Following is the full text of the Speech on the 2003-04 Budget delivered by the Financial Secretary, Mr Antony Leung, in the Legislative Council today (March 5):
I move that the Appropriation Bill 2003 be read a second time.
2. Charles Dickens once wrote, "It was the best of times; it was the worst of times".(Note 1) This phrase is an apt description of Hong Kong's present situation. The world, with war imminent in the Middle East, faces major uncertainties. In Hong Kong, the unemployment rate persists at a high level, and job losses remain a worry. The psychological and material impacts of negative equity have suppressed demand for consumption and investment. The public has yet to recover its confidence in the future of our economy and vents its dissatisfaction at the Government. It is, if you will, the worst of times. In contrast, the Mainland's economy is growing rapidly, and investors worldwide compete for a share in her markets. Hong Kong, as the most cosmopolitan commercial city in China and the region, possesses geographical and institutional advantages. As the economy has been restructuring over the past five years, Hong Kong has seen a substantial reduction in the cost of doing business, and this has enhanced our competitiveness. Exports of goods and services again show growth, and tourism continues to flourish. Our citizens have gradually come to realise the inevitability of change. As the Chinese saying goes, "from need to change, from change to solution". To renew our strengths and set a new course, this could well be the best of times.
3. Against such a background, the preparation of this year's Budget has put me in a dilemma. Prudent fiscal management is not simply a matter of balancing the books, but also the interests of various sectors of the community. Cutting expenditure will inevitably affect civil service colleagues. Public expectations of the level of government services will have to be adjusted as well. Raising revenue will increase the burden on taxpayers and thus opposition from the community.
4. My task is clear: not only to manage public finances properly, but also to propose measures aimed at implementing the plan for economic development and improving people's livelihood mapped out by the Chief Executive.
5. For us to forge ahead, the Government needs to work together with the people, united in determination and with wisdom to meet all challenges, turning adversity into opportunity.
Economic Performance and Current Situation
6. Hong Kong's economy is on an upward trend. Economic growth in real terms picked up significantly, rising from 0.6% in 2001 to 2.3% in 2002, with the main impetus coming from robust growth in exports of goods and services. Nevertheless, deflation has been more serious than we expected, as evidenced by a drop of 3% in the Composite Consumer Price Index and 2.7% in the general price level of the economy as measured by the GDP deflator. As deflation persisted, local consumption and investment remained weak. The nominal rate of economic growth fell by 0.6% for the whole year, about the same level as forecast last March.
7. Though the economy has shown signs of improvement in real terms, the Government's huge fiscal deficit, if not resolved early, will dampen investors' confidence and stifle economic recovery. The consolidated deficit for 2002-03 is forecast to be $70 billion, $24.8 billion more than the original estimate. This is mainly because government revenue is 19.2% less than originally estimated. Capital revenue is forecast to be $29.1 billion less than the original estimate. This substantial decrease is related to the Government's announcement in November last year to suspend land sales for one year, which has resulted in a $13.9 billion drop in land revenue against the original estimate. Additionally, the Government is studying a merger of the two railway corporations and has postponed the sale of the second tranche of MTR Corporation shares, reducing revenue by a further $15 billion.
8. The fact that capital revenue fell short of expectations has no doubt aggravated the deficit but the problem emerged well before this financial year. In four of the past five years, the Consolidated Account registered a deficit. That for 2002-03 amounted to 5.5% of GDP. The Operating Account, which reflects government day-to-day revenue and expenditure, has been in deficit five years in a row, and this has been increasing at an astonishing rate. Excluding investment income from the fiscal reserves, the operating deficit hit $67.6 billion in 2002-03, equivalent to 5.3% of GDP.
Causes of our Fiscal Deficit
9. The persistent problem of huge deficits is a reflection of four changes that Hong Kong is facing: cyclical economic adjustment; economic restructuring; population ageing; and evolution of government policies.
10. The impact of cyclical economic adjustment is mainly reflected in the consolidation of the property market and the bursting of the bubble economy, which have resulted in substantial decreases in revenues generated directly and indirectly from real estate activities.
11. As for economic restructuring, the continuing expansion of the regional economy centred in southern China is greatly enhancing the mobility of production and services. Quite a few of Hong Kong's economic activities have shifted outwards. The majority of our industrial production processes have moved across the boundary in the past 20 years. Hong Kong's import and export trade, once dominated by domestic exports, has become re-export-led, and its development is marked by a recent shift towards offshore trade. Our service industries have also gradually expanded outwards. In the face of challenges brought about by economic restructuring, the Government is pursuing policies that help to increase external demand and promote the development of high value-added industries. Because Hong Kong has a territorial-based tax system, economic restructuring has a profound impact on our public finances.
12. The ageing population has also brought challenges to our public finances. Over the past decade, the percentage of persons aged 65 and above has increased from 9% of the population to 11%, and is forecast to rise to 24% by 2031. An ageing population will lead to an increase in government expenditure on social welfare and health services. The declining proportion of the population in the workforce will also result in reduced revenue.
13. The fourth development is the evolution of government policies. The services provided by the Government over the past decade have improved in both quality and quantity. In addition, due to rigidity in the pay adjustment mechanism for the Government and subvented organisations, the increase in unit costs has been greater than that of the price level in the overall economy. As a result, over the past decade, public expenditure in money terms has increased by an annual average of 8.3%, which is higher than the 4.9% annual average nominal economic growth over the same period. The share of public expenditure in the economy has increased from 15.6% to 21.5% for this year. There has been substantial growth in public expenditure in the major policy areas:
($ billion) ($ billion)
Education 22.2 [2.8%] 54.9 [4.3%]
Health 13.6 [1.7%] 33.9 [2.7%]
Social Welfare 7.3 [0.9%] 32.6 [2.6%]
Housing 12.9 [1.6%] 29.1 [2.3%]
[ ] expenditure as a percentage of GDP
14. Moreover, the Government has reduced taxes, fees and charges several times in recent years. Revenue from various government fees and charges, as a percentage of total government recurrent expenditure, has decreased from 18% to 6% over the past decade.
