Pearls and Irritations

The Hong Kong Special Administrative Region (HKSAR) of the People’s Republic of China (PRC) has a serious housing problem.  There has been much discussion over the last several years about how this has amplified social discontent.  This conversation intensified during the major 2019 protests that became a lengthy anti-government and anti-Beijing rebellion.

Critical arguments have focussed prominently on the serious lack of housing accessibility due to very high purchase prices and the elevated profits of major, private housing developers.  The basic problem, as stated, is not unfounded, but the full picture on housing in Hong Kong is far more complex and interesting, while still deeply concerning.

As it happens, Hong Kong faced a more formidable housing crisis over 60 years ago, to which it responded with a remarkably successful solution.  I argue below that the essential outline of an answer to today’s housing crisis can be found within the exceptional remedies applied to that earlier housing emergency.  To understand why this is so, it is instructive to look, in some detail, at how Hong Kong’s housing regime came to be where it is today.

The Public Revenue System in Hong Kong

One can reasonably claim that Hong Kong is a remarkable tax policy museum.  For a First World jurisdiction, it has an unusually limited range of taxes – there is no prescribed, general Sales Tax, nor any formal Capital Gains Tax, for example.  Yet one can also argue that has been a centre of revenue policy innovation.  The innovation, above all, has pivoted on successfully accessing non-usual sources of public revenue (especially land-related revenues).  The result is that tax reform has been kept to a minimum.  Hong Kong thus retains a Revenue Regime (RR) which is (formally) low tax, clearly simple (with low compliance costs) and it has generated revenues sufficient to build excellent infrastructure, to provide often first rate government services, to enable Hong Kong to stay virtually debt free and to amass huge fiscal reserves. It is, as happens, also a system well-equipped to pay for and maintain a robust Rule of Law regime.

From its inception, British Hong Kong (BHK) was a Free Port, so Customs Duties were not available as a source of revenue.  Also from the outset, the British did not allow any sale of freehold land.  All land was made available as leasehold land (with strict conditions attached to each particular lease).  Landholders wishing to vary the building-usage allowed under a particular lease had, on each such occasion, to pay a premium to the Hong Kong government to secure the variation.  They still do.

This policy traces its roots to Britain’s bleak experience in losing the American Revolutionary War – and its American colonies – some 60 years earlier.  That war was significantly triggered by disputes over London-sourced taxation and price-setting.  The Colonial Office thereafter emphasized the importance of making new colonies – including Hong Kong – internally self-financing as far as possible.

In pursuit of this outcome, the practice of restricting the availability of land for development In Hong Kong evolved.  The notably hilly terrain added sense to this approach.  But this policy also helped drive the price of available land up towards the limits of what the market would accept and, thus, revenue receipts.  When one factored in the consistent strong, opium-based, growth in the economy over the first 50-plus years of British Hong Kong, the government found that its land-based revenue regime more than compensated for the shortfall in expected funding from the originally planned opium-based revenue stream

The colony’s fiscal foundations proved to be so sturdy that, within around 40 years of its founding, the Hong Kong Government had already amassed more than one year of total, normal, public expenditure in fiscal reserves.  A by-product of this policy was the retention of remarkably extensive areas of green-space surrounding Hong Kong’s far smaller, built-up area.

This land-related revenue regime was further strengthened as the total area comprising the Crown Colony increased significantly, initially in 1860 and then in 1898.  The expansion of Hong Kong increased the Hong Kong Government’s “land-bank” greatly.

The land-based revenue system remains a mainstay of the Hong Kong fiscal regime to this day.  These foundations were fundamental in allowing the colony to thrive without need to resort to any sort of direct income taxation for around 100 years – and when such taxes came they were kept low and simple.

A good way to get a feel for just how financially significant this system is, in operation, is to look at an example.  In 1995, the Hong Kong Government put a parcel of land (Lot 129) of around 180,000 square feet up for sale on Ap Lei Chau, which is an island located to the south of Hong Kong island.  Ap Lei Chau is connected by a causeway bridge to neighbouring Aberdeen on Hong Kong island.  The whole area is densely populated.  As is the case across much of Hong Kong, these high density urban areas are surrounded by wooded mountains and the sea.

