Is it necessary to have VAT/GST in Hong Kong?
Limitations of Research: the researcher could not use all the internet sources because some of them are written in Chinese, the researcher followed the structure that is provided by you but I have noticed that there is repetition in the points that are mentioned in the objectives and the points that are mentioned in the chapter plan, also there is a repetition in the resources that are mentioned in the data and information needs and the points in relevant literature consulted.
The researcher shall bear no responsibility for any confusion caused by the un-clarity of the attached document.
Introduction:
More than 120 countries have imposed Goods and Services Tax, the only developed country that has not imposed this tax is Hong Kong.
VAT or GST has been introduced by France in 1954(Ministry of Economy, Finance and Industry).
All the developed countries (except Hong Kong) and most of the developing countries have followed France in imposing VAT/GST because this tax is considered:
Fair: VAT/GST is considered a fair tax because it relates the amount of collected tax to the amount of consumption; the more you consume, the more you pay VAT.
Simplicity: unlike any other taxes, VAT/GST is considered a straightforward tax; it is imposed according to a known percentage on the value of the products and services
Efficiency: this tax is very efficient, it is very easy to collect it and it is very difficult to avoid it.
Chapter2: Objectives:
The purpose of this research is to find out whether VAT/GST is a suitable tax for Hong Kong or not.
The research has covered very large material and literature about Hong Kong and similar economies to Hong Kong such as Singapore.
The research also aimed to show that most of the governments of the world are broadening their budgets by imposing VAT/GST on customers while they are trying to reduce income and corporate taxes.
Chapter3: Literature consulted:
The research has covered a large part of literature published by global accredited organizations such as Price Waterhouse coopers, Ernest Young and the government of Hong Kong.
The major text books have been used to give us a broad idea about the issue in research while the specialized working papers, Internet articles and government websites have been used in order to give us a clear idea about the issue in research.
The research consulted working papers published by several universities and bodies in order to explain the theoretical principles behind imposing VAT/GST (Hubbard,G,R(1997)and the impact of VAT/GST on the informal sector in developed countries.
Chapter4: Proposed Methodology:
we can see from the above chart the deficit that have faced Hong Kong from 1997 until 2003, the revenue was very low compared to the spending which proved to be steady.
”During the same year, about 70% of the total revenue collected by the Inland Revenue Department came from profits tax and salaries tax. Nevertheless, the profits and salaries tax nets are very narrow and shrinking. Less than 40% of our workforce of 3.2 million people pay any salaries tax, and only 10,000 people pay the maximum salaries tax rate of 15%. About 5% of the payers of profits tax contribute to 80% of the profits tax revenue. Further loss of profits could occur as a result of globalisation. Besides, the spread of e-commerce will have implications on all governments’ abilities to assess and collect business-related taxes. In this regard, both the Financial Secretary and the Secretary for the Treasury expressed their concerns on the impact of the exponential growth of e-commerce on Hong Kong’s territorial-based tax system. The Government will set up a Task Force to review public finances and an independent committee on new broad-based taxes”, Wong, J(no date given)
The research has depended on major questionnaire that have been distributed to citizens and companies in Hong Kong in order to get their opinion about VAT/GST tax.
The response that I have got from this questionnaire has been used in predicting the change in consumption behavior by the citizens of Hong Kong.
The research has also depended on comparative analysis in order to see how Hong Kong economy will be affected and how the whole tax system will be redesigned.
The research depended on some graphs to illustrate the topic further.
Chapter5: Data and Information needs and sources:
This research needs theortical as well as practical data and comparative analysis.
This research is different because it assesses the potential of something that might happen in the future.
The researcher has conducted a questionnaire in order to measure the acceptance of the people to VAT and their views about the fiscal position of their country.
The researcher tried to make sure that the sample is random, so the results are random too and not biased.
The research required me to use some theoretical concepts in order to assess the impact of VAT.
The research also depended on comparative analysis in order to see what happened to similar economies that have implemented VAT/GST.