15. Against the background of regionalisation and an ageing population, and as high levels of wages and welfare are no longer supported by high land prices, a structural fiscal deficit is inevitable.
16. We have studied these issues in recent years. In February last year, the Task Force on Review of Public Finances submitted its report on the structural problems of our public finances. At about the same time, the Advisory Committee on New Broad-based Taxes published its report on widening the tax base. The report explored the relationship between direct and indirect taxes and our public finances, and recommended, inter alia, introduction of a Goods and Services Tax when appropriate.
17. Considering the characteristics of Hong Kong's economy and its past trends, we believe that the principles of "big market, small government" and low taxation are the cornerstones of Hong Kong's development. Last year, I proposed to contain public expenditure to 20% of GDP or below. Besides controlling public expenditure, the Government also considers that it is necessary in the long term to introduce a Goods and Services Tax to broaden the tax base and secure a stable source of public revenue. In view of the present economic situation, we will not introduce such a tax for the time being. We will continue to study details for future implementation.
18. Since the problem of a huge fiscal deficit is serious and needs to be addressed immediately, the Government must propose specific measures to eliminate it.
The Urgency of Solving the Deficit Problem
19. Some commentators claim that, as Hong Kong is undergoing economic restructuring and has been suffering from deflation and high unemployment for consecutive years, the Government should, given its fiscal reserves, reduce taxes and increase public expenditure to stimulate the economy, thus solving the problem of the fiscal deficit. I disagree. The European Union (EU) requires its member states to contain their fiscal deficit within 3% of GDP. Though the United States (US) is facing a huge deficit, the total amount will not exceed 3% of its GDP either. In contrast, our fiscal deficit is as high as 5.5%. If the situation continues deteriorating, it may lead to an outflow of capital, thus pushing up interest rates. It will also impede the trend of economic recovery and could even trigger a financial crisis.
20. Many economists and international financial institutions have commented that the fiscal deficit poses potential problems for Hong Kong's economy. In its annual visit last month, a delegation from the International Monetary Fund (IMF) observed that "the continued deterioration of the fiscal position has made it the main source of potential macroeconomic vulnerabilities". The IMF called on the Government to formulate "a well-specified deficit reduction plan to bolster market confidence. Despite the uncertain macroeconomic outlook, credible fiscal consolidation has to begin in fiscal year 2003. This will require the implementation of sizeable structural deficit reduction measures in fiscal year 2003 and a commitment to more substantial consolidation, supported by concrete measures, in the next three years." (Note 2)
21. The Government has repeatedly stressed that the problem of the fiscal deficit has to be solved with a three-pronged approach, namely boost the economy, cut expenditure and raise revenue. There is general support in the community for this. Economic growth is a key to solving the problem. Failure to find a decisive solution will in turn stifle economic development. The two are interactive.
22. As Hong Kong's economy is externally-oriented, any attempt to stimulate it through expenditure increases and tax reduction will have limited impact. We believe that a more effective way to address the problem of deflation without increasing our financial burden is to increase external demand, which means attracting more visitors, overseas talent and investment immigrants to come to Hong Kong; more foreign enterprises to set up regional offices here; more people to attend schools in Hong Kong and seek medical treatment at our private hospitals; and more foreign capital inflows into Hong Kong's financial market. These measures will reinforce the vigour of various sectors.
Development and Prospects
23. In January, the Chief Executive set a direction for the economic development of Hong Kong in his Policy Address. We are implementing concrete measures to carry out the plan to develop our economy and improve people's livelihood. I will give a brief description of the following five areas:
Big market, small government
Building Hong Kong into a regional metropolis
Developing human resources and infrastructure
Enhancing core industries
Increasing employment opportunities.
Big Market, Small Government
24. We believe that a free market will lead to optimal distribution of resources, promote economic growth and create employment opportunities. In his Policy Address, the Chief Executive set out "big market, small government" as the underlying principle of the Administration's philosophy of governance.
25. To contain the growth in public expenditure so that the public sector will not become a burden on the community is fundamental to realising the principle of "big market, small government". The target I set last year to reduce public expenditure to 20% of GDP or below in the medium term was for the purpose of restraining the growth of public expenditure.
26. Second, the Government must continue to support the market in policy-making instead of participating in it directly. We will review our regulatory regimes from time to time and modernise rules and regulations to ensure that they remain up-to-date. The introduction of a new housing policy has clarified the Government's role in the housing market. The Government will supply land in response to market demand and provide low-rent public housing for those in need. However, it will no longer act as a property developer by building houses for sale to the public. The task force to be appointed by the Chief Executive will study further measures to improve the business environment.
27. Third, the Government has also clearly stated that it would adopt the "3R1M" approach, that is to reprioritise the provision of services, reorganise the structure of government departments, reengineer procedures and make full use of the market, so as to optimise resources and provide better services for the public. Over the past year, some government bureaux and departments have been merged and more services have been outsourced. We will also continue to encourage private-sector participation in the provision of services and infrastructure projects.
Building Hong Kong into a Regional Metropolis
28. The Special Administrative Region (SAR) Government has in recent years intensified its co-operation with the Pearl River Delta (PRD). We have facilitated the flow of people and goods by redeploying resources and streamlining procedures, and are building Hong Kong into a regional metropolis. With the support of the Central Government and the Guangdong Provincial and Municipal Governments, we have achieved substantial progress. In the fourth quarter of last year, the flow of people through the land control points was 9% higher than for the same period in 2001. The number of goods vehicles crossing the boundary also rose by 8%.
