Don’t fall for the fallacy – HK needs a NARROWER tax base

In view of recent reports of HK fiscal deficits, the pundits are yet again out in force, staging the tired chorus (including the organisation never engaged in any profitable enterprise, the IMF) of how HK’s tax take is too volatile and we should reform to ‘broaden the tax base’ and so on and so forth, to the point that even the HKSAR govt has been hypnotised into starting its own initiative looking into this most unsuitable direction to take for an open economy which survives on being a ‘super connector’ (this is the HKSAR’s own term!) of people, goods, capital, and ideas:

Figure 1: resist the temptation Chief Executive Lee, stay narrow and stay competitive

To illustrate the point more explicitly, we have compiled the total number of levies in the key subcategories of taxation for a number of jurisdictions (HK vs Singapore and Switzerland as small open regions, and Australia and UK as traditional OECD large economies). What is clear from the exercise is that the fewer taxes levied in an economy, the higher the economic growth, and vice versa:

We further collected all the government revenue information of the same jurisdictions and put them in the same general groupings but shown in proportion of total revenues.

It is worth quickly explaining what the tax groupings are:

a)     direct taxation on people’s economic activities – ie tax on income, profits & capital gains;

b)     indirect taxes, in the following activity groupings:

1.  taxes levied on labour market activities (eg payroll taxes, royalties);
2.  taxes on property transactions (mostly stamp duty and rates);
3.  taxes on consumption (ie GST, VAT, plus vehicle and insurance taxes);
4. traditional social engineering levies (the so called sin taxes on gambling, alcohol, tobacco);
5. new social engineering levies (all the woke and communistic charges that became so popular in recent years, such as climate change tax, carbon credits); and
6. border related tariffs/duties (besides traditional tariffs we also include airport taxes – essentially a charge on foreign people crossing borders).

We argue below how careful design of tax regimes can serve as important factors in promoting the competitiveness and economic vibrancy of an economy, and how the proportions need to be adjusted as policy priorities that all governments should pay attention to.

Open free economies tax less on income

What jumps out from the charts below are that Hong Kong and Singapore rely on significant land sale revenues (dark red in Charts 1 and 2) as their fiscal income, which helps when both are amongst the most expensive property markets in the world!

Further, HK’s simple and low tax regime as an advantage is also clear – 4 of the tax categories had nil, or near zero incomes, making it low friction for commerce, and less cumbersome administration of the same taxes as would be the case in other countries. Singapore is less simple but still has one near-zero intake category (thankfully the ‘new social engineering’ group).

Finally, both city economies have much lower direct tax takes – with HK at 49% and Singapore an even lower 42% (dark blue area) – thus rewarding work and enterprise more than their bigger competitors:

Chart 1: HK govt income – low on direct taxation

Chart 2: Singapore GST helps reduce other tax burden

In the other extreme, UK’s takes more out of income (66% of tax revenue is from income/profit taxes) than all the jurisdictions in our study; of what is left in the tax payer’s pocket, the UK takes a larger slice through consumption taxes (19.8% of tax take vs Australia’s 11.1%, light green in Chart 4) than the other countries. Besides higher tax on income and consumption, the UK also has the most number of headings under which it taxes its people, making it even more unpalatable for the average wage earning tax payer:

Chart 3: Percentage of Tax Revenue Breakdown in Australia

Chart 4: Percentage of Tax Revenue Breakdown in UK

Isn’t it ironic therefore that the proponents of ‘broader tax base’ are heeding the preachings coming from largely high tax jurisdictions?

Can HK cancel income/profit tax and levy sales tax instead?

The USA did not have income tax until the 16^th Amendment was passed in 1913, before that Article 1, Section 9, Clause 4 of the US constitution forbade direct taxation explicitly. The fact that this provision was inserted in Article 1 of the constitution is significant evidence that the founding fathers did not intend the state to infringe on the freedom of the people to generate and keep their own wealth.

HK’s situation is perhaps also conducive to a move away from income taxes – by virtual of its vast trade and re-export flows, immense tariff or sales tax intake could be achieved without burdening either its wage earning population, or profit making enterprises.

The other advantage of a move from income tax to sales tax is the more stable income stream compared to volatile sources such as land sales and even income/profits taxes.

Theoretically speaking, private consumption expenditure, when taxed at a mere 10% tax rate on 80% of total consumption can already generate HK$188billion of revenue (Table 2):

Table 2: Theoretical sales tax collectable for various tax rate scenarios

Table 3: Sales tax at 14% on 80% of consumption more than covers all income tax and corporation tax takes

In other words, Hong Kong can collect enough sales tax with a rate of 13.5% on 80% of private consumption expenditure to cover all the income and corporation taxes foregone if we were to make such a transition tomorrow.

Revisiting study: less income tax leak = more economic growth

In our earlier research looking at tax composition amongst US states, it was clear that more sales tax than income tax allows people keep more of their wealth, and is better for ecnomic growth, and similarly giving individuals equal or better treatment than company also engenders prosperity (the study can be seen here – English: web, blog, linkedin, facebook; Chinese: web, blog, linkedin, facebook).

