Question

Read the following article, which is an abstract from a press release by the Hong Kong Government’s Information Service Department on 11th

October 2017, and then answer the questions that follow.

CE: Tax relief, new convention venues, innovation and technology to boost Hong Kong’s economy

In her maiden Policy Address today (October 11), the Chief Executive, Mrs Carrie Lam, outlined plans to diversify Hong Kong’s economy and create more opportunities for the city.

“While upholding the free market principle, the Government has to actively enhance its role in boosting our economic vibrancy through efforts in various areas, including land supply, talent, government-to-government business, policy directions, investment, business-friendly environment and taxation,” Mrs. Lam said.

Mrs. Lam unveiled new tax measures to reduce the burden on companies, including a two-tiered profits tax system that would lower the profits tax rate to 8.25 per cent – half the current standard rate – on the first $2 million of profit.

“To ensure that the tax benefits will target small and medium-sized enterprises (SMEs), we will introduce restrictions such that each group of enterprises may only nominate one enterprise to benefit from the lower tax rate,” she said. This, Mrs Lam said, would “provide further tax relief to small and medium-sized enterprises”. The standard profits tax rate of 16.5 per cent would remain unchanged for profit beyond $2 million.

In addition, the Chief Executive proposed that the first $2 million in eligible research and development (R&D) expenditure enjoy a 300 per cent tax deduction and 200 per cent for the remainder. A bill to implement the two initiatives will be submitted to the Legislative Council as soon as possible.

(Source: http://www.ird.gov.hk/eng/ppr/archives/17101101.htm)

Required

a State and briefly explain the objectives of a good tax system an d the characteristics it should possess.

b Briefly comment on the proposed measures in the article above by referring to your answer to (a). (You might need to refer to other materials to understand more about the background and to get some basic understanding of Hong Kong profits tax.)

Answer 1

a. A good tax system should have the following objectives

1. One of the most important objectives is to ensure that the country develops economically. This can be achieved through capital growth. Capital growth is largely derived from public/ private investments and tax incomes that the government generates by taxing individuals and corporates. A good tax system would maintain a good balance of savings to the country’s income. Also, it should be ensured that the expenditure is in productive sectors like infrastructure, technology etc.
2. A good tax system should work towards the ultimate aim of 100% Employment. A near complete employment ensures increase in demand for various goods and services. This in turn would help in increased Gross domestic product (GDP) and would further increase the country’s income due to multiplier effect on income.
3. A good tax system should work towards maintaining the inflation rate stable i.e Maintaining stable price of goods and services. The government can decrease inflation by increasing taxes. However, increasing taxes would cause increased personal/ corporate savings and lead to decreased consumption which would be harmful for the economy. Hence a well-balanced tax rate should be used to check inflation but ensure economic growth of the country.
4. A good tax system should minimize the effect of a downturn by decreasing taxes and ensure good tax collections during economic boom period by increased taxations. Also, it should work towards decreasing income inequality. i.e. higher taxes for the rich and lower taxes for the poor
5. A good tax system should work towards a point where the income generated from the countries’ exports is greater that its expenditure on imports. This would decrease the Balance of Payments issues like currency depreciation or currency devaluation.

A good tax system should have the following characteristics:

1. The tax paid by individuals/ corporates is essentially a compulsory contribution and not a voluntary one. The amount of taxes is dependent on various factors like income levels in case of individuals and Profits left after payment of interest in case of corporates.
2. The tax is considered as a responsibility which may be personal or organizational.
3. The tax enables the government to generate income from individual’s income through salaries, dividends, interest etc. and organizational operational profits
4. The tax enables the government to earn income from administration like registration fees levied on registration of births, marriages, corporate registrations etc.; license fees for use of national property, charges levied by the government for welfare of the society etc.

b. Since the press release talks about reduction in the profits tax rate from 16.5% to 8.25% for Small and Medium enterprises(SME) on their first $2 million of profits, the government is essentially trying to reduce the burden of taxes on SME and ensure such enterprises grow.

At the same time the profits tax rate for other corporates have been kept stable. This would ensure good government revenue from tax collections and enhance growth of SME and thereby increase consumption of goods and services by such SMEs.

Also, the press release talks about corporates investing first $2 million in research and development (R&D) activities would get 300% tax deduction and thereafter 200% tax for the remainder of R&D expenses. This would encourage the corporates greatly to invest in R&D for enjoying the tax benefits. This would lead to improvement in productive sectors like technology, health, infrastructure etc. thereby enhancing long term economic growth.