President Bush gave former Sens. Connie Mack of Florida and John Breaux of Louisiana the unenviable task of trying to say something new and interesting about tax reform.
When it comes to designing a simple tax system that does the least damage to the economy, it would be difficult to find a better role model than Hong Kong. As The Economist wrote a few years ago, "The territory's tradition of simple and low taxes ... is widely seen as a main reason for its stunning rise to prosperity." Many advantages of the Hong Kong tax system have been widely emulated in Asia, yet remain poorly understood in this country. One such misunderstanding may have resulted in an unfortunate spat between two old friends, Steve Moore and Bruce Bartlett.
Moore proposes that individual taxpayers should be allowed to either pay taxes under the current rules, or instead forego deductions for mortgage interest and charitable deductions and pay 20 percent on that broader measure of income. "Bruce Bartlett attacked this plan as a gimmick," writes Moore. "But he fails to realize this is precisely how the Hong Kong tax system works. Hong Kong has a complicated system and a simple flat tax, and filers choose between the two."
Gimmick or not, Moore's "freedom to choose flat tax" is not remotely similar to the Hong Kong tax system, which is not complicated in any respect. I may have been partly at fault for that misunderstanding.
Steve Moore and Bruce Bartlett were advisers to Jack Kemp's tax reform commission in 1995, and I was research director. Asked by one commissioner about Hong Kong's "flat tax," I replied that the tax on salaries is not flat but steeply progressive. There are four marginal tax brackets of 2 percent, 8 percent, 14 percent and 20 percent. I would prefer a single tax rate, for reasons I explained last November in "The Case for One Tax Rate." But any tax with a top rate of 20 percent is hard to fault.
Unlike the United States, Hong Kong is not plagued with tax credits that create random spikes in marginal tax rates as the credits are phased out. But Hong Kong does allow charitable deductions up to 25 percent of salary income and a mortgage interest deduction up to about $13,000 (in U.S. dollars). Other deductions are allowed for adult education, care of elderly relatives and retirement savings plans.
Personal exemptions are so generous that most employees owe little or no tax on salaries. For those with high salaries, however, it is cheaper to forego personal exemptions (but not deductions) and pay a 16 percent "standard rate." Only the top 2 percent usually pay that standard rate, yet they account for nearly half of all revenue from the salaries tax.