Although the SAR govt’s budget deficit in the coming few years shouldn’t be too worrying, it’s still a threat to public finances if it drags on for too long, economists say. The accounting industry reckons the problem of a structural deficit should be addressed in light of changes in the global tax environment. Oswald Chan reports.

Following successive budget deficits from 1998 to 2004, the Hong Kong government will be in the red again with a budget deficit estimated at HK$37.8 billion (US$4.88 billion) for the 2019-20 financial year, or 1.3 percent of the city’s gross domestic product, compared with an earlier surplus estimate of HK$16.8 billion.

As Hong Kong’s economy is battered by the novel coronavirus pandemic, the SAR government in April forked out HK$137.5 billion of the second-round Anti-epidemic Fund (AEF) in a bid to steer the beleaguered economy out of recession as social distancing rules severely crimp economic activities.

Together with the first-round AEF measures, as well as the relief measures of HK$120 billion proposed in the budget, the total expenses amount to some HK$290 billion, equivalent to 10 percent of the GDP. 

Financial Secretary Paul Chan Mo-po projected the government deficit will swell to a whopping total of between HK$280 billion and HK$300 billion for the 2020-21 fiscal year.

Economists say the government shouldn’t be unduly bothered about budget deficits in the coming years as the local economy could rebound, boosting its coffers

As a result, the government’s fiscal reserve will be reduced from about HK$1.1 trillion to around HK$800 billion to HK$900 billion, equivalent to 14 to 15 months of government expenditure.

From 2021-22 to 2024-25, the government’s estimated deficits would range between HK$7.4 billion and HK$17 billion as revenues would be unable to keep pace with drastic expenditure increases, especially recurrent expenditures, the finance chief said when delivering the budget speech in February before unveiling the second round of the AEF.

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The finance chief said in a Bloomberg interview in March that the possibility of introducing a sales tax cannot be ruled out while the government recognizes the importance of consultations as it understands the controversies involved.

The government could not persuade community stakeholders to accept a sales tax to broaden its narrow tax base after it scrapped a plan to impose a 5 percent goods and services tax in December 2006 amid fierce opposition.

As the government is likely to operate in the red in the following years, does it mean the administration is determined to tackle the deep-rooted issue of a narrow tax base by reviving the sales tax idea? Is it really worried that a structural deficit is looming?

Structural deficit?

Economists say the government shouldn’t be unduly bothered about budget deficits in the coming years as the local economy could rebound, boosting its coffers.

“If Hong Kong runs a government budget due to the economic slowdown, it’s not a structural budget deficit. A structural budget deficit means the government is operating in the red even when the external economic environment is buoyant,” Terence Chong Tai-leung, a professor at the Chinese University of Hong Kong’s Economics Department, told China Daily.

“The projected government budget deficit only refers to estimates that can be revised if Hong Kong’s overall economic environment changes,” he explained.

Agnes Chan, managing director of EY Hong Kong and Macao, is on the same page. “While the projected budget deficits for 2021-22 to 2024-25 range from HK$7.4 billion to HK$17 billion, they shouldn’t be too significant as they represent merely 0.2 percent to 0.6 percent of Hong Kong’s GDP in the relevant years, based on the city’s economic growth rate of 2.8 percent, as well as the average growth rate of 2.9 percent in the past 10 years,” she said.

However, other economists believe that although the short-term trend of the budget deficit is a reason for concern, the impact of a few long-term trends on the government’s finances should be taken into account.

“The Hong Kong government’s revenues are heavily reliant on the property and equity markets, so when the economy is slipping, it will exert pressure on government finances. Moreover, the lack of a clear monetary policy in Hong Kong means the government is almost entirely dependent on a fiscal stimulus to boost the economy when needed, thus exerting more pressure on public finances,” Wan Qian, an economist with Bloomberg Economics (Hong Kong), told China Daily.

“In the coming decade, the population dividend Hong Kong has been enjoying for years will disappear, while a shrinking working population is another factor that’ll affect public finances. The government, in the meantime, also needs to spend more on social welfare and medical care that’s crucial for promoting social stability. This will also, inevitably, lead to a spike in public spending,” she said.

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By leveraging the current HK$1.1 trillion fiscal reserves as financial ammunition that can shield the city from financial crises in the coming few years, the administration should start mulling various indirect tax items that can enhance the existing narrow tax base.

Billy Mak Sui-choi, a professor at Baptist University’s Department of Finance and Decision Sciences, Hong Kong

Billy Mak Sui-choi, a professor at Baptist University’s Department of Finance and Decision Sciences, agreed that Hong Kong has to tackle budget deficits as the growth of recurrent expenditures has outpaced growth in recurrent income since 1997.

