What are the characteristics of a good tax system? Discuss the advantages and disadvantages of the introduction of a broad-based consumption tax in Hong Kong.

Q: What are the characteristics of a good tax system? Discuss the advantages and disadvantages of the introduction of a broad-based consumption tax in Hong Kong.

Introduction

From the fiscal year 1998 to 2002, Hong Kong recorded deficit budgets. The former Financial Secretary, Mr. Donald Tsang, projected that the deficit will continue for the next three years (ACNBT, 2001). To alleviate the situation, the Advisor Committee on New Broad-based Taxes (ACNBT) was established to consider and recommend new taxes for Hong Kong so that it can widen the tax base to increase its sources of tax revenue and fiscal incomes. In August 2001, the ACNBT distributed a consultative document titled “A Broader-Based Tax System for Hong Kong”. The ACNBT raised nine options for the new taxes. Among all of them, the “General Consumption Tax” was being highlighted as it could yield $18 billion tax revenue by imposing a 3% tax rate.

In this essay, I would like to first discuss the major characteristics of a good tax system. Then I will define what ‘broad-based consumption tax’ is. Finally, I will assess both the advantages and disadvantages of introducing this new tax in Hong Kong. In fact, in the essay, I am not intend to create any new idea, but just to argue against the introduction of the consumption tax in Hong Kong

Criterions of a Good Tax System

The basis upon which we judge whether or not a tax system can be considered desirable must include several factors. It is essential if a particular tax is capable of raising sufficient or required amount of revenue. A very narrowly based tax, such as one that applied only to Coca-Cola, would very likely to be ineffective. By consuming Pepsi, people could easily avoid the tax. In this case, the revenues collected by the government might actually fall to zero even if the tax rate per each can of Coca-Cola were set quite high. Government, therefore, tend to rely on broad-based taxes to generate their needed income.

Another criteria of a good tax system lies on its fairness or equity. A tax system viewed by people as unfair, or evil, will be resented. Such a situation will not only make the job of government difficult, it can even lead to rebellion. Yet, it is better to have a flexible and dynamic tax system so as to ensure that they keep pace with technological and commercial development. For instance, taxpayers in Hong Kong can choose either pay by credit card, cheuqe or telephone.

For a tax system judged be good, compliance costs for taxpayers and administrative costs for the tax authorities should be kept minimal. Meanwhile, The tax rules should be clear and simple to understand so that the taxpayers can anticipate the tax consequences in advance and knowing when, where and how tax is to be accounted.

This is a preview of the whole essay

There is much concern on equity in the tax system. A tax system, basically, is a major means of effecting redistribution. This occurs first by ensuring that taxes are raised in an equitable manner, and second by using the tax revenues on the expenditure side of the government budget to provide cash payments and goods to low income people. Equity could be enhanced by two main concepts, namely, horizontal equity and vertical equity (Murdoch, 2003). The former refers to those with equal fiscal capacity should be treated (taxed) equally, while the latter means that people with different fiscal capacity should be treated (taxed) unequally and this refers to a progressive tax system.

Last but not least, tax neutrality is one of the good taxation principles raised by OECD. It means that as far as possible, the relative price between two commodities should remain unchanged after the imposition of tax. One typical situation in which tax neutrality is possible is the case that the market supply is totally inelastic. Ins such case, the resource allocation, relative price and market choices will not be distorted.

Background Information of Consumption Tax

“Consumption tax is an excise tax levied in additional to Value Added Tax (VAT) on a limited range of goods, primarily luxury items”, Hong suggested (1995, p. 24). It is intended to be passed on from the merchant who actually carries the tax receipts to the statehouse, to the consumer who enjoys the goods and services upon which the tax has been placed.

The imposition of consumption tax has been a recurrent theme in the past decade. As early as May 1989, the Finance Branch of the Hong Kong SAR government issued a consultation document called “Consultation Paper on Sales Tax”. The consultation document proposed to broaden the tax base in Hong Kong through the introduction of a broad based Wholesales Sales Tax. It mainly emphasizes on the weakness of the existing fiscal structure that building on a narrowed tax base. In 2000, the ACNBT recalled the introduction of the consumption tax as one of the options to broaden the tax base and the tax was suggested to be applied on all goods and services.

Advantages of Introducing Consumption Tax

The ACNBT analyzed the comparative advantages of imposing the Consumption Tax in terms of broadness, neutrality, fairness, revenue yield, effectiveness, efficiency, international competitiveness, flexibility, certainty and simplicity. These advantages will be elaborated in the following.