29. We will continue to improve facilities at our boundary crossings and construct new cross-boundary links. In the second half of this year, we will begin the construction of the Shenzhen Western Corridor link to Shekou in Shenzhen. We are studying the feasibility of constructing a new vehicular bridge at Lok Ma Chau to facilitate the cross-boundary transportation of cargo. Moreover, the SAR and the Mainland are currently discussing the construction of a bridge linking Hong Kong, Macau and the western part of the PRD as well as a Guangzhou-Shenzhen-Hong Kong express railway. The feasibility of simplifying visa application procedures for Mainland residents to visit Hong Kong is also under study with the aim of enabling individual travellers from Guangdong to visit Hong Kong in a personal capacity.
30. Hong Kong is a strategic two-way platform for business between the Mainland and the rest of the world. To attract more overseas companies to invest in the Greater PRD and to set up office in Hong Kong, the Government will provide additional funding of $200 million over the coming five years for promotional activities. To enhance the effectiveness of our promotional efforts, we will work together with the business sector and the Guangdong authorities to run overseas promotions. Many local businessmen have expressed their strong support for such a partnership. They are ready and willing to contribute their time and make use of their international connections to help the Government promote the investment strengths offered by Hong Kong and the Greater PRD. Invest Hong Kong will co-ordinate such promotions.
31. We are speeding up our discussion on the Mainland/Hong Kong Closer Economic Partnership Arrangement with the Central Government, with a view to reaching an arrangement on the main parts in June. We have made progress in recent discussions.
Developing Human Resources and Infrastructure
32. Human resources are the cornerstone of a knowledge-based economy. A developed knowledge-based economy requires world-class universities to nurture talent. Many world-renowned tertiary institutions make use of private donations to enhance university education. To encourage universities in Hong Kong to be more proactive fund-raisers, the Government will set up a $1 billion fund to award matching grants to universities which succeed in securing private donations for purposes other than the construction of campus buildings. Details are being formulated and will be announced by the Education and Manpower Bureau in due course. I will also later propose to raise the ceiling for tax-exempted private donations.
33. Apart from training local people, we will seek to attract more foreign talent to Hong Kong. The Government announced a population policy a week ago with proposals to ease restrictions on the entry of Mainland professionals and to expand the scope for investment immigration. We believe that, with more professionals coming to Hong Kong, our economic vitality will be enhanced and local consumer spending will increase, thereby bringing more employment opportunities for our citizens.
34. Another idea to draw in talent is to attract young people to receive basic education here and remain in Hong Kong to further their studies. On completion of their tertiary education, they can apply to stay and make their careers here. This will help to develop our economy and alleviate the problem of an ageing population. Local students can also benefit from an expansion of their horizons through interacting and learning together with students from other places. In this connection, the Government is considering how the relevant policies, including immigration and education, could support such an initiative.
35. Some consider that the Government should take the opportunity of the current economic downturn to invest substantially in infrastructure. We agree. The Government will press on with projects that yield economic and social benefits to Hong Kong. The average annual provision earmarked for infrastructure works is about $29 billion over the next five years, similar to that for the past few years.
36. At the same time, to speed up project delivery, increase opportunities for investment in Hong Kong and further the principle of "big market, small government", we will introduce a list of infrastructure projects for private sector participation on a trial basis. We will invite the private sector to submit expressions of interest on 10 or so recreational and cultural facilities projects worth about $2.5 billion. If private corporations can put forward development packages for individual projects, the Government will consider offering the projects through competitive bidding to the market for development. Depending on market feedback, the format for private sector participation may cover design, build and operate, or other options involving private financing. The Home Affairs Bureau is working on the details. We will consider extending the scheme, if successful, to cover projects under the purview of other bureaux.
Enhancing Core Industries
37. To stay competitive, Hong Kong must excel in three aspects: quality, creativity and speed. The core industries in Hong Kong, comprising financial services, logistics, tourism, and producer and professional services, possess a considerable competitive edge in these three aspects.
38. In order to maintain Hong Kong's status as an international financial centre, we must move up the value chain to attract quality companies to list in Hong Kong and investors to participate in our market. The Financial Services and the Treasury Bureau is working with the organisations concerned to implement the Corporate Governance Action Plan announced in mid-January. This will upgrade the standard of governance for listed companies and the quality of the equity market. Within this month, I expect to receive the Expert Group's report making recommendations on the regulatory structure and operation of the securities market in respect of listing matters to further improve market quality.
39. With the rapid accumulation of capital in the region, Hong Kong is making strides to become the bond and fund management centre for Asia. The Hong Kong Monetary Authority (HKMA) has already established a Real Time Gross Settlement System for the Hong Kong Dollar and the US Dollar. The HKMA has also established links with the Mainland's government bond and international bond settlement systems so as to reduce the settlement risk of bond trading. The HKMA co-operates actively with central banks in the region on development of an Asian Bond Fund to promote the growth of Asian bond markets. The Mortgage Corporation, Airport Authority, MTR Corporation and Kowloon-Canton Railway Corporation will step up the issuance of bonds in Hong Kong. I welcome investment banks to enhance their fixed-income operations in Hong Kong, including secondary trading.
40. Fund management is the core activity of the financial services industry. It is well-developed in Hong Kong, and the Government encourages fund managers to expand their business here. The Securities and Futures Commission has approved the issue of qualified retail hedge funds and will consult the industry on codes relating to real estate investment trusts.
41. In order to foster the development of retail bonds and other financial products, we will introduce a bill to amend the Companies Ordinance by July to simplify the procedures for the registration and issue of prospectuses. We will make tax proposals to assist the development of the bond market and the fund management industry. I will return to this later.
