PROPOSED GST IN HONG KONG: TIME TO PAY THE PIPER?

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 003170 SIPDIS SIPDIS STATE FOR EAP/CM AND EB TREASURY FOR OASIA GKEOPKE STATE PASS USTR USDOC FOR 4420 NSC FOR DWILDER/KTONG E.O. 12958: DECL: 08/07/2016 TAGS: ECON EFIN PGOV HK CH SUBJECT: PROPOSED GST IN HONG KONG: TIME TO PAY THE PIPER? Classified By: Acting E/P Chief Jeff Zaiser. Reasons B,D ¶1. (C) Summary and Comment: On July 18, the Hong Kong Government's (HKG) Financial Services and the Treasury Bureau (FSTB) launched a nine month public consultation on a proposal for a new Goods and Services Tax (GST). Although the proposal has gained some support from economists concerned about the HKG's future ability to meet increasing expenditure needs with its current narrow tax base, most of the Hong Kong public and Hong Kong political parties have voiced strong opposition to the proposed tax. The usually pro-government Liberal Party held an unexpectedly large anti-GST rally on Sunday, August 6, indicating the high degree of antipathy towards the new proposal. The Democratic Party also announced its intention to hold an anti-GST rally on August 20. Given the broad public opposition, there is little chance that the new tax proposal will be implemented, and many of our contacts believe the proposal is "designed to fail," possibly in order to allow the Government to claim that it has listened to the will of the people. End Summary and Comment. What is the GST? -------------- ¶2. (U) The GST as currently proposed by the HKG is a multi-stage indirect value-added tax (VAT) aimed at all forms of domestic consumption, including imports and the sale and rental of commercial properties. Although the tax is ultimately charged against consumers, it differs from a simple sales tax in that the GST is collected at each stage of the production and distribution chain by registered vendors against the value added on goods and services. Under the GST framework, each registered vendor charges GST on its sales (output tax) and can also reclaim credits for the tax paid on its purchases (input tax). The HKG decided to focus on a GST instead of other types of taxes based upon its 2001-2002 report, "Final Report of the Advisory Committee on New Broad-Based Taxes." In this report, the HKG concluded that the GST was the least economically damaging tax that it could use to broaden its tax base. See paragraph 10 for a summary of the main aspects of the current GST proposal. HKG: We Need More Stable Revenue -------------- ; ¶3. (C) According to Financial Secretary Henry Tang, the primary reason for introduction of the GST is that Hong Kong's narrow tax base leaves the Government's revenue flow extremely vulnerable to sudden shifts in the economy. (Note: Most of the HKG's tax income currently comes from property and corporate taxes.) On August 4, Principal Assistant Secretary for Financial Services and the Treasury Vincent SIPDIS Tang pointed out to Econoff that Hong Kong's narrow tax base had led to massive budget deficits during the most severe part of the economic downturn in 2001 and 2002. Although the HKG currently enjoys a significant overall surplus, Tang cautioned that provision of services for Hong Kong's aging population will result in an increasing financial burden. To meet that need, Tang believes the new tax should be introduced now, during an economic boom; if the HKG tried to introduce the GST during an economic recession, Tang said the proposal would be "dead before it started." ¶4. (C) The HKG estimates that the GST will generate 27.9 billion HKD (approximately USD 348 million) per year in net revenue, of which approximately 7.2 billion would be used to compensate low income families. Another 300 million HKD would be allocated to GST relief measures for businesses and charities, bringing the overall increase in Government revenue from the GST at about 20.4 billion HKD in the first year. Despite these positive figures, Vincent Tang acknowledged that the HKG still faces a difficult uphill battle in the court of public opinion. He argued, though, that the GST as proposed would only have a short term impact upon the economy for two reasons. First, the five percent GST would be balanced by reductions in the corporate profit tax and the salary tax. Second, the GST proposal provides for many relief measures and is designed to have a high threshold, five million HKD in business turnover, for mandatory participation in the scheme - a threshold which would allow 90% of all small and medium enterprises (SMEs) to opt out of the scheme. Tang emphasized, however, that the HKG would "never consider" imposing the new tax against the HONG KONG 00003170 002 OF 003 will of the people of Hong Kong, citing the nine-month public consultation period as evidence of the HKG's determination to tread carefully. The Case for GST -------------- ¶5. (C) On August 1, Hong Kong University of Science and Technology Business School Dean and Hong Kong Consumer Council Chairman K.C. Chan told us that Henry Tang has wanted to introduce the GST concept for "quite some time." He said the HKG has actually been under pressure from many prominent economists and advisors, including himself, to broaden its tax base for many years. Because Henry Tang does not actually expect the GST proposal to pass at this time, Chan said he is willing to propose the GST now to mollify advocates of the GST, while avoiding the "political poison" of being the one to actually usher in a new tax. Chan deplored the automatic negative response by the public and the political parties, arguing that the actual negative impact of a new GST would be negligible. He argued that a five percent tax increase would not affect business investment or tourist arrivals in Hong Kong; instead, he believed business investment would continue as