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Hongkong's Budget of emptiness

It is not clear whether Financial Secretary Antony Leung was shying away from big decisions in his first Budget. Or whether Chief Executive Tung Chee-hwa was unwilling to start his second term by making himself even less popular by backing real change in Hongkong's fiscal regime.Whatever the cause, the Budget was a massive wasted opportunity to tackle the structural fiscal problems that the government at last recognizes exist.

Two weeks ago I wrote that the government seemed to be moving towards decisive action, with two studies appearing just before the Budget that could provide the basis for real change. These were the Report of the Task Force on Review of Public Finances and the final report of the Advisory Committee on New Broad-based taxes. Neither report could have come as a surprise. The Public Finances report was mainly a collection of past statistics and future projections which added almost nothing to the sum of knowledge on the subject other than a few details on revenue sources not otherwise readily available and various projections of what might happen if nothing changes. The Broad Based taxes committee has earlier published its detailed investigation of the tax options and indicated quite clearly where its preferences lay.

Thus Mr Leung had before him well in advance of his Budget documents which could form the basis of his own strategy. That would not have meant accepting all the recommendations, but at least making decisions and explaining them in the context of the reports. In fact, the Budget went out of its way to make matters even worse than they are already.

Here I am not referring to the planned overall deficit of HK$45 billion or even the more significant and unchanged deficit of HK$49 billion on operating account. Given the overall weakness of the economy, in macro-economic terms it is quite justifiable for Mr Leung to continue to cushion the fall with a deficit equal to around 3.6% of GDP - down from 5% in the fiscal year just ending. Imagine the impact if expenditure had been cut in line with revenue over the past year. It is also reasonable for Mr Leung to aim for a gradual future reduction in the deficit rather than try shock tactics which could be counter-productive economically as well as painful socially. He is thus not aiming to get back to overall Budget surplus until 2005-06 and operating surplus the following year. Even with these projections, Hongkong will still have fiscal reserves at the low point of HK$271 billion or 100% of annual expenditure.

Mr Leung's macro economic projections are also quite conservative. For this year the government estimates that the economy will grow by only 1%, with deflation continuing at an even faster pace than in 2001, capital spending falling further, and consumption also slipping slightly. The only bright spot in the official forecasts is a 4.5% pick up in services exports, thanks mainly to mainland trade and tourism. This looks overly pessimistic to me but it's better to be cautious. For the longer term, forecasts for GDP growth have been cut to 3%, which is also modest assuming that population growth continues at around 1% a year.

The problem of Mr Leung's Budget lies not in macro economics but in the lack of policy direction and the direction of his specific Budget proposals. · A HK$2.6 billion cut in rates. These are the simplest, broadest-based, most stable, easiest to collect taxes in existence. As the advisory committee noted, they should be used more not less. A further concessions is a retrograde step which makes a nonsense of government claims to be tackling its structural problems. · Reducing water, trade effluent and sewerage charges, at a cost of HK$1.3 billion. Again, this flies in the face of (sensible) assertions that people should pay for all but the most basic usage of such facilities. It is also contrary to professed claims to be cleaning up the environment. ·

The introduction (in 2003-04) of a $18 land departure tax, dishonestly named the Boundary Facilities Improvement Tax. To start with, the amount is absurd and can only add to delays. Secondly, to claim that there has to be a link between it and improvement to border crossing facilities is patently untrue and quite contrary to normal government operational principles. The departure tax has limited fiscal advantage. It is also contrary to official claims to develop cross-border linkages and exploit the relationship with the Pearl River Delta. This is yet another device to protect business friends, the developers and retail interests who have long and successfully been fighting against easier border crossing. It is a disgrace. But why are the patriots so silent about this blow to the One Country concept?

A further sop to developers is also apparent in the low level of land sales for the coming year. It is a scandal that the supply of land is being controlled primarily not by the government - which ought to provide a steady and known quantity - but by the developers through the application system. It is hard to imagine a system less compatible with a free market and more open to corruption than this. The stench gets worse by the year. On the burning question of the Goods and Services Tax, Mr Leung has run away. He is neither for nor against it. His weasel words: "The government will continue to study the details of a Goods and Services Tax for implementation as and when necessary".

Personally I am opposed to such a tax as costly to collect and regressive. It would be easier to raise the same money through big reductions in salaries tax allowances, particularly for those in the top 10% income bracket. (The modest 15% top rate in practice only kicks in when income for a family with two children hits HK$2.8 million, a level exceeded by only a small fraction of households). Rates could also play a bigger role. The point however is that Mr Leung is avoiding all decisions. He has delayed a decision on GST, avoided the issue of salaries tax allowances and retreated on rates. What sort of leadership is this?

His commitments to cut spending are all in the future. Operating spending in the coming year is set to grow by 5%, even while nominal GDP is static. The improvement in the overall budget position will entirely due to asset sales (mainly MTRC shares held over from this year) and a pick up in investment income. The latter used to be steady, representing returns from mostly fixed income securities held by the Exchange Fund. It has become very erratic thanks to the government's market interventions. Even the MTRC share sale is a case of robbing Peter to pay Paul as the corporation's profits largely come from sweetheart land deals with the government, at a cost to the revenue.

The 4.75% promised cut in government salaries is justifiable (it should be much higher at the top end) and popular. But this will be a one off affair. There is scant indication from Mr Leung as to how he will achieve his target of near zero growth in operating expenditure in the succeeding two years as promised in his medium range forecast. Nor is it obvious that government spending is at an unsupportable level of GDP. The Financial Secretary made much of the Public Sector now accounting for over 22% of GDP. But this includes trading operations such as the Housing Authority.

Government capital spending can also at times be exaggerated as money is deemed spent once it has been transferred to one of the capital funds, not when it is actually spent on a project. Spending also includes gross outgoings of revolving funds which receive large repayments. Nor does it make much difference in practice to the economy or even the Budget if capital works are funded directly or through a public corporation such as the Airport.

The figures to keep one's eye on are the operating revenue and expenditure figures. What we do not have much clue about is how we get from where we are now to where Mr Leung says we should be in 2006-07 either on the spending or revenue sides. But that is not surprising given his unwillingness to address the structural issues highlighted by the recent reports. ends