Government recurrent expenditures have been rising at an accelerating pace since 1997. According to budget estimates, expenditures began going up from HK$150 billion to HK$200 billion in the first decade (from 1997-98 to 2007-08) after the handover, and climbed further to HK$305 billion in the following seven years (from 2007-08 to 2014-15) and to HK$403 billion after four years (from 2014-15 to 2018-19). The amount will further balloon from HK$442 billion in 2019-20 to HK$486 billion in 2020-21.

According to a report by the Working Group on Long-Term Fiscal Planning appointed by then-financial secretary John Tsang Chun-wah in 2014, a structural deficit could come within a decade or so should the government’s expenditure growth keep exceeding the GDP and revenue growth based on long-term projections.

“By leveraging the current HK$1.1 trillion fiscal reserves as financial ammunition that can shield the city from financial crises in the coming few years, the administration should start mulling various indirect tax items that can enhance the existing narrow tax base,” Mak said.

Tax reform advised

There have been diverse views on which type of indirect tax item is more feasible for diversifying government revenue sources. A sales tax is regressive in nature as it will weigh more on low-income family finances, while the rich will be relatively less affected. Levying a sales tax also entails administrative costs, and the amount of sales tax receipts would be very small compared with income from land premiums and stamp duties.

On the other hand, Mak thinks the government should be extremely prudent in deciding whether to levy a capital gains tax or a dividends tax because these taxes are not conducive to the development of the financial services industry.

Chong suggests raising the existing 0.1 percent stamp duty on shares trading as a viable indirect tax item.

“Due to the launch of the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect, the cross-boundary stocks trading volume is set to go up further. Higher stamp duties on trading of shares will provide a huge single source of government revenue without disrupting the city’s low and simple tax regime, or drastically reducing the shares trading volume,” Chong said.

Major accountancy firms like PwC, Ernst & Young and the Hong Kong Institute of Certified Public Accountants agreed that the government should address the need to identify new revenue sources, but said the issue of structural deficit should be examined in light of the changes in the international law landscape.

“With the Organization for Economic Cooperation and Development’s proposal for a global minimum corporate tax rate and the European Union’s review of a Hong Kong territorial-based tax system, it’s imperative that the administration conduct a root-and-branch review of the city’s tax code that has not been reviewed for decades,” said Anthony Lau, Greater China divisional president 2020 at CPA Australia.

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By imposing a global minimum tax rate, the proposal aims to eliminate the huge advantages that some multinational companies enjoy by shifting their operations to low-tax regimes, hence minimizing the taxes they would otherwise be paying.

Under the proposal, if the tax paid by a multinational corporation in Hong Kong is lower than the new global minimum tax rate, its parent company will be subject to additional taxes or defensive measures imposed by source jurisdictions where these multinational companies are located.

If such a global minimum tax is levied, then multinationals may not have the incentive to operate in Hong Kong, resulting in fewer tax receipts.

“The OECD’s BEPS (base erosion and profit sharing) initiatives are affecting the international tax environment immensely. While exploring new sources of tax revenue, it may also be a good chance for the government to make reforms to render the whole taxation system more competitive and aligned with the international business environment,” Sarah Chan, Deloitte China tax partner, told China Daily.

Besides expanding the tax base and offering fiscal stimulus, the government can also avert a structural deficit by investing its fiscal reserves

Lau reckoned that although Hong Kong can broaden its tax base by levying new indirect taxes, it should not be considered as disrupting its simple and low-tax regime if the local tax system is still seen as low and simple compared to global standards.

Investing fiscal reserves

Besides expanding the tax base and offering fiscal stimulus, the government can also avert a structural deficit by investing its fiscal reserves.

“By allocating a portion of the Future Fund into the innovation, bio-pharmaceutical and artificial intelligence sectors, the government can lift the economy without having to increase expenditures,” Lau said.

The SAR government will allocate 10 percent, or HK$22 billion, of the HK$224.5 billion Future Fund, which was established in January 2016 with a 10-year investment time frame, investing in a new private equity fund of companies, projects and funds with a Hong Kong nexus in innovation and the technology industry (Hong Kong Growth Portfolio) for the first time, the financial secretary said in his budget speech in February.

With a composite rate of return of 4.5 percent in 2017, 9.6 percent in 2018 and 6.1 percent last year, the remaining proceeds of the Future Fund will be placed in the Exchange Fund’s Long-Term Growth Portfolio, investing in private equities and investments in properties outside Hong Kong, as well as the Exchange Fund’s Investment Portfolio or other investment assets.

Contact the writer at oswald@chinadailyhk.com