How Hong Kong Could Scrap Income Tax and Prosper

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(Bloomberg Gadfly) -- It may be a good problem to have, but it's a problem nevertheless.

In his annual budget speech Wednesday, Hong Kong Financial Secretary Paul Chan announced a surplus of HK$138 billion ($17.6 billion) for the fiscal year 2017-18. That's eight times the original government forecast of HK$16.3 billion.

Too much of a good thing plagues both Hong Kong and Singapore. The city economies have a deluge of money coming into government coffers now, but as their populations age, social security and healthcare expenditure will surge just as income taxes start to bring in less. Today's bumper harvests could turn into deficits within a decade

To ward off that scenario, Singapore plans to increase its 7 percent goods and services tax by 2 percentage points between 2021 and 2025. Hong Kong, which doesn't have a sales tax, would find it almost impossible to adopt a regressive levy now when inequality in the Chinese territory is already at a record high.

What's to be done? Leave GST aside. Hong Kong could take a different leaf out of Singapore's playbook: living off assets.

Starting a decade ago, the island state turned its three reservoirs of wealth -- the central bank, the sovereign wealth fund GIC Pte, and the state investment firm Temasek Holdings Pte -- into the single biggest contributor to government revenue, more than any tax or levy. The annual budget claims up to half of realized and unrealized investment gains. The rest is reinvested.

The last thing Hong Kong needs is a state investment firm to meddle in the economy. But leaving its accumulated fiscal war chest of HK$1 trillion at the central bank's Exchange Fund to earn measly interest income on the world's safest securities is too conservative.

Without risking the Hong Kong dollar's peg to the U.S. currency (which is what the Exchange Fund protects), the city could set aside some of the funds it garners from land premiums and stamp duties to purchase riskier overseas assets. About HK$221 billion, or 37 percent of total revenue for the coming fiscal year, is expected from those two levies, which are also the most volatile. Sequestering, say, half of the take would mean borrowing to finance HK$86 billion in planned infrastructure spending. It would be wise to do so for several reasons.

First, with gross government debt of 0.1 percent of GDP, there's zero risk to Hong Kong's AA+ credit rating.

Second, higher sovereign and quasi-sovereign issuance would accord wealthy Hong Kongers a wider menu of risk-free investment options. Chan vowed to step up the issue of  "silver bonds," which are notes aimed at providing elderly citizens with steady coupons. Singapore, by contrast, is planning to rely much more heavily on the bond market to finance everything from a new airport terminal to a high-speed train link with Malaysia. To maintain its competitiveness, Hong Kong should match its rival's aggressiveness.  

Third, pressure to release more land to developers won't go away in the world's least affordable housing market. The government will offer 27 residential plots in the coming financial year alone, so earning more revenue from premiums. That could lead to yet another overshoot on the estimated HK$46.6 billion budget surplus for the coming fiscal year.

Fourth, don't lose sight of population aging. A recent flu epidemic underscored an embarrassing shortage of public health-care facilities. Hong Kongers demanded to know why their rich government couldn't give them shorter hospital waiting times. Chan was forced to earmark HK$6 billion to the Hospital Authority in his 2018-19 budget.

That's just the beginning. Outlays on chronic diseases and elderly care will keep rising. At the same time, however, the ambitious Bay Area project -- a seamless urban agglomeration linking Hong Kong with Macau and China's industrial powerhouse of Guangdong -- will also need lumpy financing, especially in transport.

With assets financed by borrowing, and a portfolio of overseas holdings earning investment returns, the tension between today's needs and tomorrow's demands can be resolved.

Next year, levies on wages are expected to fetch half as much revenue as stamp duties on property and stock-market transactions: Chan trimmed salary taxes in his budget, forgoing HK$22.6 billion. That's a good start, because higher take-home pay will make an overburdened middle class feel more optimistic about their biggest expenditure: housing. The revenue from land released to meet additional housing demand can also be reinvested in foreign assets.

Eventually, Hong Kong could find itself in a situation where it doesn't even need to collect income taxes.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

©2018 Bloomberg L.P.

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