Hong Kong must not allow its tax policy to be used as a political weapon

Arthur Laffer says any efforts to tinker with it, to pander to special interests, should be resisted

PUBLISHED : Tuesday, 26 August, 2014, 12:05pm
UPDATED : Wednesday, 27 August, 2014, 1:54am

I have oft cited Hong Kong's long-standing flat-rate income tax structure as a successful policy which, if implemented in the US, could dramatically improve the US economy. A flat-rate tax on personal and corporate income, together with all of America's other great attributes, would precipitate a flood of new investment and bring about quick repatriation of significant US funds held abroad.

There are many good reasons why Hong Kong is one of the most prosperous cities in the world, and other financial centres and economies would be wise to learn from its policies. The success of Hong Kong's flat income tax model, dating back to 1947, and similar policies in some enlightened states in the US should give us pause for thought.

Civil servants and governments should carefully consider the impact of allowing tax policy to be used for politicking or pandering. Instead, officials should focus on collecting the requisite revenues needed to run government in the least damaging fashion and spending those proceeds in the most beneficial manner.

Evidence shows that lower tax rates improve economic performance. In every decade since the 1960s, US states with no or low income tax rates have consistently outperformed states with high rates.

We also know that for tax codes to work as intended, they require widespread voluntary compliance from taxpayers. But taxes are a negative incentive - they tell people what not to do. If you tax something, you know you'll get less of it, but you don't know how. Therefore, in order to generate high levels of voluntary compliance, you need to minimise the incentives to avoid taxation.

Remember, jobs and wealth are created by those who are taxed, not by those doing the taxing. Government, by its nature, doesn't create resources but redistributes them. To minimise the damage taxes do to the economy, governments should raise revenue with a low-rate flat tax that provides people and businesses with the fewest incentives to avoid or not report taxable income, and the least number of places where they can escape taxation.

Hong Kong remains a prudent example of this.

The danger with success of any kind is the temptation to tinker with it. In the area of tax policy, sometimes the motivation is an economic one - the perceived opportunity to boost tax revenues; in other circumstances, it is driven by political or even "moral" expediency - so we see fiddling at the margins of a successful system in order to pander to special interests rather than the common interest.

In many cases, tax policy is no longer implemented to raise the requisite revenues in the least economically damaging fashion, but has become a political weapon, wielded to meet all sorts of marginal interests: penalising the rich with increases in income tax rates, smokers with ever higher duties and those who depend on their cars with hikes in fuel taxes.

We have seen this notably in Britain and the US, with the erosion of many of the hard-fought gains of Margaret Thatcher and Ronald Reagan. As the so-called Laffer curve has often demonstrated, at some point, increasing the tax rate becomes counterproductive and leads to a drop in revenue.

Tobacco taxation is probably one of the best - though arguably most contentious - examples of a policy which, even if well-intentioned, very often undermines itself and the broader tax environment. The simple fact is that, if the price differential between legitimate manufactured and distributed goods and those on which no duty has been paid becomes too great, it will encourage black market activity and mass tax evasion.

Few politicians anywhere would campaign on a platform of lowering tobacco duties, but the lessons for those eyeing similar measures on high-sugar and high-fat foods, as well as alcohol, are clear: the market tolerance for such tax increases is limited, and excessive tax increases ultimately prove counterproductive.

Public health objectives are not met when smokers simply switch from tax-paid to smuggled cigarettes while the forgone tax revenues that could have been used to fund public programmes end up in the hands of criminals.

I certainly don't believe that a body such as the World Health Organisation - which is urging governments worldwide to impose tobacco excise taxes of at least 70 per cent - should have a role in the taxation policies or fiscal management of sovereign states. It mirrors a worrying trend at the United Nations, which is attempting to tax air travel, energy use and financial transactions.

Taxation policies are rarely universally liked or endorsed, but as Thatcher once so brilliantly said: "If you just set out to be liked, you would be prepared to compromise on anything, wouldn't you, at any time? And you would achieve nothing."

Dr Arthur B. Laffer is founder and chairman of Laffer Associates. He was a member of US president Ronald Reagan's economic policy advisory board and advised Margaret Thatcher on fiscal policy during the 1980s