long as Hong Kong's underlying economic situation did not change drastically, and tourists would continue to be drawn by Hong Kong's other attractions. ¶6. (C) On August 2, Hong Kong General Chamber of Commerce Chief Economist David O'Rear told us that although he supported the idea of broadening Hong Kong's tax base, the real issue was forcing the HKG to rein in surging government expenditures, which eventually would force the Government to introduce new taxes to generate income. He observed that during the previous recession, the HKG had been forced to spend one-third of its financial reserves to cover budget deficits. If there had to be a new tax, O'Rear believed the GST would inflict less damage on the economy than any of the other options. He dismissed accusations that the GST would be a regressive tax aimed at shifting the tax burden to the poor, pointing out that compensation to low income families included in the GST proposal would result in a "profit" for most of them. O'Rear also claimed that other possible negative economic impacts generated by a new GST would be easily overcome by the new economic activity generated by the proposed concurrent cuts in Hong Kong's corporate profit and salary taxes. The Case Against GST -------------- ¶7. (C) On August 3, Vice Chair Shirley Chan of the Hong Kong Retail Management Association, which represents 500 retail companies employing approximately two-thirds of the total retail workforce in Hong Kong, explained her opposition to the new tax. Aside from the potential damage to Hong Kong's unique "brand image" as a tax-free shoppers paradise, the fact that the proposed GST would complicate Hong Kong's simple and attractive tax system would drive away many prospective investors in Hong Kong. Chan also pointed out that many retail shops would incur a significantly heavier tax burden, even while they were forced to hire more personnel to handle the additional administrative procedures involved in collecting and refunding (to tourists) the GST. Chan also doubted that the HKG would have the political will to actually slash the corporate profit tax, as most corporations were satisfied with the current corporate tax rate. Finally, Chan said her greatest concern was that Hong Kong would follow the trend of all other countries that have introduced GSTs and succumb to the temptation to repeatedly raise the tax rate. ¶8. (C) Most of the major political parties in Hong Kong, including the generally pro-government Democratic Alliance for the Betterment and Progress of Hong Kong (DAB) and the Liberal Party, have publicly opposed the GST proposal. On August 3, Liberal Party wholesale and retail sector representative Vincent Fang Kang, who is Chairman of the newly-formed Coalition Against Sales Tax, told Econoff that despite the narrowness of the tax base, the current tax system has worked well for many years. Many years of budgetary surpluses have given the HKG financial reserves of approximately one trillion HKD (approximately USD 125 billion),and he therefore saw no need to expand the tax base HONG KONG 00003170 003 OF 003 "any time soon." He also observed that most countries using a GST, such as the United Kingdom, still continue to run budget deficits despite their high VAT rates. He also suggested that the extra paperwork costs and bureaucratic hassles of a new GST would encourage businesses to relocate to China or Macau, effectively "killing" Hong Kong's competitiveness as a hub for logistical services. Anti-GST Rally -------------- ¶9. (C) On August 6, Fang and the Liberal Party organized a rally to demonstrate the public's opposition to the new GST. They claimed that up to 6,000 people from more than 70 trade organizations participated, although the police estimated the crowd at approximately 3,000. Liberal Party vice-chairperson Miriam Lau said the large turnout was unexpected and that the Liberal Party would continue to campaign against the GST in coming months. The Democratic Party stated that it would launch a city-wide signature campaign against the GST on August 13 and would organize its own anti-GST rally on August ¶20. Summary of GST Proposals -------------- ¶10. (U) Summary of GST Proposals: - The GST rate should be a low and uniform rate. - The registration threshold for businesses will be an annual turnover of HKD 5 million, thus excluding most small and medium enterprises. - The tax base will be road based (what does this mean?) and provide for few exemptions, thus keeping down the costs of compliance for businesses. - There will be no special treatment for food, health, education, or e-business, to minimize complexity. - Export goods and international supplies will be "zero-rated," in other words functionally exempt from the GST to maintain Hong Kong's competitiveness as an international trading and logistics hub. - The HKG will implement a Tourist Refund Scheme (TRS) to refund GST to tourists who spend at least HKD $1,500. - Financial services will be mostly exempt from the GST. - Commercial property sales and rentals will be covered by the GST but residential sales and rentals will be exempt. - A Deferred GST Payment Scheme (DGPS) and Qualifying Exporters Scheme (QES) will be set up to mitigate upfront GST costs on traders at the time of importation. - Non-profit organizations and charities will be able to register for the GST so they can reclaim input tax on GST charged against them for purchases they make but will not be compelled to register for the scheme. - The HKG will be regarded as a "taxable person" to enable it to reclaim input tax; HKG commercial and non-regulatory activities would also be taxable to maintain a level playing field between the HKG and the private sector. - Transitional rules will be drawn up to mitigate the immediate economic impact of GST upon its implementation. Sakaue