A Sound and Progressive Fiscal Policy

36.    Mr President, in preparing this Budget, I have carefully considered the views of different sectors and note some gaps in the understanding of the Government's fiscal position.  Please allow me an opportunity to offer some clarifications and suggest policy approaches, taking into account the three objectives of public finance, the macro-economic outlook and the Government's financial position.

Annual Surplus

37.    Some sectors have suggested that since we are running a substantial fiscal surplus this year, the Government should reduce taxes and introduce more recurrent measures to alleviate people's financial burden.

38.    As we all know, Hong Kong has a narrow tax base, and our revenue sources are concentrated.  Profits tax, salaries tax, stamp duties, rates and land revenue account for about 75 per cent of total government revenue in 2015-16.  Nevertheless, as a small and open economy, Hong Kong is particularly susceptible to global economic fluctuations, which is beyond the Government's control.  Should there be any abrupt deterioration or fluctuation in the external economic environment, government revenue would be directly affected, and the consequences could be unpredictable.  Analysis based on statistics over the past 25 years shows that although government revenue has grown broadly in line with the GDP, the former is often far more volatile than the latter.  This has brought challenges to our public finances.  Take this year as an example.  The vast majority of the Government's surplus comes from the far higher-than-expected land revenue and stamp duties on properties.  Our property market has experienced a market boom of nearly eight years.  Property prices are still at a record high though trading in the market has turned quieter.  Supply of private residential flats in the future is expected to gradually pick up to an average of nearly 20 000 units a year.  It is difficult to tell whether revenue from land sales in the future will continue to hit successive new highs.  In fact, over the past decade, land revenue varied considerably from a low level of less than $17 billion in 2008-09 to over $117 billion in 2016-17.

39.    Government revenue may fluctuate with the ups and downs of the economic cycle.  Government expenditure, however, is far more rigid and public services cannot be trimmed or suspended arbitrarily.  The current-term Government has introduced many new measures on poverty alleviation and support for the disadvantaged, such as the OALA and the Low-income Working Family Allowance (LIFA).  To keep pace with the rapid ageing of our population, financial commitment on associated measures will increase at a fast rate.  Take the Public Transport Fare Concession Scheme for the Elderly and Eligible Persons with Disabilities (also known as the "$2 Public Transport Fare Concession Scheme") and the Elderly Health Care Voucher Scheme as examples.  Between 2012-13 and 2017-18, recurrent expenditure on the two schemes would see an over four-fold and ten-fold increase to nearly $1.2 billion and $2.1 billion respectively, representing a sharp growth.  These are measures that benefit our community; cuts or cancellation cannot be taken lightly.

40.    Being a responsible government, we should remain vigilant.  Before committing to new recurrent initiatives, we must be satisfied that these initiatives can be funded in a sustainable manner in the long run.  Windfall revenue of a capital nature is no justification for substantial increases in recurrent expenditure.  It is much the same as an employee who may happily spend a bit more upon receiving a large sum of year-end bonus in a certain year but would not recklessly make any unaffordable long-term financial commitment.  So, in my view, in considering how our annual surplus is to be deployed, we should take into account the source and nature of the surplus, alongside the prevailing economic situation and external environment, the future needs of society and the expectations of the community, so as to ensure optimal allocation of resources.

Fiscal Reserves

41.    It has also been suggested that the fiscal reserves of over $900 billion is just too much, and instead of being miserly, the Government should consider major tax cuts and step up its efforts to relieve people's hardship.  While I share the view that the Government, with its existing fiscal strength, can afford to be more proactive, we should avoid reckless commitments.  Public spending must be fit for purpose.

42.    Article 107 of the Basic Law stipulates that "The Hong Kong Special Administrative Region shall follow the principle of keeping expenditure within the limits of revenues in drawing up its budget, and strive to achieve a fiscal balance, avoid deficits and keep the budget commensurate with the growth rate of its gross domestic product".  I agree that the implementation of this Article should not be a "straitjacket" which restrains our annual revenue and expenditure.  Instead, there should be a certain degree of flexibility.  In fact, Hong Kong, as a small externally-oriented economy, is highly susceptible to the influence of the external environment and cyclical fluctuations, and short-term fiscal imbalance is probably inevitable. Some expenditure increases are justifiable, as in the case of welfare spending since the Government is catching up on service delivery.  Some other expenditure items are investments and the potential return may only be realised in future.  I consider that it is most important to spend only when necessary and to act with prudence and strive for an overall fiscal balance over time.

43.    The total expenditure of the Government has increased year after year from $380 billion in 2012-13 to over $490 billion in 2017-18.  Total and recurrent expenditure of the current-term Government would have respectively grown on average by 5.4 per cent and as much as 7.2 per cent per annum between 2012-13 and 2017-18.  Compared with the nominal GDP growth of five per cent and government revenue growth of 3.4 per cent for the same period, expenditure growth of the current-term Government is considerable.  However, the growth of government expenditure cannot keep outpacing economic growth for an undue period, lest the risk of a structural deficit would emerge.

44.    In assessing whether the level of fiscal reserves is appropriate, we ought to consider the Government's prevailing recurrent funding requirements and the medium- to long-term financial implications upon full implementation of policy initiatives, such as the "$2 Public Transport Fare Concession Scheme" and the Elderly Health Care Voucher Scheme mentioned in paragraph 39, and the enhanced OALA and the provision of subsidy in respect of the MPF "offsetting" arrangement as announced in this year's Policy Address.  In addition, our medium and long-term commitments include a sum of over $300 billion for ongoing works projects and about $450 billion for civil service pension obligations in the next ten years.  The Government's financial burden cannot be taken lightly.

