Commentary on the 2006 Budget

The economy

The Financial Secretary ("FS"), Mr. Henry Tang, delivered his third budget speech on 22 February 2006.  The figures contained in the budget revealed a robust performance by the economy in 2005/06. Real growth in gross domestic product ("GDP") was 7.3% in 2005 following 8.1% growth in 2004.  The government is expecting growth of 4% - 5% growth in 2006 while the trend growth rate over the period 2007-2010 is predicted to be 4% in real terms. Nominal GDP in 2005 reached a new high of HK$1,382 billion, surpassing the previous peak in 1997. Inflation for 2005 stood at 1.1% and is forecast to be 2.3% in 2006.  The FS also announced that total employment had reached a new high of 3.43 million and the unemployment rate had fallen to a four-year low of 5.2%.

Public finances

The FS anticipated a consolidated budget surplus of HK$4.1 billion for 2005/06, compared with a deficit of HK$10.5 billion forecast in last year's budget.  The overall expected surplus is the result of an estimated HK$5.8 billion surplus on the operating account and a deficit of $1.7 billion on the capital account.  A consolidated budget surplus of HK$5.6 billion is now forecast for 2006/07, compared with a deficit of HK$1.2 billion for the same period forecast at the time of last year's budget.  The fiscal reserves are expected to stand at HK$300.8 billion as at 31 March 2006 and to be maintained in the range HK$300b to HK390b over the next five years, equivalent to 15 to 17 months of total government expenditure.

The positive outturn for 2005/06 means that the government is expecting to achieve the three fiscal targets set by the FS in his 2004 budget, three years ahead of schedule.  These are:

• Operating expenditure below HK$200b.  This was achieved in 2004/05 and is expected to have been maintained in 2005/06.  The estimate for 2005/06 expenditure, stated in the Budget Speech, was HK$194.7 billion, while expenditure in 2004/05 amounted to $196.9b.  (However, operating costs are expected to grow to $230.7b by 2010/11).
• Fiscal balance in both the operating and consolidated accounts, which is expected to have been achieved as of 2005/06.
• Public expenditure to be kept at below 20% of GDP.  This was achieved in 2004/05 and will be maintained.  Public expenditure is forecast to be 18.2% of GDP in 2006/07 and to fall to 16.1% in 2010/11.
  

Provisional financial results for the year ended 31 March 2006, announced on 29 April 2006, indicated that the FS had underestimated the consolidated budget surplus by around HK$10b.  The figure for the overall surplus has now been adjusted to HK$14b and for the fiscal reserves, as at 31 March 2006, to HK$310.7b.

Tax measures

As regards specific revenue measures and concessions in the budget, these included:

• Salaries tax –
  • The marginal rates of the second, third and top salaries tax bands was lowered by 1% each, to 7%, 13% and 19%, respectively, commencing 2006/07, while the rate applicable to the first HK$30,000 of assessable income remains at 2%.  This will cost the government around $1.5 billion annually.  The Institute's budget submission (see below) had called for a review of the progressive rates with a view to reducing the burden on middle income earners.
  • Extending the salaries tax relief for home loan mortgage interest (of up to HK$100,000 per annum) from seven to ten years.  The proposal will cost the government some HK$1.2 billion in 2006/07 and is in line with a proposal contained in the Institute's budget submission.
  • No changes were proposed to the personal tax allowances, or to the standard salaries tax rate, which remains at 16%.
• Profits tax: No change.  The rates remain at 17.5% for corporations and 16% for unincorporated businesses.
• Property tax and rates: No changes.  The property tax rate remains at 16% and rates stay at 5% of the rateable value.  In relation to the latter, the FS indicated that rateable values had increased by 9.2% in the latest revaluation exercise.
• Financial services –
  • The levy on trading in securities, futures and options contracts will be reduced by 20%.
  • The FS also encouraged the Legislative Council ("LegCo") to complete its scrutiny of the Financial Reporting Council ("FRC") Bill as soon as possible, so that the establishment of the FRC could proceed.
  • Separately, the Revenue (Profits Tax Exemption for Offshore Funds Bill) was passed by LegCo on 1 March 2006.  This legislation implements a measure announced in the 2004/05 Budget Speech.
• Amongst other important tax matters mentioned in the budget were -
  • Goods and services tax (GST): The FS announced that a nine-month public consultation would be launched in the middle of 2006.  He pointed out that, even after a decision to proceed is made, implementation would still take another three years.
  • The FS specifically ruled out two measures, which have been advocated by the Institute, other professional bodies and chambers of commerce, namely, group loss relief and loss-carry back arrangements.  Of the former, he said that group relief is too easily abused, and he ruled out loss-carry back because of the pressure this could place on tax revenue during periods of economic downturn.