Chapter6: Chapter Plan:
Understanding the principles behind using an expenditure tax like GST/VAT:
Definition of GST:
Goods and Services tax is imposed on:
Goods and Services tax is broad-based and equitable and is capable of yielding sizeable and steady revenues.
VAT or GST is a consumption tax, it is paid by the consumer of the product or the service as a percentage of the final price.
It is related to all commercial activities involving the production and distribution of services; it is not charged on companies which mean that companies can deduct from their VAT liabilities the amount of tax they have paid to other taxable persons on purchases for their business activities.
Hong Kong government is considering introducing VAT/GST tax in 2009(Hong Kong’s Inland Revenue).
Difference between VAT and Sales Tax:
VAT is imposed on every stage of production while Sales tax is actually collected in the form of extra charge by the retailer, who remits the tax to the government.
VAT and the Theory of Economics:
There have been a long debate between different economic schools of thought around the world about tax reform.
Some economists prefer income tax to VAT/GST because it provides fair treatment to the citizens of the country while others prefer VAT/GST.
According to Hubbard,G,R(1997), some economists support VAT for the following reasons:
Imposing VAT instead of income tax will encourage capital accumulation and savings.
Removing income and profit taxes will remove distortions in the allocation of capital among different economic sectors.
A broad based consumption tax would avoid potential costly distortions of firm’s financial structures.
Importance of VAT:
Today it is a key source of government revenue in over 120 countries. About 4 billion people, 70 percent of the world’s population, now live in countries with a VAT, and it raises about $18 trillion in tax revenue, Liam E., Michael K., Jean-Paul B. and Victoria S(1991)
VAT has advantages and disadvantages:
Disadvantages of imposing VAT:
VAT discourages specialist economic activity and fragmentation in the production because VAT will be fragmented; VAT encourages integration in order to avoid compounded VAT.
VAT encourages financing big governments: in the 1960s, the size of governments in the US and the UK were approximately equal, in the year 2002, the size of the government in Europe have exceeded the size of the US government, many analysts attribute the difference between the sizes of the two governments to VAT, The expansion of the government will lead to higher prices and inefficient production, the thing that will lead to more taxes in the future.
VAT will reduce the available capital to private businesses and raise interest rates, increasing interest rates will stifle economic growth and reduce the potential growth.
Advantages of imposing VAT:
VAT could finance the debt of the government because it provides stable and steady stream of income that is capable of financing development projects.
VAT could reduce consumption and make the citizens of any country save and invest more money.
By encouraging integration, VAT could push the economy towards mergers that will reduce the stages of production; VAT simply tends to encourage big businesses to get bigger by buying other companies, this could yield economies of scale and generate synergies..
Selectivity: the government can select the products and services that it needs to impose VAT on, for example, most government exclude food from VAT, by using VAT governments could take into its consideration the difficult economic situation of the poor and decide the exclusions that apply to them.
VAT is a secure way to finance the government’s structural deficit, VAT covers most of the economic segments in the economy and it is very difficult to evade it.
Introduce a historical background, economy and tax system in Hong Kong:
The Modern History of Hong Kong:
Hong Kong was a British dependency from the 1840s until July 1, 1997, when it passed to Chinese sovereignty as the Hong Kong Special Administrative Region (SAR), Pannell,C(1998).
The British control of Hong Kong began in 1842, when China was forced to cede Hong Kong Island to Great Britain after the First Opium War. In 1984 Great Britain and China signed the Sino-British Joint Declaration, which stipulated that Hong Kong return to Chinese rule in 1997 as a Special Administrative Region (SAR) of China. The Joint Declaration and a Chinese law called the Basic Law, which followed in 1990, provide for the SAR to operate with a high degree of economic autonomy for 50 years beyond 1997, Reference: China Connection.
In the Fifties of the last century, the threat of the cold world was looming over the world.
Investors were looking for a safe heaven to locate their businesses and investments in a neutral place away from the eastern and the western camps, investors found in Hong Kong a promising country that is able to deliver good business environment that could foster growth and political stability at the same time.
