How Hong Kong Can Build A Great Society

by James A. Dorn

One of the greatest liberals of the last century, F.A. Hayek, wrote his classic The Road to Serfdom 60 years ago to warn against the dangers posed by post-war socialism. He believed with David Hume that "it is seldom that liberty of any kind is lost all at once".

To stem the growth of big government and the erosion of economic and personal freedom that accompanies that growth, Hayek argued passionately for a liberal international order grounded in limited government, free trade and the rule of law. His message is as relevant today as it was in 1944.

Hayek's vision of a market-liberal order with private property, freedom of contract and limited government rested on the work of Adam Smith and other 18th-century liberals. A central concept in that body of work is the notion of spontaneous order, or what Smith called a "simple system of natural liberty". According to Smith, when "all systems either of preference or of restraint" are abolished, "the obvious and simple system of natural liberty establishes itself of its own accord".

James Dorn is vice-president for academic affairs at the Cato Institute in Washington and author of The Rise of Government and the Decline of Morality.

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In such a system, "every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest in his own way, and to bring forth his industry and capital into competition with those of any other man, or order of men". Smith dismissed central planning as a utopian vision because "no human wisdom or knowledge could ever be sufficient" to direct resources towards "the employments most suitable to the interest of the society".

The duties of the sovereign are definite and few: first, protect "society from the violence and invasion of other independent societies"; second, safeguard "every member of the society from the injustice or oppression of every other member of it", as much as possible; and third, erect and maintain "certain public works and certain public institutions". When government is limited to those core functions, "a great society" will emerge.

In 1850, Frederic Bastiat, a well-known French liberal, wrote: "It is under the law of justice, under the rule of right, under the influence of liberty, security, stability and responsibility, that every man will attain to the full worth and dignity of his being, and that mankind will achieve ... the progress to which it is destined." Hayek grasped these liberal principles and, in The Road to Serfdom and other works, expounded them and warned against creeping socialism in the west.

He understood that substituting socialist ends - in particular, "freedom from want" - for capitalist means - competition and choice - would destroy the very freedom necessary for a great society. Under economic liberalism, the individual, not the collective, is at the centre, and consent rather than coercion is the organising principle.

Attempts to plan economic life and achieve "social justice" wrought havoc in the 20th century. The Soviet Union and the People's Republic of China learned the hard way that Marx was wrong and Hayek was right. What still needs to be emphasised, however, is Hayek's message that "political freedom is meaningless without economic freedom".

When private property rights are violated and economic freedom is attenuated by various forms of government intervention, our other freedoms are threatened. The Jews in Nazi Germany first had their economic liberties violated. The rest of the horrors followed.

Any infringement of economic liberty must be nipped in the bud. Hong Kong's phenomenal success is due to its adherence to economic liberalism, as advocated by Sir John Cowperthwaite, Hong Kong's financial secretary from 1961 to 1971. His advocacy of the principle of nonintervention, and insistence on limited government under the rule of law, created the freedom for individuals to trade and to prosper. But that does not mean Hong Kong's future is secure. Constant vigilance is necessary to prevent the erosion of the principles of a market-liberal order.

As Nobel laureate economist James Buchanan has written: "Liberals should not lean back and say, 'our work is done.' The organisation and the intellectual bankruptcy of socialism in our time has not removed the relevance of a renewed and continuing discourse in political philosophy. We need discourse to preserve, save, and recreate that which we may, properly, call the soul of classical liberalism."

Many emerging market countries still have a long way to go before they reach the level of economic and personal freedom envisioned by Hayek. Many developed countries, including the United States, have expanded the welfare state without recognising the danger it poses to the future of freedom.

The challenge for Hong Kong in the 21st century is to hold on to and strengthen economic freedom and limited government while at the same time creating a constitutional democracy that supports, rather than erodes, liberal principles.

What Beijing needs to learn from Hong Kong

What Beijing needs to learn from Hong Kong

by James A. Dorn

Long before the Scottish Enlightenment, the great Chinese philosopher Lao Tzu taught that when the ruler engages "in no activity, the people, of themselves, become prosperous". Commenting on the principle of non-intervention, or wu wei, a young Chinese liberal recently wrote: "If our government had understood the importance of non-interference, it would be good news for both the Chinese economy and the world."

