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Financial Secretary John Tsang Chun-wah (Left) and Chief Executive Leung Chun-ying. Photo: David Wong
Opinion
Monitor
by Tom Holland
Monitor
by Tom Holland

Hong Kong government must change the way it taxes property

The lump-sum land-premium system should be replaced with a scheme whereby rental income is collected from leaseholders

In his budget speech earlier this year, Financial Secretary John Tsang Chun-wah painted a grim picture of Hong Kong's economic future, and of the outlook for the government's finances.

"With an increase in the number of the elderly, a shrinking working population, reduction in the number of taxpayers and decelerated economic growth, I expect that the growth of government revenue will drop substantially if our tax regime remains unchanged," he warned.

"Meanwhile, expenditure on welfare and health care will soar. We may not be able to make ends meet."

The government should [be] collecting revenue over the whole lifetime of property projects

Tsang quickly ruled out plugging the gap by drawing down the government's accumulated reserves, which if you include the exchange fund's accumulated surplus and the sums squirrelled away in accounts like the lotteries fund, now amount to some HK$1.5 trillion.

"Recurrent expenditure must be funded by sustainable revenue," Tsang declared, saying he would set up a committee "to explore ways to make more comprehensive planning for our public finances".

Many observers concluded that Tsang was paving the way for another government attempt to impose a goods and services tax on the city.

But there are far better ways to retool Hong Kong's revenue regime to meet the demands of future health and welfare spending than hitting the population with a tax that it has already been rejected once before.

One obvious way would be to change the way the government raises money from Hong Kong's property market.

Last year, the government raised HK$85 billion, a fifth of its total revenues, from property sales and land premium payments, the fees developers pay for a change in land use.

Yet, although these are major income sources, the government is reluctant to use the money, classifying it as capital revenue, and insisting it can only be spent on capital projects.

That might have been a sensible attitude in the 1970s, when Hong Kong badly needed infrastructure investment.

But these days the artificial distinction between recurring and capital revenues looks out of date, leading the government to lock away vast sums of public money while prompting officials to waste a fortune on gold-plated construction projects like the Zhuhai bridge, for which there is little, if any, demand.

Instead of booking its land revenues as capital income - which it then fritters away on wasteful investments that will never generate a positive economic return - the government should move away from demanding up-front lump sums from developers and towards collecting steady revenue streams over the whole lifetime of property projects.

There are several ways it could do this. One suggestion is for the government to turn to a property value tax, which would be set as a percentage of current market value, to be paid annually by property owners. In effect this would mean raising existing property rates from their current 5 per cent of annual rental value to, say, 20 per cent.

That would provide a steady income stream, and with the gain in recurring revenues offset by lower land premiums, it would encourage Hong Kong's property barons to develop more of their land banks.

But there are disadvantages to the idea. Firstly, replacing a hidden tax on householders, which is what land premiums amount to, with a visible tax in the form of higher rates would be highly unpopular, even if there was no net change in government revenues.

What's more, the government would be able to change the tax rate arbitrarily, which would discourage private investment. And any investments that increased nearby land values, like a new MTR rail line, would penalise existing owners who chose not to cash in.

A better solution would be the one outlined by governance watchdog David Webb, who three years ago called for the government to abandon lump-sum land-premium payments in favour of collecting regular rental income from leaseholders.

With the terms fixed in advance, annual rents would not be subject to arbitrary change (although they would still be linked to rateable values).

In addition, by lowering the barriers to entry in the real estate market, switching from premium payments to regular rents would increase competition among developers and, consequently, reduce home prices.

Above all, by emphasising rents over up-front lump-sum payments, officials would no longer be sucking money out of Hong Kong's economy either to lock it away as unneeded capital reserves or to waste it on unnecessary building projects.

Instead, the government would secure a steady revenue stream which is largely immune to swings in the economic cycle; just what it needs to fund the future welfare obligations John Tsang is so worried about.

This article appeared in the South China Morning Post print edition as: Government must change the way it taxes property
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