Task Force on Review of Public Finances

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Task Force on Review of Public Finances
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Introduction

• Alert sign for Hong Kong fiscal system
• Hong Kong fiscal system undergoing structural
  changes
• Trust that Members and the community understand
  the importance of prudent fiscal management to
  the long term prosperity and stability of Hong
  Kong

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Alert sign for Hong Kong fiscal system

• Operating deficits and consolidated deficits will
  persist for each of the next five years if the
  current revenue and expenditure policies are to
  continue and the economy is assumed to grow at a
  steady (i.e. medium growth) rate. Position as
  follows

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Alert sign for Hong Kong fiscal system
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Projected Fiscal Balance and Fiscal Reserves
2001-02 to 2006-07Current Policies Scenario
(Medium Growth)
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Alert sign for Hong Kong fiscal systemProjected
operating and consolidated deficits to persist in
the next 20 years
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Projected Fiscal Balance and Fiscal Reserves
2001-02 to 2021-22Current Policies Scenario
(Medium Growth)
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Causes for the alert

• Changes in the economy
• Changes in government revenue
• Changes in government expenditure

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Changes in the economy 1991-1997

• Upsurge of the asset markets
• Average real GDP growth 5.2 per annum
• Inflation
• average GDP deflator 6.9 per annum
• average CCPI 8.5 per annum

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Changes in the economy 1998-2001

• Asian financial crisis
• Global economic downturn
• Average real GDP growth 1.9 per annum
• Deflation
• average GDP deflator 3.0 per annum
• average CCPI 1.6 per annum

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Year-on-Year GDP Growth Rates in Real and
Nominal Terms
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GDP Deflator and Composite CPI
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Changes in government revenue (1)A fundamental
change has occurred in the property market since
1998/99
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Changes in government revenue (1) A fundamental
change has occurred in the property market since
1998/99
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Changes in government revenue (1) A fundamental
change has occurred in the property market since
1998/99
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Changes in government revenue (2)Since 1997-98,
investment income from the fiscal reserves became
a key operating revenue item. Its importance has
been increasing.
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Changes in government revenue (2)Since 1997-98,
investment income from the fiscal reserves became
a key operating revenue item. Its importance has
been increasing.
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Changes in government revenue (2)

• To finance increasing annual operating
  expenditure by investment income at a constant
  proportion, annual investment income will have to
  increase accordingly.
• To achieve the above objective, there are
  theoretically two means
• rate of investment return will have to increase
  year after year but this is not quite possible
  with the global trend towards low inflation
• alternatively, there needs to be fiscal surplus
  year after year to increase the fiscal reserves
  and in turn the investment income

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Changes in government revenue (2)

• However, with the recent consecutive years of
  deficits, the level of fiscal reserves has been
  falling. From 430 bn on 1 April 2001, the
  reserves are projected to decrease to 369 bn by
  the end of the current fiscal year.

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Changes in government revenue (3)

• Outreach of the Hong Kong economy to the Mainland
  and elsewhere, plus acceleration of economic
  globalisation may conceivably adversely affect
  direct tax revenue, particularly profits tax and
  salaries tax
• This is due to the territorial source-based tax
  system practised in Hong Kong
• With available data, the magnitude of the effect
  cannot be quantified at this stage

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Changes in government expenditure (1)

• Higher differential price movements in government
  expenditure than that of the economy government
  prices slower to adjust
• Partly due to the heavy weighting of the salaries
  and personnel-related component (eg pension) in
  government operating expenditure
• The effect will worsen in a deflationary
  environment because government wages have not
  adjusted downwards in line with prices in the
  economy in general

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Changes in the GCE Deflator andGDP Deflator
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Changes in government expenditure (2) Ageing
population, dependency ratio to increase
substantially in 2010s
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Changes in government expenditure (3)

• Since 1998, Government has maintained growth of
  expenditure higher than growth of the economy in
  order not to exacerbate the economic downturn
• As a result, growth in government expenditure has
  far exceeded growth of the economy in money (or
  nominal) terms one of the reasons for the
  strain on the fiscal system

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Cumulative Growth Rate in Government Expenditure,
Government Revenue and GDP in Nominal Terms
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Government Revenue, Government Expenditure and
Public Sector Expenditure as a Percentage of GDP
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Budget Model

• Economic parameters
• Demographic parameters
• Revenue and expenditure parameters

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Budget Model Economic parameters

• Calender Year 2002 2003 - 2006 2007-2021
• Real GDP Growth Rate 1.0 3.5 3.0
• GDP Deflator -1.5 0.9 2.0
• Nominal GDP Growth Rate -0.5 4.4
  5.1

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Budget Model Revenue and expenditure parameters

• Revenue
• each major revenue item aligned with an economic
  driver
• eg. In the longer term,
• profit tax yield 9.3 of gross operating
  surplus of previous year
• salaries tax yield 5.0 of compensation of
  employees of previous year

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Budget Model Revenue and expenditure parameters

• Expenditure
• current expenditure control guideline, growth of
  government expenditure aligned to trend real
  growth of economy
• addition of 80 basis points on top of GDP
  deflator to reflect government expenditure price
  rigidity
• social consequences of ageing population

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Budget Model Projections

• To achieve consolidated balance in five years'
  time, revenue increase and/or expenditure cut
  measures averaging 35 billion per annum, about
  12.3 of annual government expenditure, will be
  required from 2002-03 to 2006-07 under medium
  growth assumptions
• Beyond 2006-07, revenue increase and/or
  expenditure cut measures will need to increase
  to
• 89 billion in 2011-12, being 21.9 of government
  expenditure
• 141 billion in 2016-17, being 26.0 of
  government expenditure
• 215 billion in 2021-22, being 29.7 of
  government expenditure
• Revenue increase and/or expenditure cut has
  already taken into account amount of measure in
  previous period.

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Budget Model Projections

• Assuming that the level of fiscal reserves should
  be maintained at 18 months of government
  expenditure starting in 2016-17 and thereafter,
  the revenue increase and/or expenditure cut
  measures will be
• 127 billion in 2011-12, being 31.3 of
  government expenditure
• 186 billion in 2016-17, being 34.3 of
  government expenditure
• 236 billion in 2021-22, being 32.6 of
  government expenditure
• Revenue increase and/or expenditure cut has
  already taken into account amount of measure in
  previous period.

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Budget Model Projections

• Assuming that the level of fiscal reserves should
  be maintained at 12 months of government
  expenditure 2007-08 and thereafter, the revenue
  increase and/or expenditure cut measures will be
• 107 billion in 2011-12, being 26.4 of
  government expenditure
• 159 billion in 2016-17, being 29.3 of
  government expenditure
• 235 billion in 2021-22, being 32.4 of
  government expenditure
• Revenue increase and/or expenditure cut has
  already taken into account amount of measure in
  previous period.

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Annual Revenue and/or Expenditure Measures
Required under Different Scenarios (Medium Growth)
Revenue increase and/or expenditure cut has
already taken into account amount of measure in
previous period.
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Fiscal Reserves Levelsunder Different Scenarios
(Medium Growth)
Revenue increase and/or expenditure cut has
already taken into account amount of measure in
previous period.
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Conclusion

• Change fiscal lifestyle
• Expenditure reinforce existing guideline by
  having regard to trend GDP growth in money (or
  nominal) terms in addition to GDP growth in real
  terms
• Revenue consider views of Advisory Committee on
  New Broad-based Taxes and others