42. The insurance industry is an important component of the financial market. To enhance the effectiveness of the Office of the Commissioner of Insurance, we are studying arrangements to turn it into an agency independent of the Government. Such an arrangement is in line with international regulatory trends.
43. Hong Kong is one of the busiest container ports and air cargo hubs in the world. Last year, our port ranked first with a throughput of 19 million twenty-foot equivalent units (TEUs). Our airport has also ranked first in the world since 1996 in terms of its volume of international air cargo. Last year, it handled a record 2.48 million tonnes.
44. The Government has done much to support the development of the logistics industry. As mentioned earlier, we are taking steps to raise the capacity for cargo traffic at our land crossings. More improvements will follow in the coming years. As regards maritime transport, the first berth of Container Terminal 9 will be completed later this year, and when all its berths are in full operation in 2005, port capacity will increase by 20%. To ensure that our port remains competitive, the Government will complete the site selection study for Container Terminal 10 by the end of this year.
45. In recent years, there has been remarkable growth in our air cargo volume. Looking to the future we have plenty of room for further development. Last year, the Airport Authority awarded a franchise for the development of an express cargo terminal. The Airport Authority is also exploring opportunities for co-operation with the airport in Shenzhen to develop their potential further. To strengthen our status as an aviation hub, the Government will work hard to secure additional air traffic rights for Hong Kong.
46. We are taking forward the development of a logistics park on North Lantau and the Digital Trade and Transportation Network (DTTN) system. DTTN will provide an open electronic platform through which relevant sectors, financial institutions and government departments can exchange data at higher speed and lower cost.
47. In recent years, tourism has been one of the fastest-growing sectors of the economy. Last year, the number of visitors increased by 21%. The Hong Kong Tourism Board is forecasting a growth rate in excess of 8% this year. This encouraging development is attributable to the joint efforts of the Government and the tourism industry itself. It is clear that service quality is an important part of our competitive advantage. Many tourists choose to shop in Hong Kong because our goods are fashionable and of guaranteed quality.
48. The tourism industry workforce in Hong Kong enjoys a high reputation for its service quality. Two "thank you" letters from Shanghai clearly bear this out. A tourist from Shanghai shopped in a department store in Hong Kong but forgot to take his purchase away with him, while another left behind a mobile phone while shopping in a leather goods store. On their way back to the stores, these two tourists were worried about how they would be able to explain their problems to the salespersons and retrieve their belongings. However, not only were they able to get them without any difficulty, they were also courteously treated at every stage by those they encountered. It had never crossed their mind that their plight could be resolved in such a prompt and simple manner. They recounted their happy experience to the media after returning to Shanghai. The magazine that published the two stories made the following comment: "The Chinese tourists told their relatives and friends about the quality services they received and Hong Kong's reputation as an international city was built up. This shows that every individual makes his contribution to the investment environment." (Note 3)
49. The Government will continue to promote tourism. New tourist attractions are coming on stream. In addition, we will work together with the business sector to create new lighting effects on both sides of Victoria Harbour. The light show held at the Hong Kong Cultural Centre during Chinese New Year was one such attempt. We hope that more can be done by the end of this year, when a new sightseeing ferry service will be operating. Visitors will be able to enjoy the most spectacular night view in the world from the ferries or from either side of the harbour.
Producer and Professional Services
50. As the economic development of the Mainland continues, the producer and professional services of Hong Kong will have ample further opportunities. Last year, large-scale trade promotion activities held by the SAR Government in Chongqing, Shandong and Jiangsu were well-received, with many professional organisations and enterprises participating. This year, the SAR Government will continue to organise promotional activities in other provinces and cities, including the PRD, to develop business opportunities for the service industries of Hong Kong.
Creative Industries, High-Tech Industries
51. The remarkable international achievements of the local film industry prove that the creative industries of Hong Kong have great development potential. We will foster this development by strengthening co-operation between the Government and these industries. We have set up a $50 million Film Guarantee Fund to address the problem of securing film production finance. The Hong Kong Asia Film Financing Forum, with the support of the Film Development Fund, will be held in April to help the industry to attract overseas investment. The Commerce, Industry and Technology Bureau and the Home Affairs Bureau will welcome suggestions from those concerned on promoting the development of various creative industries.
52. The Government also supports high-tech industries. The Science Park is strengthening its support facilities to enhance Hong Kong's capability in integrated circuit design and photonics technology, thereby increasing the related industries' competitiveness in research, product development and design. We will set up a Wireless Solution Development Centre and a Digital Media Centre in the Cyberport this year to strengthen support for industries, particularly small- and medium-sized enterprises, in respect of their technical development. Apart from facilitating the development of technology, products and services, this will give a new dimension to the growth of Hong Kong's creative industries.
Increasing Employment Opportunities
53. Hong Kong relies on the development of knowledge-based and high value-added economic activities for survival. However, for some members of our labour force, the pace of economic restructuring in Hong Kong may prove too fast. Some industries have ceased to be competitive and their workers need to switch to other trades in order to find a job. To address this problem, the Government will take action on three fronts:
First, continue to promote industries such as tourism and the local community economy, which can provide jobs for those with comparatively low educational qualifications and skills. Our tourism sector is making significant progress while development of the local community economy has made a good start.
Second, reinforce various vocational programmes. At present, we provide over $1 billion each year for various training and retraining opportunities for those in need. The newly-established Manpower Development Committee will examine how to optimise the use of resources and will launch new training programmes and formats to meet the needs of the labour market better.
