It’s Time for Hong Kong to Abolish Salaries Tax

It’s Time for Hong Kong to Abolish Salaries Tax
Photo Credit: Depositephotos

What you need to know

The government is too rich to levy salaries tax.

Salaries tax in Hong Kong is levied on employees’ earning. It was introduced in 1940 for raising revenue to support World War II, but it remained after the war. Those who work in Hong Kong are required to pay tax for salaries (and related incomes) earned here at progressive rates ranging from 2 percent to 17 percent, with cap at 15 percent after deducting certain allowances and deductibles.

Not so important in Hong Kong

Different from personal income tax in the United States — in which it is the most important revenue source of the federal government — salaries tax in Hong Kong has a minor role in maintaining the government’s operation for the provision of public services.

In Hong Kong, land sales and profit tax are always the most important government revenue sources that they accounted for 28 percent to 45 percent during the last two decades from the financial year (FY) 1997/98. On the other hand, salaries tax accounted for only 10 percent to 13 percent for most years of the same period. In fact, due to property price surges, stamp duties collected from property and stock transactions have exceeded the amount of salaries tax collected since FY 2014/15, making salaries tax an even more unimportant revenue item. (Note 1)

The government taking away too much

The government has been having healthy, and sometimes unhealthy, huge annual fiscal surpluses. In eight out of the last 20 years, the government recorded fiscal surpluses equivalent to more than 3 percent of the gross domestic product (GDP) in the same year. The annual fiscal surplus has already accumulated to a huge fiscal reserve equivalent to around 38 percent of Hong Kong's GDP in 2016 and is sufficient for the government’s two-years operation without any income. In summary, Hong Kong government is rich, and to some extent, too rich.

Recently, Joseph Yam, the ex-central banker of Hong Kong and a sitting cabinet member, commented:

[A] budget surplus means that the government is taking away more money from society than it is spending to promote the wellbeing of society.

The latest trend indicated the same. On Aug. 31, 2017, Hong Kong government announced its monthly financial results for the four months ended July 31, 2017, that it already had a surplus of HK$32.9 billion (US$4 billion). Usually, the government records deficits in the early months of a FY. It is uncommon for it to have surplus at this stage that this was the second occasion since FY 1997/98. In 2007/08, the final fiscal surplus was record-breaking HK$123.7 billion, equivalent to around 7.5 percent of GDP in 2007. It is possible that we would have another record-breaking surplus this year, adding another over HK$100 billion to the already too large coffer.

The government is too rich

It should be noted that the government’s official “fiscal reserve” it announced, i.e. HK$900+ billion, is not its only coffer. The government has created more coffers for saving, such as the accumulated surplus of over HK$600 billion in the Exchange Fund.

The government’s existing biggest headache in managing the public money is that it has too much money to spend and too few projects to spend on. Of course the community has been urging the government to improve the public services, such as introducing universal old age pension, building more public housing and improving the public medical services, but the government either turns a deaf ear to these requests, or rebuts the requests with “policy reasons,” leaving the huge fiscal reserve untouched over the decades.

The solution to overspending

In recent months, Joseph Yam, a non-official member of the Executive Council of Hong Kong, has been criticizing the conservative public finance policy in the last government and is seen as paving the way to increase public spending. However, the community is skeptical about the potential spending proposals, as the government has already been wasting too much public money on white elephant infrastructure projects — such as the “Hi-speed” railway system, and the Hong Kong-Zhuhai-Macao Bridge — which are seen as a way for the government to please Beijing instead of benefiting local society.

Given the government’s continuous surpluses and that it does not spend the reserves wisely, for the purpose of benefiting the general public it is better for the government to collect less money, so as to bring down the fiscal reserves to a more reasonable level.

Why salaries tax?

Among the possible options for abolishment, I opine that salaries tax is the option, because of its distortion effect on salaries earners’ incentives of working and consumption, and its extremely inefficient tax collection process.

In Hong Kong, not everyone is required to pay salaries tax. The working population of the city is about 4 million. Among them, the government issued tax returns to some 1.8 million employees. A personal allowance is provided such that those earning less than the median income are not required to pay salaries tax at all, or even if someone has to, the amount would be negligible.

As a result of the progressive tax rate, those high-earning taxpayers are paying far more than those low-earning taxpayers, such that the highest income groups who earned more than HK$900,000 per year in FY 2014/15, accounting for only 9 percent of the taxpayers, paid 76 percent of the salaries tax. The total amount of tax collected from 81 percent of the taxpayers, or 1.45 million people, with annual income less than HK$600,000, only accounts for 10 percent of salaries tax. Abolishing the salaries tax would give some relieves to middle class who are under high financial pressure due to the high spending in the city. One would easily come to the conclusion that it may be better to just abolish salaries tax to save resources, especially when the tax collected is useless.

Any threat to government income?

Some may still worry that abolishing salaries tax may result in a fiscal deficit. I have no such concerns and neither does Yam, who considers that occasional deficits would not be in contravention of the mini-constitution. Moreover, I believe that the government may improve its income without hurting its citizens.

Apart from land sales and profit tax, the government has been earning “investment income” by investing its fiscal reserve in the financial markets. The reserve is traditionally placed in the Exchange Fund managed by Hong Kong Monetary Authority (HKMA). In the past when Yam was the chief executive of HKMA, the investment income of the fund was good at 6.1 percent compounded annual return. However, since his successor took over his job in 2009, the investment performance has been poor that the compounded annual return was 2.1 percent (Note 2). The government should look into the operation of HKMA to seek ways in improving the latter’s investment performance so as to enhance investment income of the government.

Notes:

1. Deducted from government income, expenditure and GDP figures available the Census and Statistics Department.

2. Deducted from figures from Chart 1, P. 125 of Annual Report 2016 of HKMA

Editor: Olivia Yang