Taxation Systems in Hong Kong
According to the “Final Report to the Financial Secretary” prepared by the Advisory Committee on New Broad-based Taxes set up the Hong Kong Government in 2001, the definitions of three major taxation principles, efficient, effective, and equitable are explained in below. Efficient means a taxation system “must be operationally efficient to minimize compliance cost for taxpayers and administration cost for government”. Effective is defined as a system that is “revenue productive. They should produce the amount of tax revenue required in a timely manner. Revenue yield should be sustainable over time and be insulated as far as reasonably possible from adverse economic cycles”. Equitable means “taxing in proportion to taxpayers’ abilities to pay”. There are two types of equity a tax system should achieve: vertical equity and horizontal equity. While vertical equity concerns with the ability to pay, horizontal equity is about economic neutrality. It means a tax system should have a minimal impact on economic decisions and resource allocation in the private sector. In the following, the merits of the three most common taxation mechanisms, income tax, property tax, and sales tax are analysed in terms of their efficiency, effectiveness, and equitability in application to the local situation of Hong Kong. Income Tax The Hong Kong Government is heavily relied on income tax as the main revenue source. According to Inland Revenue Department, income tax and profit tax account for 69% of the total tax revenue in the fiscal year of 2009-10. Total income tax is composed of salary tax derived from employment domestically, personal assessment, and profit arises from business profit.
Kitman Mok 2 Urban Economics Efficiency Hong Kong is well- known for the simple tax system. With a population close to seven millions, only 1.4 million people in Hong Kong are liable to pay tax. Most taxpayers can prepare their tax returns on their own, because income tax base is narrow and deductions and allowances are few and straightforward. Also, Hong Kong employs a provisional tax system whereas tax is paid in advance in compliance with an estimated tax payable from last year. As Hsu (2001) reports, this practice reduces the administrative cost of filing “pay as you earn” tax that are common in other countries such as Canada and the U.K. Compare to other developed jurisdictions, tax administration in Hong Kong is relatively easy, many transactions costs are avoided. Nevertheless efficiency level is highly depends upon the enforcement effort in reducing tax evasions and avoidance activities. Especially for the profit income gained by business owners, illegal tax evasions and legal avoidances through tax planning may decrease income tax’s efficiency when compare with other sources of tax revenue. Effectiveness Income tax is highly volatile and sensitive to the fluctuation of business cycles. Changes in employment level and salary rate have strong effects on income tax revenue. During recession employment is unstable; hence income tax revenue is affected. On the other hand, profit derived from businesses is diminished during economic downturns. Thus tax revenue from business profit is minimized. As a result, even though income tax contributes a substantial share of revenue when the economy prospers, it is not a reliable source of revenue in a long-run especially when the economic climate is unclear.
Kitman Mok 3 Urban Economics Equitability Comparing with other countries around the world, Hong Kong’s tax revenue is very low in terms of the total GDP composition. While only about one- third of the total labor force is paying income tax, tax rate is progressive which means the higher the taxable income, the higher the tax rate. In addition, in the 2010-11 Budget, the government announced a deduction to allow individuals enjoy a 75 % reduction of total income tax with a ceiling of HK$6,000 per case. This measure further...
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