Since the general consumption tax will be taxed on personal consumption, everyone needs to pay whenever he or she consumes. Thus, the scope of the tax is very broad and it is relatively difficult to evade from the tax. Meanwhile, it meets the criteria of neutrality as the consumption tax will be imposed on almost every aspects of consumption rather than on a particular item. In addition, the amount taxed is according to one’s spending capacity. In order words, a person will be taxed more as he or she consumes more. Therefore, the imposition of consumption tax can achieve the aim of fairness.

If 3% of consumption tax is imposed on almost all personal consumption, it is estimated that the tax will bring additional $18 billion or even more to the tax revenue in Hong Kong. Relatively speaking, 3% of consumption tax is considerably mild, neither will it cause a serious economic distortion nor weaken the international competitiveness of Hong Kong. Moreover, it is flexible, certain and simple to be applied on different situations. With its high flexibility, undoubtedly, the tax can adapt to the changes in both business practice and technology so as to bring stable revenue to Hong Kong government. As a whole, in terms of revenue yield, effectiveness, efficiency, international competitiveness, flexibility and certainty and simplicity, the consumption tax have these potencies to be the most appropriate method to broaden the tax base.

As far as the potencies concerned, the ACNBT have confidence towards consumption tax that can be the most appropriate method to broaden the tax base is the experience from other countries. According to KPMG Australia (KPMG, 2001), it reported that consumption tax accounted for 18% of the tax revenue and 7% of GDP in the OECD Benchmark in 1998. It also accounted for 12% of tax revenue and 3% of GDP in the Asia Pacific Benchmark. However, Hong Kong is the only developed country which does not practice taxes on general consumption.

Negative Impacts of Introducing Consumption Tax

First, citizens may be unwilling to consume in Hong Kong if they do not support the tax. As such, the tax cannot be collected successfully and the government is unable to receive enough revenue. When Singapore introduced its own 3% GST in April 1994, for instance, retail sales sharply decreased by 11% in the following quarter. So it is predicted that imposition of the consumption tax Hong Kong would decrease the local consumption intention of local citizens.

It is believed that there will be more citizens shift their consumption towards China as the tax imposed. Most, but not all, of the people expressed that the imposition of consumption tax in Hong Kong would lower their consumption intention and they would increase their frequency and expenses of consuming and shopping in China.

The price level in Hong Kong will definitely be raised up, stagnate the local consumption and affects the retail revenue if the consumption tax is imposed in this crucial time. It will further weaken the competitive power of the local retail market. Therefore, imposing the consumption tax would be a stumbling block of the local retail market’s recovery (Hong Kong Economic and Trade Association, 2000).

Consumption tax rate is the same among both the poor and rich groups. So it is regressive tax in nature. The tax amount bone by the lower income groups would be relatively greater than that by the higher income groups in terms of income. It will greater the burden of the poor group, especially under this poor economic condition. As a consequence, it will eventually widen the income gap between these two groups and income redistribution effects will be resulted (Gentry & Hubbard, 1997, p1).

Conclusion

There is no doubt that the imposition of consumption tax can stabilize the income source as well as to increase the government financial income which can solve both structural operating deficit and cyclical operating deficit. Most importantly, imposing consumption tax can benefit the financial status in the future.

Nevertheless, it is advised that consumption tax should not be imposed in Hong Kong at present. As mentioned above, it is not a wrong time to impose and there are numbers of undesirable impacts followed. So the government has to consider deliberately before having any planning or action.

Strictly speaking, imposing consumption tax cannot effectively solve the problem of narrow tax base as the extra tax revenue from general consumption 3% consumption tax is not able to cover the huge expenditure and deficit of the government. With a serious financial deficit, the most important thing for the government to do is to minimize or reduce her expenditure to avoid inefficient use of resources and to improve the value for money. For example, cutting the salary of civil servant by 4.75% can save $6 billions in a financial year. Not only does it alleviate the deficit problem, but reduce social discontent towards the government also.

Bibliography

Anonymous 2003 “Notes on Taxation Principles and Policy”, in the unit reader C281 Public Sector Economics, Murdoch University, Perth.

Advisory Committee on New Broad-based Taxes, HKSAR, Consultation Document: A Boarder-based Tax System, August 2001

Gentry, W. M. & Hubbard, R. G (1997) “Introduction”, Distributional Implications of a Consumption Tax, AEI Press, Washington. pp. 1 – 4.

Hong, L. F. 1995 “People’s Republic of China: Value Added Tax, Consumption Tax and Business Tax”, Bulletin for International Bureau of Fiscal Documentation, January.

KPMG, “Tax-Base Study ”, 2001