Lot 129 is located along the Ap Lei Chau waterfront, across the road from numerous small-scale shipyards which service the local fishing fleet and the many pleasure junks and luxury yachts moored in the large Aberdeen Typhoon Shelter.  The government sold the Lot 129 lease – for industrial use – for just under US$30 million in 1995 to a secondary commercial-industrial developer.  By 2005, two primary residential property developers had acquired a significant interest in Lot 129 (by now valued at about US$74 million).  The two property developers needed to have the lease modified to allow a major, high-end residential development in several modern high-rise tower blocks to proceed.  The lease modification premium – paid to the government – to convert the lease from the original-sale industrial use to the high-end residential use was approximately US$504 million.  The Hong Kong Government thus derived US$534 million within around 10 years, virtually at two strokes of a pen, from the two Lot 129 transactions.

It is important to note that a key feature of this land-based revenue system is that the public land-revenues are mainly collected “up front”.  Leases in BHK typically had durations of 75, 99 or (less commonly) 999 years – with renewal rights.  Government Rent per annum (where lease-stipulated) was minimal: customarily 3% of a conservatively estimated annual, potential rent-value.  The drawbacks of relying on this “up front” payment system have been well argued by a number of commentators (for example, it crowds out smaller, less cash-rich developers and thus curbs competition).  For successive Hong Kong Governments this system has proved highly attractive, however.  For one thing, the transaction costs associated with collecting very large amounts of public revenue each year are kept remarkably low.

Since the establishment of the HKSAR within the PRC on July 1, 1997, almost all new government leases have been granted for 50 years.  The government has confirmed, however, that it has complete power to issue or renew leases beyond 2047.  The great majority of leases include a right to renew.

Hong Kong, thus, developed the use of land as a long-term, fundamental revenue source in a way no other First World jurisdiction has.  Elsewhere, primary urban land has largely been sold off into private hands.  Only in Hong Kong does government retain an indefinite, profit-sharing, core proprietorial interest in all land.  Henry George, the 19^th century (American) Patron Saint of Land Taxation (one of whose followers, Lizzie Maggie, created the precursor to the game of Monopoly) never conceived of such a system.  But had George understood it in detail, it is likely he would have approved and may have adopted key aspects of what he saw into his own exceptional taxation framework.

Hong Kong’s first ever income tax was the War Revenue Ordinance passed by the Legislative Council  (LegCo) in 1940 enacted in response, above all, to the rapidly expanding invasion of China by Japan.  It created a system of schedules, establishing three separate taxes on different categories of income – a Property Tax with a flat rate, a Salaries Tax with progressive rates and a Profits Tax with a flat rate for corporations and progressive rates for unincorporated firms.  The Ordinance exempted all offshore income from taxation.

In drafting the Ordinance, the War Revenue Committee copied the schedular British Income Tax system introduced by Prime Minister Addington in 1803, despite the fact that the British system itself had been reformed in 1910 to base tax liability on a taxpayer’s total income.

The new, post-war, 1947 tax legislation passed by LegCo, the Inland Revenue Ordinance (IRO), retained the basic schedular structure and the restricted territorial ambit of the War Revenue Ordinance.  Since 1947, the IRO has been formally re-examined on three occasions, in 1954, 1968, and 1976, by Review Committees.  No major alterations have been made to the IRO, however.

 One decisive role of the PRC-enacted, mini-constitution of the HKSAR, the Basic Law, is to provide for the highest degree of fiscal separation between Hong Kong and the Mainland (Two Systems) within the PRC (One Country).  Particular effort has been put into drafting provisions in the Basic Law which are designed to install a constitutional, “fiscal firewall” between the two Tax Systems.

