SPECIAL REPORT: THE FLAT-TAX PROPOSALS : Flat-Tax Backers Look Closer at Hong Kong’s Taxation System

Aside from the tiny oil-rich kingdom of Brunei, whose subjects don’t pay any income tax, Hong Kong’s simple levy may be the best deal going. And U.S. proponents of the flat tax, now making their rounds in Washington, are taking a closer look at the system here, where most taxpayers pay a top rate of 15%, corporations pay a flat 16.5% and capital gains are tax-free.

The system here is not a flat tax, but its simple approach has numerous parallels to the ideas being advanced in the United States.

More than half of Hong Kongers pay no income tax because they earn so little. Only those who make more than $60,000 a year--the majority of those who pay taxes--pay the top rate in a simple, four-step system that starts at 2% on income of $10,000. The only other levies are an inheritance and a sin tax.

The majority of the territory’s revenue come from the wealthiest 5%--and even at the low rate, their contributions are enough to support Hong Kong’s admittedly modest spending and leave a healthy surplus.

“In pure taxation terms, it’s as perfect a system as an economist could want,” says Jim Rohwer, chief economist at Credit Suisse First Boston and the author of a bullish book on the region, “Asia Rising.”

Of course, Hong Kong isn’t the United States. The colony has enjoyed a decade-long boom. There is no military to speak of, no Social Security and only a modest welfare system. Nor is there any wealth-sharing philosophy driving the tax system, which is designed simply to collect revenue.

But it seems to work well for Hong Kong, and advocates insist that the basic and straightforward approach would be a blessing for any government.

Come budget time, when most governments are grappling with deficits, the territory is pondering how to spend its surplus. Its reserves are nearly $18 billion, and economists project that when China reclaims the territory in 1997, Hong Kong will have $45 billion or so in its coffers.

China will inherit a treasury that Chris Patten, Hong Kong’s last British governor, calls “the largest dowry since Cleopatra.”

The tax system’s biggest virtue here is its simplicity. The tax form is larger than the symbolic postcard that U.S. Republican presidential candidate Steve Forbes waves on stump speeches--but not much.

Hong Kong accountant Edwin Liu can fill out the four-page form in 15 minutes, he says, though it probably takes the average person half an hour.

“The tax system is too simple. I can’t make a living just preparing tax returns, so I have to do this,” says Liu, presenting a name card listing eight companies he has started, including an employment agency and a business center.

His card is as potent a symbol of the virtues of the low-tax system as the postcard-size return. A low and simple tax, analysts argue, stimulates growth by keeping more dollars invested in the economy and rewarding savings.

“It keeps the economy motoring along to increase profits and salaries,” says Ian Perkins, chief economist of Hong Kong’s General Chamber of Commerce. “And it encourages an entrepreneurial culture. I would think twice about taking that second job or starting a second business if I had to pay half my profits to the government.”

Hong Kong’s engine is certainly purring. The economy grew 4.5% last year--its 30th straight year of expansion. The boom, of course, owes much to the territory’s thriving trade with China, which has also had a decade of double-digit growth.

But the tax policy creates a virtuous cycle, many economists say. And the low tax rate makes it a magnet for international businesses that only have to pay levies on money made in Hong Kong itself, unlike the U.S. tax system that in some cases takes a cut of every dollar earned worldwide.

That impressive growth, coupled with a conservative fiscal policy, has been a formula for success. The British-run bureaucracy is relatively streamlined compared with the U.S. government; its motto is “Hong Kong must live within its means.” The government sets aside funds for social programs and infrastructure projects and doesn’t spend money it doesn’t have.

“We try to keep it as pure as possible,” says Allan Gill, deputy commissioner of the Inland Revenue Department. “The idea is not to redistribute wealth or to subsidize industry.”

That fiscal philosophy is the fundamental difference from the current U.S. system, which actively aims to share the wealth. “In Hong Kong, it’s a pure revenue-raising device separate from the decision-making process,” says economist Rohwer, describing how the lobbying of interest groups in the U.S. causes “immense distortions.”

His recent book partly ascribes the region’s rapid ascent to authoritarian governments that give priority to economic development over social payoffs--the popular demands of a democracy are bad for the budget.

The main criticism of Hong Kong’s system is that it skimps on social welfare, exploiting a Confucian tradition that calls for adult children to care for their parents so that the government doesn’t have to. Still, almost half of Hong Kong’s citizens now live in subsidized housing and receive help with education and health care.

“Our welfare system isn’t regarded as particularly generous,” concedes Inland Revenue’s Gill, explaining that social spending takes up just 7.3% of the budget. In a belated effort before the 1997 hand-over, the government recently expanded some social programs and instituted a mandatory pension plan.

[When the pension plan was announced in October, communist China, which has been eyeing Hong Kong’s fat reserves, accused it of “creeping welfarism.”]

But plenty think it’s not enough. Of six elderly men clustered around a mah-jongg table in a public park, five say they will go home to a room in their children’s apartments. But one will sleep in a wire-mesh box in a men’s dorm occupied by “cage men.”

“There’s no one to take care of me,” he says with one finger on a mah-jongg tile, looking for the next move.

The cage man says he hopes to get some help from a local church, and indeed charitable donations are one of the few allowable tax deductions.

Homeowners get no relief for mortgage payments, unlike those in the U.S., and housing costs, driven artificially high by premiums on land and construction, constitute a hidden tax.

But overall, Hong Kong taxpayers seem to think the system is fair, and prove it in the ultimate test--they pay their taxes.

“The more complicated you make it, the more ways there are to abuse it,” tax official Gill says. He notes that there will always be evaders, but at 15%, it’s not worth it to hire high-priced accountants to find loopholes.

“The world over, people want to pay as little as possible,” he says. “We try to help them out.”