Adopting the same analysis in the prior study, we now add our five candidate tax regimes to the study, by plotting them on the same two measurements:

1.    sales tax less income tax (x axis) – higher value means consumption rather than savings are being taxed, thus encouraging investment for longer term;

2.    income tax less corporation tax (y axix) – a low reading indicates either there is a booming corporate sector or individuals get to keep more of their salaries.

Below chart shows that with current tax compositions, HK and Singapore (near the red states) are better positioned than Switzerland/Australia/UK which are situated in the more oppressive quadrant (amongst the purple states) of the original distribution:

Chart 5: lower income tax for HK/SGP suggests better economic prospects

Then if we replace all HK income/corporation taxes with sales taxes as outlined above, HK’s position improves massively – becoming the jurisdiction furthest right in the study universe (right hand red diamond, Chart 6) and leaving Singapore well and truly in the dust:

Chart 6: by replacing income/corporation tax with sales tax, HK beats all US states on tax attractiveness

The above scenario places Hong Kong very much near (if not at) the top of the (Sales Tax – Income Tax) axis amongst the 130+ countries in the world collecting sales taxes. By abolishing the income and corporation taxes, Hong Kong’s global competitiveness and attractiveness for almost all global companies and high income talents, not to mention vast amounts of tax refugees in developed countries where simply being rich is a sin, and having income anywhere outside the country’s borders is a reason to be taxed.

 

Given the significant benefit of not just economic attractiveness, but also a massive reduction in administrative burdens that the whole tax collection bureaucracy brings with the income/corporation tax regimes, improvements in citizen’s privacy standards (no need to declare what, how, and when you earn your incomes), Hong Kong can truly become a beacon of freedom and commerce. Chief Executive Lee and Financial Secretary Chan should ignore the cacophony of calls from vested interest groups calling for ‘boradening tax base’ including accountants, regulators, and academics, whose livelihood only improves if we have complex and oppressive tax systems, for it is they who get work / compensations when we go down that road. HK deserves better.

 

The author would like to thank Tia Yik Ethan from The University of Hong Kong majoring in Finance for assisting in data collection, analysis, and drafting of this article.

 

Which US states are tax friendly… and cheap? 20220930

 As interest rates spike and cost of living crises bite across the world, it is even more important now to choose one’s investment (or living) destinations carefully. On top of the usual comparisons of tax rates between jurisdictions (see earlier article “LowerUS State Tax Drives Population Inflows, Home Price Rises”), this article employs a slightly different angle – the composition of tax takes between host governments. We undertake this exercise using Tax Foundations’ data which breaks down state tax income by four main components: corporate income tax, individual income tax, sales tax, and property tax.

Preferring low income tax and fair individual-corporate balance

For most income earning job holders who may also be home owners, it may be reasonable to assume that they prefer paying lower income tax. On top of that we would also assume that when individuals are paying similar (or lower) levels of tax compared to companies, the smaller guy (individual) would be getting more fairly treated or allowed more individual liberty.

One way to quantify these preferences is to plot these preferences on a scattergram using two measurements:

1. Higher sales tax take vs income tax – meaning more of the government’s income comes from consumption rather than savings, thus encouraging investment for longer term if not implying low absolute income tax rates, this is captured below on the X-axis;
2. Lower individuals tax than corporates – put another way, this state of affairs results either when there is a booming corporate sector (leading to higher corporate income taxes) or when the resident individuals get to keep more of their salaries/profits instead of just the big corporates being able to do that (as they have the clout/resources to negotiate/threaten govts into large tax concessions) – this metric is captured on the Y-axis:

Chart 1: higher sales & corporate tax takes vs individual taxes are ‘good’, and vice versa

The spread of the scatter is surprisingly linear, and we have highlighted the ‘desirable’ end of the spectrum in red – states that fall into this category include: Texas, Wyoming, Nevada, Washington, South Dakota, Tennessee, Florida, Alaska and New Hampshire.

On the other extreme (the high individual tax states) we have these ‘bad’ states in purple: Oregon, Maryland, Massachusetts, and Delaware, Virginia, and New York.

States with low income tax AND low property tax

For property investors, lower property tax burden is also an important consideration, so this is what we did next - bombining the two metrics from last section into one (now represented by % sales tax + % corporate tax - % individual tax x 2), and then comparing the result to the proportion of state tax income from property. The results are shown in the chart below:

Chart 2: winners from last section which are also low property tax states – represented by red text in orange shade

The results are interesting – the number of states that meet both low income tax and low property tax criteria now falls, with Tennessee, Nevada, Washington, South Dakota, now the remaining front runners and Florida just scraping in. A new entry however has popped up in the form of New Mexico (represented as N.M. above), which has one of the lowest property taxes (plus great weather) so may well be a good choice too for investors who are not earning a big income? On the opposite end of the spectrum (unfavourable individual tax states), Delaware has lower property tax burdens also, but probably not ideal for the average middle class property owner given its reputation of being a corporate tax haven… the other regulars which score badly on both fronts are Oregon, MA, and Montana.

