Flat Tax
Principles and Issues
5 International evidence
There is a void in the debate about the applicability of a flat tax on income to Canada: the debate is exclusively theoretical. Opponents of the flat tax foretell fiscal doom-and-gloom should the allegedly untested flat tax ever be introduced as an instrument of public policy. The demonstrated successes of the flat tax, however, are usually ignored and this section attempts to fill the void.
For several decades, various jurisdictions have operated their highly successful fiscal policies on the basis of a flat tax. Both Hong Kong and the Channel Islands have largely insulated themselves from the mediocre, frequently poor, performance of most Western economies, in no small measure, by implementing tax systems characterized by fairness, simplicity, and efficiency.
Hong Kong
On July 1, 1997, following 150 years of British administration, the city-state of Hong Kong became a Special Administrative Region of the People's Republic of China (PRC). Under the constitutional terms of the transfer, known as the Basic Law, the existing economic, legal, and social systems will be maintained for at least 50 years: "While the mainland PRC will continue to practise `socialism with Chinese characteristics', Hong Kong is to continue the practice of `capitalism with Chinese characteristics' " (Cullen 1994: 512). This section provides an overview of the central fiscal characteristics of Hong Kong.
The island of Hong Kong, on which 6.8 million people reside, contains no natural resources. Yet, Hong Kong succeeds as the world's eighth-largest trading economy. How is this possible? According to The Economist magazine: "The territory's tradition of simple and low taxes, combined with a comparatively easy-going government . . . is widely seen as a main reason for its stunning rise to prosperity" (The Economist 2000).
According to The Fraser Institute's publication, Economic Freedom of the World: 2000 Annual Report: "The latest economic freedom index stands at a level of 9.4 (out of 10), maintaining Hong Kong's primacy as the most economically free place on earth" (Gwartney and Lawson 2000: 49 ). Hong Kong's tried and trusted non-interventionist economic policy is, in fact, constitutionally mandated. For example, government spending is not permitted to grow at a rate higher than that of the economy. As Milton and Rose Friedman observed, "Though government spending has grown as the economy has grown, it remains among the lowest in the world as a fraction of the income of the people. As a result, low taxes preserve incentives" (Friedman and Friedman 1980: 34).
In theory, Hong Kong's tax system, "is designed to be as neutral as possible so as to avoid any distortive effects on the economy while at the same time generating sufficient revenue to finance the government's socio-economic policies and programmes" (Jao 1978: 253). In practice, therefore, a moderately narrow tax base is combined with very low tax rates. Hong Kong does not have a general income tax, does not tax stock dividends, capital gains, wealth, or gifts, and has no value-added tax, general sales tax, or payroll tax. There is a flat-rate tax of 16% on corporate profits and a property tax.
Hong Kong has had a version of the flat tax on income since its original tax system came into effect with the Inland Revenue Ordinance of 1947.24 Hong Kong has a Salaries Tax on all employment income. The original tax law legislated a standard rate of 10% on salaries. Currently, the maximum limit on salaries and wages is a flat rate of 15% on gross income, less personal exemptions (the current basic allowance is HK$200,000 [US$25,641] for a married person), expenses, and charitable donations (the current standard rate of 15% came into effect in 1966). Income tax was flattened further when the top marginal rate of 30% was eliminated in 1978. Critically, the government's "philosophy is not only to keep each and every taxation levy . . . simple and easy for the taxpayers, but also productive and inexpensive for the government to administer" (Anthony Au-Yeung, Deputy Commissioner of Inland Revenue, in Lai 1982: 199).
The Salaries Tax operates according to a sliding scale. The effective rates of income tax are: 10.2% for a single person; 5.7% for a single person with two dependent parents; 3.5% for a married person with no children; 1.4% for a married person with two children; and 0.14% for a married person with two children and two dependent parents.
In Hong Kong, personal and child allowances are so high (including a maximum deduction of 10% of taxable income for charitable donations) that 70% of the population pay no income tax whatsoever; a further 28% of the population pay below the 15% flat rate, which, consequently, is paid only by the most affluent 2% of Hong Kong's residents.
Commenting on the flattening of the income tax, economist Y.C. Jao observes: "Since 1976 there has been further simplification and rationalization of Hong Kong's tax system, which on balance has resulted in a lower burden of personal taxation, higher tax yield and hence a larger fiscal surplus" (Jao 1981: 406)." He continues: "The remarkable growth and industrialization of the economy during the post-war period provides a recent and striking illustration of the positive effects of a congenial tax system" (Jao 1981: 253)."
During the second-half of the twentieth century, the Hong Kong economy grew at a phenomenal pace. Indeed: "The combination of simplicity and low taxation, to the extent that it minimizes the adverse effects of taxation on work effort, saving and risk-taking, has played its part in Hong Kong's remarkable post-war economic growth and development" (Jao 1981: 401).
