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Speech by the FS at dinner of Business and Professionals Federation of HK (English only)

     Following is the speech by the Financial Secretary, Mr John C Tsang, at a dinner of the Business and Professionals Federation of Hong Kong tonight (May 7):

Sir David (Akers-Jones), Dr Wong (David Wong), Distinguished guests, ladies and gentlemen,

     Good Evening.

     It is my great pleasure to join you all this evening.

     First of all, I wish to thank members of the Business and Professionals Federation for your contribution to solving many critical issues affecting Hong Kong's development over the years.

     We have just completed the initial phase of the constitutional reform consultation.  I hope Federation members will continue to play an active part in helping to bring about a consensus in our community in the realisation of universal suffrage for the Chief Executive Election in Hong Kong in 2017.

     Government's fiscal future is another critical topic for our community.  I believe that it is important for us to discuss and to consider rationally and pragmatically how we, as a community, should manage our finances in a sensible and sustainable manner.

     I am delighted to have this opportunity today to share with you some of my views on government's approach to fiscal management as well as some of the initiatives that we are employing to cope with the anticipated challenges to our public finance in the years to come.  It is essential that leaders like yourselves should have a thorough understanding of the issues.

     An ageing population puts massive pressure on public finance of economies, as demonstrated by vivid classical examples, such as Japan starting some 20 years ago.  Hong Kong is no exception.  Studies that we have prepared in the context of the formulation of our Population Policy have made it clear that Hong Kong is facing the dilemma of a shrinking workforce starting from 2018.

     In order to gain a better understanding of how this phenomenon will impact on our public finance, I set up the Working Group on Long-Term Fiscal Planning last year, with experts and scholars from different professional sectors.  The Working Group prepared a fiscal sustainability appraisal on the state of public finance in Hong Kong.  It published its report in early March, providing a scientific and objective reference on our projected fiscal situation up to 2041.  Since its publication, the Report has been favourably commended by a number of organisations, including the IMF, as a useful tool to gauge the fiscal health of an economy.

     The key finding of the Working Group is simply that if government expenditure were to outpace our economic and revenue growth, structural deficit would be inevitable.  This seems to be rather obvious, and in order to avoid getting into such a dire position, we need to promote economic growth while containing excessive growth in expenditure and broadening, or at least, safeguarding our revenue base.  

     In formulating a fiscal strategy to achieve this simple and common sense objective, we need to strike a proper balance between allowing flexibility and upholding fiscal discipline, as well as between coping with immediate community needs and preserving longer term fiscal sustainability.

     We are taking a multi-pronged approach, involving expenditure, revenue and savings, to ensure that fiscal sustainability and economic competitiveness can be maintained.  I shall elaborate on each of these three areas in turn.

     On expenditure, my priority is to ensure that the growth of government expenditure harmonises with the growth forecasts of our economy and our revenue.  This does not mean that we are cutting back on our services.  Expenditure will continue to grow and government services will continue to improve to better help those in need.

     My guiding principle is to maintain public expenditure at about 20 per cent of our nominal GDP.  The 20 per cent mark is an indicator for fiscal management, not a rigid target.  This is a suitable level for Hong Kong because it helps to maintain our competitiveness and to ensure that Government does not consume too much of the limited resources that we share with the private sector, which is usually more efficient in making use of the resources to create wealth.  More importantly, government revenue does not generally exceed 20 per cent of GDP.  If we were to spend more than 20 per cent, we would get into a deficit situation.  And if the situation were to continue, we would need at some stage to find ways to increase revenue or to borrow.  Both of these approaches would not serve to enhance the competitiveness of Hong Kong.

     As a first step in containing expenditure growth, we are starting from within Government with four initial measures:

(I) containing overall government expenditure growth within the forecast nominal GDP growth rates over the medium term, and in the current period we are looking at a rate of 5.5 per cent;
(II) revising service priorities and re-engineering work procedures to save recurrent expenditure for the provision of new and targeted services;
(III) strengthening the mechanism of financial impact assessment; and
(IV) adjusting implementation schedules of new works projects to prevent undertaking too many projects at any one time and pushing up construction costs.

