Hong Kong has no public debt. The government typically runs a surplus, and has accumulated fiscal reserves of HK$592 billion (US$76 billion) – equivalent to 34% of GDP, enough for nearly two years’ expenditure. The territory accomplishes this with low taxes. Hong Kong has no sales or value-added tax, no capital gains tax, no inheritance tax, and some of the lowest income and profits taxes in the world. High personal allowances exempt many workers from payment of tax on their salaries. The rest pay a maximum average rate of 16% (the same as the tax on business profits), with marginal rates that range from 2% to 17%. Low-income workers benefit not only from zero or minimal taxes, but also from housing subsidies (half of Hong Kong’s population lives in subsidised public flats).
David Pilling, Asia editor of the Financial Times, thinks that the apparent low taxes are an illusion. Hong Kong`s land policies, he writes, create “huge distortions and opacities, making it hard to talk sensibly about levels of tax and expenditure”.
The land system is a legacy of British colonialism. London wanted Hong Kong to be self-financing. So the colonial authorities raised money by leasing land, an apparently free source of revenue that persists to this day. The state hives off chunks of land in plots so large that only the biggest developers can bid for it. Developers also pay the government an upfront premium in return for permission to convert its use, say from agriculture to commercial, a hey-presto transformation that releases more value.
Civic Exchange [a Hong Kong think-tank] estimates no less than 45 per cent of government revenue comes from land, including land premiums, property rates and taxes on property developers’ handsome profits. Hemlock, the nom de plume of a business writer with close connections to Hong Kong’s tycoons, compares the property cartel that benefits from this arrangement to “feudal lords granted the right to gather tax from the peasants”. The tax in question is rent. Hong Kong’s is the highest in the world. According to DTZ, the property consultancy, the cost of office space in central Hong Kong pips that of even central London, Tokyo and Zurich.
Spiriting cash from land creates distortions. The top rate of income tax, at just 17 per cent, is legendarily low. But it turns out to be precisely that: a legend. Taxes are extracted, invisibly, via rent. There are also disguised expenditures. Take the MTR Corporation, which runs Hong Kong’s underground train system and airport express line. Such is the extent of the land holdings granted to it that some call MTR a property company with a train running through it. Land allocations require no legislative oversight. Nor are they accounted for as expenditure. By this means, Hong Kong has conjured a cheap and gleaming transport system seemingly out of nothing.
There are physical distortions, too. One is that half of Hong Kong’s citizens are herded into cramped government flats. Paying commercial rent or buying an apartment is quite beyond the reach of poor or even middle-class families, leaving them dependent on subsidised housing.
David Pilling, “Hong Kong’s land system that time forgot“, Financial Times, 10 March 2011.
Mr Pilling believes that Hong Kong land prices (hence commercial rents) are high because government charges for land use. If the land taxes and lease payments were removed, would the price of land fall? Only if the supply of land increases. But land – especially in tiny Hong Kong – is essentially fixed. Land can be reclaimed from the sea (as was done for the new Hong Kong airport), but this is very expensive. The burden of taxation of any factor in fixed supply falls entirely on those who control use of the factor, in this case the land developers. If the Hong Kong government were to end its policy of charging for land use, obtaining the lost revenue from a sales tax or higher income taxes, the prices and rents of commercial apartments and offices would not fall.
It is certainly true that looking only at data on taxation, rather than total government revenue or expenditure, distorts the fiscal picture of Hong Kong. But this does not imply that the revenue system of Hong Kong creates `”huge distortions”. Quite the contrary. Taxes on land create almost no distortions because they have no effect on supply or demand. For a full explanation, see any first-year economics text. It matters not a whit whether the revenue collected by government is called ‘lease payments’ or ‘tax payments’; the analysis is the same. Hong Kong should be praised – not condemned – for relying so heavily on land revenues to finance government expenditures.