Job market

• Amongst the job-market related measures the FS announced -
  • The introduction of a "Quality Migrant Scheme", with a limited quota of 1,000 entrants per year. Applicants who meet certain eligibility criteria in terms of academic attainment, professional qualifications, work experience, etc., will be able to come to Hong Kong for one year, together with their families, to look for work, without having first secured a job.
  • The provision of short-term travel support on a trial basis to financially needy, unemployed, non-CSSA recipients, who have completed full-time courses with the Employees Retraining Board and are living further afield, to encourage them to take up employment.
  • During discussions on the Appropriation Bill 2006, which was passed by LegCo on 29 April 2006, the FS further announced that he had agreed in principle to a proposal to launch a more general transport subsidy trial scheme for low-income residents of remote districts, to encourage them to work.
  • In his speech on the Appropriation Bill 2006, the FS also announced that, if the financial climate continued to improve, the government would consider certain other measures proposed by political parties, such as tax relief for the tuition fees of associate degree courses, and a one-off allowance for parents of newborn babies, to encourage childbirth.

Institute's reaction

The Institute's president, Mr. Paul Chan, hosted a press briefing immediately after the Budget. While commenting that the proposed budget was prudent, but too conservative, in relation to granting tax breaks to the middle class and enhancing the competitiveness of Hong Kong, the Institute noted that the budget should also provide a map for Hong Kong's future economic development.  The president urged the government to take stock of the economic significance of the financial, commercial services, tourism and logistics sectors, and consider whether these sectors could provide the engine for Hong Kong's growth and prosperity over the next decade.

The decision to rule out group loss relief is a disappointment.  The Institute has being proposing the introduction of this measure for some years and is unconvinced about the rationale for rejecting it.  Group relief is available in a number of developed markets around the world and the Institute is not aware that it has given rise to major problems of abuse in those jurisdictions. 

Furthermore, with the introduction of new international accounting standards, which may require asset revaluations, for example, to be reflected in the profit and loss account, "unrealised" profits may now become liable to tax.  This could put companies under cash flow pressure.  Meanwhile, unlike a number of other jurisdictions, Hong Kong has no group tax relief or loss carry-back provisions to help alleviate the problem.

The FS's proposal on GST is in line with the Institute's budget submission, which pointed to the need to move ahead with consultation and specify a timetable for implementation of a GST (see TechWatch Issues No.20 and 40).  The Institute believes that, given the structural fiscal problem previously identified by the Task Force on Review of Public Finances, and the narrowness of the Hong Kong's tax base, the government should focus on broadening the tax base, rather than continuing to rely on increases in direct taxes as a primary source of any future requirements for additional revenue.

The FS stated that the government was studying alternative arrangements for health care financing, and would conduct a public consultation later in the year, and that, in finalising an overall package, the proposal to provide a tax deduction for contributions to private medical insurance schemes would be considered.  The Institute's budget submission emphasised that it was critically important to determine how to maintain a financially sustainable public health care system over the long term.

To promote environmental protection, the FS reiterated the need to impose green taxes in accordance with the "polluter pays" principle.  He confirmed that a Product Eco-responsibility Bill would be introduced into LegCo in 2006 to provide a legal framework for producer responsibility schemes covering, inter alia, vehicle tyres and plastic bags.  The Institute has previously advocated consideration of a more coordinated green tax policy in Hong Kong and adopting the "user/polluter pays" concept in relation to polluters.

The Institute also noted that Quality Migrant Scheme could be of some help in bridging the skill gap during the period of Hong Kong's continuing economic transition.