     I can assure you that I shall continue to give priority to spending programmes that help promote Hong Kong's long-term economic development, in particular those programmes that concern education and basic infrastructure.  And I shall continue to invest in social programmes and facilities, especially those that we need to support an ageing population in the foreseeable future.

     Containing expenditure growth is vital, but spending wisely and efficiently is perhaps equally, if not more, important.  I shall ask government departments and subvented organisations to review their programmes, eliminating inefficiencies and duplications, and to channel resources to priority services that would really meet community needs.

     When new expenditure programmes are considered, their longer term affordability has to be clearly assured, paying regard to fiscal discipline and fiscal sustainability.  We need to "live within our means", so to speak, and that is actually a requirement of Article 107 of the Basic Law.

     I am not saying that we have now arrived at a critical juncture where our finances are encountering difficulty.  Not at all.

     The Government's financial position is still healthy, allowing us to implement the committed initiatives, and perhaps more.  But to safeguard our future, it is better to start planning when conditions are still good.

     We have now enjoyed 10 successive years of budget surpluses, with our fiscal reserves exceeding $700 billion.  Looking ahead, we expect continuing, albeit slower, economic growth.  So, no need to panic yet.

     Our current strong financial position allows us to consider saving up part of our fiscal surplus in anticipation of future spending pressure.  The Working Group has studied similar plans put in place by other economies in making its recommendation on the Future Fund.

     Research shows that some economies have created funds for stabilisation and savings purposes.  Depending on their specific objectives, these funds are called Stabilisation Funds, Savings Funds, Funds for Future Generations, and others of similar nature.  They are meant to be locked up for an agreed period, or until the savings have accrued beyond planned levels.

     The Australian Government, for example, established a Future Fund in 2006 to strengthen their long-term financial position.  It makes provision for unfunded superannuation liabilities, which will become payable when an ageing population is likely to place significant pressure on the Australian Government's finances.  

     In Singapore, a constitutional safeguard has been put in place to prevent the Government of the day from drawing on past reserves accumulated by previous governments unless specifically approved by the President.  What's more, only up to 50 per cent of the net investment return on past reserves could be deployed as government spending each year.  These safeguards create an effective savings mechanism that allows reserves to be saved and invested for the future.

     In Hong Kong's case, given the anticipated fiscal pressure that the long-term projection has highlighted, the Working Group believes that the call for prudence and the need to save for the next generation is more urgent and critical now than in the past.  The objective is to set aside a portion of the fiscal reserve and annual surplus, invest them on a longer term basis, and release the provision after a designated period to help relieve the pressure on future generations.

     The community may wish to focus on the size of the Future Fund and avoid confusion with the other parts of the Fiscal Reserves which serve other purposes.  The Working Group has recommended that the Future Fund, notionally held against the Land Fund, with regular top-ups from its own investment returns and perhaps contributions from portions of future surpluses, should not be accounted for as part of the Fiscal Reserves.

     Since its establishment, the Land Fund has served as a de facto standby facility for Government.  With a ready "endowment" of some $220 billion, the Future Fund will be able to build on its investment returns.  To avoid the Future Fund from being drawn down too readily at the expense of future generations, there should be a time bar before withdrawals can be made.  Given that it is a lump sum of money, the Future Fund should not be used to meet recurrent fiscal commitments.  It is more suitable for one-off capital expenditures.

     In view of the importance of infrastructure in promoting economic development, I think the Future Fund could be drawn upon to sustain strategically important projects when we are unable to provide the necessary funding or accord the necessary priority to cover spending for selected infrastructural projects during an economic downturn.

     The proposal to set up a Future Fund calls for public discussion and consideration.  After the passage of the Appropriation Bill, and, given the pace of the filibuster it is quite difficult to anticipate when that would be, I shall ask the Working Group to conduct further in-depth studies on the recommendation and put forward specific proposals.

