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Why Hong Kong and Singapore should tax wealth more

South China Morning Post logo South China Morning Post 11/3/2019 Donald Low
a person standing in front of a colorful background: Singapore: it’s a land of crazy rich Asians. But should they be a little less rich? Photo: Alamy © Alamy Singapore: it’s a land of crazy rich Asians. But should they be a little less rich? Photo: Alamy

In recent weeks, the finance ministers of Hong Kong and Singapore delivered their budget statements for the coming financial year. Both statements were notably silent on wealth taxes, an issue that has attracted growing attention in the United States and Europe in the decade since the global financial crisis.

Hong Kong and Singapore were very much part of the international consensus in the late 1990s and early 2000s that viewed lower taxes on capital as necessary for attracting wealthy individuals and investments. In both places, capital was (and still is) taxed very lightly. The estate duty was abolished in Hong Kong in 2006; Singapore followed suit in 2008. Capital gains, interest and dividend income are exempt from taxation in both jurisdictions. Only property and rental income are taxed.

Since the global financial crisis, there have been growing calls in the developed world for higher taxes on wealth to mitigate rising inequality and shore up tax bases. But Hong Kong and Singapore are in the fortuitous position of not requiring additional sources of revenue (at least not in the short term). Nonetheless, it is worth asking whether both places should consider having low and simple taxes on capital on the grounds of social equity.

An art installation for the Hong Kong Pulse Light Festival. Photo: AP © AP An art installation for the Hong Kong Pulse Light Festival. Photo: AP

The impetus for this comes partly from the seminal work of the French economist, Thomas Piketty. As Piketty explains in Capital in the 21st Century, differences in wealth are a far greater source of inequality than differences in labour income. Wealth, which arises from the ownership of capital, is much more unevenly distributed than labour.

Piketty also observes that except in times of war and depression, the rate of return on capital has averaged nearly 5 per cent. In mature economies, labour incomes are increasing at a much slower rate. Inequality, Piketty posits, rises when the rate of return on capital exceeds the growth rate of the economy.

Hong Kong and Singapore are now both mature economies growing at well below 5 per cent, even as we would expect the long-term rate of return on capital to be close to its historical average of 5 per cent. If we care about rising inequality, we should be taxing wealth more.

AND BEFORE YOU OBJECT

There are, broadly speaking, four main objections to a low and simple tax regime on wealth.

The first objection is a philosophical one. Some people argue that taxing wealth is immoral – that it penalises frugal and successful individuals. This moral objection is flawed on at least three levels. First, even classical liberals such as Adam Smith, Jeremy Bentham and John Stuart Mill – who were all against a coercive state – believed inheritance taxes were necessary to prevent a hereditary elite from becoming entrenched. They also believed taxing the very rich, who often lived off inherited properties and landed estates, would permit lower taxes on the rest, allowing them to save more.

a large body of water with a city in the background: The Singapore skyline. Photo: AFP © AFP The Singapore skyline. Photo: AFP

Second, heirs have seldom done anything to deserve their wealth. Their inheritances are mostly, if not entirely, due to biological luck. Taxing inheritances does not punish frugality; it is simply a means of redistributing some of the windfall gains that beneficiaries have obtained through little effort of their own.

Third, the idea that wealth should be entirely exempt from taxation is based on the mistaken belief that one’s success in accumulating wealth is due only to his/her ability; it denies that luck or being born into the right environment has anything to do with it.

As Warren Buffett, arguably the world’s most successful investor, put it: “I personally think that society is responsible for a very significant percentage of what I’ve earned. If you stick me down in the middle of Bangladesh or Peru or someplace, you’ll find out how much this talent is going to produce in the wrong kind of soil. I will be struggling 30 years later.” Viewed this way, taxing wealth is not just moral, it is a moral imperative.

The second objection is a more practical one and has to do with the concern that taxing wealth (whether inheritances, capital gains, dividends or interest income) would discourage savings and investment. This is a legitimate concern. But the question is by how much.

Basic economics tells us that with any tax increase, there is both a substitution effect and an income effect. The substitution effect says that a (higher) tax on wealth means that the alternative – of not accumulating (more) wealth – becomes more attractive. But the income effect predicts that people would save or invest more to achieve their target levels of wealth. Which effect dominates is an empirical question, not an ideological one. It is also likely that at very low rates of taxation, the income effect would dominate.

One way of seeing why a low tax on wealth would not significantly alter people’s accumulation of wealth is to look at income taxes. Just because a higher tax rate may, at the margins, cause some people to work less does not mean that the correct rate of income taxation is zero. It simply means that we should not set income tax rates at levels so high that the substitution effect dominates.

The third objection to wealth taxes is that the government (whether Hong Kong or Singapore’s) has sufficient revenues that it does not need to introduce new taxes on wealth. This argument is also flawed. In the first place, it is not true that both governments do not need to find ways to raise more revenue. With ageing populations and high levels of inequality, both places could do with more redistributive taxation and higher levels of social spending.

a man holding a beer bottle and a glass of wine: A luxury wine store in Hong Kong. Photo: AFP © AFP A luxury wine store in Hong Kong. Photo: AFP

More importantly, while we all dislike taxes, low and simple wealth taxes are the least distorting. Taxing incomes from work more may be equitable, but it runs the risk of discouraging work if rates are raised too high. Taxing consumption is regressive since the poor spend a larger share of their incomes. By contrast, a low tax on wealth is both efficient (since it does not penalise income from work) and equitable (since the wealthy derive a much larger proportion of their income from their ownership of capital than the rest of society).

The fourth objection to taxes on wealth is that they are administratively burdensome or would lead to tax evasion or fraud. The latter objection is mostly nonsensical. There are many taxes that people seek to avoid, but this is not a good argument for not having those taxes at all. The risk of tax evasion is, at best, an argument for keeping those taxes low (to encourage compliance); it is not an argument for abolishing them.

A more serious objection is that the costs of administering taxes on inheritances, capital gains, dividends and interest income are so prohibitively high as to render them ineffective in raising additional revenue. While administrative costs are a key consideration in whether we should have those taxes, they are not the only, or even the primary, consideration.

Taxes perform a variety of functions. Besides raising revenue, promoting fairness and equity, and repricing (think taxes on vehicles, petroleum, tobacco and alcohol), a fourth function is to reflect and reinforce desirable social norms. In the case of wealth taxes, the salutary value of the state signalling that passive income and windfall gains are due partly to luck (biological, financial or otherwise), and are not wholly the result of our own effort or skill, should not be underestimated.

Meanwhile, not having wealth taxes at all sends the wrong signal: it says that earning a passive income from one’s ownership of capital or from inherited wealth is favoured over earning an income from one’s labour.

Finally, there is little evidence that the administrative burden of taxes on capital gains, dividends and interest income would be overwhelming. Both Singapore and Hong Kong have highly capable tax administrations. In the early 2000s, partly because of tax competition, Singapore abolished taxes on interest and dividends. The argument was not that it was costly to collect these taxes, or that evasion was rife. Rather the justification was to make Singapore a more attractive place, especially vis-à-vis Hong Kong, to attract and accumulate wealth.

In an era of rising wealth inequality, surely it is not a bad idea for both cities to question these shibboleths.

Donald Low is Professor of Practice and Director (Leadership and Public Policy) at the Hong Kong University of Science and Technology

This article originally appeared on the South China Morning Post (SCMP), the leading news media reporting on China and Asia. For more SCMP stories, please download our mobile app, follow us on Twitter, and like us on Facebook.

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.

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