(Reprinted from HKCER Letters, Vol. 79 May-Jun 2004)


GST and Government Bond

Stephen Ching


Mr. Henry Tang's first budget includes an innovative idea that caught media attention. Tang proposed a Personalized Vehicle Registration Marks Scheme that allows vehicle owners to choose their preferred license plates. Under this scheme, a license plate can be any combination of up to eight letters and numbers.

Whether a GST should be introduced in Hong Kong has been debated for years, without resolution. Tang's budget mentions that the government has set up an internal committee to study the implementation of a GST in Hong Kong, and the government is expected to make a decision in a year. The budget also outlines a plan for issuing government bonds of not more than HK$20 billion in 2004-05, although issuing bonds has been rare in Hong Kong. Before taking on these two subjects, I return to the Personalized Vehicle Registration Marks Scheme.

Personalized Vehicle Registration Marks Scheme

The Personalized Vehicle Registration Marks Scheme is a win-win scheme. On the one hand, it provides vehicle owners with a new option for obtaining their preferred license plates. On the other hand, it brings extra revenue to the treasury. The scheme substantially widens vehicle owners' choice of license plates. It works as follows: A vehicle owner first chooses a preferred license plate and then bids for the plate. The license plate is ultimately awarded to the highest bidder. It is estimated that the scheme will generate $70 million, and this estimate appears reasonable. In addition, the scheme costs the government and taxpayers virtually nothing.

However, there will be some losses. The Lottery Fund and owners of existing valuable license plates will incur costs as a result of the scheme, but these costs are not expected to be significant. To minimize them, the government could set a relatively high starting bid for license plates under the new scheme.

An idea with as many potential benefits as this one should be pushed further. One suggestion is to follow a practice of private developers, who occasionally separate the rights to naming a property from the property itself and sell the two separately. The rights to name government properties, including infrastructures and new streets, could be auctioned to generate revenue. The city boundaries of Hong Kong are still expanding. New streets are being created each year. The proceeds from selling names of new streets alone would be sizeable. It might be inappropriate to sell names of old streets, owing to the inconvenience of changing street names. To gain popular support, the government could channel part of the proceeds to charity.

A Goods and Services Tax

As previously stated, Tang's budget mentions that the government has set up an internal committee to study the implementation of a GST in Hong Kong. The government has argued that introducing a GST could broaden the tax base, helping stabilize tax revenue. Many people concur with the view that a tax with a broader base is a better tax, but I am not among them. My view is that public policies should be based on social interest, and a tax with a broader base is not necessarily better for the society. This is an important point that merits elaboration. Let me use the evolution of monetary policy to illustrate it.

An important and costly lesson from the evolution of monetary policy is that monetary policy should be independent from the administrative branch of government. Although independent monetary policy is now taken for granted, historically this has not been the case. Under a system in which monetary policy is not independent, if the administration overspends, it can finance extra spending by printing money, which is not possible when monetary policy is independent. When it is independent, the only options available for financing extra spending are (1) issuing bonds and (2) raising taxes. Clearly, it is much easier to print money than to issue bonds or raise taxes, and the availability of this easy source of revenue creates an incentive problem. It undermines fiscal discipline, leading to overexpansion of the scale and scope of government.

The problem with an enormous government is that it displaces the more efficient and dynamic private market, hampering economic growth. In addition, an excessively large money supply leads to hyperinflation, which has a severe negative affect on earnings. This loss in earning is, in effect, the inflation tax. The base of the inflation tax is the broadest possible, and coverage is almost universal. Basically, the inflation tax reduces the real wealth of everyone proportionate to each individual's wealth. The inflation tax is also a fair tax, as measured in this way. However, hyperinflation is a painful experience that no government wants to repeat. The solution is to make monetary policy independent from the administration, preventing the administration from financing public expenditures by printing money.

This example illustrates how a broad-based tax can harm society and shows why I have always opposed the introduction of a GST to broaden the tax base.

The government has also pointed out that a rising number of countries have adopted a GST and that Hong Kong is the only developed economy that does not have one. I would counter that, first of all, using a different tax system, per se, is not necessary a problem. Hong Kong's economic system has other unique features, (e.g. the one country, two currencies system). Should we abolish the Hong Kong dollar simply because the one country, two currencies system is different from that of other countries?

The concern about being the only developed economy without a GST is nevertheless a valid one. Some countries have recently used a GST to lower their direct taxes (e.g. the profits tax and the salaries tax) to attract foreign capital and talent. This will threaten Hong Kong's traditional low-tax competitive advantage. To maintain this competitive advantage, introducing a GST in Hong Kong seems inevitable.

As pointed out earlier, the fundamental problem of a GST is that it provides an easy source of revenue, undermining fiscal discipline and leading to overexpansion of government. The key issue at stake in introducing a GST is how to prevent the government from abusing it. The government will promise not to abuse it, but, no matter how genuine the promise, the government will be unable to keep it. The government will not be able to resist different political pressures when an easy source of revenue is available and will eventually raise the GST rate to meet various political demands. This explains why the GST is addictive.

The issue can be addressed by articulating practical principles that can prevent the government from abusing a GST. One such principle I see is revenue neutrality, that is, all the revenue received from a GST are used to lower direct taxes, making the total tax revenue unchanged. Under this principle, a GST can be used to cope with international tax competition. At the same time, the government is committed to lowering direct taxes when introducing a GST, thus preserving Hong Kong's low-tax competitive advantage.

Government Bonds

Another one of Hong Kong's traditional competitive advantages is its prudent fiscal policy of avoiding budget deficits. Consequently, fiscal reserves were abundant in Hong Kong until recently. There was no need for the government to issue bonds, and it did so rarely. However, the Hong Kong Special Administrative Region has suffered fiscal deficits for a number of years. Fiscal reserves have already dropped only slightly more than one-year government expenditures. The budget proposes to issue bonds of less than HK$20 billion in 2004-05. It claims that the bonds could (1) enhance the government's flexibility in using its capital and (2) help develop the Hong Kong bond market.

That issuing bonds will enhance flexibility in capital utilization is hardly disputable. The current low-interest-rate environment is also favorable to issuing bonds. The impact of HK$20 billion bonds on Hong Kong's bond market will be, however, marginal. Recall that a few years ago the U.S. government used its fiscal surplus to retire a sizeable amount of outstanding treasury bonds. The U.S. bond market was affected almost instantaneously. If the government really wants to develop Hong Kong's bond market, it needs to issue a large amount of bonds on a recurring basis, but this is using the end to justify the means.

All in all, Tang's budget is a good one, since it emphasizes giving the public a much-needed break. "Carpenter Li" (Li Ruihuan) reminded the Hong Kong people not to "cleanse the tea stain off the purple sand teapot" (drop Hong Kong's traditional competitive advantages). I believe that giving the public a break means letting the tea stain the teapot once again.

The Chinese version of this article was published in Ming Pao Monthly, April 2004, pp. 46-47.

Stephen Ching is Associate Professor at the School of Economics and Finance, The University of Hong Kong.


| Index | Research Projects | HKCER Letters |
| Speaker Program / Conference | Index of Economic Freedom |

The Hong Kong Centre for Economic Research
School of Economics and Finance
The University of Hong Kong
Phone: (852) 2547-8313 Fax: (852) 2548-6319
email: hkcer@econ.hku.hk