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Tsang is breaking his tax cut pledge at the very worst time

SCMP – another broken promise from a Colonial era bureaucrat used to taking orders rather than making them

The chief executive’s back-pedalling on a vow to lower the city’s profits tax makes no sense when the government is running surpluses and sitting on huge reserves

It looks as if Donald Tsang Yam-kuen is going to renege on his promise to cut corporate taxes just when a tax cut is most affordable and exactly when it could do Hong Kong the most good.

It seems a long time ago now, but back in 2007 ahead of his re-election as chief executive, Tsang promised to cut the city’s profit tax rate to 15 per cent.

“If there’s economic growth, the chance of having tax cuts … is much higher,” he said at the time.

Since then Hong Kong has enjoyed growth, strong growth. Assuming the city’s economic output grew 5 per cent last year in line with the government’s November forecast, Hong Kong will have clocked up an average annual growth rate of 3.6 per cent in the five years since Tsang made his promise.

That might not sound much, but 3.6 per cent counts as rapid growth for an economy as developed as Hong Kong. And when you consider that the last five years have seen the worst global financial crisis and economic slump since the Great Depression of the 1930s, then by any reasonable measure Hong Kong’s economy has been steaming ahead at full speed.

But although Tsang did reduce the profits tax from 17.5 per cent to 16.5 per cent in 2008, it now looks as if he is going to welsh on his promise to cut the rate further to 15 per cent before he steps down in June.

“It’s hard to meet my vow to cut corporate tax,” he said in a radio interview yesterday. “We may see the emergence of a worldwide recession. So it’s hard to have room to do such a thing right now.”

His reasoning reveals an economic rationale so contorted, it is hard to believe Tsang was once reckoned one of Hong Kong’s stronger financial secretaries.

Sure, in Western Europe or the United States, the prospect of a recession makes it harder for governments to cut taxes. That’s because in a recession the unemployment rate rises, pushing up the cost of government welfare payments even as the overall tax take falls because of slowing activity.

As a result, government deficits soar. Tax cuts would only exacerbate the problem, pushing debt levels even higher.

But Hong Kong is an altogether different kettle of fish. The city is entering this downturn with what most developed economies would consider full employment. The government has few social security obligations; welfare payments make up a negligible portion of its expenditure. And it is not running a deficit, but a handsome surplus.

As the first chart shows, Hong Kong has consistently run budget surpluses for the last seven years. And according to accountants PricewaterhouseCoopers, it will turn in another for the financial year ending this March, recording an estimated surplus of HK$30 billion.

What’s more, the government has plenty of fiscal firepower in reserve. As the second chart shows, at the end of November it boasted accumulated fiscal reserves of HK$617 billion. Added to the exchange fund’s accumulated surplus of HK$567 billion, that means there is a whopping HK$1.2 trillion of spare cash in the kitty.

So it’s hard to see why Tsang thinks there’s no room for a tax cut right now. In fact, with plentiful reserves and a global slowdown looming, this is exactly the time that the Hong Kong government should be considering a little counter-cyclical tax reduction to stimulate economic activity.

It would be little, too. Last year the government collected HK$93 billion in profit tax. A reduction in the rate from 16.5 to 15 per cent would have reduced that take by roughly HK$8.5 billion, or just 2.2 per cent of overall revenues, barely enough to dent the budget surplus.

Granted, in a downturn a cut in corporate taxes coupled with the likely slump in property-related revenues could push the government’s budget into deficit.

But, as we’ve seen the government can afford to go into the red for a while and a downturn is exactly the time when it should be running a deficit.

A reduction in the profit tax in next month’s budget would boost business confidence, support economic activity and enhance Hong Kong’s competitiveness.

It’s what the city needs. Tsang should keep his promise.

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