Article 106 of the Basic Law provides that Hong Kong is to have its own independent finances and prohibits the PRC from raising taxes in Hong Kong or sharing the HKSAR’s tax revenue.  Article 108 further provides that:

The Hong Kong Special Administrative Region shall practise an independent taxation system.  The Hong Kong Special Administrative Region shall, taking the low tax policy previously pursued in Hong Kong as reference, enact laws on its own concerning types of taxes, tax rates, tax reductions, allowances and exemptions, and other matters of taxation.

Housing in British Hong Kong

The critical role of adequate basic housing in maintaining colonial stability was made starkly clear to the BHK Government on the evening of Christmas Day, December 25, 1953, when a devastating fire swept through the Shek Kip Mei squatter area in Kowloon.  Some 53,000 immigrants from the Mainland, whom the BHK Government had no choice but to look after, were made homeless overnight.  The Governor, Sir Alexander Grantham launched what was to become one the most massive public housing projects in any large city, worldwide.  Grantham was able to commence this project because the BHK government could, both: supply the land on which to build; and fund the construction expenditure.  Initial temporary housing was erected within two months.  Between 1954 and 1964 the BHK Government built more than 140 multi-story “Resettlement Blocks” as they were known.  In 1971, the then new Governor, Sir Murray Maclehose, announced a still bigger public housing programme to house close to 2 million people in flats (small as they were) fitted with decent facilities.

The remarkable outcome has been the creation of Hong Kong’s vast stock of Public Rental Housing (PRH) – now over 800,000 flats – and the mass provision of subsidized Home Ownership Scheme (HOS) residences – now in excess of 400,000 flats.  All such flats are small with average living space per person at around 11 square metres.  Older PRH estates are often conveniently located and even new estates normally have good public transport access.

Rents average less than $US250 per month or 10-15% of disposable income.  As that income normally falls below the taxable threshold, resulting in zero liability for Salaries Tax, PRH residents typically have enjoyed disposable incomes of 85%-90% of gross income, after rent.  Thus, the large majority of low income Hong Kong residents are comparatively well housed, though in small flats.  A system exists, too, for passing on a PRH flat from one generation to the next, subject to a means test regime.  Almost 30% of Hong Kong residents live in PRH with about another 20% living in subsidized, privately owned housing.

But how was this housing revolution was funded when private market residential flats prices have long been, per square foot, among the highest in the world?  Because the BHK Government had retained the freehold title of virtually all land, the then readily available land used to build PRH and HOS flats came at zero nominal cost as the scheme was implemented.  And all that public revenue from (high value) land-related transactions greatly assisted in the creation of the ample fiscal reserves which readily funded building costs.

The completed flats have been let at low rent to stable, reliable tenants, on the whole, so that bad debt and excessive wear-and-tear problems are minimized.

The very worst off, amongst those living below the Poverty Line in Hong Kong were – and still are – the poor who lack access to PRH.  Stuck in low income jobs (if that fortunate) families of four or more can find themselves with no choice but to rent (an often non-legal) “subdivided unit” of 10 square metres or even less.  This is where the poverty gap in Hong Kong is intolerably evident.  Around 230,000 people are estimated to live in more than 100,000 such subdivided units.  The PRH waiting list for such people averages almost six years, according to one recent report.

An Antipodean Comparative Perspective

Some comparative context is useful to add perspective on these difficult housing problems facing Hong Kong.  New Zealand and Australia do not face the very constrained land-availability problems of Hong Kong.  Both are wealthy First World jurisdictions blessed with significant natural resources.  Yet according to recorded figures, homelessness is a significantly greater problem in both jurisdictions compared to Hong Kong.

The official Hong Kong homelessness rate was under 1,200 in 2018.  Academic studies, looking at street-sleepers, say that the real rate is at least 2,000.  In a population of 7.7 million this is equivalent to a rate of .015% to .026%.  (The poor in Hong Kong renting sub-divided units endure very harsh, cramped living conditions, of course – but they do have a fixed home to return to each evening.)