Impressively, Hong Kong's flat tax "has proved itself capable of generating a sufficiently high level of government expenditure such that fiscal surpluses have been recorded in no less than 27 out of the 31 post-war fiscal years" (Jao 1981: 253). It may be observed, therefore, that: "A comparatively low level of taxation contributes significantly to economic prosperity and thus increases revenue yields despite high tax thresholds" (Lai 1982: 199).
The Channel Islands
Situated in the English Channel off the northwest coast of France, the Channel Islands are made up of two larger islands, Guernsey (population 59,000) and Jersey (population 75,000), three much smaller islands (Alderney, Herm, and Sark), and several tiny islets. The Channel Islands operate under a special constitutional status bestowed by the British crown.
Guernsey
This section focuses primarily upon the fiscal policies of Guernsey, while also outlining the similar policies followed, and results generated, by Jersey. Neither Guernsey nor Jersey is a member of the European Union (EU), although both hold special status under a relationship with the EU established when the United Kingdom joined the European Economic Community. Overall, both Guernsey and Jersey have "maintained the islands' rare combination of low taxation, considerable economic prosperity, and political stability, whilst still preserving a highly attractive environment" (Deloitte Haskins & Sells 1978: 4). The tax systems employed in Guernsey and Jersey are quite similar. Both islands employ a 20% standard rate of income tax for individuals and corporations. Neither island imposes a tax on capital gains, a tax on capital transfer, or a withholding tax; both refrain from taxing interest on bank deposits. Neither Guernsey nor Jersey collect a value-added tax.
Hence, while historically Guernsey had higher rates of income tax than did Jersey, since the establishment of a flat tax of 20% on income in 1960, the island has not increased the rate of income tax. The question, however, remains--to what effect? The island's GDP has more than trebled since 1965. Since 1996, economic growth has outpaced a booming British economy and GDP per capita increased from £7,510 in 1970 to £16,960 in 1998.
Although Guernsey's 20% standard rate of income tax is already very low by international standards, the 20% flat tax is complemented by generous personal allowances and reliefs, which include allowances both for single and for married persons, as well as allowances for children and dependent relatives. Income-tax receipts nevertheless account for 74% of total general revenue.25 The significant increases in revenue allowed for a comparable increase in government expenditure on health care, social services, and education. A rising revenue stream has ensured that Guernsey's public finances are consistently balanced.
Jersey
The income tax was introduced into Jersey in 1928 and was modelled, unsurprisingly, on Britain's income tax code. The island's introductory standard rate was 2.5%. The standard rate was raised to 20% in 1940, the level at which it remains 60 years later. It is a flat tax that applies to both individual and corporate income.
The 20% flat tax is also complemented by generous personal allowances and reliefs comparable to those provided in Guernsey. Income tax provides 90% of the island's revenue, even higher than is the case in Guernsey. Similar to the Guernsey tax system, the Jersey tax system is described as "a pure imputation system in that no income is taxed twice. For example, dividends paid by a Jersey company are not deductible in the company's computation but are treated as taxed income in the hands of the shareholder" (Deloitte Haskins & Sells 1978: 7).
A legislative committee summarized Jersey's economic development philosophy in the following terms:
New forms of taxation should be avoided wherever possible, and . . . efforts should be directed more at maximizing the tax yield with the present form of taxation by the encouragement of profit growth with business activities of a level and nature that are consistent with population growth. (State of Jersey 1991: 10).
How has this policy served the largest of the Channel Islands? It has been observed that Jersey suffers from the "problems" of affluence and low unemployment (Johns and Le Marchant 1993: 110). GDP, a principal measure of macroeconomic affluence, rose 90% in real terms between 1980 and 1990. Meanwhile, per-capita income stood at £8,153 in 1981; by 1990, it had risen to £14,000.
Conclusion
It is equally true of both Hong Kong and the Channel Islands that, "The necessary process of change and development to provide for continued economic prosperity requires the continued ability both of individuals to start up in business, and of the successful to expand at the expense of the unsuccessful" (Colin Powell, Chief Economic Adviser to the States of Jersey; quoted in Johns and Le Marchant 1993: 112). Within these jurisdictions there exist long-standing commitments to fiscal policies centred upon fairness, simplicity, and efficiency. As demonstrated by their respective post-war experiences, such fiscal policies based upon the flat tax are positive influences upon economic growth, employment, and the overall standard of living.
info@fraserinstitute.ca
4th Floor, 1770 Burrard Street, Vancouver, BC, Canada, V6J 3G7
Tel: (604) 688-0221 Fax: (604) 688-8539 Book Orders: 1-800-665-3558 ext. 580
You can contact us at the above email address for any comments or information requests. Please report any dead links or technical problems.