Growth in Hong Kong depends on several other economies such as the growth in the US economy and the growth in China and Southeast Asia in general.
Growth in Hong Kong is related to oil prices and world wide prices; Hong Kong is a small island with very little raw resources, it depends on exporting raw materials from abroad in order to manufacture them on its land and re-export them again to other parts of the world.
Manufacturing:
In 1950s, Hong Kong attracted manufacturing jobs and the vast majority of its work force where working in factories.
In 1980s, Hong Kong had about 905,000 manufacturing workers and manufacturing was the most important economic sector, Economist Intelligence Unit (2003).
Until 1990s, Factories were manufacturing products that depended on labour intensive work force, after that manufacturing jobs started dropping because of the climbing costs of labour and land.
In 1990s, the number of manufacturing jobs was about 575,000 jobs.
In 2001, the manufacturing sector contributed to less than 5% of the GDP, Economist Intelligence Unit (2003).
Like most of the developed nations, Manufacturing in Hong Kong is becoming concentrated on manufacturing hi-tech products and services.
The manufacturing sector has been replaced by rapidly expanding service sector, in 1991; the service sector has generated 72.3% of the GDP in Hong Kong and in 2002, the service sector has generated about 83.9% of the GDP, Economist Intelligence Unit (2003).
Services:
A- Banking:
The banking sector is now the most important economic sector in Hong Kong, Hong Kong is currently the fifth largest banking centre in the world.
Hong Kong offered investors a very good opportunity to invest in a growing emerging economy.
Investors benefited from tax free capital gains and high dividends.
B- Tourism:
Tourism is a significant source of economic growth in Hong Kong; nearly 9 million people visit Hong Kong every year, Tourists spend around $7 billion every year.
Tourism is the third source of foreign exchange reserves in Hong Kong.
The banking and the tourism sectors have delivered a very good growth to the Hong Kong economy.
In 1996, Hong Kong’s per capita gross domestic product (GDP) was second to Japan and Singapore in Asia and exceeded that of the United Kingdom, Canada, and Australia, Reference: internet article: Marimari (no date given).
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Sources of Success:
Hong Kong offered investors business-friendly laws and gave complete freedom to the movement of capital in order to encourage investments and promote growth.
Hong Kong is duty free zone and there are few barriers to trade goods and services; this has made the country an important link ring between the east and the west.
Hong Kong left market forces decide wages and prices; the government did not legislate any minimum wage requirement or anti-trust laws.
Competition in Hong Kong:
The decline of the manufacturing sector has caused the decline of competition in Hong Kong.
Competition is considered an essential part of the market system.
Competition benefits consumers and businesses, it benefits consumer by lowering prices and it benefits businesses by allocating resources in a more efficient ways.
Competition is very important to the health of Hong Kong economy, competition gives world economies the flexibility to adjust its prices in the case of external shock (macro-economic shock) Sturm,P, Jahangir,A, Breuer,P, Nishigaki,Y (2000).
Emerging economies that depend on fixed exchange rates usually suffer from real exchange rate appreciation.
The real exchange rate appreciation could be treated by either:
Switching to a flexible exchange rate: according to the “law of one price” flexible exchange rate will adjust exchange rates in order to make tradable products have the same price everywhere in the world.
Lowering prices: lowering prices of products is an important toll in avoiding international competition, lowering prices could only happen if the structure of the market is competitive.
Having a competitive market structure in lowering prices and keeping international capital flows coming to Hong Kong.
Tax Regime in Hong Kong:
Hong Kong tax regime is based on a territorial-based tax regime; the tax is imposed on incomes that arise from Hong Kong, Hong Kong’ Inland Revenue.
The economy of Hong Kong has gained a competitive advantage because it imposes no taxes on capital gains and dividends; this has encouraged many investors to invest in that country and established an important financial centre in Asia.
Hong Kong has the following simple tax structure:
Property Tax: Property tax is levied on rental income from land and buildings situated in Hong Kong.
Salaries Tax: Salaries tax is imposed on incomes derived from working in Hong Kong or if incomes derived from services rendered from Hong Kong.
