How to achieve a fine balance

Hong Kong depends, more than most economies, on property-related revenue - notably land-sales premiums, stamp duty and rates. The city's profits and salaries taxes are low, and many residents pay little or no taxes. Hence, our tax base is said to be too narrow.

Actually, property-related revenue is broadly based. When the government sells land, every citizen is contributing his or her stake in that public land to pay for public spending. And one result of economic growth, to which all workers contribute, is the appreciation of property values over time as productivity increases. Property buyers reap the benefit but pay stamp duty, rates and, for corporations, profits tax.

The predominance of property-related revenue has meant that profits and salaries taxes can stay low. That attracts individual and business enterprises, thereby generating jobs and contributing to Hong Kong's economic success.

Property-related revenue has only one major drawback: their volatility. The prices and transaction volumes of property sales - and hence the public revenue they generate - vary depending on expectations for the economy. Property-market excesses can in turn worsen economic cycles.

But the excesses are inevitably corrected. In this cyclical process, the market always returns to its equilibrium level.

Take the ratio between the price of a basic 600-sq-ft flat and the economic output per person, or gross domestic product per capita. Its average level over the past 25 years - about 10.6 - provides an indicator of that equilibrium level.

Property prices above this level would make Hong Kong uncompetitive internationally, and so would eventually fall back. Prices below that level would be bid up.

Using a couple of simple, transparent indicators like this, the government should, first, set aside funds in its budget during good times - when both property prices and transaction volumes exceed their equilibrium values - as provisions for subsequent lean years.

Second, the government cannot possibly be a market follower when deciding prices for land sales. Instead, it should follow a policy of flexible land supply, to keep property prices as close to their equilibrium level as possible. This means keeping prices broadly stable.

Property cycles would then become milder, but would not disappear, since economic cycles are likely to continue to exist. Currently, the price-to-GDP per capita ratio, at about 9.7, is below the equilibrium level. This suggests that target prices for upcoming land sales should be on the high side, until the excess of supply is absorbed.

Third, the government should disengage itself from housing. Assistance for housing should consist solely of allowances, to help recipients rent or buy homes on the market. The resulting efficiency gains would eliminate any need for a goods and services tax, asset sales or debt issues.

This would help grass-roots families to own homes, and so enjoy a share in the appreciation of property values. They would pay stamp duty and rates, broadening the tax base. And, since they would eventually own their flats, the looming fiscal burden of an ageing population would be eased.

In the longer term, property prices will always be determined solely by the city's productivity.

But the government has both the need and capability to limit economic and financial volatility.

It does this by fulfilling a key role in the market, guided only by basic economic principles and Hong Kong's unique set of circumstances.

James Lee writes as an independent commentator

This article originally appeared on the website www.hongkongbetter.com