Analysis: HK GST would correct budget gap

SINGAPORE, Aug. 19 (UPI) -- Despite likely public resistance, a sales tax in Hong Kong would broaden the tax base and help to correct the former British colony's structural fiscal deficit. Such sales tax would be a sustainable and stable source of government revenue, especially given that land revenues have been very volatile since the 1997 market slump, economists say.

"Such a tax, in our opinion, forms one of the missing links in the government's fiscal consolidation efforts...given that the March budget measures failed to fully address the operating deficit for this fiscal year," says Pieter van der Schaft, analyst at Barclays Capital.

"It is common knowledge that Hong Kong needs to widen the tax base. Leung alluded to the possibility of a general sales tax (GST) in his budget. In our view, it is inevitable," adds Mike Moran, North East Asia economist at Standard Chartered Bank.

A GST instantly broadens the tax base by taxing people's spending rather than their earnings.

According to the local press, the newly appointed financial secretary Henry Tang has agreed to step up the groundwork for the implementation of a sales tax, even though it is not official government policy yet. Such groundwork would reduce the lead-time once it is proposed.

Although former Finance Secretary Anthony Leung had earlier stated that the government was looking to introduce a sales tax by 2006, plans to introduce it had been put on hold given Hong Kong's current economic downturn and its deflationary pressures.

However, several arguments are said to have swayed the government into setting up the investigative taskforce: The need to reduce the extremely pro-cyclical nature of Hong Kong's government finances; the need to broaden the tax base fairly - Out of 3.2 million working population, 2 million don't pay any tax at all and only 11,000 taxpayers reportedly pay the full 15 percent income tax; and the limited room to raise further taxes or cut further spending.

In its last budget, the government announced several measures to help structurally reduce the budget deficit by US$4.73 billion over the next three years to bring the budget in balance. These included large spending cuts (mainly on civil servant salaries), raising revenues through high taxes

But the measures proposed are not seen as sufficient to address the fundamental deficiencies in the local tax system, the very narrow tax base. Moreover, the government's revenue projections are deemed optimistic as partly linked to economic growth expectation (3 percent GDP growth)

"What is of particular concern is Hong Kong's recurrent operating deficit. This is the shortfall incurred from the day-to-day operation of government. It is here that the largest chunk of the current deficit resides and perhaps the more difficult to curtail," says Moran.

While Hong Kong was able to fund its recurring operating deficit from large windfalls from land sales during the property boom years, the golden goose may well have been lost for good, Moran notes. "This means that self-sufficiency in the operating account is crucial to fiscal stability," he says.

The tough budget has also left little leeway to meet future growth in expenditures, including social welfare payments, which are rising rapidly due to Hong Kong's ageing population and rising structural unemployment.

"As such, the sales tax is badly needed as part of the government's fiscal consolidation efforts, if it is to achieve its balanced budget target by 2006/2007," says van der Schaft.

He believes the positive effects of a sales tax would outweigh the negative effects on Hong Kong's economy, pointing that the government's fiscal policy stance has little impact on the economy, given its very open nature.

Estimates from the Civic Exchange, a local think tank, project that a 3 percent GST could raise $2.3 billion, while a 6 percent GST could raise $4.6 billion, greater than the government's total 2001/2002 forecasted receipts from salaries tax.

"The additional revenue from a GST would allow the government to reverse some of the tax hikes announced this year. This would help restore part of the erosion in tax differentials with regional competitors like Singapore," Moran points.

"We would view a sales tax - which would likely be pegged at a 3 percent flat rate - as a positive, even if the tax is only introduced by 2006 at the earliest," adds van der Schaft.

Yet, even if the government decides on such tax it is unlikely to be implemented in the near future, many economists say.

"I think they will wait for strong economic upturn to introduce it, likely after late 2005 as Disney theme park opens and CEPA works. At the current moment, it is a gesture and signals to the market, in additional to the privatization plan of the airport, that the new financial secretary and government will seriously tackle the budget deficit problem," says Daniel Chan, economist at DBS Bank.

The fiscal deficit hit $7.95 billion (or 4.9 percent of GDP) last year and is officially forecast to reach $8.7 billion (5.4 percent of GDP) this year. However, Tang has already warned that the deficit will exceed the target this year, because of extra spending due to the SARS outbreak.

Tang also indicated on Monday that plans to balance the fiscal budget by 2006/07 were not realistic and admitted he would need more time to set a new timetable.

Both Barclays and CSFB are projecting a deficit of $12.1 billion or 7.6 percent of GDP for this year.