Profits Tax: profits that are generated in Hong Kong are subject to taxes, profits of unincorporated business stands at a rate of 15% and corporations at 16.5%.
The relationship between Hong Kong and the foreign exchange rate:
The currency in Hong Kong is Hong Kong dollar which is pegged to the US dollar, if Hong Kong government wanted that peg to continue, it should tighten its fiscal deficit.
The currency of Hong Kong is an investment asset, many investors diversify their currency allocations, this diversified allocation to the funds of the global investors results in an important cash inflow to Hong Kong.
For the Hong Kong dollar to get part of the allocation, Hong Kong should stabilize its budget in order to attract more foreign investment.
Analyze why the government considers launching a broad-based tax;
Narrow tax base:
Hong Kong has very narrow tax base, narrow tax base means that the collected revenues do not provide enough revenue to cover the expenditure of the country.
If we compare TAX/GDP ratio in Hong Kong compared to other Asia Pacific and OECD countries we find out that Hong Kong has the lowest ratio of TAX/GDP.
Hong Kong has a narrow tax base because the tax base is shrinking since 1998; sound tax systems are based on growing and stable (not volatile) tax base.
Hong Kong has the lowest corporate tax rate among the OECD countries, the current corporate tax stands at 16%.
Erosion of Tax Base:
The erosion of tax base is actually a result of several factors, such as: sliding house prices, illegal betting, e-commerce and online stock trading.
In the following section I will explain each of these factors separately:
sliding house prices:
For a long time, Hong Kong depended on land and property transactions to contribute to government revenue of Hong Kong.
Collected tax from property in Hong Kong(stamp duty, rates and shares and estate duties) is well above the international benchmarks as a percentage of GDP, Property from taxes/GDP=24% for Hong Kong against 5% for the OECD and 10% for the Asia Pacific countries), Reference: Hong Kong Government, Tax Base Study.
Hong Kong depends on Land sales revenues in financing its budget, this has made Hong Kong increasingly dependent on non-tax revenues.
In the tax base study that has been conducted by the government of Hong Kong and KPMG consultancy, the study reports the fact that Hong Kong’s non-tax revenue is about 80% of its tax revenues against 16% for OECD benchmark.
Because Hong Kong has enjoyed a buoyant business environment for years, banks started granting credit very easily to businesses, the expansion of credit was accompanied by rising house prices, land prices started going up sharply from 1984 to 1997, Gerlach, S & Peng, W(2002).
Many companies found working in the construction sector very profitable because they can make profit from two sources:
Net profits from building new houses and buildings.
Profits from capital gains resulting from continuous increase in house prices.
The construction sector was one the most attractive economic sectors in the country.
Foreign and national banks expanded credit to companies which operate in the construction sector; the banking sector played an “accelerator” role in the run-up of the property prices.
The government in Hong Kong has constructed its tax system around the fact that land prices are going up all the time because they are in demand.
Because of the financial crises of August 1997 that hit south east Asia and also because of the government policy on housing, Revenues from land sales and land utilization(lease, rent) dropped dramatically, suddenly the government found its huge revenues from land dwindling.
On the 16th of January 2000, the secretary for the treasury stated that:
“The other significant factor supporting our finances, in recent years, has been the high levels of revenue from land and property transactions. But as property prices stabilize, the huge windfalls are unlikely to recur in the future”
illegal betting:
Hong Kong’s treasury depended on revenues from betting activities in the country.
Hefty taxes has made too many people start thinking about illegal betting, Schuman,M(2004).
On the 16th of January 2000, the secretary for the treasury stated that:
“The impact of illegal gambling and the rise of gambling through the Internet threaten to erode our income from betting tax”
Hong Kong’s Home Affairs bureau said handle plunged 30% from 1996-97 to 65 billion Hong Kong dollars (US$8.3 billion; euro6.5 billion) in 2003-04, while government revenue from betting dropped from HK$12.3 billion (US$1.6 billion; euro1.24 billion) to HK$8.78 billion (US$1.13 billion; euro882 million).
