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Peter Liang argues that Hong Kong must come up with a pension system which respects the city's traditional obligations to fiscal discipline and its low-tax regime

The debate on pension reform has brought to the forefront the underlying principles of government finance. According to Chief Secretary for Administration Carrie Lam Cheng Yuet-ngor, these were misunderstood by many skeptics of government projections in the consultation document issued two weeks ago.

Those skeptics charged that the government had exaggerated the public expenditure required to fund a universal pension scheme in future with the population continuing to age rapidly. In the consultation document, the government projected that such a scheme would threaten to drain the fiscal reserves at an alarming rate. This would make a tax increase inevitable.

However, critics of the government position have remained adamant, arguing that the fiscal reserves, which amounted to HK$828 billion at the close of the previous fiscal year on March 31, 2015, belong to the people and should be used for the benefit of the people. They are right on that point and, as many economists can attest, keeping too large a reserve fund is not necessarily a good thing because of complications in managing it to achieve a maximum return.

What is more, the government has always adhered to the policy of returning wealth to the people in order to achieve maximum economic efficiency under Hong Kong's free-market system. Obviously, many people fail to understand why the government needs to keep such a large reserve fund and, in the current debate, caricatured the government as a miser who can think of nothing but money.

These are, of course, unfair charges because there is a constitutional requirement for the government to maintain a large reserve fund. This is to meet various contingent liabilities without the need to borrow. The most frequent use of the reserves is to cover seasonal budgetary shortfalls. A sizable reserve fund is also needed to show that the government has the resources needed to defend the linked exchange rate system when called upon to do so.

Those critics who accused the government of exaggeration may not remember that fateful day in 1997 when the government had to mobilize HK$100 billion to keep the currency attackers at bay. And for several years following the outbreak of the SARS epidemic which plunged the economy into a deep slump, the government had to draw down billions of dollars a year from the reserves to cover the budget deficits.

Hong Kong's traditional budgetary discipline is enshrined in the Basic Law. This specifically stipulates that the government must keep expenditure under control and "strive to achieve a fiscal balance".

That discipline requires the government to keep a very close lid on the expansion of recurrent expenditure, particularly social services. In the past, the government followed the self-imposed rule of limiting recurrent expenditure to what can be financed by recurrent revenues, while capital expenditure was funded by sales of public land.

Although that line has been blurred in recent years most senior financial officials, steeped in Hong Kong's budgetary traditions, have remained vigilant about runaway recurrent spending. For that reason, they undoubtedly view the proposal of universal pension with great apprehension.

Budgetary discipline has practically ruled out the option of debt financing. The only other way for the government to pay for chronic budgetary deficits is to raise taxes.

Increasing tax is a contentious issue in any developed economy. It could have a particularly devastating impact on Hong Kong, which counts on its low tax base as a major advantage as an international financial center and regional business hub. While affirming the independence of Hong Kong's taxation system, the Basic Law stipulates that the low tax policy previously pursued should serve as a reference.

The government has said that it would resurrect an earlier proposal to broaden the tax base by introducing a sales tax to fund the projected increase in expenditure on social services to meet growing demand. But that proposal was shelved in face of stiff public opposition. This was because it was seen to penalize the poor who have to spend a larger portion of their family incomes on purchasing needed goods and services than the rich.

Whether that argument against indirect tax is valid is not the issue here. What it shows is that Hong Kong people are so used to a simple and low tax regime that any suggestion of changing this would invariably incite strong public protests.

The government is not playing Ebenezer Scrooge, the ultimate Victorian miser in Charles Dickens' A Christmas Carol. It is just trying to be realistic about the pension reform.

The author is a veteran current affairs commentator.

(HK Edition 01/04/2016 page11)