How Hong Kong’s tax regime short-changes residents by encouraging speculation and evading the city’s funding needs

Stefano Mariani says the missing piece in Hong Kong’s budget is tax reform, as Hongkongers have not made the connection between the city’s ‘simple and low’ tax regime and its housing, infrastructure and retirement protection problems

Hong Kong Budget 2018-2019

Stefano Mariani

Published: 12:01pm, 1 Mar 2018

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Wednesday’s budget again raised the vexed question on which the future of our city’s public finances depends: whither tax reform?

The usual array of middle-class tax breaks are beginning to assume the character of cynical bribes. They represent a short-termist approach to public expenditure, the fiscal equivalent of bread and circuses. Because tax is not an electoral issue in Hong Kong, inasmuch as most residents pay no tax at all, it has been difficult for the government to formulate a clear understanding of what tax policy should aim to achieve.

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Michael Littlewood, a former professor at the University of Hong Kong, dubbed his study on tax law in Hong Kong “the history of Hong Kong’s troublingly successful tax system”, noting that a combination of low rates and simple tax administration made the jurisdiction especially attractive as an investment hub.

The notion of success, however, is relative and must be measured against prevailing social, economic and cultural priorities. A tax system that worked well in the glory days of frenetic growth in the 70s and 80s is not the tax system that will best serve Hong Kong in the three decades or so leading up to 2047.

Society, and its discontents, have changed. The budget surplus, which is not being put to any apparent gainful use, is in stark contrast to the pauperisation of large cross-sections of the population. But money must be spent in order to spend money: if any part of the surplus is to be applied to social programmes, the physical, human, and administrative infrastructure to bring those programmes into existence and sustain them must first be put in place. That requires an extensive capital outlay and long-term funding commitments.

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Our Inland Revenue Ordinance is a creature of the early 20th century and was envisaged by the colonial office as appropriate for a bustling entrepôt colony, not a 21st-century metropolis.

It may be important to keep our tax regime simple and low, but our tax laws must be fit for the purpose. Here, the distinction between tax rates and the structure of the tax legislation is important. If setting the tax rate low were sufficient to attract investment, then Somalia and Yemen should be booming centres of entrepreneurship.

Hong Kong has failed to attract high-value-added, knowledge-based industries to the same extent as Singapore and, increasingly, Shenzhen, not because the tax rates are too high but because the tax system tends to create perverse incentives that oppose the government’s stated aim to diversify the economy and improve quality of life.

Why make a high-risk investment in a tech start-up when there are guaranteed tax-free returns to be gained from speculating in the property market? Why think seriously about tax policy when one can fob off the electorate with a few “sweeteners” and kick the can down the road?

Perhaps the main reason for which there is no grass-roots pressure for tax reform is that voters have not correlated inflated property prices, low-quality housing stock, strained infrastructure and low levels of public pension provision with the structural deficiencies of our tax laws. By not taxing capital gains on real estate, speculation is enabled by allowing raw economic gain from property investment to be collected free of tax, while trading gains from the “real” economy are covered at the full rate of profits tax. Similarly, offshore dividends and capital wealth – for example, residential property that is hoarded and left empty purely for investment purposes – are not taxable. Consequently, we tend to attract rent-seekers, not entrepreneurs.

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In January, I drafted a law reform project paper arguing for some modest measures.

First, a capital-gains tax should be introduced on the disposal of residential property which is not the principal residence of the vendor.

Second, a flat annual tax should be levied on the holding of vacant residential property to discourage hoarding and to cool down the rental market.

Third, offshore dividends that are remitted or spent in Hong Kong should be taxed, thereby eliminating the indefensible absurdity whereby the salary of a resident employee is chargeable to salaries tax, but a dividend received by a resident investor from an offshore company is not.

The paper was submitted by Dennis Kwok, a Legislative Council member, to the attention of the financial secretary. The Financial Services and Tax Bureau’s response was non-committal, suggesting that the enactment of the proposed reforms would interfere with its policy of a “simple and low” tax system. But that conclusion does not follow: by expanding the tax base, the government could afford to further decrease headline rates of tax in a bid to support both salaried earners and small businesses, which are among the stated priorities of the financial secretary set forth in his budget speech.

For the government’s facile reasoning on tax reform to be challenged, taxation must become a political issue. Both civil society and Legco members interested in a sustainable future for Hong Kong’s economy have a duty to press the government to explain clearly how it envisages tackling the structural imbalances in Hong Kong’s tax laws and ensure that these begin to reflect the funding needs of the city not as it was, but as we wish it to be.

Stefano Mariani is a lawyer and revenue law specialist, who has published widely in the field of taxation. The views expressed in the article are solely those of the author

This article appeared in the South China Morning Post print edition as: Tax reform, not sweeteners, will benefit Hong Kong

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