Homelessness estimates for New Zealand range from an official government figure of 4,000 to an academic study figure of 41,000 in a population of almost 4.8 million, equivalent to a rate ranging from .083% to .85%.  In Australia, homelessness was estimated, by the Australian Bureau of Statistics at over 115,000 in 2018, in a population of just on 25 million, which translates as rate of .46%.  It is true that different measuring methods may be being used but these figures are at least indicative.  Using the minimum comparative figure, New Zealand has a homelessness rate which is more than three times the higher estimate for the HKSAR.  Using the highest New Zealand and Hong Kong estimates, the New Zealand rate is over 32 times higher.  In Australia, the rate is almost 18 times higher.

Some other comparative statistics related to the provision of PRH in New Zealand and Australia are worth noting.  Housing New Zealand has about 62,000 PRH units available for rent – a ratio of units to total population of 1.3%.  The ration in Australia is somewhat higher than that for New Zealand at 1.7%.  Just looking at PRH flats in Hong Kong (not including HOS flats) the comparative ratio is just on 11.4 % – almost nine times higher than in New Zealand and almost seven time higher than in Australia.  In both New Zealand and Australia, rents for PRH are typically about 25% (or more) of total income compared to 10-15% in Hong Kong.

Housing in the HKSAR

So why does the HKSAR face such a housing crisis today?

First, consider the demand-side of the explanation.  Basic claims for better access to decent accommodation have continued to rise.  Apart from close to a quarter of a million, penurious Hong Kong residents  living in tiny, sub-standard flats waiting to move to PRH, other demand-factors are applying pressure.  Under a long-sanctioned (by the British) migration programme, over 50,000 family-reunion Mainlanders per year (of typically modest means) are allowed to take up permanent residence in Hong Kong.  This typically has added over 1 million new residents to the Hong Kong population every 20 years.  Then there is the mass of younger HKSAR residents who, not unreasonably, very much aspire to move out of the family home and into a home of their own.

Next – and crucially – compared to several decades ago, the Hong Kong Government has now run up against major land shortage problems making it more difficult than ever to build badly needed additional PRH flats and HOS flats.  This land shortfall is not, however, a product of a dire shortage of physical land within the HKSAR.  It is far more a consequence of entrenched policies restricting land usage – and land creation.  Some of these policies are of very long-standing.

For political-historical (and hilly-geography) reasons, measurably less than 30% of the total HKSAR area (today) of some 1100 square kilometres is subject to high density development.  Over 70% is designated as “countryside” which includes low-rise accommodation, farmland and remarkably expansive “country parks”.  Moreover, for political-environmental reasons, land-reclamation, a consistent practice from 1842 and throughout the BHK era, has become increasingly difficult to implement.

The government has ambitious plans to increase the supply of housing by 450,000 public and private units (70% public and 30% private) over the coming years through until 2029 – using, inter alia, re-zoned farmland and low density areas and so called “brownfield” sites (without reclaiming areas in country parks).  This is, though, a project constrained by an abundance of contemporary, rights-influenced, legal and NIMBY (Not In My Back Yard) obstacles.

The government is, thus, also planning a massive reclamation to create around 1,700 hectares of new land (in essence, a new island) close to the eastern end of Lantau Island, not so far from Kowloon and Hong Kong Island.  Housing could be provided here for over one million people by 2035.

The Lantau Tomorrow proposal is, predictably, controversial, though many of the criticisms amount to making the perfect and enemy of the good.  Few places have had greater, successful experience with land reclamation than Hong Kong.  Only the government can “build”: new land.  With new land, the NIMBY problems are far less acute and by building its own new land, the bargaining power of the government will be enhanced as it deals with the leasehold-owners (often major developers) of farmland and related sites.  The cost is great and there are risks.  Completing the project may initially involve spending much of the fiscal reserve fund.  This would reduce the cash reserves but the land reclaimed would create a, potentially more valuable asset-reserve.  One conservative estimate suggests that the value of the land created should exceed the reclamation cost by 14% (US$145 billion vs US$128 billion).  It is planned that much of the created land would be sold (on a leasehold basis) to private developers creating a prominent cash replenishment of fiscal reserves.