Meanwhile, the amount of cash and betting slips seized from illegal soccer and horse gambling operators jumped from HK$9.38 million (US$1.20 million; euro942,000) in 2001 to HK$19.7 million (US$2.53 million; euro1.98 million) in 2004, according to the government.
The government said handle is projected to drop another 30% by 2007-08 if no action is taken, Reference: the associated press (2005).
e-commerce:
Hong Kong tax system is based upon territorial system, which means that profits and incomes that are derived from Hong Kong should be taxed according to Hong Kong tax laws, the development of e-commerce and the expansion in on-line selling to customers who are not based in Hong Kong through websites that belong to the global network makes hard for the government of Hong Kong to draw a clear line between the income that is derived from the internet and the income that is derived from Hong Kong.
On the 16th of January 2000, the secretary for the treasury stated that:
“The spread of e-commerce will have implications on all governments’ abilities to assess and collect business-related taxes. For us, the impact will be further accentuated by the territorial-base of our taxation regime”
online stock market trading:
the development of modern communications and the development of the financial markets made trading on-line possible from all over the world, trading has been made very easy by websites that are based on the web, the development of futures, options and spread betting markets have made possible to trade 24 hours a day.
It is very hard to impose taxes on online trading because the companies who established these websites do not have a physical place in Hong Kong.
On the 16th of January 2000, the secretary for the treasury stated that:
“The acceleration in global stock market trading through the Internet will require us to consider whether the stamp duty we charge on stock transactions can be maintained at its present level, or whether by doing so we would impede the further development of the Hong Kong stock market”
Hong Kong has a prolonged problem in tax revenues resulting from low income tax on working population and the constant decrease in the number of working individuals because of aging.
The secretary of treasury addressed this problem by saying:
“For we all take for granted the low level of taxation which we enjoy in Hong Kong. For example, less than 40% of the workforce pay any salaries tax, and only 10,000 people pay the maximum salaries tax rate of 15%. Companies pay profits tax at 16%, and only profits arising in Hong Kong are subject to tax.
Also we have no taxes on other income or capital gains, no sales or value-added taxes on what we buy, and duty is payable on very few commodities.
So much for revenue, on the expenditure side, the community expects more and better public services. An ageing population will place increasing demands on our health and welfare services. The need to tackle pollution will bring substantial costs. We need to reconcile this need for additional spending with a contracting revenue base.
Based on the above reasons the treasury of Hong Kong is considering widening the tax base a strategic option.
Expanding the tax base is a constitutional obligation as well as an economical obligation.
Hong Kong has to reduce its deficit if it wants to keep the value of its dollar strong and able to attract investors.
…. These sound practices are now enshrined in the Basic Law. So we are under a constitutional obligation to keep our finances in a healthy state. With a fiscal deficit last year, and a projected deficit this year and next year, the law and prudent financial management demand that we bring our finances back into the black in the near term. This would also have the added advantage of maintaining our fiscal reserves at the level necessary to help support the Hong Kong Dollar, an indisputable requirement given the events of 1998.
5- Aging population:
Hong Kong has an aging population; this has put an increasing pressure on the social security system and the infrastructure.
This has made the secretary of the treasury to state:
“The directions indicate that the continuation of current revenue and expenditure policy is not an option“
Considered that introducing general consumption tax is the most suitable for Hong Kong?
In order to see if the general consumption tax is the most suitable tax or not we have to evaluate all Hong Kong tax options.
Tax Options for Hong Kong:
1- Reduce Personal Allowance: Hong Kong tax systems is one of the most generous tax systems in the world, as we have said earlier fewer than 40% of the work force pay taxes, some tax experts are suggesting the government reducing its tax free income allowance in order to increase tax collection revenues, experts say that a reduction in the basic allowance of 10% will raise about $2bn revenue, even if Hong Kong decided to reduce the personal allowance by 50% this will raise 90% of its traditional revenue from the existing tax base is simply contributing more revenue, this options will not be suitable to Hong Kong because it does not broaden the tax base, this option will increase the weight of salaries tax in the overall tax collection, KPMG Tax base study.