45.    To demonstrate the Government's determination in and commitment to making good use of surplus and investing in the future, we have set aside substantial resources for housing and healthcare.  The Housing Reserve, which was established in 2014 to support large-scale public housing development programme, now stands at $77 billion.  Last year, the Government also set aside $200 billion for the implementation of a ten-year hospital development plan to improve public healthcare facilities and services.  I will make provisions for elderly services and rehabilitation services for persons with disabilities as well as sports development when determining the use of surplus for this financial year.

46.    The economic crises caused by the financial plight of many European countries and the US in the past decade have pointed to pitfalls that Hong Kong should avoid.  In fact, from 1998 to 2004 when Hong Kong's economy was ensnared in difficulties during the Asian Financial Crisis and the I&T bubble burst, government revenue plunged far more sharply than that of GDP.  We experienced five years of fiscal deficits, which depleted 40 per cent or over $180 billion of our fiscal reserves, leaving these at a level equivalent to only 13 months instead of 28 months of government spending.

47.    I believe that the two objectives of our fiscal policy are maintaining healthy public finances and strengthening resilience to withstand economic fluctuations.  We should not just keep looking back to the prosperous years in the past.  Instead, we should stay alert to the challenges ahead.  Under the linked exchange rate system, there is very limited room to adjust our monetary policy.  Therefore, we have to rely on a sound and progressive fiscal policy to ensure that we can stay strong and have adequate resources to continuously increase public investment, enhance our competitiveness, cater for social development needs and improve people's livelihood.  This also enables us to promptly launch counter-cyclical measures to stabilise the economy in times of economic downturn, so as to minimise the impact of economic fluctuations on people's livelihood.

48.    Our position as an international financial centre is crucial to both Hong Kong and our country.  The cornerstone of financial stability is confidence.  A sound financial management philosophy and strong fiscal position of the Government are vital for maintaining international confidence in Hong Kong.  We may recall how a single financial crisis has exposed the excessive budget deficits in many advanced economies in Europe and the US.  A domino effect was triggered off, bringing down the international ratings of all these economies, and giving them a hard blow to their economies and financial systems.  With these examples, Hong Kong must reflect on our own position seriously.  Hong Kong has recently been recognised by the International Monetary Fund again for our strong policy framework, including the linked exchange rate system, vigorous regulation and supervision of the financial system and ample buffers, which enable us to cope with external economic risks.

49.    As such, we should spend only when necessary and make good use of the reserves to benefit the society.  At the same time, we must maintain strict fiscal discipline and ensure that our expenditure growth will be broadly in line with affordability.  We must also maintain adequate fiscal reserves to support socio-economic development, deal with emergencies and cope with the challenges posed by a rapidly ageing population.

Value for Money and User Pays Principles

50.    To achieve more efficient use of resources, the Government should adhere to the "value for money" principle, rectify unsustainable policies and adjust expenditure items that are repetitive, inappropriate and ineffective.  To ensure the effective use of our public resources and to preserve the revenue base, government departments should continue to review their fees and charges in a timely manner and in accordance with the "cost recovery" and "user pays" principles.

Tax Policy

51.    Another topic that people frequently talk about is our tax policy.  There have been calls for tax cuts, providing tax concessions to support the development of certain industries and broadening the tax base.

52.    Hong Kong has all along been maintaining a low, simple and territorial-source-based tax regime, which comprises mainly of direct taxes.  As an advocate of free trade, Hong Kong does not impose duties on import or export goods except for four types of dutiable commodities.  These were the key competitive advantages underpinning our success in the past.  However, the global competitive environment is fast-changing.  Neighbouring countries, European countries, the US and Free Trade Zones in the Mainland are using tax concession as a means to compete for investment and promote the development of targeted industries.  Some countries have even adjusted their taxation structure.  Recently, individual European countries and the US indicated that they would consider reducing profits tax in a bid to enhance competitiveness.  Besides, the international community is taking forward measures to counter money laundering, tax base erosion and profit shifting.  Hong Kong should complement these global efforts.  How can we ensure that our competitive advantages would not be undermined?

53.    With social advancement and economic development, the Government will continue to increase expenditure in social welfare, education, healthcare, housing supply, infrastructure and district facilities, etc.  We should be mindful of our narrow tax base, concentration of revenue from a few industries and volatility of Government's revenue in response to economic fluctuations.  Using 2015-16 as an example, revenue from land sales and profits tax accounted for 14 per cent and 31 per cent of government revenue respectively, with the financial and real estate industries contributing over 40 per cent of the profits tax receipts.  Volatility in the global economy and financial market in the future or significant adjustment in asset prices will affect government revenue and fiscal affordability.

54.    As a responsible government, we have to cope with the huge expenditure needs under different economic scenarios.  We cannot propose a tax cut which erodes our revenue base.  Neither can we adjust our tax rates frequently as this would affect the predictability of our tax regime and dent investor confidence.  We have to examine the international competitiveness of our tax regime and address the problem of a narrow tax base.  I plan to set up a tax policy unit in the Financial Services and the Treasury Bureau to comprehensively examine these tax issues from a macro perspective.  On the one hand, we will seek to align our tax practices with international standards and actively study ways to foster the development of pillar industries, industries over which we have advantages and emerging industries through tax measures including enhanced deductions for I&T expenditure, so as to ensure that Hong Kong remains competitive and can create wealth.  On the other hand, we will enhance our tax regime and explore broadening the tax base and increasing revenue, so as to ensure that adequate resources are available to support the sustainable development of our society.