This huge new reclamation also has significant potential to assist in ways no other proposals can, for example, by allowing the complete relocation (and redevelopment) of large, ageing PRH estates while retaining “neighbourhood” characteristics.

Another Comparative Perspective

Interestingly, Singapore is now providing some fresh evidence of the long-term (stability-maintaining) wisdom of the Hong Kong approach.  In notable respects the Singapore public housing system is superior to that in Hong Kong.  In particular, living space is unmistakably better and Singapore uses an “owner-occupier” model where almost all occupiers (over 80% of the population) live in flats which are owned under a 99 year lease.  However, these leases do not have any renewal rights.

The reason is that it is a long-standing policy of the Singapore Government that such leased-flats are to be handed back to the government after 99 years to allow for redistribution to future generations.  As certain leases now have less than 50 years to run, some owners are finding that their primary asset is beginning to depreciate in value and re-selling to other eligible buyers is made more difficult.

The Singapore Government is trying to explain that owning such a flat was never meant to be an indefinitely secure, appreciating investment and to convince owners that it is in the public interest that this is so.  This is not an easy task and it looks set to grow more difficult as time passes.

 Conclusion

I argued at the outset that seeing Hong Kong’s housing predicament primarily in terms of sky high purchases prices and maximum developer profits provides a notably incomplete portrait of the overall housing position in the HKSAR leading to an abbreviated misreading of the whole picture.

Frankly, Hong Kong has long lived with these price and profit realities.  They are very significantly a product of the land-related revenue system which has done such a remarkable job of boosting public revenues in HK since 1842, while supporting a low-rate, simple general taxation system.  Curbing the supply of land for private housing has not only boosted developer profits – it has also singularly enhanced public revenues.

However, this core element in Hong Kong’s unique revenue system created a major problem in that it was pricing even basic, decent housing far beyond the reach of the lower paid and, indeed, was making it unaffordable for a clear majority of residents.  This was a result of the system’s inherent tendency to push land prices higher combined with policies producing a shortage of available land for high density usage and the almost always steady growth in demand.

For more than six decades successive Hong Kong Governments have applied a distinctive solution which has involved creating one of the most extensive systems for providing public housing (or social housing as it is now often called) seen anywhere on this scale.  The government has used land over which it had so prudently retained ultimate ownership and ample saved funds, not least from the land-related revenue streams, to bring about this housing revolution.   It is, in many respects, an extraordinary public policy achievement.

The result, today, is that the government still directly provides PRH for around 2.5 million Hong Kong residents – and it continues to build (and rebuild) PRH on a very large scale.  Meanwhile, the HOS flats, which permit flat purchases by lower-income groups at discounted prices has been a primary and effective way of allowing access to home ownership to purchasers who would otherwise be shut out of the market.  These buyers do not have to pay the cost of the underlying land value on first purchase (effectively from the government) – this is collected at the time of certain resale transactions.  These flats house around 1.5 million residents.

The solution has, however, always left too many behind.  This was so during the BHK era.  And it remains the case today.  Intense levels of demand continue to exceed supply – and it is not hard to see why.  There are the pressing needs of the poorest Hong Kong residents living in over 100,000 tiny, sub-standard flats and paying, per square foot, extremely high rents.  Then there are the 50,000 family-reunion Mainlanders immigrants per year and the conspicuous number of younger HKSAR residents who face inordinate difficulty in securing a home of their own.

Since mid-2020, new measures have being applied by Beijing in the HKSAR to help rebuild stability following the exceptional political rioting in 2019.  These remedies are quite drastic, including a conspicuous reduction in the role of democratic elections.  But they are a direct and calibrated response to an extended, offshore supported insurrection in the HKSAR – followed by a further election-based, political destabilization project – both of which unfolded during the ongoing escalation of the US-led, confrontational, Sino-containment project.

