Liang Hongfu

Sound fiscal discipline

By Liang Hongfu (China Daily)
Updated: 2005-11-15 06:22

As the mainland government is moving to reform the nation's outdated tax system, many discussions have focused on examples in the United States and Hong Kong, representing the opposite extremes of fiscal philosophy.

It is widely believed among scholars and business people that the US income tax system is too complicated to be practically applied to the mainland. As explained by Professor Lang Xianping, from the Chinese University of Hong Kong, in a recent television talk show he hosted, the working of the US system hinges on two factors: a strong sense of civic responsibility on the part of the tax payers and a robust enforcement mechanism backed by tough laws against tax evasion. These factors are lacking on the mainland, according to Lang and others.

In contrast, the Hong Kong salary tax system seems simple and straightforward because other income streams, such as bank deposit interest, dividend or rental, are not taxed. But this simplicity belies a highly disciplined fiscal philosophy that forms the bedrock of the Hong Kong economy and accounts for much of its success and resilience.

Outsiders may wonder how a modern society like Hong Kong, which provides its citizens with adequate social welfare and excellent medical services that are basically free, can be financed by such a narrow tax base. The answer to that question lies in the Hong Kong government fiscal policy which has remained largely unchanged since the late 1970s. That policy is called "positive non-interventionism."

The guiding principle established in the late 1970s dictates that recurrent expenditure, including welfare, medical, education and civil service pay, must not exceed recurrent revenue, which consists mainly of salary tax, plus property rates, stamp duty and various public service fees and charges. This self-imposed fiscal discipline was closely adhered to by successive financial secretaries.

Under that guiding principle, all public works projects, including the building of roads, bridges, schools, hospitals and other infrastructure facilities, were to be financed by income from the sales of public land. It helped, of course, that the government is the biggest land owner in Hong Kong and large tracts of land are recovered each year through the levelling of hills or large-scale reclamation.

For this reason, government fiscal management can obviously benefit greatly from high land price, supported by an active property market. Many economists have equated the lofty housing cost to an indirect tax on the relatively more affluent segment of the public, who are not living in government-subsidized housing.

If that is counted, then the tax rate in Hong Kong on the richer half of the population is indeed high. At one time, the monthly mortgage payment or rent could amount to up to two thirds of the combined income of an average household.

This fiscal policy works when the government is agile enough to adjust its spending pattern in accordance to the economic cycle. To increase public spending during an economy upturn is easy. Any politician is happy to do that. Cutting back quickly and decisively in anticipation of an economic downturn, however, requires the discipline of true believers in "positive non-interventionism."

Despite its integrity, the fiscal policy of the Hong Kong government can hit some really rough patches if the economy is allowed to swing too far to either extreme and stay there for too long a time. The bursting of the pre-1997 property bubble is a case in point. Rampant speculation had pushed property prices to levels that few home-buyers in Hong Kong could afford. The outbreak of the Asian financial crisis in October 1997 led to a massive outflow of speculative capital from the Hong Kong property market, precipitating a spectacular crash in prices.

The property market slump, which lasted almost four years, dragged the economy into a prolonged recession from 1998 to 2003. The suddenness and magnitude of the collapse had made any meaningful fiscal adjustment untenable because it was deemed politically unacceptable to rescind the many longer-term commitments in social welfare and other related spending made during the economic boom. As a result, the Hong Kong government has to grapple with the new problem of what has become known as "structural budget deficit."

Nobody has seriously questioned the merits of the tax regime that has worked so well for Hong Kong for so long. Many economists and tax experts maintain that there is nothing wrong with the system. But the fiscal discipline that this system requires was somehow compromised, they say.

Email: jamesleung@ chinadaily.com.cn

(China Daily 11/15/2005 page4)