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Friday, February 28, 2014, 08:38
A taxing problem
By Oswald Chan

A taxing problem

New social welfare programs in January’s Policy Address will mean HK$25 billion more to Hong Kong’s already massive recurrent expenditures near capacity. A government working group estimated the city will face a structural deficit in 2021 at the earliest. Oswald Chan reports.

The Working Group on Long-Term Fiscal Planning (the Working Group), established in last June, just two days ago predicted a structural fiscal deficit may happen in Hong Kong based on different assumptions.

If the government expenditure growth rate rises at a different pace while its revenue growth rate remains constant in the next 20 to 30 years, a structural deficit will happen in Hong Kong based in the following different time spans. (See table)

This comes amid the scenario when Chief Executive Leung Chun-ying outlined several new welfare initiatives in last month’s policy address. The initiatives raised immediate anxiety that the additional HK$25 billion ($3.23 billion) tacked on to recurrent expenditures could plunge city revenues into long term deficit, if the trend continues.

The renewed anxiety is grounded in long-standing complaints about Hong Kong’s limited tax base. The SAR relies heavily on direct taxation — salaries tax and profit tax. There is also the heavy reliance on income from land premiums and other stamp duties. These have become increasing controversial since they not only have driven the price of housing beyond the means of average people, but are likely to become unreliable as income sources, in the face of global macroeconomic changes.

Indirect taxation

The government cannot shape its fiscal budget around unpredictable revenues. Raising direct taxes such as salaries and profits taxes, is not considered feasible, since that would only crimp the city’s competitive position. The practical alternative, seen by many experts is a return to indirect taxation — a value-added tax (VAT) or something similar.

Indirect taxes are not likely to get a smooth ride in the public forum either. That was made abundantly clear in 2006, when the government floated a proposal for a goods and services tax (GST). That touched off an outcry from the business community, the public at large and opposition camp politicians.  

The importance of direct taxation for the city’s future may be inferred from an examination of the figures. The profits tax, salaries tax, stamp duty and land premiums accounted for 65 percent of the 2012-2013 government revenues, according to the Hong Kong Taxation Institute (HKTI).

In tax assessment year, 2011-2012, only 94,900 (11 percent) of 864,000 registered corporations paid any profits tax. Around 64 percent of profits tax revenues for the year came from the top 800 taxpaying corporations. In the same year, only about 1.6 million (45 percent) of the working population of 3.6 million paid salaries taxes. Roughly 80 percent of salaries tax revenues were contributed by some 200,000 taxpayers.

Financial Secretary John Tsang confessed that he was concerned about the prospect of a structural budgetary deficit.

“We have seen examples of governments spending beyond their means in recent years in Europe and America. This not only undermines the stability of a society but also gives rise to far-reaching consequences for the future,” Tsang said in the concluding remarks in the Wednesday Budget.

Depletion danger

From 1997 to 2014, the cumulative growth in government expenditure was 126.4 percent, outpacing revenue growth which amounted to only 54.7 percent during the same period. Again  — the growth of recurrent government expenditures from 1997 to 2014 was 95 percent; during a period when the city’s nominal gross domestic product (GDP) growth rate was only 56.7 percent.

The figures show that government expenditures cumulative growth rate (126.4 percent) is roughly 120 percent more than the city’s economic cumulative growth (56.7 percent) in the last 17 years, illuminating the potential danger that the government’s fiscal reserves may be depleted if increased revenues cannot offset hikes in government spending.

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