     Growing pressure on fiscal sustainability does not mean cutting back on current expenditure or stalling new initiatives.  After all, economic expansion is expected to continue.  It merely requires greater focus on long-term affordability and sustainability, as well as collective effort to preserve, stabilise and, where possible, broaden the revenue base.

     On revenue policies, my priority is to protect the direct tax regime to avoid erosion of the tax base for our profits and salaries tax income.  Beyond that, we must keep revenue policies business-friendly, competitive and attractive.  After all, direct tax contributes about 40 per cent of our annual income.  We must also be alert to opportunities that may offer new or more revenue streams.  Indeed, maintaining Hong Kong's competitiveness and stimulating long-term economic growth is the foremost priority for our fiscal policy.

     To preserve our revenue, we need to ensure that all the income receivable is duly received in full by our Treasury.  To prevent revenue loss, departments concerned need to step up tax enforcement to combat tax evasion and avoidance.  To stabilise the revenue base, all departments need to review their fees and charges according to the user-pay principle.

     In the medium-to-long term, we need to explore ways to broaden the revenue base.  The limited types of tax that we have and the low tax rates that we impose currently are landmark features that underpin Hong Kong's competitiveness and attractiveness.

     On the flipside of the coin, we are more reliant than our competitors in the region on our direct tax return.  Unfortunately, direct tax tends to be sensitive to fluctuations in the economy.  From a risk management perspective, therefore, we should try to identify new or additional revenue sources while preserving existing streams.

     Introducing new taxes would always be unpopular and controversial. Government has conducted a number of reviews on tax policies over the years.  The Advisory Committee on New Broad-based Taxes, which was set up in the year 2000, conducted an extensive amount of research on how to broaden our tax base.

     In 2006, we even launched an extensive consultation exercise on introducing the Goods and Services Tax (GST).  At the conclusion of the exercise, there was a clear consensus that we should address our narrow tax base, but the community rejected the introduction of GST.

     Since the Working Group has alerted us to the long-term fiscal challenges, I feel obliged to address the fundamental issue of broadening the revenue base at a suitable time in future.  After the measures to contain expenditure growth mentioned earlier have been finalised, it would be opportune for us to revisit previous researches, analyses and consultation results to explore ways to push forward another comprehensive tax review, taking into account the Working Group's projections.

     I must emphasise that Government does not have any plan at this time to introduce new taxes, but in principle, we always keep an open mind.  And in considering the various options on broadening our tax revenue in future, we shall have regard to three principal criteria:

(i) First, the option must be effective in broadening the revenue base and in providing stable income to meet our future needs.
(ii) Second, the option must be fair and generally in line with the "capacity to pay" principle.
(iii) Third, the option must remain faithful to our simple and low tax system in order to maintain our competitiveness in attracting capital and talent.

     It is no easy task and the work involved will be arduous.  We shall keep the community informed of our views and consult them on specific proposals in due course.

     The phrase "Living within our means" is about more than just spending what we earn.  We need to ensure that we keep earning as much as we want to spend.  We need to ensure that the engine for growth in the economy remains in high gear all the time.  Otherwise, government revenue would not be able to keep pace with our spending aspirations.  In other words, the growth of the economy is closely intertwined with the growth in government revenue and in government expenditure.

     We must consolidate Hong Kong's position as an international hub, move our economy up the value-added chain, overcome the development constraints, such as land and labour, and add impetus to the Hong Kong economy.

     Ladies and gentlemen, Abraham Lincoln, once said that the best way to predict your future is to create it.

     I have mentioned some of the issues that challenge our sustainable growth amid an ageing population.  Hong Kong is in a strong enough fiscal position to overcome these challenges in future, but we must act sensibly now.  And I have every confidence that with your continued support, we shall find the right path to improve our city's competitiveness and create a stable and prosperous future for our future generations.

     Thank you.

Ends/Wednesday, May 7, 2014
Issued at HKT 22:15


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