Third, in the face of economic restructuring and the persistently high rate of unemployment, provide additional non-recurrent funding of $270 million to ease unemployment. Of this, $50 million is earmarked for expansion of the Re-employment Training Programme for the Middle-aged, increasing the number of places from 2 000 to 12 000. Another $26 million will be allocated for the provision of attachment training for 2 000 university graduates to enhance their job-related skills. The remaining $200 million, coupled with resources redeployed internally, will be used to extend about 3 600 temporary jobs. We will also enhance the training of local domestic helpers to improve their skills. In addition, we will launch new Intensive Employment Assistance Projects with an allocation of $100 million from the Lotteries Fund to assist longer-term Comprehensive Social Security Assistance recipients to get back to work.
54. Looking ahead, external economic factors will continue to have a mixed effect on the overall economy of Hong Kong in 2003. The EU and US economies will still be affected by the unstable situation in the Middle East, whereas the Mainland's accelerated institutional reforms will support the continued growth of its economy. We forecast that our GDP will rise 3% in real terms in 2003, and that, in the face of persistent deflation, the Composite Consumer Price Index will drop by 1.5% and the general price level of the economy by 2%. For the whole year, the economic growth rate is forecast to be 1% in nominal terms.
55. Over the medium term period 2003 to 2007, we forecast a trend GDP growth rate of 3% per annum in real terms. There will be gradual easing of deflation. Over the same period, our forecast trend rate of overall price change in the economy is 0% per annum and the trend growth rate of nominal GDP is 3%.
56. I have already mentioned that our forecast fiscal deficit in 2002-03 will be $70 billion. Total government spending will be $243.3 billion, whereas government revenue will be $173.3 billion. I forecast that our fiscal reserves will drop to $303 billion by 31 March this year.
The Targets and Pace for Eliminating the Deficit
57. Last year, I set three medium term targets for our public finances, which are to achieve the following by 2006-07:
> attain a balanced Operating Account;
> restore balance in the Consolidated Account; and
> reduce public expenditure(Note 4) to 20% of GDP
I remain convinced that these three targets are in the overall interest of Hong Kong.
58. To remove the uncertainty caused by the fiscal deficit and to restore investors' confidence, specific proposals must be made and carried out as soon as possible in order to demonstrate our determination. In view of the current economic environment in Hong Kong, we also need to avoid aggravating the problem of deflation and dampening consumer sentiment. In order to strike a balance, I will adopt clear targets, a practicable pace and a step-by-step approach to implementation in proposing revenue-raising and expenditure-cutting measures.
59. We estimate that between now and 2006-07 economic growth will bring the Government about $30 billion in additional revenue. To achieve fiscal balance by 2006-07, we aim to generate a further $20 billion through raising revenue and another $20 billion through cutting down on expenditure in the next four years.
Controlling Public Expenditure
60. To contain growth in public expenditure, we must reduce operating expenditure. We are particularly concerned about operating expenditure, as it comprises expenditure on the daily operations of the Government and the public sector, and is rather difficult to adjust. Over the long term, the Government aims to achieve surpluses in the Operating Account so as to provide funding to finance capital expenditure. For the time being, we are unable to achieve this goal, but we must strive to avoid operating deficits in the medium term.
61. The Government has now set a target to reduce operating expenditure from $220 billion, as originally estimated, to $200 billion by 2006-07. In controlling expenditure, departments will, through reprioritisation of service provision, reorganisation of structure and reengineering of procedures, ensure that essential services are not affected. The Government is committed to ensuring administrative efficiency through optimal use of resources, reducing the rigidity of government prices, and controlling the size of the public sector workforce.
The Size and Pay of the Civil Service
62. The Chief Executive in his Policy Address announced that the establishment of the civil service would be reduced by 10% to about 160 000 posts by 2006-07, the recruitment of civil servants would be frozen with effect from 1 April this year, and the second round of the Voluntary Retirement (VR) Scheme would be launched.
63. In addition, the salary of civil servants will be reduced to the level in cash terms as at 30 June 1997. This pay reduction will be carried out in two phases. With the full implementation of the civil service pay reduction, the Government will save about $7 billion annually on salary expenses and subsidies to subvented organisations.
64. The Government will work out with civil servants an improved pay adjustment mechanism that better reflects the principle of broad comparability of civil service pay with the private sector. It is the Government's aim to complete this exercise, including a pay level survey, within 2004.
Expenditure on Social Welfare
65. Social welfare is another item of public expenditure that has been growing very quickly. It now accounts for 15.5% of operating expenditure, with 10.6% for social security payments. The Government will continue to provide vulnerable members of the community and others in need with a basic "safety net", so that nobody will become homeless, suffer from hunger, or be deprived of schooling and medical treatment because of financial difficulties. However, in light of structural changes in the population, the increasing growth of social security payments demands our attention. The Secretary for Health, Welfare and Food announced detailed proposals on adjustment to social security payments last week. The proposed adjustments are based on the movements of the Social Security Assistance Index of Prices, and are meant to restore social security payments to their original intended buying power. The adjustments to social security payments for elderly and disabled persons will be implemented in two phases over the next two years. The proposed adjustments are reflected in the Estimates for 2003-04 presented to this Council today.
66. We estimate that, after full implementation of the proposed social security payment adjustments, annual expenditure in this area will be reduced by about
$1.71 billion. Despite this adjustment, we anticipate that expenditure on social security payments will continue to grow substantially in the next few years. We will keep the social security schemes under regular review to establish an effective and financially-sustainable basic safety net that provides assistance to individuals and families in financial difficulties.
Doing More With Less
67. The resources we are using come from the public. We must use them cost-effectively. The Chief Secretary for Administration has designated the Director of Administration, together with the Head of the Efficiency Unit, to co-ordinate the efforts of departments in using resources more cost-effectively and in avoiding waste. The Civil Service Bureau has recently issued a circular to all Heads of Departments, encouraging colleagues to participate actively in the Staff Suggestions Scheme by putting forward cost-saving measures. I also call upon the public to give us their suggestions to help the Government optimise the use of its resources.
