Submission on 2005/06 Budget
19 January 2005
The Honourable Henry Tang Ying-yen, GBS, JP
SUBMISSION ON 2005/06 BUDGET
We are writing with our proposals for your 2005/06 Budget.
We believe that the present economic recovery presents an excellent opportunity for the financing of Government to be reformed. Fiscal reform should include the following main measures - reduction in the cost and size of the civil service through privatization, and other efficiency improvements; and elimination of features of the tax system that give rise to inequities or economic distortions. We oppose the introduction of tax incentives intended to foster particular sectors or activities. And because of its far-reaching social consequences, no goods and services tax should be introduced until the Chief Executive and the legislature are elected by universal suffrage.
Our views are set out in more detail below.
1. Expenditure reduction
It appears that because of the economic recovery and surging stock and property markets, the fiscal deficit will be reduced more rapidly than had been expected. However, this should not give ground for complacency. Since so great a proportion of the government's revenue is based on the asset markets (stamp duty, land premium and rates), any slowdown or contraction of these markets would again plunge the territory into fiscal deficit. The opportunity should be taken, in the present favourable conditions, to take the necessarily difficult steps towards reform. The highest priority step, in our view, is reduction in the cost and size of the civil service.
Such reduction should be achieved by reducing the scope of the service, especially through privatization and contracting out (see below), and by reducing the remuneration of civil servants to a level more comparable with that of private sector employees.
In terms of remuneration, the pay comparability survey exercise should be completed, and action taken forthwith to implement its findings. It is a disgrace that the survey has not been conducted since the 1980s. Secondly, unreasonable pay terms, such as overseas education allowances and housing allowances (see 5 below), should be eliminated. In this regard we understand that the Administration is presently reviewing certain perks, such as overseas passage, and hope that the review is brought to a speedy conclusion with the elimination of these anachronistic benefits.
We are aware that Article 100 of the Basic Law states that public servants may retain pay, allowances, benefits and conditions of service no less favourable than before the handover. We believe that this cannot be interpreted to mean that no pay reduction for civil servants is possible. As indicated above, it is a matter of great public importance that their pay is reduced to more reasonable levels. The Government should pursue the current court case to the Court of Final Appeal (CFA) in the hope of obtaining a favourable verdict. If the CFA should eventually confirm that Article 100 does indeed mean that civil servants' pay cannot be reduced, then the necessary process should be begun to amend this term of the Basic Law. Acknowledging that such amendment will take time, it then would become all the more important to reduce the size of the civil service by privatization, contracting out, etc.
Reduction in the size and cost of the civil service, though essential, will not reap their full benefit without thoroughgoing management reform of the civil service at the micro level. It will be important to introduce some form of activity-based costing and performance management methodology that systematically links resources to the results that the resources are applied to achieve. Automation of work processes, for example through web-based technology, is also important.
We believe that many individual civil servants see the need for management reforms and would be supportive of such reforms. However, we understand that because of the accountability system, which gives a higher degree of autonomy to the ministers, it has become more difficult to introduce management reforms across the service. We therefore suggest consideration of enabling legislation, such as a "Government Efficiency Act", that will provide a foundation for management reform of the civil service.
We welcome the effort that the Government has made so far to put privatization on the agenda and move forward with selected initiatives. However, the effort falls far short of an effective strategy.
Firstly, the privatization initiatives so far adopted have not actually resulted in smaller government. The Government remains the largest shareholder in the privatized MTRC. The toll roads and tunnels remain in Government hands, albeit that their revenues have been sold in securitized form to private investors. And even if the Link REIT had gone ahead, the monies raised, we understand, would have flowed back to the Housing Authority and presumably been reinvested in more public housing.
We also have reservations about the supposed partnerships with the private sector that have featured in recent projects. These seem to involve the transfer of large tracts of land to developers in return for doubtful benefits to the public. The West Kowloon development is the latest unfortunate example of this kind. Such exercises should be suspended, and the notion of public-private partnership (PPP) properly developed and discussed in public, as we elaborate below.
Most importantly, as highlighted by the controversy over the Link listing, the Government has not persuaded the community of the benefits of privatization. International experience has shown that there can indeed be a wealth of benefits - not merely the raising of revenue for government but more importantly, the release of resources into the private sector where they can be more efficiently utilized. However, there are often losers in the privatization process as well; arrangement has to be made for them. And the privatization of a monopoly intact, without proper supervision, can result in economic disbenefits. And some operations may be better retained within government. It is therefore important to engage the community in thorough discussion of the government's privatization plans. As far as we are aware, the Government has issued no consultation paper on the issue.
We urge the development and issuance of a consultation paper on privatization, which should include an initial list of enterprises and operations to be privatized, and proper explanation of the policy of PPP if it is to be pursued. There also needs to be a proper legal foundation for the privatization process, including an enabling law, and possibly amendments to existing ordinances. A thorough review of the legal aspects is needed.
3. No GST without constitutional reform
As we have stated in previous submissions, we recognize the economic benefits of a goods and services tax (GST). From the viewpoint of economic impact, a GST which taxes expenditure is preferable to profits tax and salaries tax which are charges on endeavour. A GST is a relatively stable source of revenue, which Hong Kong needs. And, depending on the rate applied, a GST has a high potential yield.
