It's time for some big thinking about Hong Kong's tax system

With the prospect of shrinking revenue ahead, this column will get the debate started with some inventive – and fair – options to fill the coffers

PUBLISHED : Tuesday, 06 August, 2013, 12:00am
UPDATED : Tuesday, 06 August, 2013, 4:17am

Whenever organisations like the World Bank, the Heritage Foundation or the World Economic Forum compile their league tables of global competitiveness, Hong Kong always draws fulsome praise for its low and simple tax regime.

With its salaries tax capped at just 15 per cent, a profits tax of 16.5 per cent, and no dividend, capital gains or goods and services taxes, the city is typically ranked only behind the oil-rich states of the Persian Gulf for the attractiveness of its tax regime.

Hong Kong's inhabitants, have a more nuanced view.

They know the territory can only operate such a lenient tax regime because the government relies for so much of its revenues on the city's property market.

Income from land sales, land premium - the fees developers pay for a change in land use - property rates and stamp duty on real estate deals together make up around 25 per cent of the government's revenues.

Add in the profits tax paid by developers and the salaries tax levied on their employees, and the contribution of the property sector to the government's coffers climbs to somewhere near 50 per cent.

This reliance on the property market has fostered an institutional bias within the government in favour of high property prices. By restricting the supply of new building land, the government has bumped up property prices, maximising its income from land premium payments, stamp duties and other property-related revenue sources.

As a result, for the last nine years the government has been able to run hefty budget surpluses and accumulate handsome reserves while operating what looks to outsiders like an enviably light tax regime.

But there is a price to be paid. The high property prices and rents passed on to ordinary people and companies act as a hidden tax, pushing up the effective rate and making Hong Kong a lot less attractive than all the surveys indicate.

Worse, because of Hong Kong's exchange rate peg to the US dollar, there is a pronounced pro-cyclical element to the government's revenue model.

For the last few years interest rates have been low and the economic times good. In response the property market has boomed, generating enormous fiscal surpluses.

But when rates rise - as they are likely to some time in the next two or three years - and the economy turns down, property prices will plunge, land revenues will evaporate and the Hong Kong government will slide from surplus into deficit.

That shouldn't matter. The government has more than enough reserves stashed away to tide the city through any cyclical downturn.

But inevitably officials will regard the deficit as a serious structural problem, and begin talking about how Hong Kong urgently needs to broaden its tax base in order to stabilise the government's revenue stream.

We've heard all this before, of course. When the government slipped into deficit in 1999, august international bodies all advised Hong Kong to overhaul its tax regime. When he became chief executive in 2005, Donald Tsang Yam-kuen duly attempted to introduce a universal goods and services tax (GST).

Along with many others, this column opposed the idea on the grounds that GSTs are deeply regressive: they fall disproportionately on the poor.

With a GST, a householder earning HK$10,000 a month who has to spend all his wages on living expenses pays GST on 100 per cent of his income. In contrast, his wealthy neighbour who makes HK$100,000 and spends only HK$50,000 pays tax on just half his earnings.

Opposition to Tsang's proposed GST was so vehement that he was forced to abandon his proposals. But with the government so dependent on the property market, when prices turn down once again the idea is bound to resurface.

Happily, there are plenty of more inventive ways the government could overhaul its antiquated revenue system to ensure a steadier income without hitting the city's poor.

Over the next few weeks, this column will explore some of them and ask which would best suit Hong Kong, both allowing the government to raise the revenues it needs and ensuring that the city retains its position near the top of international rankings for its enviably low and simple tax regime.

Hopefully, we can start a spirited debate on the subject, pre-empting any future government attempt to force a lousy solution on Hong Kong's long-suffering populace.