Flexible Financial Management
68. Last year, I put forward some guiding principles to be adopted by the Government in the management of its finances. One of these was the planning of expenditure in nominal or money terms, in order to avoid the tendency for the rise in the price level of government expenditure to exceed the rise in the general price level of the economy. We have already brought this new arrangement into effect.
69. Starting from this year, with the implementation of the accountability system, each policy bureau has been given an expenditure ceiling, i.e. the operating expenditure envelope. Directors of Bureaux now have greater flexibility to deploy resources within their operating expenditure envelope, and may retain for future use part of the savings achieved, thus providing incentives to save.
Estimates of Expenditure
Allocation of Operating Expenditure
70. Operating expenditure is estimated to be $213.6 billion for 2003-04, $212.2 billion for 2004-05, $203.4 billion for 2005-06, and $200 billion as targeted for 2006-07. Within these amounts, the Government will in the coming two years earmark a total of $8.6 billion to implement the second VR Scheme.
71. To cut operating expenditure by $20 billion to $200 billion in four years entails a reduction of about 9%. In practice, the reduction to be borne by departments would be greater than 9% because some items, including civil service pensions and social security payments, will continue to increase. In order to achieve the overall expenditure reduction target, all departments will have to absorb such increases by making greater reductions.
72. We estimate that the Government's total recurrent expenditure for 2003-04 will be $207 billion, an increase of 1% over the original estimate of $204.9 billion for 2002-03, with 23.8% for Education, 15.8% for Social Welfare, 15.4% for Health, 15.1% for Support, and 12.1% for Security. In preparing the future allocation of expenditure, consideration will be given to the community's priorities.
Estimates of Capital Expenditure
73. The estimate of capital expenditure for 2003-04 is $43.2 billion, an increase of 0.8% over the original estimate for this year. From 2003-04 to 2007-08, annual capital expenditure will average $42.5 billion, of which around $29 billion will be set aside for works projects.
74. Total public expenditure for 2006-07 is estimated to be $262.5 billion, or 18.4% of GDP forecast for that year, in line with my target set last March of containing public expenditure at not more than 20% of GDP.
75. It is necessary to raise additional revenue of $20 billion between now and 2006-07. The proposals that I am now going to make will raise revenue by $14 billion, and the remaining $6 billion will be raised by measures to be proposed as appropriate over the next three years.
76. After thorough consideration of the impact on taxpayers and the economy, I put forth the following measures to help stabilise revenue, broaden the tax base, resolve the budget deficit, and ensure financial stability. I will also propose some tax relief measures to tie in with the population policy and promote further development of education and financial services. I believe that the proposed measures strike a fair and reasonable balance that is consistent with the overall interest of the community.
77. I propose that the marginal tax rates and tax bands under salaries tax revert to their levels before the concessions made in 1998-99. The size of the incremental steps will be increased from 5% to 6%, and the marginal tax rates will be adjusted upward to 2%, 8%, 14% and 20% respectively. The bandwidth will be reduced from $35,000 to $30,000.
78. I propose that the basic and married person's allowances revert to their levels before the concessions made in 1998-99, from $108,000 to $100,000 and from $216,000 to $200,000 respectively. In 1998-99, the allowance for single parent was increased by 44% to the same level as the basic allowance. I propose that the single parent allowance also be reduced to $100,000. Following implementation of the proposals, about 90,000 more employed persons will come into the tax net, thus helping to broaden the tax base.
79. I also propose that the standard rate of tax be increased from 15% to 16%.
80. Considering the prevailing economic situation and that the public's burden is still rather heavy, I propose that all the above proposals should be implemented in two equal phases in 2003-04 and 2004-05. This will provide some relief to taxpayers.
81. In addition, I propose that the exemption for holiday warrant and passage be removed.
82. I have decided that the allowances for dependent grandparent, parent, brother or sister, disabled dependant, and deduction for self-education expenses and other deductions should remain unchanged. However, in support of the population policy, I propose to increase the allowance for the third to ninth child from $15,000 to $30,000, equivalent to that for the first and second child.
83. When fully implemented, the foregoing proposals will generate about $6.8 billion additional revenue for the Government in a full year. Detailed proposals concerning the salaries tax adjustments are set out in the Supplement to this Speech.
84. We are fully aware that salaries tax increases will have a direct impact on the public, but my proposals should have limited impact on lower to middle income taxpayers. For instance, the tax liabilities of those with monthly incomes of $8,300 to $16,700 will be increased by an average of only $60 a month, with the effective tax rate increasing from 0.7% to 1.2%. The tax liabilities of those with monthly incomes of $25,000 to $33,000 will be increased on average by $410 a month, with the effective tax rate increasing from 3.6% to 5%.
85. I propose that the profits tax rate for corporations be increased from 16% to 17.5% with effect from 2003-04. In addition, I propose that the rate of deeming assessable profits for certain payments such as royalties be increased from 10% to 30%.
86. I further propose that the profits tax rate for unincorporated businesses be increased from 15% to 16%, to be implemented in two phases in two years, in line with the adjustments in the standard rate of salaries tax.
87. Hong Kong has a simple profits tax system with consistently low tax rates and many concessions. We do not have capital gains tax nor do we impose tax on dividends. The proposed rates are still lower than those in neighbouring economies, and the 18.5% rate we had in the 1980s. Our competitive edge will not be affected by the revision in profits tax rates. When fully implemented, the proposals will generate additional revenue of $3.5 billion for the Government in a full year.
88. I propose that the property tax rate be increased by one percentage point to 16% and be implemented over two years in line with the salaries tax standard rate adjustment. The proposal, when fully implemented, will generate $70 million additional revenue for the Government in a full year.
