Public Consultation on Tax Reform Final Report June 2007 Financial Services and the Treasury Bureau The Government of the Hong Kong Special Administrative Region CONTENTS Page Executive Summary i Chapter 1 Background 1 Chapter 2 Is there a need for Hong Kong to broaden the tax 5 base? Chapter 3 Is GST an appropriate option to broaden the tax 9 base? Chapter 4 Other options to broaden the tax base 13 Chapter 5 Conclusion 21 Appendix A Motions passed by the 18 District Councils in connection with the consultation on Tax Reform Appendix B Websites of the minutes of meetings held by the 18 District Councils in connection with the consultation on Tax Reform Executive Summary The Government published on 18 July 2006 a Consultation Document entitled “Broadening the Tax Base, Ensuring our Future Prosperity: What’s the Best Option for Hong Kong?” and launched a public consultation exercise for some nine months on how to reform Hong Kong’s tax system for broadening our tax base. The Consultation Document explains in detail the existing problems of Hong Kong’s narrow tax base and the possible challenges that we will face in the future. The purpose of the public consultation is to raise the community’s awareness of our narrow tax base and the problems it brings, and to stimulate public discussion on ways of broadening it. The public consultation ended on 31 March 2007. We received about 2 400 written submissions from the public by e-mail, post, facsimile, etc. during the consultation period. Government representatives attended some 350 meetings and seminars to explain to the public the contents and recommendations of the Consultation Document, and to listen to their views directly on tax reform. Moreover, the Government commissioned an independent agency to conduct regular opinion surveys between July 2006 and March 2007 on broadening the tax base. During the consultation, we can see that the public has gained a better understanding of the relevant issues and they generally agree that Hong Kong’s tax base is narrow. They recognise the problems of our tax system: our revenue relies heavily on Salaries Tax, Profits Tax and non-tax revenue (including land premium and investment income from our fiscal reserves). Such income is susceptible to the ups and downs of economic cycles, which render our public finances highly volatile. - i - The community is also aware that our population is ageing rapidly and the pressure of the government expenditure on health care and social welfare would increase. However, government revenue from Salaries Tax would drop and this would reduce the Government’s flexibility in dealing with additional long-term expenditure items. Moreover, in order to maintain our competitiveness, we have to cope with a number of challenges. These include globalisation and the trend that many overseas economies are reducing their direct tax rates to attract capital and talent. In addition, we have to upgrade our human capital. As education and training are long-term investment, they need to be funded by stable revenue. The public generally agrees that there are deficiencies in our narrow tax base, and is more receptive to the need to broaden our tax base. They also broadly agree that a more stable revenue base would enhance our fiscal health in order to cope with the aforementioned longer-term challenges. In the Consultation Document, we recommend the introduction of a Goods and Services Tax (GST) as we consider that it is the most appropriate option to broaden our tax base. The community has held extensive discussions on this proposal. Members of the public are mainly concerned about the regressive nature of GST, which would widen the wealth gap and add to the financial burden of low-income earners. They are also concerned that GST would dampen public consumption and tourist spending. Some are also worried that GST, if introduced, would complicate our tax system and undermine our competitiveness. We have proposed a number of tax relief and compensation measures to address the regressivity of this tax, and have provided the public with additional information and overseas - ii - experience in implementing GST to illustrate that its introduction would not lead to the problems that they are concerned about. Despite such efforts, we have been unable to remove their worries. Although the public generally understands that GST is effective in broadening the tax base and stabilising public finances, they cannot accept at this point in time that it is an appropriate option to tackle the narrow tax base problems. In view that the public was strongly against GST when we conducted the Interim Review last December, we considered that there was insufficient public support nor were the conditions right for the introduction of GST. We have, however, decided to continue to listen to public views on other options for broadening the tax base. Regarding other options to broaden the tax base, many have proposed introducing a green tax, a land and sea departure tax, a tax on luxury goods, a progressive Profits Tax and reducing personal allowances under Salaries Tax. In addition, some people and organisations have put forward other options such as introducing a capital gains tax, increasing the progressive element of Salaries Tax, introducing a tax on dividends, a tax on interest, taxing the worldwide income of businesses and individuals, and increasing Rates on tenements. Apart from the above suggestions, there are some views that the rapidly ageing population would increase government expenditure on health care. To relieve the Government of the pressure of this expenditure, they suggest that the Government should study the health care financing proposals as soon as possible. - iii - As to how we should broaden our tax base, the public does not have any clear inclinations or mainstream views on which option or options that the Government should adopt. From the views gathered, there are suggestions that the Government should not rely on only a single option but should deploy a basket of options to broaden the tax base and stabilise our revenue source. In considering the most appropriate options for broadening the tax base, we consider that we should take account of the following three principles: (a) The option must be effective in broadening the tax base and providing stable and considerable revenue for the Government to meet its future needs; (b) The option must be fair and in line with the “capacity to pay” principle, and should not widen the wealth gap; and (c) The option is in line with our simple and low tax system so as to attract capital and talent and maintain our competitiveness. In light of the above, we are of the view that no single option other than GST can satisfy all these conditions. In fact, the Advisory Committee on New Broad-based Taxes (Advisory Committee) had examined most of the above options in depth and pointed out in its Report released in 2002 that they are not long-term solutions to our problems of narrow tax base. As for green tax, it has frequently been mentioned by the public but was not studied by the Advisory Committee at that time. Although the - iv - objective of introducing this tax is not solely to increase government revenue, it is an option worth exploring when we consider the introduction of new taxes. While the introduction of a green tax or adoption of a basket of options can partly achieve the effect of increasing government revenue, such initiatives cannot effectively broaden the tax base. As our economy has recovered and the Government’s financial position has improved, the public generally does not consider that there is any urgency for introducing tax reform immediately to broaden the tax base. In the face of our ageing population, Hong Kong’s dependency ratio would be rising rapidly. Moreover, globalisation would bring challenges to our education and manpower training. In the long run, our narrow tax base would limit our ability to allocate resources to invest for the future and to respond to these challenges. This would affect the stability of our public finances and undermine our competitiveness. Hence, we recommend that : (a) having raised public awareness on the deficiencies of a narrow tax base, the Government should continue to study options for broadening the tax base and address this fundamental issue at a suitable time in the future; (b) in studying the options for broadening the tax base, the Government should take into full account the views collected in this consultation exercise and should consult the public further on those options which are more practical; - v - (c) as the problem of ageing population is getting more serious and this would bring additional pressure to our public finances, the Government should consult the public on the health care financing proposals as soon as possible; and (d) to enhance Hong Kong’s competitiveness, the Government should continue to advance education and manpower training, and should explore sustainable financial arrangements so as to respond to the long-term needs. - vi - Chapter 1 Background 1. The Government has all along been very concerned about the problems of Hong Kong’s narrow tax base. In 2000, it established the Advisory Committee on New Broad-based Taxes (Advisory Committee) to study the various possible options to broaden the tax base. 2. The Advisory Committee studied the tax base of Hong Kong in depth and compared the tax base of Hong Kong with those of other developed jurisdictions. In its Final Report published in February 2002, the Advisory Committee pointed out that by international standards, the tax base of Hong Kong is very narrow. After comparing the various options for broadening the tax base, the Advisory Committee considered that the most viable option is to introduce a Goods and Services Tax (GST).