Hong Kong's Hodgepodge Budget

WSJ March 1, 2013

Hong Kong Financial Secretary John Tsang on Wednesday unveiled another budget without a coherent strategy. His collection of one-off spending and tax relief measures undermines fiscal principles, makes social objectives harder to achieve, and damages the economy through interventions that are alien to Hong Kong.

For the sixth year since he became financial secretary, Mr. Tsang's forecast of a small deficit has turned into a huge surplus -- this year of HK$64 billion (US$8.3 billion) or 15% of expenditure. In an effort to prevent a similar outcome in the fiscal year beginning April 1, he has again waived what is one of his most stable and economically neutral taxes -- rates payable on the rental value of all real estate.

This contradicts the government's avowed aim of achieving a more stable income through less reliance on the capital revenue (mostly land sales) that currently makes up 18% of revenue. The budget also kept property and stock transaction taxes that make little sense in a modern service-based economy. These also take Hong Kong further away from its goal of focusing taxation on expenditure rather than income.

Another contradiction was the continued electric power subsidy to all households. Why government should subsidize any particular form of consumption is a mystery, but electricity is an especially bizarre choice, given that the government says it encourages energy conservation to reduce air pollution.

If anything, a tax on power consumption would make better sense, as it would fall equally across all sectors and in rough proportion to household incomes. It could even allow the abolition of transaction taxes and cuts in income and profits taxes.

After these and other reliefs totaling HK$33 billion, Mr. Tsang still had to disguise his revenue excess by stuffing HK$25 billion into various funds that will not be spent till some unknown time in the future. Such tactics hurt transparency and give bureaucrats and their political masters excessive discretionary power.

The biggest single reason for the government's large surplus is rising property prices, which has added to profits and transaction tax revenues. Yet here again the government contradicts itself.

There are two reasons for asset price inflation: ultra low interest rates thanks to Ben Bernanke, and a land shortage created by the monopoly supplier -- the government. Now Mr. Tsang wants to put a lid on prices through discriminatory tax and administrative measures. These are more likely to reduce transactions than prices. Meanwhile the government refuses to expand the supply of land for development or reduce the premiums for changes in land use.

Another problem with land sale revenue is that it goes straight into the Capital Works Reserve Fund, creating a huge pool of money for spending on infrastructure regardless of economic need. Several of these projects should be corporatized and financed by bond issues, which would require them to demonstrate their viability.

Revenues for the capital works fund are now HK$73 billion, and spending will reach HK$77 billion in the coming year compared with just HK$44 billion on 2009-10. Total capital spending is now almost HK$100 billion, or 10 times what is being spent on cleaning up the environment. This despite the damage that poor air quality is doing to health and the city's competitiveness.

The growth in infrastructure projects comes at a time when the population is barely growing and the economic focus should be on knowledge-based rather than labor-intensive activity. The spending was justified by Mr. Tsang as job-creating, even though Hong Kong has a shortage of construction workers. Infrastructure has been the main driver of the rise in public expenditure, which now exceeds the long-term goal of 20% of GDP.

It is not only excess revenues which has led Hong Kong down the path of government intervention. The bureaucratic mindset is a contributing factor. Mr. Tsang even claimed government credit for the success of Hong Kong's design, architecture and advertising industries, suggesting that official encouragement of them had "borne fruit."

Meanwhile he continues to expand the government's Mortgage Corporation lending to small and medium-sized enterprises. This creates more jobs for bureaucrats at the expense of a private sector more than capable of providing funds for viable businesses.

The only forward-looking aspect of Mr. Tsang's budget speech was reference to the impact of a rapidly aging population on future health and welfare spending. However, he did almost nothing to address the cause or Hong Kong's least-wanted record -- the world's lowest fertility rate. This is mainly attributable to the very high cost of bearing and rearing children in the city.

There are several ways that this could be addressed at a fraction of the HK$100 billion spend on physical capital. They include provision of nursery schools, longer maternity leave, job protection for mothers and generous child support payments rather than tax breaks. But apparently Mr. Tsang does not regard children as an investment. Only concrete qualifies.

Hong Kong's new Chief Executive C.Y. Leung promised new thinking and firm action based on old free market principles. Instead his financial secretary has given it an incoherent jumble of decisions unworthy of being called policy.





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