TNAG-0575-FCO40-708-Visits-of-Anthony-Crosland--Secretary-of-State-for-Foreign-a-1976 — Page 13

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Mr Janyrin (HKIOD K 245)

HONG KONG : POLITICAL ADVISER'S MINUTE OF 13 MAY

Your covering minute of 19 May: Alan Donald's assertion that China would be particularly sensitive to increased taxation in Hong Kong adds a completely new dimension to the Planning Paper proposals on public expenditure. There was no apparent reference to this factor in the Governor's Despatch and, indeed, I thought that both he and the Office were agreed that we must be 'masters in our own home' I definitely think we should probe Donald further and that in the meantime his observations in this field should be treated with a degree of cir- cumspection.

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2. As I understand the position, we attach considerable importance to Hong Kong's being a harmonious and prosperous society with a minimum of embarrassment to HMG in the 1980's. We do not see it as in anyone's interests (Hong Kong's, China's or our own) that any initiatives stemming from the Planning Paper should impair the growth rate of the economy. In my view, it just does not make sense to take the line that China would be prepared to sacrifice tranquility in Hong Kong and the fragility of Hong Kong's relationship with HMG in the longer-term by resisting tax increases on corporations conceived as part of a programme of social reform simply so as to secure maximum foreign exchange earnings in the shorter-term. (I can well see that China would not be favourably disposed to Hong Kong extending the ambit of the salaries tax charge to the lower paid, but we have never suggested a regressive measure of this kind and we know it is oppo- sed by the Minister.) Surely China, like us, sees the need for a 'middle way' whereby, with modest changes in taxation (and that is all we are likely to sug- gest over the next few years), we could in some measure meet the aspirations of the local community, and dissipate some of the criticisms that we do not as fully with the spirit of ILO Conventions (for example, on social security) as we might, yet without slowing-down the economy.

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3. What I suspect is that Donald has seized on the probable vociferousness of the communist press in the run-up to the Budget. It would come as no surprise to learn that at the time increased taxes were being regarded as almost inevitable and that the recession they would not only harm business interests but would be bound to hit the already hard-pressed, belt-tightening Chinese worker. I would not be at all surprised to learn that since the Budget (which proposed virtually no changes in taxation) the communist press has been rather quieter in this field. and you will see from your draft letter to Donald, attached, that I am suggesting we ask for the dates when the press criticisms appeared. The point I am making is that I have my doubts as to whether it can be inferred from current or recent press reactions, with the recession barely over, that there would be outright opposition to increased levies for purposes of income redistribution in (say) 1978/79 and 1979/80 (which is really what we have in mind) when the economy is expected calmly to be chalking-up growth rates averaging some 6-7% a year.

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Incidentally, I don't agree with you that the burden of increased taxation could fall principally on payers of salaries tax. If the ratio of public expendi- ture to the gross domestic product is to be raised to 25% by 1979/80, there would indisputably have to be a fairly hefty increase in the yield from profits tax (perhaps of the order of 20%, bringing the standard rate up from 15% to 18%); and this would probably be the case even if the tax base were widened.

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I would also refer to Mr Lipsey's comment that the Planning Paper/prospects are seen as a 'minimum first step'. As far as the budgetary aspects are

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