Internal migration proves thesis right

To prove our hypothesis that the above identified low tax states are indeed attractive, we take a look at how domestic migration played out in recent years. As a percent of state populations in 2017, we look at the proportional net internal migration numbers and use this statistic as a proxy for how people either flock to, or flee from individual states. Here are the results

Chart 3: Low tax states attract population inflows

Perhaps not surprisingly, our ‘attractive’ states (in red text) invariably saw net domestic migration versus the high tax states (purple text) seeing outflows. So our top 3 states (from Chart 2) are also states here with the highest population inflows (Nevada, Florida, Tennessee), whereas the bottom states also saw meaningful outflows (Maryland, New York, and MA).

Housing price to income ratio

To add icing on the cake, cities from some of our top states also appear on the cheapest housing market list – according to the 2022 Numbeo home price to income ratio rankings, the good affordability cities (ie with low multiples and high rankings) seem to feature our top states from the foregoing analysis, while the reverse seems to be the case for the expensive cities. In the chart below, the number in brackets after the city is the ranking number out of 40, and the colouring follows the same scheme we have used in the earlier charts:

Chart 4: Home price to income ratio – affordable tax states also have affordable homes?

This may sound too good to be true, but if the trend of continuous inflows persist, perhaps the cheap home price states will not stay cheap for long…

 

 

The author would like to thank Jasper Tan Cheuk Him from The University of Hong Kong majoring in Economics and Finance for assisting in data collection, analysis, and drafting of this article.

Lower US State Tax Drives Population Inflows, Home Price Rises

Posted on 9th December, 2019 Stand News :

We have discussed how Hong Kong’s low tax reputation was increasingly at risk as even large economies have caught up in lowering their top tax brackets in recent years (see HK govt complacency losing out in competitive tax cutting). One of the most aggressive of these being the USA under the pro-business Trump administration.

In this article we explore further how the intra-USA tax competition is panning out and how this may impact property prices in the longer term.

Lower corporate tax leads to more employment

Looking at the current top corporate tax rates amongst the US states, it is possible to reach a conclusion that those states with low tax rates may be enjoying large growths in populations as companies move their activities to these jurisdictions.

In our study in the rest of the article, we will focus on several poster-child states, namely Texas, Delaware, Florida (known for lower taxes), as well as California, New York, and Illinois (famed for more regulations and higher burden for the corporates). These will be coloured orange in subsequent charts.

In low corporate tax states, such as Nevada/Washing/S Dakota (marked green), population growths reached as high as mid teens over the past ten years (2010-2019), compared to the high tax states (marked red) with low single digit growth or even falls (eg Illinois):

Chart 1: low tax leads to population inflows

Individual taxes also impact population movements
Just having lower corporate taxes may not be enough, as take-home pay for the employees will also impact on the desire of people to stay or leave a state. We therefore looked also at tax burden on residents, which measures all state and local taxes, and specifically, property taxes, income taxes, and sales and excise taxes.

The outcome of the study are equally persuasive, with our highlighted low tax states again featuring high population growths (Delaware, Florida, Texas), whilst the high tax burden states New York, alongside Hawaii & Maine seeing anaemic increases over the same decade:

Chart 2: High tax burden (as of 2019) resulted in lower population growth

Changes in tax rates an easy policy tool to spur growth?
So which states have done the most to attract immigration? Delaware and Florida (within our highlight set) seemed to have done the most, and indeed achieved the best results, compared to Hawaii and Louisiana on the other extreme, resulting in minimal growth in the number of residents over a decade:

Chart 3: Tax cuts attract, hikes repel

So here may be the best guide for anyone contemplating moves, be it for jobs, studies, or even retirements, the lowest current state of tax burdens in descending order:

Chart 4 : Tax burden by states 2019 vs National average tax burden 2019

Other personal reasons aside, it seems our highlight states of Delaware and Florida should be on most mover’s consideration list, whilst even those in jobs or studies now may want to think twice fore remaining in places like New Yor and Hawaii?

Immigration – housing demand – home price outperformance
The natural conclusion from the above studies must be that, for property investors, level of taxes would have a bearing on the performance of home prices, and tax cuts should lead to outperformance.

Again, the states with tax cuts over the past decade (eg, Florida) saw some of the best home price increases, whereas Louisiana and Vermont were much more modest in their price action over the same period:

Chart 5: low tax seem to benefit home prices too

So in conclusion, property investing may benefit from buying in accommodative tax jurisdictions and even more in jurisdictions where large reductions in tax burdens are being implemented. This is certainly a lesson for Hong Kong, where our globally competitive low tax advantage has now become almost non-existent, when the power hogging administrators prefer taking the money from the people first and then return little favours in the form of the so called ‘Economic Relief Measures’.

Finally, here is the map view of the US population growth rates, with the names of the states coded in high to low tax change colours:

Chart 6 : high population growth (deep blue) coincides with bigger tax cuts (green texts), and vice versa for lower tax cuts (red texts)

The author would like to thank Christy Leung of City University of Hong Kong for assisting in data collection, analysis, and drafting this article.