To restore peace to Hong Kong, big business, developers, homeowners and the taxman must all accept the pain of drastic economic reform

High land prices, the currency peg and low taxes are flaws in Hong Kong’s deeply unfair economic system, which needs to be overhauled
Big businesses and existing homeowners are among those who must make painful sacrifices if the city’s problems are to be solved

Andy Xie

Published: 6:00am, 28 Oct 2019

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Hong Kong must reform its economic policy to restore social calm. While political issues are important and should be addressed, economics is critical to any lasting peace. The essence of Hong Kong’s current economic policy, which is billed as a laissez-faire nirvana, is a regressive tax in the form of high land prices. It strangles the middle class.

When economic growth is fast, it obscures the negative impact of the policy. But prolonged slow growth exposes the corrosive effect the policy has on wealth equality and labour income. As young people’s aspirations are extinguished, a social explosion is inevitable.

Chief Executive Carrie Lam Cheng Yuet-ngor’s policy address, while delivered under difficult circumstances, was very disappointing content-wise. A new initiative to allow homebuyers to borrow up to 90 per cent of the value of flats is sugar-coated poison. Under current circumstances, is a 10 per cent drop in property prices imaginable?

If so, the loan-to-value ratio of 90 per cent seems like a trap for the middle class. It just allows property developers to unload flats at good prices in a depressed market. This continues Hong Kong’s policy bias towards the super rich, at the expense of the middle class.

The Hong Kong government has long touted its tolerance of dubious business behaviour as laissez-faire economics. At best, it is an excuse for laziness. At worst, it is collusion with tycoons to squeeze every last drop out of ordinary people. The land shortage could be seen as an intended outcome of this collusion. There are many other examples. The odds are good that Hong Kong’s laissez-faire economics is corruption in disguise.

Supermarkets’ high profit margins act as another regressive tax, which hits those in low-income brackets the hardest. Yet another egregious example is construction costs. Building costs in Hong Kong are among the world’s highest, approaching New York levels, while those in Shenzhen are among the lowest. To make housing affordable, Hong Kong has to address both the issues of land supply and construction costs.

Hong Kong’s currency peg is a key factor in the unfairness of its economic structure. It should be abandoned at an opportune time

High land prices have raised much revenue for the Hong Kong government. While they are in fact indirect taxes, the government can claim they are business revenue that makes possible low direct taxes, or none at all, for most people. The perception that little or no tax is being paid has given the government extraordinary freedom of expenditure, whether it is extraordinarily low welfare subsidies for the poor or generous compensation for government employees.

The Hong Kong dollar’s peg to the US dollar has deepened the flaws in the system. The US Federal Reserve has been pursuing an expansionary monetary policy over much of the past three decades. Hong Kong is effectively importing super-low interest rates via the currency peg.

It covers up the burden of housing debt and allows developers to constantly push up prices, while exposing Hong Kong’s labour force to unchecked international competition. Hong Kong’s currency peg is a key factor in the unfairness of its economic structure. It should be abandoned at an opportune time.

To overcome the land crunch, Hong Kong must remove the incentive to hoard land. Unless the system changes, any new initiative to increase supply is likely to get bogged down in a political mire. This is how the current system works.

A remedy would be to introduce a high land appreciation tax; 60 per cent is a good number to start with. The tax should be assessed and collected annually. When such a tax is introduced, the government would suddenly find zero resistance to its initiative to increase land supply.

As the government stops relying on high land prices for revenue, it should start collecting progressive taxes on property and income, just like in a normal economy. For example, the tax rate could be zero on properties under HK$5 million, 1 per cent on those between HK$5 million and HK$10 million, 2 per cent on those between HK$10 million and HK$20 million, and 3 per cent on more expensive properties.

In addition to the standard income-tax rate of 15 per cent, there could be a tax rate of 25 per cent on incomes above HK$5 million. To close loopholes, business income should be taxed at the same rates.

If the violence continues in Hong Kong, the only winner is Beijing

The government has been talking about a housing shortage forever. It can’t go on like this. Introducing policy initiatives to raise hope isn’t enough. The government must take concrete measures to boost housing supply immediately. Mainland China is developing a vast industry for manufacturing building parts. It is easy for Hong Kong to leverage its proximity to the mainland, and it is possible to solve the housing problem within five years.

Hong Kong should keep increasing housing supply until prices fall to within a reasonable range of around one month’s salary for one square metre. Some might argue that construction costs are already at this level, which means they are too high. When Hong Kong’s economic structure normalises, prices will normalise, too.

The necessary restructuring of Hong Kong’s economy would inevitably hurt some interest groups. Big businesses would obviously lose their huge profit margins and become like their counterparts elsewhere. Clearly, they could be expected to fight to keep their privileges. As they have good access to Beijing, meaningful economic reform is unlikely to happen without political determination at the top.

Economic reform would also hurt existing homeowners, mainly those who own large or multiple units. Big businesses will certainly try to kill reform by citing homeowners. This was how then chief executive Tung Chee-hwa’s initiative to build 85,000 homes was killed off. Hong Kong must accept some pain to enjoy a rebirth. Otherwise, today’s youth have no hope of owning a home fit for raising a family. How, then, will stability return to society?

Andy Xie is an independent economist

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