Hong Kong faces huge budget surplus

PricewaterhouseCoopers expects the government to offer one-off tax cuts and grants, but few general tax reductions, as it struggles with an estimated $13.5 billion surplus.
PricewaterhouseCoopers (PWC) says the Hong Kong government is likely to hand taxpayers between HK$34.8 billion ($4.5 billion) and $37.8 billion in one-off tax cuts and grants as it decides what to do with its mounting budget surplus.

ôThe government will not want to systematise tax reductions, but it will be looking at one-off grants to taxpayers, as a way to give some of that surplus back,ö says Guy Ellis, a tax partner at PWC, at a press conference in Hong Kong.

But the one-off cuts will barely put a dent in the HK$105 billion ($13.5 billion) budget surplus that PWC is forecasting for 2007/2008.

The final consolidated surplus (or budget surplus, which can be seen as the equivalent of an individualÆs current account) will be the biggest on record for Hong Kong.

In line with past pledges to return excess money to the community, PWC estimates the government could spend: HK$20 billion on one-off salaries and profits tax rebates; HK$3 billion on adjusting some marginal tax bands; HK$0.8 billion on decreasing the standard tax rate; HK$10 billion on waiving quarterly property rates; HK$0.3 billion on reducing stamp duty; HK$4.2 billion on decreasing the profits tax; and HK$0.8 billion on reducing salaries tax. But it will only spend between HK$2 billion and HK$3 billion in increases in grants to vulnerable groups such as children, dependent parents and grandparents, single parents and those with disabled dependents. This could be raised, however, given the controversy surrounding some reports of increased poverty levels in Hong Kong.

Hong KongÆs tax revenue is notoriously volatile. Over the past few years, the deficit has swung between massive deficits and equally massive surpluses. This year, frenzied stockmarket activity, and to a lesser extent real estate activity, has lead to stamp duty adding HK$200 million per day to government coffers. Average turnover has been HK$100 billion per day this year.

In response to the cash bonanzas, Ellis believes the government could be looking at reducing the standard income tax rate for individuals to 15% from its current level of 16.5%. Company profit tax could be reduced to 16.5% from its current 17.5%. (Singapore has just reduced its company tax to 18%). The company profit tax contributed HK$77 billion in the past fiscal year (April 1 2007 to March 31 2008), equivalent to 25% of the governmentÆs total revenue.

Ellis says that governments all around the world are looking at moving to more indirect forms of taxation. In the Czech Republic, for example, income tax levels have been slashed to 15% and are to be cut even further to 12%.

ôHong KongÆs tax base is incredibly narrow. This is worrying for the government, because it would only take a few thousand top taxpayers leaving, or a few dozen of the top tax-paying companies leaving, to blow a hole in government finances,ö says Ellis.

Hong KongÆs tax base is highly unusual. Despite the low tax rate by Western standards, the top 200,000 taxpayers pay 80% of total tax. That equates to just 40,000 people paying 60% of all income tax. In the corporate sector, 800 companies pay 60% of the profit tax. Two-thirds of the working population of 3.7 million donÆt pay income tax at all. This is not necessarily a good thing, as not paying tax removes incentives from the population to monitor its government.

The governmentÆs tax revenue is also disproportionately dependent on very volatile economic indicators such as the stockmarket and real estate. When recessions bite, these tax resources collapse û but the government, with monthly expenses of HK$20 billion per month, still has to operate somehow.

ItÆs for this reason that the government has been keen to introduce the goods and services tax (GST). The GST is seen as being unfair and has provoked bitter opposition. ôBut consumption (on which GST is based) will be more stable than the stockmarket, giving the government better-balanced tax income,ö says Ellis. In addition, GST need not be highly inequitable to the poor, since staple and/or basic items can be exempt from GST.

Despite the massive surplus this year, previous years have delivered almost equally large losses. In 2003/04 the deficit was HK$40 billion, HK$62 billion in 2002/03, and HK$63 billion in 2001/02. In 2006/07 the surplus was HK$58 billion, of which the government handed back HK$20 billion in tax breaks and grants. The balance goes to the fiscal reserves.

Founded in 1935, Hong KongÆs Exchange Fund currently amounts to HK$1.2 trillion, and backs Hong KongÆs currency arrangement with the US dollar. The Exchange Fund comprises both the accumulated surplus and the fiscal reserves. The latter are placed with the Exchange Fund to be invested. Existing fiscal reserves amount to HK$447 billion. The fiscal reserves are the excess of government revenue over government expenses. ItÆs out of these funds that the government pays for its huge infrastructure projects, for example. Currently, the fiscal reserves amount to two years of government expenditure.

Hong KongÆs financial secretary John Tsang will announce the actual surplus in his maiden speech on February 27 2008.
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