
2. Instead of rises in the personal allowances, we recommend that the progressive bands are widened, and are pleased that a start was made on this process last year.
   
   
3. In view of the excessive level of reserves, we recommend that the maximum salaries tax rate be reduced by at least 1% per year for the next five years, bringing down the overall maximum rate to 10%. This proposal could be modified if a comprehensive alternative plan to reduce reserves were devised. The full cost of this concession would be reduced (1) by widening the tax net by reducing the real value of personal allowances (as proposed above), and (2) by eliminating the concessionary treatment of accommodation provided by the employer, which tends to exacerbate the problems in the residential housing market.
   
   
4. On profits tax, we have proposed in previous submissions that the rate be reduced in annual increments of 1% over a period of years to a level of 10%, in order to deal with the problem of excessive reserves. Unless a comprehensive plan for reserve reduction can be devised we recommand that a start be made on implementing this strategy in your next budget.
   
   
5. We understand that the system of annual depreciation allowances is currently under review. We have proposed for a number of years that the current system of initial and annual allowances is simplified into one flat annual rate, of say 25%, and the initial allowance abolished.
   
   
6. While we support action to deter tax evasion and to investigate suspected cases of evasion, we draw attention to the dangers of going too far down this road. We do not want Hong Kong to become like some overseas developed countries where a significant proportion of the national resources are consumed in compliance and avoidance effort. We recommend that a study be undertaken of the full economic effects of the field audit and investigation programmes before more resources are dedicated to this work.
   

We thank you for your attention and I hope that these suggestions are helpful.

Yours sincerely

Alan LUNG Ka-lun
Chairman