The Communist Party's decision to fire upon innocent students during the Tiananmen Square demonstrations in 1989 was a huge step backwards. But today, as a result of further economic liberalisation, China is much freer than it was during the pre-reform era when Mao Zedong ruled with an iron fist.

Housing is being rapidly privatised, long-term land leases have been instituted, the non-state sector accounts for more than 70 per cent of industrial-output value, real per capita incomes have more than quadrupled, capitalists can join the party, the constitution recognises the importance of the private sector, internet use is rapidly spreading, and China is a member of the World Trade Organisation.

James Dorn is a China specialist at the Cato Institute in Washington and co-editor of China's Future: Constructive Partner or Emerging Threat?

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Those positive developments have created a new middle class and revitalised civil society. But they have not been sufficient to end the party's monopoly on political power, which continues to corrupt and politicise everyday life. Most important, there is still no rule of law to protect property rights. When the state owns the presses, controls the media, requires internal passports and limits all political speech, individuals lose their autonomy.

China's leaders have placed great emphasis on achieving robust economic growth. Yet, as Justin Yifu Lin, a prominent economist at Peking University, has noted: "It is essential for the continuous growth of the Chinese economy to establish a transparent legal system that protects property rights." The dilemma, of course, is that the stronger the protection of property rights, the weaker the power of the party.

The party, however, is not monolithic. Like any political body, there are factions. The challenge is for the reform wing to out-manoeuvre the hardliners and push ahead with liberalisation. Most of that effort will be towards creating a market economy, but economic liberalisation normally generates the demand for political reform, as witnessed in Taiwan and South Korea.

Moreover, Hong Kong's demand for limiting the reach of the Chinese government, as witnessed by the mass demonstrations against the proposed anti-subversion law, is a sign that Hong Kong's quest for political freedom may spread to the mainland. As the Wall Street Journal said: "Having been forced to give ground on civil liberties, Beijing is learning in Hong Kong that economic freedom has political consequences."

Although China's march towards market liberalism has been slow, it has been steady. Mindsets are changing as more people become exposed to western culture and commerce. The private sector is gaining ground and with it the demand for political reform and less state intervention. In a recent article in the China Business Weekly, Jia Hepeng cited economist Friedrich Hayek and wrote: "Deeper involvement of the government could destroy the spontaneous order of the market."

In June, one of China's leading advocates of constitutional reform, Cao Siyuan, held a major forum entitled, the Chinese Constitution: Protecting Private Property and Constitutional Amendment. Like other liberals, he understands that private property and freedom of contract (free-trade) are human rights that should be protected by law. The recent ban on constitutional debate following Mr Cao's forum, though troublesome, is not expected to prevent the National People's Congress from amending the constitution this year to give stronger protection to the private sector.

Hong Kong has taught us that economic liberalism is a catalyst for peace and prosperity. We must continue to advocate it, but also remember that economic reform is not enough. Ultimately, the Chinese people must embark on political reform. By deepening relations with China's liberals, the US can help them advance the cause of freedom.

Li Shenzhi, one of China's leading liberals, wrote: "The revival of the liberalist tradition ... will bring a free China into a globalising world and will be beneficial and glorious for the entire world." Although Li died in April, his words will remain to inspire the younger generation of liberals who are struggling to transform China into a normal civil society in which both economic and personal freedoms are protected by a constitution of liberty.

Hong Kong's Excellent Taxes

Hong Kong's Excellent Taxes

by Alan Reynolds

President Bush gave former Sens. Connie Mack of Florida and John Breaux of Louisiana the unenviable task of trying to say something new and interesting about tax reform.

When it comes to designing a simple tax system that does the least damage to the economy, it would be difficult to find a better role model than Hong Kong. As The Economist wrote a few years ago, "The territory's tradition of simple and low taxes ... is widely seen as a main reason for its stunning rise to prosperity." Many advantages of the Hong Kong tax system have been widely emulated in Asia, yet remain poorly understood in this country. One such misunderstanding may have resulted in an unfortunate spat between two old friends, Steve Moore and Bruce Bartlett.