Motor Vehicles First Registration Tax
89. The motor vehicles first registration tax (FRT) was last adjusted in 1994. The 2000-01 Budget mentioned the need to review the scope of FRT exemptions so as to update the system. We have completed the review in consultation with the trade and found that the practice of exempting air conditioners, audio equipment, anti-theft devices and distributors' warranties from the taxable value is no longer appropriate in view of changing trade practices. It is now common for vehicles to be fitted with such equipment before import. Providing such exemptions creates a loophole in the tax system. I therefore propose to abolish them. In response to the trade's requests, I also propose to increase the bandwidths and introduce a marginal tax system for private cars. In addition, we shall make suitable adjustments to the tax bands and tax rates for revenue purposes. The adjustment in tax rates will be progressive and will have a greater impact on expensive vehicles. Detailed proposals concerning the adjustments are set out in the Supplement to this Speech.
90. These new tax measures take immediate effect under a Public Revenue Protection Order published in the Gazette today. They will generate $700 million additional revenue for the Government in a full year.
91. To promote the use of electric vehicles, we propose to extend the exemptions for these vehicles for a further three years to 31 March 2006. This will reduce government revenue by $400,000 in a full year.
Air Passenger Departure Tax
92. I propose that the Air Passenger Departure Tax be increased from $80 to $120. The revised rate is still lower than the past high level of $150. This will generate approximately $400 million in additional revenue for the Government in a full year.
93. I propose that the duty on exotic horse racing bets be increased from 19% to 20%. This will generate additional revenue of $150 million for the Government in a full year.
Boundary Facilities Improvement Tax
94. Last year I proposed to introduce a Boundary Facilities Improvement Tax to help finance the improvement of boundary facilities. Boundary facilities improvement works now being carried out or planned by the SAR will cost over $14 billion. We have looked into the details of implementing the Boundary Facilities Improvement Tax and have recently briefed this Council. The bill will be introduced into this Council in the second quarter of this year. This tax will generate additional revenue of over $1 billion in a full year.
Football Betting Duty
95. As announced earlier, the Government intends to regulate football betting and introduce a football betting duty. The Government has reached an agreement with the Hong Kong Jockey Club on a betting duty, at a rate of 50% of gross profits. The annual revenue so generated for the Government is estimated to be $1.5 billion. The bill will be introduced into this Council shortly.
96. To encourage private donations to educational and other charitable organisations, I propose to raise the existing ceiling for tax-exempted donations to approved charitable organisations from 10% of assessable income or profits to 25%. This proposal will cost the Government about $100 million in a full year.
97. To reinforce the status of Hong Kong as an international financial centre and to remove the concerns of offshore fund managers, we will amend the Inland Revenue Ordinance to exempt offshore funds from profits tax. This will bring Hong Kong in line with major financial markets such as New York and London.
98. At present, subscriptions to and redemptions of units in Hong Kong from unit trust funds domiciled outside Hong Kong are exempted from the fixed stamp duty of $5. However, this concession is not applicable to unit trust funds domiciled in Hong Kong. I propose to extend the exemption to them as well.
99. These measures will have minimal impact on government revenue.
100. At present, only trading profits from qualified debt instruments with a maturity period of five years or more are eligible for a 50% concession on profits tax. To promote development of the bond market, I propose to reduce the eligible maturity period from five to three years, and grant a 100% concession on profits tax for qualified debt instruments with a maturity period of seven years or more. This proposal will cost the Government $17 million a year.
Duty on Ultra Low Sulphur Diesel
101. In view of the present economic situation and the operating difficulties of the transport industry, I have decided to extend the duty concession for ultra low sulphur diesel for another year to the end of March 2004, maintaining the duty rate at $1.11 per litre. This proposal will cost $1 billion.
102. The recent revaluation exercise indicates that, as a consequence of drops in market rent, rateable values of premises have fallen by an average of 8%. With the new rateable values coming into effect on 1 April, the majority of rate-payers will have their burden reduced.
103. The above revenue-raising proposals will increase government revenue by $6 billion in 2003-04, $13 billion in 2004-05 and $14 billion each year from 2005-06 onwards. I will consider proposing other revenue measures in the next few years that will bring an additional $6 billion in order to meet the target of raising $20 billion by 2006-07.
Government Fees and Charges
104. Last year, I announced that government fees and charges would be frozen until the end of March 2003. As most major fees and charges have been frozen for more than five years, and given the present serious deficit situation, I have decided not to extend this measure. I shall consider with the Policy Bureaux how best to adjust individual fees and charges.
105. Land revenue is one source of capital revenue. Following the announcement last November to suspend land sales for one year, the Government will thereafter only sell sites initiated by application. While this enables land supply to better meet market demands, it has become more difficult for the Government to forecast its revenue. The Government estimates that land revenue from 2003-04 to 2007-08 will be as follows:
Year 2003-04 2004-05 2005-06 2006-07 2007-08
---- ------- ------- ------- ------- -------
Land 2.5 13.3 19.3 20 20.6
106. To make up the shortage of revenue, the Government plans to sell or securitise a total of $112 billion worth of assets in the next five years. The estimated revenue is as follows:
Year 2003-04 2004-05 2005-06 2006-07 2007-08
---- ------- ------- ------- ------- -------
Total 21 30 24 21 16
($ billion)Government Bonds
107. Some have suggested that the Government should issue bonds, and employ financial management techniques to generate revenue which could be classified as income under our cash-based accounting system, so as to avoid substantially raising tax and cutting expenditure. The Government is not totally against issuing bonds. The questions that have to be considered are the use of the funds so raised, and the interest costs so incurred.
