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Letter to Donald Tsang - Submission on 1999/2000 Budget (26/01/99)

26 January 1999

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

Dear Mr Tsang,  

1999/2000 BUDGET  

We are writing to you to make our submission for the 1999/2000 Budget.  

In our submissions in prior years we have consistently emphasised three things that taxation policy should address. These are, the excessive level of reserves, the excessive reliance on land-related taxes, and, partly in consequence of the first two, the need for a fundamental review of the tax system.  

We acknowledge that progress has been made by the Government in respect of the first two areas. The substantial budget deficit expected for the current year will somewhat reduce the level of reserves, and the suspension of land sales will temporarily reduce the take from land-related taxes. We urge that this foundation be built upon by taking up our third major recommendation: a full review of the tax system. Such review would underpin these ad hoc developments and set the framework for the long term fiscal security of the territory.  

Our proposals in full are as follows:  

1. Return the fiscal reserves to the people  

The 1998/99 Budget forecast a surplus of HK$10 billion, which would bring the estimated total fiscal reserves to HK$527 billion by the year 2001/2. Since then, various measures aimed at stimulating the economy have reduced the reserves somewhat, and the deficit for the year 1998/99 is likely to be in the range HK$20 to HK$50 billion. However, we believe that the level of reserves is still far too high. We do not agree with the rationale for the current reserves level set out in your 1998/99 Budget; for detail, please refer to an article published in our Newsletter, which we attach to this letter for your convenient reference.  

With excessive fiscal reserves it is difficult to avoid wasteful spending and appropriation by special interest groups. Such large reserves amount in essence to a nationalisation of a large portion of the society's savings, a function that is both wasteful in itself and unjustifiable in a supposedly free economy like Hong Kong. A plan should be developed to reduce the level of reserves in the long run to an approximate balance or even a moderate deficit. To return the reserves to their rightful owners, the people of Hong Kong, we favour measures such as the tax holidays and rebates that the Government has in fact recently used, or even a dividend such has been employed for example by the US state of Alaska. However, we prefer a coherent plan for the systematic reduction of the level of reserves, rather than the series of ad hoc measures we have seen to date.  

2. Reduce reliance on land taxes  

As acknowledged in the Chief Executive's Policy Address, in the years up to 1997, Hong Kong experienced a property price bubble that distorted the economy and led directly to the current recession. We believe that a major contributor to the bubble economy was the Government's policy of maximising the revenues from the disposal of land by restricting the supply, which as monopoly supplier it was in a position to do. We urge that a rational land release policy be adopted and the policy of revenue-maximisation dropped.  

The recent cancellation of land sales, far from alleviating this problem, unfortunately reinforces the underlying policy. Such restriction of land supply was intended to, and in the short run appears to have, boosted property prices, and if maintained will reverse the correction that had been taking place and put the economy back on the property price roller coaster again. The Government's refusal to set a date for the resumption of land sales creates an uncertainty that further exacerbates the problem.  

We strongly recommend that the Government's conflict of interest in both controlling the supply of land and raising the major part of its revenue from it can only be overcome by hiving off the function of land release to an independent commission or authority. This Land Authority would be charged with the production and disposal of land and perform its role do so in accordance with a long term plan announced in advance, based on research into social and economic need for land. Overall, the supply of land should be boosted in order to lower property prices and make more adequate accommodation and recreation space available for Hong Kong's citizens and businesses.  

3. Fees and charges  

As we have stated in prior submissions, we believe that there should be a review of the basis of charging for various Government services. In the past, these charges have been raised repeatedly such that they have become a major source of revenue, a tendency that has been exacerbated by the increased use of trading funds. Although there has been a freeze on charges this year, it does not substantially affect the trend.  

Our concerns on Government fees and charges are as follows:  

Firstly, if the service can be charged for on a commercial basis, we would question whether it should be in the public sector at all. We would see the role of Government as providing services of a public nature, such as welfare or education, the costs of which are normally difficult to recover directly from the beneficiaries. Where a service can be charged for directly, we suggest that in many if not all cases such service could be carried out as well or better by the private sector.  

Secondly, in the absence of full accrual accounting, (see point 5 below), the prices charged by the Government are likely to be inappropriate. For example, the full cost of inputs such as land and internal service support may not be fully reflected in the department's costs.  

Thirdly, where Government's charged services are provided on a monopoly basis, there is the risk of overcharging to the extent of exploiting the consumer.  

Fourthly, rises in Government charges have at times been significant enough to make a major contribution to inflation; these rises have also contributed to a general expectation of increasing charges in other sectors of the economy, thus boosting inflation indirectly.  

The present high level of Government charging leads to a perception of double taxation, i.e. in addition to paying taxes directly to fund Government services, citizens find themselves paying indirect "taxation" in the form of service charges as well. We believe that there should be a complete review of the Government's policy of charging for services. Such review should establish criteria for the scope of services to be provided by Government and Government-related units, as opposed to the private sector, and in respect of the former, the basis of charging.  