Moore proposes that individual taxpayers should be allowed to either pay taxes under the current rules, or instead forego deductions for mortgage interest and charitable deductions and pay 20 percent on that broader measure of income. "Bruce Bartlett attacked this plan as a gimmick," writes Moore. "But he fails to realize this is precisely how the Hong Kong tax system works. Hong Kong has a complicated system and a simple flat tax, and filers choose between the two."

Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.

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Gimmick or not, Moore's "freedom to choose flat tax" is not remotely similar to the Hong Kong tax system, which is not complicated in any respect. I may have been partly at fault for that misunderstanding.

Steve Moore and Bruce Bartlett were advisers to Jack Kemp's tax reform commission in 1995, and I was research director. Asked by one commissioner about Hong Kong's "flat tax," I replied that the tax on salaries is not flat but steeply progressive. There are four marginal tax brackets of 2 percent, 8 percent, 14 percent and 20 percent. I would prefer a single tax rate, for reasons I explained last November in "The Case for One Tax Rate." But any tax with a top rate of 20 percent is hard to fault.

Unlike the United States, Hong Kong is not plagued with tax credits that create random spikes in marginal tax rates as the credits are phased out. But Hong Kong does allow charitable deductions up to 25 percent of salary income and a mortgage interest deduction up to about $13,000 (in U.S. dollars). Other deductions are allowed for adult education, care of elderly relatives and retirement savings plans.

Personal exemptions are so generous that most employees owe little or no tax on salaries. For those with high salaries, however, it is cheaper to forego personal exemptions (but not deductions) and pay a 16 percent "standard rate." Only the top 2 percent usually pay that standard rate, yet they account for nearly half of all revenue from the salaries tax.

Groping for an explanation of the standard rate a decade ago, I suggested it was something like an "alternative maximum tax" -- a phrase Moore has used to describe his own, very different tax proposal. But the standard rate is automatic, not a matter of choice. Taxpayers fill out a one-page online return declaring their salary and deductions, and the government sends them a bill.

The standard rate does not make Hong Kong's tax system simpler, but it does make it more efficient. Academic studies of optimal taxation have long concluded that marginal tax rates should be lowest at the highest levels of income. As Joseph Stiglitz wrote in 1987, "the marginal tax rate on the highest income (ability) individual should be zero." Hong Kong does not go quite that far, but the marginal rate is reduced from 20 to 16 at the highest incomes, while keeping their average tax high by eliminating personal exemptions.

As clever as this is, it is not the most interesting aspect of the Hong Kong tax system. What makes taxes in Hong Kong so uniquely simple and effective is that businesses pay all the taxes on income originating in business (profits), and employees pay all the taxes on salaries.

Hong Kong has no payroll tax for Social Security, no general sales or value-added tax, no tariffs on imports and no personal tax on income from financial assets. What Hong Kong has is called a "Dual Tax" -- progressive tax rates on labor income but a flat tax of 17.5 percent on corporate profits, 16 percent on property owners and unincorporated enterprises.

The low tax on profits brings in substantially more revenue than the tax on salaries, in marked contrast to the United States, which collects little from profits taxes that are nominally twice as high. Corporations in Hong Kong pay the profits tax before distributing dividends to shareholders, so there is no extra tax on dividends to be collected from individuals. Reinvested profits result in more business income to tax in the future, so there is no extra tax on capital gains to be collected from individuals.

Companies in Hong Kong deduct interest payments, however, so it would be theoretically appropriate to tax individuals on income they receive from local corporate bonds. This exemplifies the key tax principle of symmetry: Whatever is a deductible expense for those making any payment ought to be taxable income for those receiving that payment. But there would still be no need for individuals to report interest income, because a flat tax can easily be collected at the source, before the check goes out.

The United States could easily adopt something similar to the Hong Kong tax. It would require no wrenching changes, such as giving up interest deductibility for corporations or homeowners. Some tax rates would presumably have to be higher (the 2 percent rate is ridiculously low anyway), but not as much higher as you might think.

Hong Kong's taxes on salaries and profits amounted to about 7 percent of GDP last year, while combined U.S. corporate and individual taxes brought in only 8.6 percent of GDP. Since a larger percentage of American employees have higher salaries, a salary tax such as Hong Kong's would raise more money even without higher tax rates.

The Hong Kong tax system has one major advantage over even the most elegant theoretical alternatives. It has been tested for more than 50 years. It works.