The government economic spokesmen say that the deficit in terms of the GDP is coming down. True but that is not because of any action to reduce expenditure or to increase tax revenue. It is due to the increase in nominal GDP and part of that increase is the inflation component. This ratio is not based on the real GDP but the nominal GDP. As long as we have inflationary growth the ratio could come down. But does this resolve the problem? No because it depends on inflation to reduce the deficit.
Similarly the Gross Public Debt to GDP ratio also comes down if we have inflationary growth - higher the inflation lower the ratio. The real position is that if we do not take steps to reduce the budget deficit in absolute terms or run a primary account surplus ( budget deficit excluding interest) we will get the country into a unsustainable debtor position and debt default will be the inevitable outcome.
In USA the government and the opposition party set up a joint committee to work out expenditure reduction proposals. But we cannot expect any such co-operation given the hostility of the government to the opposition. The country has a political system that is dysfunctional and cannot resolve any economic problems.
The first step is to see that the public sector enterprises stop being a drain on the Treasury. The two biggest failures are the CEB and the CPC. The failure to recover costs by these two enterprise means the whole system of market prices as a system of allocating resources is hopelessly distorted. The Government is committed to the IMF to eliminate their losses by 2011. Fat hope that any such resolution of their deficits will take place!
The next step is to freeze public sector recruitment and salaries. There is no chance of this either for the Government thinks the problem of educated youth unemployment can be resolved only by absorbing them to the public sector.
The next priority is to postpone or do without some of the capital investment projects. This too is against the so-called Mahinda chinthanaya.
This leaves the tax system. Most of the private sector companies are over-burdened by taxes. They are unable to make a sufficient return on equity to enable them to invest more. They cannot plough back any profits or provide sufficient return to the shareholders. The cost of capital is high and the real rate of interest is too high. The nominal rate was brought down by government fiat but unless it is monitored, the banks will find many excuses not to follow low interest lending. The lack of competition in banking enables them to dictate the lending rates and charge any risk premium from businessmen who do not belong to the first class borrowers list.
The government is perhaps waiting for the report of the Taxation Commission. Any tax will reduce supply according to economic theory. So any increase in taxes will be at the expense of private sector growth. Economic growth occurs when businesses increase investment and hire more workers to expand their operations. But the firms are not being adequately compensated for risk taking. Nor can they get enough credit from the banking system because the State sector is pre-empting resources.
Government can promote economic growth by pursuing policies that do not create excessive burdens on the ability of entrepreneurs to make investments and create jobs. Economic studies have shown that lower corporate tax rates can substantially boost growth. A high corporate tax rate decreases economic growth because it reduces the incentive to take risks, accumulate capital and engage in entrepreneurial activity. The most pro-growth tax systems are characterized by broad based low rate taxes.
Hong Kong – Taxation System
When it comes to designing a simple tax system that does the least damage to the economy, it would be difficult to find a better model than Hong Kong. As The Economist wrote a few years ago, "The territory’s tradition of simple and low taxes ... is widely seen as a main reason for its stunning rise to prosperity.’’
Hong Kong taxes are among the lowest in the world, and its tax regime is simple and predictable. Hong Kong’s simple and low tax system is a great attraction to foreign investors. This low fiscal burden for all, domestic or international players, corporates and individuals alike makes Hong Kong attractive. In fact low tax is the most cited reason for regional offices to set up in Hong Kong! This tax regime makes Hong Kong one of the lowest tax environments among developed economies.
Hong Kong operates a territorial basis of taxation under which taxes are only imposed on profits or income with a Hong Kong source. Foreign-sourced income is not taxable even if remitted to Hong Kong. The principal direct taxes are profits tax on business profits, salaries tax on salaries and property tax on income from property. Hong Kong does not have any capital gains tax, withholding tax on dividends and interest, inheritance tax; value added tax and collection of social security contributions. Few items attract duty.
The profits tax rate is the same for foreign and local companies - a low 16.5 percent. The actual tax bill is often even less after various deductions and depreciation allowances.
There is no capital gains tax in Hong Kong, withholding tax on dividends and interest or collection of social security benefits. The salaries tax rate is at a maximum rate of 15 percent, imposed only on all salary income of individuals derived in or from Hong Kong. We can broad base the income tax by removing the tax exemption of public employees and politicians including judges.
The property tax applies to owners of land or buildings situated in Hong Kong- 16 percent (for 2004/05) of the rental income from the land or buildings and an allowance of 20 percent is permitted for repairs and maintenance. There is no sales tax or VAT in Hong Kong. The limited tax base, combined with exceptionally low tax rates, makes Hong Kong’s tax incidence much lower than in virtually all other developed economies.
Profits Tax
Incorporated and unincorporated businesses are taxed at different rates - incorporated businesses at 16.5% and unincorporated at 15%. Profits tax is paid initially on the basis of profits made in the year preceding the year of assessment and is subsequently adjusted according to profits actually made in the assessment year. Some general details in calculating profits tax: deductible items include: all expenses incurred in the production of assessable profits; losses of the company (can also be carried forward indefinitely) ; capital allowances on capital expenditure (varying between 4-20%) and plant and machinery, up to an immediate write off of 100% ; certain trademark and patent registration fees; contributions to an employee retirement scheme, up to specified limits ; some costs attributable to scientific research. items exempt from profits tax - interest income, other than that received by financial institutions, and dividends received from corporations capital gains there is no withholding tax on dividends paid by corporations groups cannot file a consolidated tax return in Hong Kong.
Profits tax produces about 20% of the Government’s revenue.
Salaries Tax
Taxpayers receive their salary gross i.e. the tax is not deducted. Salaries tax is demanded on a yearly basis, and is normally paid in two installments between December and March.
Foreign nationals who spend less than 60 days in Hong Kong in any year of assessment are exempt from salaries tax.
Taxable income includes: Commissions; bonuses; awards; gratuities; allowances; like housing allowance. Deductions include: allowances prescribed in the Ordinance, charitable donations and certain payments for relevant educational courses.
The earnings of husbands and wives are reported and assessed separately. However they may elect to be assessed jointly if this results in a lower tax bill or if allowances are unused.
Salaries tax is calculated in two ways and the taxpayer pays the lesser amount. The two methods are: tax calculated at a stepped rate on the net income figure i.e. after tax allowances. The stepped rates are: 2% on the first HK$40,000; 7% on the next HK$40,000; 12% on the next HK$40,000 and the balance at 17%. Academic studies of optimal taxation have long concluded that marginal tax rates should be lowest at the highest levels of income. As Joseph Stiglitz wrote in 1987, "the marginal tax rate on the highest income (ability) individual should be zero." Hong Kong does not go quite that far, but the marginal rate is reduced from 20 to 16 at the highest incomes, while keeping their average tax high by eliminating personal exemptions.
Property Tax
Property tax is charged at a standard rate of 15% on rentals received less rates and an allowance of 20% for repairs and maintenance.
For corporations, rental income is included in their profits tax calculations so they are not subject to property tax.
Trade and Customs Regulations (HK)
There are no customs tariffs in Hong Kong and goods imported or exported require minimal customs formalities. Excise duties are levied only on tobacco, liquor, methyl alcohol and hydrocarbon oil, whether imported or locally manufactured. Import/ Export declaration is required within 14 days after the importation/ exportation of any articles, other than exempted articles. Many advantages of the Hong Kong tax system have been widely emulated in Asia.
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