108. Infrastructure is an investment in the future. If there is a lack of funds, the issuance of bonds is an acceptable option. The Government has issued bonds on three occasions in the past. The Financial Secretaries of the day clearly indicated that the purpose of issuing bonds was to provide funding for capital works projects. However, the problem before us now is that our Operating Account suffers from a prolonged shortage of revenue to cover expenditure. Issuance of bonds can only meet cashflow requirements but cannot solve the underlying problem. For the time being, we can draw on our fiscal reserves to cope with the deficit, and the cost of issuing bonds is higher than the investment income from the fiscal reserves. Therefore, we do not see any need to issue bonds.
Assessment and Conclusion
109. If the economy grows according to our projections and all the foregoing expenditure-cutting and revenue-raising measures are successfully implemented, we will achieve our three fiscal targets, i.e. restoring balance in the Operating and Consolidated Accounts and reducing public expenditure to 20% of GDP or below in 2006-07.
Year 2003-04 2004-05 2005-06 2006-07 2007-08
---- ------- ------- ------- ------- -------
Operating 149.2 166.0 181.9 190.9 194.5
Operating 213.6 212.2 203.4 199.8 203.0
Operating (64.4) (46.2) (21.5) (8.9) (8.5)
Operating (53.4) (37.4) (13.1) (0.5) 0.3
Capital 32.2 50.5 50.7 48.7 45.1
Capital 47.8 53.3 54.4 41.0 37.9
Consolidated (67.9) (38.2) (15.8) 8.1 8.4
Consolidated (5.3%) (2.9%) (1.1%) 0.6% 0.6%
as a percentage
110. Including the extraordinary expenditure of $3.3 billion for implementing the second VR Scheme, we forecast an operating deficit of $53.4 billion for 2003-04, $0.4 billion more than the forecast operating deficit for 2002-03. The operating deficits will gradually decline, falling to $0.5 billion in 2006-07.
111. In respect of the consolidated account, we estimate that a deficit of $67.9 billion will occur in 2003-04, $2.1 billion less than 2002-03. The consolidated deficit will decrease over the next two years and will register a surplus of $8.1 billion in 2006-07.
112. Forecasts for our fiscal reserves are as follows:
Year 2003-04 2004-05 2005-06 2006-07 2007-08
---- ------- ------- ------- ------- -------
Fiscal 239.1 200.9 185.1 193.3 201.7
As number 11 9 9 10 10
113. In the next five years, our fiscal reserves will be maintained at a level between $190 billion and $240 billion, the equivalent of nine to 11 months of government expenditure, and lower than the 12-month guideline I proposed last year. As the community and the economy cannot cope with too vigorous expenditure-cutting and revenue-raising measures, I believe it is acceptable for the fiscal reserves to be maintained at this level, even though this is not entirely satisfactory. Nevertheless, due to the significant reduction in the fiscal reserves exclusive of the Land Fund, we will move an amendment Resolution in this Council shortly to permit the transfer of funds from the Land Fund to the General Revenue Account in order to meet government expenditure requirements.
Revenue-raising and Expenditure-cutting Measures vis-a-vis Economic Growth
114. In proposing the various fiscal measures, the Government has taken into account their impact on the overall economy. The proposed measures will have only minimal impact since, based on the econometric model adopted by the Government, the growth rate of our economy and price movement will adjust downwards as a result by an annual average of 0.14% and 0.21% respectively between 2003 and 2007.
115. We believe that the package of measures announced this afternoon will enable us to restore balance in our public finances over the medium term, thereby eliminating a factor that may lead to a financial crisis. Investors' confidence in Hong Kong will also be enhanced. People's anxiety about the future will be alleviated when they see that the tax increases and expenditure cuts in the coming years will be mild.
116. Madam President, the preparation of this year's Budget has certainly been a challenging task. I visit districts frequently and talk with people from all walks of life. In preparing this Budget and deliberating various proposals, I reflected on the people I had met and the remarks they had made to me. The thought of the impact of the Government's proposals on them caused me some agony and anxiety. However, it is the people's keen expectation and encouragement that has spurred me on. Over the past few months, many friends have told me that they understand the difficulties I face and have expressed their support. During the consultation period, Members of this Council, academics, experts, representatives of the business sector and local districts gave me valuable opinions and have helped me tremendously in preparing this Budget. I wish to take this opportunity to extend my heartfelt thanks to them all.
117. As a member of the community, I am well aware of the impact of the revenue-raising and expenditure-cutting measures. However, as Financial Secretary, I know very well that a persistent fiscal deficit will undermine our financial stability. The proposals I put forward today may have short-term impact, but will prevent larger, long-term problems. I also believe that today's proposals to eliminate the deficit are not so drastic as to impede economic recovery, and that they have taken into account the affordability of those who will be affected.
118. Madam President, last month I had the honour of being invited to sing with Members of this Council the song "For A Bright Future" which has the following lyrics: "We dare to scale the mountain height: from topmost peak our vision bright."(Note 5) Hong Kong people have conquered one mountain after another and this time is no exception. Our nation is destined to become a world economic power. Hong Kong is its most cosmopolitan city and a world city for the region. We can see clearly what is in store for us. Through perseverance, we will have a bright future.
(Note 1) Extracted from A Tale of Two Cities by Charles Dickens.
(Note 2) Refer to the IMF delegation's Concluding Statement for the Article IV Consultation with the People's Republic of China in respect of the Hong Kong Special Administrative Region in February 2003.
(Note 3) Refer to Yazhou Zhoukan published on 21 October 2002.
(Note 4) Public expenditure comprises government expenditure and expenditure by the Trading Funds and the Housing Authority. Government expenditure accounts for the majority of public expenditure.
(Note 5) The lyrics are extracted from the song 'For A Bright Future' which is in Chinese.
End/Wednesday, March 5, 2003
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