2- Expand the Existing Tax Base via imposing capital gains tax: this option is not considered the best option because it will affect investment decisions negatively and lead to capital outflow from the country and make the country lose its competitive advantage.
Imposing capital gains tax may cause job losses and that will make the tax collection from salaries substantially less, so the gains from imposing capital gains tax will be offset by loss of tax from loss of income and salaries taxes.
Imposing taxes on dividends may not lead to desirable results.
3- Increase corporate taxes:
Increasing corporate taxes is one of the main issues that the government of Hong Kong is discussing, most of the analyst believe that this is not an option because increasing the corporate tax will simply cause damage to the position of Hong Kong in the global market, analysts think that there is a global trend to reduce corporate tax in all over the world.
Analysts think that countries are in competition with each other to provide facilities and tax concessions to corporations.
If Hong Kong increased its corporate tax, it would be very easy for corporations to shift their headquarters to somewhere else in the world.
According to Hong Kong Institute of Certified Public Accountants the government of Hong Kong is suggesting giving more corporate tax concessions to corporations in the following three areas:
A- Full profits tax exemption to regional headquarters/offices in
Hong Kong in respect of management consultancy income
Derived by the Hong Kong entity from associated entities
Overseas.
B- Exemption of interest income received by regional offices from
Loans made in Hong Kong to their overseas associates.
C- Group relief.
D- Loss incurred in the current year of assessment should be
permitted to be offset against the assessable profits of one
previous year.
3- Introduce New Taxes: introducing new taxes (apart from VAT/GST) could an innovative solution to Hong Kong’s structural fiscal deficit. In fact, there is no limit to the number of taxes that a government could impose in order to provide suitable macroeconomic environment for development. For example, Hong Kong could introduce environmental taxes in order to reduce carbon dioxide emissions from cars and factories, we all know that developed countries contribute significantly to the increasing stock of greenhouse gas emissions that causes global warming.
Because Hong Kong has very busy airports and sea ports, Hong Kong could impose new taxes on land and sea departures.
Experts advise the government to outsource the activities that it does not usually do efficiently, outsourcing will help the government reduce the deficit that is caused by inefficient use of resources.
Experts did not only advise the government to introduce new taxes but also to abolish some taxes. For example, abolishing taxes on alcohol beverages in order to encourage wine tourism
Experts think that applying this option will not solve Hong Kong’s structural deficit problem completely for the simple fact that Hong Kong has a reputation that it is a low tax country and if the government imposed taxes on several economic activities, Hong Kong reputation will be affected and this may have a damaging effect on the position of Hong Kong in the financial and business world.
What experts are trying to say that Hong Kong government should introduce new taxes and abolish old taxes in order to keep the current balance of taxes and respond to the modern needs of the society (such as environmental taxes).
4- Broad-Based tax on general consumption: this could be VAT (Value Added Tax), GST (Goods and Services Tax) or Sales Tax.
Kong’s structural deficit problems.
Government says that a 3% GST will yield about $18bn which stands for 1.5% of GDP.
Analysts recognize that GST is a powerful solution to Hong Kong’s Problem, 3% GST is capable of solving the problem, and in addition to that, 3% GST is in line with international standards.
This tax is not only capable of covering the government expenditures but also capable of broadening the tax base since it is imposed on nearly all kinds of consumption.
There are few points that the government needs to take in to its account when constructing the VAT/GST:
It is recommended that the VAT/GST should be simple; simplicity is the common feature of Hong Kong tax system and keeping the proposed VAT/GST simple is consistent with the rest of the tax system.
It is recommended that the VAT/GST should be comprehensive; in other words, it should include most goods and services in the economy, making the VAT/GST comprehensive will guarantee stable revenue to the government and will prevent further increases in the rate of VAT/GST.
Stability: it is advised that the rate of the VAT should stay constant for 5-10 years to come, stability in the tax rate is very important in creating stable consumption and investment decisions, consumers will base their consumption decisions upon the prices of products and s
