Alan Reynolds

A year ago, I argued that Hong Kong had enjoyed the best tax system in the world for nearly 60 years. The Hong Kong economy routinely grew by 7 percent a year (as it did last year), with no recession between 1975 and 1997. Since real gross domestic product (GDP) doubled every decade, real tax revenue could likewise double every decade without increasing as a percentage of GDP.

After the regional setback in 1998, Hong Kong suffered another unusual budget crunch because of SARS. But the government just reported a $14 billion surplus, which leaves a rainy day fund of nearly $311 billion. The report worries that "in any future economic downturn we might . . . be forced to draw down on our reserves." Yet the point of reserves is to meet emergencies.

The International Monetary Fund spent five years trying to persuade the Hong Kong government to convince its citizens to accept a new Goods and Services Tax (GST) -- a value-added tax on consumer spending. Hong Kong's brilliant and charming Financial Secretary Henry Tang eventually relented and released a report proposing a new 5 percent GST. The government welcomes comments (taxreform@fstb.gov.hk).

The "tax reform package would not need to generate additional revenue . . . for the first five years." After that, it is quite another story. Mr. Tang promised the new tax "would secure . . . our capacity to meet public expenditure needs." That doesn't sound "revenue neutral," does it? Even during those five years, the report suggests that "as an alternative to using some, or all, of the available funds for tax relief, we could increase public expenditure . . . on education, health, social welfare, law and order or infrastructure." Hong Kong's subsidies to higher education, hospitals and housing are already lavish, even by Scandinavian standards.

The temptation of enormous revenues from a GST or value-added tax (VAT) always proves disappointing soon after such taxes are introduced, which is one reason the initial tax rate is usually increased. Any such tax on sales will, of course, reduce sales. In a country like Hong Kong, a tax on retail shopping will also shrink tourism, because tourists go there to shop. They know from experience that GST or VAT rebates are difficult and limited (my family stopped shopping in Canada). The end result of a new GST is much less income tax revenue from shopkeepers' profits -- and much less income tax from people who would otherwise have been employed in those shops or producing merchandise for them. Whether or not the increased tax on sales compensates for the lost tax on profits and jobs is something that should be contemplated but never is.


Alan Reynolds

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