A crucial aspect of rebuilding Hong Kong’s stability is the wholesale restructuring of the LegCo electoral system.  For more than a decade LegCo grew increasingly dysfunctional.  It became the base for a political struggle between the pro-democracy opposition and the HKSAR Government (and Beijing).  In due course, the determined, continuous nature of these opposition tactics, which were sometimes visibly extreme, effectively rendered Hong Kong’s legislature no longer fit for purpose.  These radical new reforms have addressed what had become a severe shortfall in the ability of the HKSAR to govern itself by recasting the primary foundations of LegCo.

Despite the depletion of Hong Kong’s very large fiscal reserves due to exceptional deficit-spending to cushion the severe economic impact of the COVID pandemic, ample reserves (including within the relevant housing authorities) remain to help drive the accelerated building of substantially more social housing (for rent and for sale).  Ernst & Young estimated, in January, 2021, that COVID spending has reduced the reserves by about 30% but remaining reserves still totalled over US$100 billion.  Moreover, once the Hong Kong economy begins growing, we can expect, as in the past, to see these reserves being steadily replenished.  Finally, this enhanced building project will generate substantial reliable revenues from sales and rents as each phase is completed.

The good news, overall, is that the environment for tackling the Hong Kong housing problem has distinctly improved.  Although the government still faces that very serious land supply problem, it is now possible to consider more freely, how to address this singular impediment.

Continuing, serious research on the Lantau Tomorrow proposal makes good policy sense as component in the long-term planning to address Hong Kong’s enduring housing needs.  As noted above, advancing that proposal will also put the government in a better bargaining positing as it negotiates a way through the pricing and legal complexities required to access privately held brownfield (etc) sites.

But there is one further option that should now be seriously considered.

Singapore has a population of around 5. 5 million living within an area of 719 square kilometres compared to 7.7 million living within 1100 square kilometres in Hong Kong.  A report by Ken Chu, a leading businessman, in the South China Morning Post in 2017, noted, acutely, that in Singapore around 14% of land is used for housing with around 10% set aside as parks and nature reserves while the comparable figures in Hong Kong are 7% of land devoted to housing and around 40% set aside as country parks and reserves.

Numbers of country parks in the HKSAR include areas of low-ecological value which abut significant housing estates.   Chu, who strongly favours increasing the supply of public sector, subsidized housing, makes a cogent case that Hong Kong should look very seriously at these areas, arguing that taking just 2.5% of such land could allow the construction of over 400,000 new residential units.

Building on this land is not straight-forward as it is typically hilly; there are significant civil engineering challenges.  But a number of large public housing estates were successfully built during the BHK era on awkwardly elevated sites.  This can be done.

As explained above, this remarkably high level of green space in Hong Kong is a clear if indirect product of the British policy of greatly restricting the land available for high density development.  Today, Hong Kong’s extensive country parks are a source of justifiable pride.  They are also “protected” by voluble often strident green-group lobbying.  It is a fair bet that these civil society guardians live in sound housing – they do not live in sub-divided units.

In truth, what was once a positive British legacy has also become, over time, an impediment to sound planning in the public interest.  The taboo on resolving this conflict of priorities in order to address the most basic social need – decent housing – needs to be lifted.

Massive spending on public housing (widely defined), enabled by Hong Kong’s super-solvency, has provided a crucial foundation for the dominant, long-term social-stability which has largely prevailed since the end of World War II.  That stability has been regularly tested by intense, sometimes deadly, political protesting.  After each such ordeal, Hong Kong has, typically, collectively righted itself.  Today it needs to do so, again, as it rebuilds after the immensely damaging upheaval in 2019.

Although the HKSAR will fairly soon have a radically transformed legislature, the reformed LegCo will take time to find its feet.  However, the path has been made clear to consider a full range of imaginative solutions to the fundamentally important housing crisis in the HKSAR.  It has become feasible to work constructively on securing a significant fix for this problem over the next 10 years.  This was not conceivable working within the previous LegCo structure.

Adding to the sense of urgency, Beijing, frustrated by all of the governance difficulties regularly thrown up since 1997, is insisting that Hong Kong has to put confrontational politics aside and apply itself constructively and energetically to fix what Beijing says matters.  Housing is one elemental item at the top of that “solutions-needed” list.

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