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HK Budget Mulls Fiscal Sustainability Over Longer-Term

Thursday, February 27, 2014

While Financial Secretary John Tsang put competitiveness as the theme of his 2014/15 Budget, a significant portion of his speech looked at the maintenance of Hong Kong's healthy public finances in the face of increased spending on education, social welfare and healthcare.

He said Hong Kong's gross domestic product (GDP) growth for last year was 2.9 percent, a marked improvement over 1.5 per cent in 2012. He forecasted GDP growth of between 3 percent and 4 percent in 2014, still lower than the average annual growth rate of 4.5 percent over the past decade.

The revised estimate for government revenue for 2013/14 is HKD447.8bn (USD57.8bn), some HKD12.7bn or 2.9 percent higher than the original estimate. Amid the uncertain global economic situation, revenue from profits tax was 8.8 percent less than originally estimated, while that from salaries tax was 7.8 percent higher than the original estimate. Despite a revised estimate for government expenditure lower than the original estimate, an overall surplus of only HKD12bn is expected.

Total government revenue for 2014/15 is budgeted at HKD430.1bn, with salaries and profits tax, estimated at HKD177.5bn, remaining the major sources of revenue. Land revenue is estimated to be HKD70bn.

Tsang has budgeted for a marginal surplus of HKD9.1bn in 2014/15, with fiscal reserves estimated to be HKD755bn by the end of March 2015, representing about 34 percent of GDP and equivalent to 22 months of government expenditure.

However, despite the overall balance in Hong Kong's finances, Tsang devoted a significant part of his speech to an analysis by the Working Group on Long-Term Fiscal Planning, which was set up in June 2013 to perform a health check on the current state of Hong Kong's public finances, and make projections of Government's long-term fiscal position up to 2041/42.

According to the Working Group's analysis, Hong Kong's overall fiscal position in the short to medium term remains healthy. In the longer term, however, Government must seek to align the growth rates of its revenue and expenditure. For example, if services were to be enhanced following the historical trends at about 3 per cent annually for education, social welfare and healthcare, government expenditure would grow by 7.5 percent per year and a structural fiscal deficit would surface in seven years.

The Group recommends that the Government should "preserve, stabilize and broaden the revenue base." However, Tsang noted that, having regard to the competitiveness of Hong Kong and the impact on the community, there is little room for major tax hikes. He also understood that "it would be controversial to propose any new taxes, which need thorough consideration and public discussion."

On the other hand, to prevent revenue loss, the Inland Revenue Department (IRD) is "to step up tax enforcement and make better use of information technology to combat tax evasion and avoidance, thereby recovering tax payable." The IRD has already recovered over HKD14bn in taxes over the past three years.

He also confirmed that fees and charges are an important source of government revenue. Since last year, more than 1,300 fees and charges have been reviewed, and more than 200 increases have been proposed, reducing the loss of public revenue by around HKD60 million per year.

Amongst other measures in the Budget, as in previous years, Tsang proposed further one-off relief measures, aimed primarily at helping the public to cope with short-term financial pressure, or as a counter-cyclical measure to preserve economic stability and short-term employment. The tax relief for 2014/15 involves around HKD20bn in lost revenue, with a fiscal stimulus effect on GDP of 0.7 percent.

These measures include a reduction in profits tax, salaries tax and tax under personal assessment for 2013-14 (claimed in 2014/15) by 75 percent, subject to a ceiling of HKD10,000. The tax reductions will benefit around 1.87m taxpayers, and cost about HKD10.2bn billion.

With regard to the development of the financial services sector in Hong Kong, Tsang recorded his proposal in last year's Budget to allow private equity funds also to enjoy tax exemption for offshore funds to attract them to expand their business in Hong Kong. He confirmed that an industry consultation has been completed and the legislative work will be taken forward as soon as possible.

With regard to the proposal to introduce an open-ended fund company structure to attract more funds to establish in Hong Kong, relevant regulatory frameworks have been drawn up and consultation will begin next month.

Furthermore, while, in 2010, Tsang extended the stamp duty concession to cover exchange traded funds (ETFs) that track indices comprising not more than 40 percent of Hong Kong stocks, he has seen that the number of ETFs listed in Hong Kong have since seen a substantial increase from 69 at end-2010 to 116 at the end of last year. The daily average turnover of ETFs has also increased from HKD2.4bn to HKD3.7bn, making Hong Kong one of the largest ETF markets in the Asia-Pacific region.

He has therefore proposed to waive the stamp duty for the trading of all ETFs, so that the trading cost of ETFs with a higher percentage of Hong Kong stocks in their portfolios can be reduced as well. He hoped that this will help promote the development, management and trading of ETFs in the city.

Finally, as Hong Kong already appears to be a popular place for multinational enterprises to manage their global or regional treasury functions, and to draw more of these functions to Hong Kong and enhance its strengths in financial and professional services, Tsang has asked the Financial Services and the Treasury Bureau to set up a task force to review the requirements under the tax code for interest deductions in the taxation of corporate treasury activities, and clarify the criteria for such deductions. It is to produce concrete proposals within one year.