4. Review of revenue raising system  

In view of the scale of the three problems we mention above, and the opportunity presented by the current economic crisis for a fresh look at our financial affairs, we recommend a full scale review of the Government's revenue raising policies. Such review should cover the following points among others.  

(1) What is the need, both current and projected over the next five to ten years, for the Government to raise revenue? The formula of linking expenditure to GDP growth is conceptually unsound - it assumes that the base year proportion was optimal, but in fact the base was just merely historical accident. In the present recessionary environment it would be most unwise to stick to this principle since it would mean shrinking Government spending at a time when other sources of demand are also shrinking, thus exacerbating the recession.  

(2) What is the optimal balance of revenue sources to meet the need? As stated above, the Government has historically relied heavily on land-related taxes, but this has been damaging to the economy. There is a need to diversify the revenue sources, taking account of the economic impact of the various forms of direct and indirect taxation. We would recommend that serious consideration be given to the introduction of a goods and sales tax, such has been introduced in many countries around the world, including in Asia. A goods and sales tax, which is a tax on consumption, is widely regarded as the least economically detrimental tax. Although the administrative costs to tax collectors, businesses, is significant, with today's technology this is less of a problem than previously. Nor need such a tax impact Hong Kong's role as a shoppers' haven: many overseas jurisdictions exempt non-residents from the tax. We believe that it is time for GST to be given serious consideration.  

(3) What is the economic effect of the proposed revenue raising measures? We mention in 2 above the deleterious effect of land-related taxes and in 3 above the inflationary effect of increases in Government charges. Future fiscal policy must be much more sensitive to broader macroeconomic effects.  

(4) Some form of fiscal responsibility legislation should be considered. We have already stated our concern at the excessive reserves that the Government has accumulated in the past. However, we are also concerned at the apparent freedom of the Government to run a deficit without limit. It appears that Article 107 of the Basic Law is neither an appropriate nor an effective constraint on Government. Legislation perhaps similar to the fiscal responsibility acts in some developed countries needs to be seriously considered.  

5. Inappropriate accounting  

Sound policy-making is impossible without true and fair statement of the Government's financial position, revenues and budgets. At present, notwithstanding the introduction of Departmental Resource Accounting, the Government's basis of accounting for its finances is seriously incomplete. The Budget is compiled largely on a cash basis, with little account taken of assets and liabilities not realised in cash during the period. The various balance sheets published by the Government do not take full account of its various assets and liabilities, such as its unfunded pension commitments. We have recommended to you in a separate submission dated 12 August 1996 the adoption of full accrual accounting, ideally following the example set by New Zealand since the early 1990s. Full accrual accounting would lead to better-informed policy decisions, better control by Government over its own finances, and more accountable and effective government.  

6. Increasing complexity  

The traditional simplicity and predictability of Hong Kong's tax system has been an asset contributing in a major way to the territory's past economic success. Although we believe that this asset remains substantially intact, we are concerned at its erosion in recent years by the introduction of complex provisions to meet the needs of special interest groups. Examples include the introduction of double taxation agreements, the tax concessions for certain classes of debt instrument and mortgage interest tax relief. We would question the need for Government to support any commercial sector, since support for one sector by definition is a tax on the others. However, where support for certain sectors is considered unavoidable, we would prefer this to take the form of direct cash subsidy, which is more economically efficient, more transparent and has fewer negative side effects.  

7. Other points  

(1) On salaries tax, we have expressed concern in prior years at the repeated rises in the level of personal allowances, which result in less than half the workforce paying tax. We suppose that this is without parallel in a developed economy. This imbalance seriously impacts social stability, in that it leads a large sector of society to demand more services in the expectation that others will pay for them. We believe that tax paying should be seen as one of the duties of citizenship for all except the very low paid. Reversing the slogan of the American Revolution, "No taxation without representation", we believe that taxpaying is an essential precondition for the stable democracy envisaged for Hong Kong in the Basic Law, i.e. "No representation without taxation".¨.  

(2) We recommend that the progressive bands are widened further from the current HK$35,000. At present the progression from zero taxation to full rate is too rapid.  

(3) While we support action to deter tax evasion and to investigate suspected instances of evasion, we are concerned that Hong Kong may be going too far down this road. Although the "return" from the "investment" of Inland Revenue resources in tax audits may seem positive, the hidden costs of such audits in terms of growing complexity and unpredictability of the business environment are significant. This impacts foreign companies most, as these tend to have better books and records that are easier to audit. We recommend that study be undertaken of such full economic effects before more resources are dedicated to the audit effort. For example, a question on this issue could be included in surveys looking at the general attractiveness of Hong Kong as an international business centre.  

(4) On the initiative to cut Government costs by 5%, we appreciate the intention, but believe that this measure is too limited to be meaningful, and if pursued will have highly suboptimal results, e.g. functions that should be expanded will be cut, and others that should be reduced more will be preserved. There should be a fundamental review of the performance of Government at the departmental, unit and individual officer levels, and the introduction of strong measures to improve performance and productivity. One key measure to be considered is performance-related pay.  

We hope that the above points are helpful.  

Thank you for your attention.  

Yours sincerely,  

Alan LUNG Ka-lun  
Chairman