Hong Kong and the GST

It’s now official: the Hong Kong government will not introduce a goods and services tax, at least not in the foreseeable future. Early in December 2006, and five months into a nine-month public consultation process, the financial secretary to the government of the Hong Kong Special Administrative Region (HKSAR), Henry Tang, advised that a GST is not an option given public sentiment. He reported the public have two clear but differing views.

The majority understand that HKSAR’s tax base is narrow. And they agree this problem has to be addressed to stabilise HKSAR’s revenue, improve public finances, and to provide a buffer for any future economic downturns. However, the majority of the submissions clearly demonstrate there is no support for a goods and services tax as the solution. This conclusion was reached following the collection of 2200 written submissions and attendance at 260 meetings and seminars.

But before we consider what HKSAR’s other options may be, if any, we need to go back a little way in time.

On 17 July 2006 Tang released a consultation document, Broadening the Tax Base: Ensuring our Future Prosperity, which set out a proposed framework for the introduction of a GST in HKSAR. In releasing the document, the government indicated that it intended to consult widely with business and the community in developing the detail of the proposal.

HKSAR has built a thriving economy in an environment of relatively low taxes compared to worldwide and regional averages. A significant proportion of budgetary revenue is derived from non-tax sources, such as proceeds from land sales, and income from property and investments.

The current system of taxation mainly comprises a flat-rate profits tax of 16 per cent for corporations and 15 per cent for others including individuals; a tax on salaries that has four marginal rates (the highest is 17 per cent); and some narrow excise duties.

Interest and capital gains are largely untaxed other than in some specific circumstances, such as interest that arises in connection with a trade, and capital gains realised on the disposal of depreciable assets. Dividends are exempt.

While wishing to maintain the status of HKSAR as an attractive destination for regional headquarters and a low taxing jurisdiction, the government is nevertheless concerned about the risks associated with such a narrow revenue base.

The proposal for the introduction of a GST arose in the context of consideration of alternative options for broadening the tax base and thereby securing revenue into the future.

The consultative document notes that some of the factors leading to this concern include: the ageing population and the increased burden on the revenue (both in terms of proportionally less wage earners contributing to the tax base and the need for increased government spending on facilities to support the elderly); the need for a healthy budget surplus in case of unexpected 'shocks' such as SARS or avian influenza; and the need to be cushioned from global events such as surges in the price of oil.

The consultative document was released in order to stimulate public debate on a preferred framework and options for the GST. The proposal was for a broad-based consumption tax based on credit invoice, similar to the mechanism that operates in most other jurisdictions.

Under the proposal, imports would be taxed and exports would be zero rated – exporters could obtain credits for GST on inputs, for example.

In addition to exports, financial services were also proposed to be zero rated. Sales and rentals of residential properties were to be treated as exempt. Otherwise, a significant feature of the proposal was there were to be as few exemptions as possible. To the extent that it is appropriate to compensate certain groups for the financial impact of a GST (such as low-income households) then this was to be managed separately and not be built into the GST system by way of exemptions or concessions.

Leading up to and following the release of the consultation paper, there was significant debate in the media about the possible negative impacts of the GST. These included that the GST would not cope with accruals accounting systems, that it would affect retail spending, that it would cause long-term recession, and would divide the community along economic and social lines.

On 21 November 2006, CPA Australia provided a submission to the review largely based on our experiences of the GST in the Australian context.

The submission was drafted in the interests of the wider community in HKSAR having a fair and effective tax system, and to contribute to the debate. The submission made it clear, however, the views and recommendations expressed did not necessarily reflect the current views of the majority of CPA Australia members in HKSAR.

Given the HKSAR government’s objectives, the submission was broadly supportive of the introduction of a GST in HKSAR as the most appropriate available base-broadening measure, although stressing that such a decision was ultimately a political decision for the HKSAR government.

The submission’s main approach was to note matters that we saw as important in the implementation of the tax, both technical and administrative, and to provide some insight into the Australian experience, particularly in relation to economic impacts should the HKSAR government choose to go that way.

The main features of the CPA submission were:

• That a GST is an efficient and relatively easily implemented way of meeting the objectives of the government in relation to broadening the tax base, and that if introduced, a rate of 5 per cent (as proposed) would have been appropriate. It would have been possible to introduce the GST at a low rate in the current climate of economic stability, 5 per cent is easily computed, and should provide sufficient revenue to offset implementation costs, including some form of reimbursement for low income earners. In this context, it should be noted that the proposal is on the basis that the GST introduction would be revenue neutral and the rate and other significant features would not be changed in the first five years after implementation.
• The alternative tax-base broadening measures suggested would either place increased pressure on the existing system (for example, increasing taxes on salary and wages or reducing personal allowances), or (based on the Australian experience) would lead to increased complexity and high compliance costs (such as a capital gains tax). A tax on interest from savings is less economically attractive than a tax on expenditure.
• One area of significant concern in the community in HKSAR is the potential for the introduction of a GST to lead to an acceleration of inflation and consequential economic downturn. In the experience of some other economies that have recently introduced a GST or VAT (for example Australia, New Zealand, Singapore and Canada) this has not been the case. Although in Australia there was an increase in CPI attributed to the introduction of the GST of about 3 per cent, the price increases stabilised fairly quickly and, according to the most recently available Treasury statistics, there is no evidence of the GST having an ongoing inflationary effect. Similarly, other economic indicators such as the rate of employment and interest rates do not suggest the GST has had a long-term negative economic impact in Australia.
• Naturally, to the extent there is an immediate economic impact via increased prices from the introduction of a GST, it is important this be mitigated as much as possible for low income earners and other vulnerable members of the population. However, in order to minimise compliance costs and maintain the integrity of the GST, we consider it preferable for offsets to be made outside the tax system.
• Other lessons learned from the introduction of the GST in Australia relate to the benefit of a significant investment by the government and revenue authority on consultation, taxpayer relations and taxpayer education leading up to and in the period after implementation. But the main challenge, and one that has been faced to a greater or lesser degree by every government that has successfully introduced a GST, will be convincing a sceptical electorate that the long-term gains from a GST outweigh any short-term pain.

The majority of HKSAR’s regional neighbours have GSTs, the exception being Malaysia. And Singapore recently announced that it would consider increasing its rate of GST to 7 per cent in the government’s February 2007 budget. Yet HKSAR is not going down a similar path at this stage. For the remaining part of the consultation period Tang said: 'We will not be advocating GST. We hope the public will continue to provide views on other options, which we have uploaded onto the tax reform website.

'We will continue to listen carefully and participate in the discussions, so that by March next year [2007], upon the conclusion of the consultation, we will draw up a report for consideration by the government of the next term.'

So what are the other options if any? CPA Australia’s submission considered, albeit briefly, some of the other options such as increasing taxes on salaries, reducing personal allowances, turnover taxes, wholesale or retail taxes, capital gains taxes and taxes on interest income.

All have their advantages and disadvantages, but it is difficult to imagine that any will be more popular with the public.

Of course, the most acceptable tax is the one that applies to somebody else, and not yourself. It will be interesting to see what happens next, as it would appear that good and acceptable base-broadening options are very hard to find.

Reference: February 2007, volume 77:01, p. 56-57

This page is available online at:
http://www.cpaaustralia.com.au/cps/rde/xchg/cpa/hs.xsl/724_21137_ENA_HTML.htm