However, a GST is regressive, tending to fall disproportionately on lower income groups. The impact on these groups can be mitigated by the creation of exemptions, but exemptions complicate the administration of the tax, and their benefit is enjoyed by the population as a whole and only to a marginal extent by those actually in need. A further issue is that the burden of administration and collection of the tax falls on business, disproportionately on small business. Again, exemptions can ease the burden on small business, but this creates further complexity.
It is therefore necessary to have thorough community discussion so that the impact of a GST is understood and accepted. However, even more important than this, it has to be recognized that the introduction of a GST will fundamentally change the implicit social contract under which Hong Kong is presently governed. At present, the profits and salaries taxes are paid largely by the better-off sectors of the community, while the less well-off pay less tax. Thus the tax burden corresponds roughly to the political representation of the respective sectors of the population, which latter through the functional constituency and Election Committee is heavily weighted in favour of the rich and the middle classes. A GST, by introducing broad-based taxation charged on the population as a whole, fundamentally changes this picture. We submit that it would be unwise, and potentially destabilizing to society, to introduce a GST without having first introduced universal suffrage for the election of the legislature and Chief Executive. The benefits of political representation and the burden of taxation should not move too far apart.
4. No capital gains tax or tax on worldwide income
We note that you recently floated the ideas of capital gains tax (CGT) or tax on worldwide income as possible means to counter the fiscal deficit. However, we submit that these are both bad ideas.
CGT is a highly complex tax to administer and to compute. By the time necessary exemptions have been taken into account, and if proper allowance is made for inflation, the yield may also be low. Most important of all, it undermines the capital formation process which is at the heart of Hong Kong's success. It should be borne in mind that Hong Kong lives by capital freedom, including the freedom of the provider of capital to reap the return on his investment. The imposition of CGT would divert a considerable amount of economic activity offshore, to the loss of jobs and the reduction of incomes in Hong Kong generally. We understand that many overseas jurisdictions that have had CGT have abolished it or are considering abolition. It would be very unwise for Hong Kong to further contemplate a CGT.
The proposed taxation of worldwide income would depart from a second fundamental principle of the present tax system, which is that only income arising in the territory is taxed in the territory. As a free port, Hong Kong accommodates many individuals and businesses who have activities elsewhere, but find Hong Kong a convenient base. This is greatly to Hong Kong's benefit: these individuals and businesses bring jobs, wealth and know-how into the economy. If, however, by residence in Hong Kong, these persons were to find their worldwide activities subject to Hong Kong taxation, many of them might leave Hong Kong or reduce their activities here. In addition, as a small territory with very few double tax treaties, Hong Kong would not be in a position to properly administer taxation on world-wide income. This idea should not be taken further. Efforts should be directed at making Hong Kong a more attractive, not a less attractive, place to live and do business.
5. Salaries tax
As we have stated in numerous previous submissions, the present salaries tax bands are too wide, and the allowances too large, with the result that the bulk of salaries tax is paid by an extremely small segment of the population. We advocate a widening of the bands and reduction in allowances. The aim should be to do this in a revenue-neutral manner, e.g. by at the same time reducing the top marginal rate of tax (currently 20%).
Employees whose accommodation is paid for by their employers are attributed a benefit equivalent to only 10% of the employees other chargeable salary. In most cases, the benefit greatly exceeds this amount, i.e. the employee avoids a significant amount of tax. Such benefit is economically distorting, as well as socially inequitable. The opportunity should be taken, in the current favourable property market conditions, to abolish housing allowance.
6. No special tax concessions
We note that in your previous budget you announced various forms of subsidy for small and medium enterprises, such as land at concessionary rates and loan and support schemes. We note also that other institutions are calling for special tax exemptions, e.g. for regional headquarters or for manufacturers. We believe that there should be no subsidies to particular sectors or to promote particular activities, either directly through cash or direct grants of resources or indirectly through the tax system. Such subsidies are economically distorting and, by forcing one sector by implication to pay for another, are unfair.
7. Green taxes
We support the idea, floated in your previous budget, of taxing environmentally-damaging activities. We also recommend that you consider the introduction of electronic road pricing, which would not only help reduce vehicular pollution but also alleviate traffic congestion.
8. Reform of tax law
The Inland Revenue Ordinance has its roots in early twentieth century British colonial legislation. Many of its concepts, such as the source concept for profits tax, need clarification. Aspects of modern society, such as the taxation of the service sector and of e-commerce, need to be addressed. A fundamental overhaul of the ordinance is needed.
9. General competition law
A number of key sectors of the economy are dominated by a single supplier or a small number of suppliers who function more or less as a cartel. Examples include the property sector, supermarkets, petrol supply and air lines. Another market distortion is cross-sectoral dominance, for example where a property developer builds a residential estate and brings in its affiliated companies as suppliers to the estate. These distortions result in higher prices for consumers - which in turn contribute to poverty - and less choice. The Administration's present sector-based approach to competition is inadequate, particularly to address the problem of cross-sectoral dominance. Hong Kong should follow the example of virtually all developed societies and enact a general competition law, enforced by a strong statutory authority.
We hope that our above views are helpful to you in formulating your budget.
Alan Lung Ka-lun
Reproduction of this paper is permitted with proper attribution to the Hong Kong Democratic Foundation