Hong Kong's Interventionist Budget

By Philip Bowring

February 8 2012

Financial Secretary John Tsang's speech unveiling the new budget last week reminded everyone that Hong Kong boasts huge fiscal reserves and big budget surpluses. But the government's fortune is more the result of good luck than good judgment, and is leading it down dangerous paths. The government is undermining the simplicity and neutrality of the tax system, becoming ever more reliant on unstable income sources and increasingly interfering in parts of the economy which should be left to market forces and the private sector.

In the fiscal year just ending, capital revenue, mostly from land sales, is HK$97 billion (US$12.5 billion) out of total revenue of HK$433 billion. This bonanza was largely due to land price escalation, which resulted from the government's monopoly over land supply. In addition to raising costs for businesses and households, this has another insidious effect. Because most capital revenue goes directly into a fund which can only be used for capital works, it encourages the government to launch hugely expensive infrastructure projects which have scant commercial justification.

Money is poured into concrete rather than measures to stimulate high value-added service industries or address problems like air pollution, which deter foreign investment. Examples include a cruise liner terminal, a road bridge to Macau, a road tunnel through the heart of urban Hong Kong and a high speed rail tunnel to the heart of Kowloon. All are vanity projects which the private sector would never finance. Public sector capital spending is growing far faster than that of the private sector and is forecast to hit HK$95 billion in 2013, a threefold increase since 2007. Meanwhile, private sector construction in real terms is languishing at the levels of the 1980s.

The latest government budget also intruded into other areas of the economy which should be the preserve of the private sector. It is promising to guarantee HK$100 billion in loans to small- and medium-sized enterprises. This measure increases the power of bureaucrats to offer advantages to certain firms or industries, and gives bankers a place to dump loans of doubtful quality. The government is also enlarging the remit of an unneeded state enterprise, the Mortgage Corporation, whose highly paid officials are now being encouraged to enter the microfinance business.

Perhaps even more unwelcome is the budget's retreat from the goal of low but stable, non-discriminatory revenue raising. Instead of making an across-the-board reduction in tax levels, Mr. Tsang provided a list of temporary profits and salaries tax concessions and added to the existing range of allowances and exceptions. It has also given a limited tax holiday on what should be its most stable form of revenue -- the tax (known as rates) on the notional rent of all private residential, commercial and industrial buildings. Rates are an easy to collect, market value related, non-discriminatory, inflation-linked form of revenue. They are in effect a tax on consumption, not capital.

Instead of following through on its stated goal of taxing consumption rather than income, the budget provides HK$1,800 of free electricity to every household. A tax on power consumption would be a better idea -- easy to collect, non-discriminatory and an encouragement to energy efficiency and lower pollution.

These supposedly populist measures are making the revenue system more volatile and subject to the annual whims of government. In addition to capital revenues, it is highly reliant on variable stamp duties on share and property transactions now yielding some HK$50 billion. Tax on share transactions anyway looks increasingly vulnerable if Hong Kong faces more competition in trading of shares in mainland companies.

Back in 2006, the government aimed to make revenue more stable by creating a tax on consumption as a partial replacement for income taxes and capital revenues. It was unpopular and too complex for Hong Kong and the government withdrew the proposal. But since then, instead of looking to enhance other ways of taxing consumption it has lurched into greater reliance on windfall revenues.

All this may seem academic in the face of the big surpluses the government has recorded thanks to land prices and share turnover, but fiscal balance -- not ever greater surpluses -- should be the goal. The surpluses now total about HK$1.2 trillion, mostly invested in the low yielding securities of other governments. This cash hoard properly belongs to the community of taxpayers and would be better invested by them. As it is, the hoard gives the bureaucracy an inflated confidence in its own wisdom and enables it to waste resources on vanity projects.