TCS Daily

Only Death Is Inevitable

By Christopher Lingle - March 23, 2005 12:00 AM

In Hong Kong government authorities cite the volatility of government revenues from land sales and other sources to suggest a widening of supposedly narrow tax base is required. The imposition of a goods-and-services tax could generate up to HK$30 billion a year. The good news is that the complexities of implementing the system would forestall collection of any revenues for as much as three years after the initial decision is made.

All this might seem unnecessary, since the Hong Kong government has corrected its recent mismatch between revenues and receipts. After all, it is expected that the Hong Kong government will post a surplus of HK$11.95 billion for the fiscal year ending March, instead of a deficit originally projected of HK$42.6 billion. But the improvement in the government's fiscal balance reflected one-time gains worth HK$26 billion from bond sales and HK$31.3 billion earned from land premiums.

And so the imposition of a new sales tax is seen as part of a long-term strategy. To head off criticisms, Financial Secretary Henry Tang suggested that new tax breaks could offset the pain of the proposed tax. Only some of the tax breaks would offer solace to consumers.

One move would increase tax deductions for dependent parents and children that would lead to foregone revenues of about HK$1.07 billion (US$137 million) each year. But abolishing the estate tax is a move favoring asset-managers and small business owners that presumably spend a small proportion of their income on consumption. The scoring of this cut would involve significant annual revenue losses of HK$1.5 billion.

Many of Hong Kong's problems can be traced to its long-standing land policy. In this (increasingly dubiously characterised) bastion of free-market capitalism, the government owns almost all unused or undeveloped land. This control over land resources has introduced deep-seated distortions in the local economy, while providing benefits to a narrow set of interests. Indeed, it is no understatement that the land policy is the worst legacy of the British colonial period.

It turns out that raising taxes is generally a bad thing to do, in light of Hong Kong's weakened economy. Instead of taking the easy way out by raising taxes on consumption, the government should reconsider its land policies to examine their impact on the real estate market and local economy. It also has a complicated tax structure with over 1,000 charges for government services that include license fees for a wide variety of activities.

It might be suggested that given Hong Kong's reputation for low taxes, some increase might not be noticeable. As it is, most taxpayers to pay marginal rates on income that are no higher than 15 percent. However, including the tax component of property values means that Hong Kong citizens actually pay a very high effective tax rate.

It is a matter of government policy to keep land artificially scarce in order to maximize revenues from auctions. Like all other revenues received by governments, these funds constitute a de facto tax. Inasmuch as all citizens occupy housing, the reality is that Hong Kong citizens pay very high "hidden" taxes.

Indeed, the conventional wisdom is that lowering tax rates is the proper stance when faced with a slumping economy. In all events, Hong Kong's technocrats seem to have a short memory. High growth in its past was based upon minimal government intervention in the local economy.

Hong Kong's government could stabilize its own long-term fiscal conditions and boost the economy by radically reforming its land policies. As it is, property-related income generate about one third of total government revenues.

When land sales are included, half of total revenues come from the property sector. The proportion becomes higher when considering income from property development companies, since they account for approximately 60 percent of stock market capitalization. At the same time, banks rely heavily upon lending to this sector and the income of many other professionals arises from property transactions.

Housing prices remain off their peaks but must fall significantly lower to bring them back into a range of affordability. Increasing land sales would stabilize the source of capital revenue for the Government, boost the supply of housing in a more affordable range of prices, and provide a stimulus to the construction and non-property sectors.

One alternative that merits consideration is to follow the plans of Japan's Finance Ministry that would convert national land holdings into tradable securities. The intention is for government to sell national properties to special-purpose companies (SPCs) that will be comprised of private enterprises and financial institutions. The SPCs would issue securities using the land as collateral.

Property developers would construct buildings on the lots and pay rent for the use of the property to the SPCs. Part of the rental funds will be paid to investors in the asset-backed securities in the form of interest. By following a similar approach, the Hong Kong Government could escape from the terrible straitjacket of its land policy and avoid the ruinous effect of raising taxes.

When it purchased a substantial portion of the stock traded on the Hang Seng Index in 1998, the Hong Kong government's free market credentials fell into disrepute. It is bad enough that imposing more and higher taxes or fees will do further damage to its reputation. But the damage to the economy is a more serious consideration.

Christopher Lingle is Global Strategist for eConoLytics.


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