1 Task Force on Review of Public Finances. 2 Introduction Alert sign for Hong Kong fiscal system...

1

Task Force on Review of Public Finances

2

Introduction

• Alert sign for Hong Kong fiscal system

• Hong Kong fiscal system undergoing structural changes

• Trust that Members and the community understand the importance of prudent fiscal management to the long term prosperity and stability of Hong Kong

3

Alert sign for Hong Kong fiscal system

• Operating deficits and consolidated deficits will persist for each of the next five years if the current revenue and expenditure policies are to continue and the economy is assumed to grow at a steady (i.e. medium growth) rate. Position as follows:

4

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

Operating deficit($bn)=GDP

50

4.0%

46

3.7%

43

3.3%

47

3.5%

50

3.4%

55

3.6%

Consolidated deficit($bn)=GDP

66

5.2%

42

3.4%

55

4.3%

55

4.0%

54

3.7%

58

3.8%

Fiscal reserves(accumulative) ($bn)=GDP

369

29.3%

327

26.0%

272

21.0%

217

15.9%

163

11.2%

104

6.8%

=Months ofgovernmentexpenditure

18 15 12 9 7 4

Alert sign for Hong Kong fiscal system

5

Projected Fiscal Balance and Fiscal Reserves 2001-02 to 2006-07

Current Policies Scenario (Medium Growth)

-5.2

29.3

-3.8-3.7-4.0-4.3-3.4

26.0

21.0

15.9

11.2

6.8

-10

-5

0

5

10

15

20

25

30

35

2001-2002

2002-2003

2003-2004

2004-2005

2005-2006

2006-2007

% of GDP

Fiscal Balance Fiscal Reserve (Cumulative)

6

Alert sign for Hong Kong fiscal system

Projected operating and consolidated deficits to persist in the next 20 years

2001-02 2006-07 2011-12 2016-17 2021-22

Operating deficit($bn)=GDP

50

4.0%

55

3.6%

106

5.3%

192

7.6%

331

10.2%

Consolidated deficit($bn)=GDP

66

5.2%

58

3.8%

114

5.7%

209

8.2%

365

11.2%

Fiscal reserves(accumulated) ($bn)=GDP

369

29.3%

104

6.8%

(343)

(17.4%)

(1,178)

(46.5%)

(2,661)

(81.8%)

= months ofgovernmentexpenditure

18 4 (10) (23) (36)

Fiscal reserves projected to deplete in 2008-09

7

Projected Fiscal Balance and Fiscal Reserves 2001-02 to 2021-22

Current Policies Scenario (Medium Growth)

-5.7

-5.2 -3.8-8.2

-11.2

-81.8

-46.5

-17.4

29.3

6.8

-100

-80

-60

-40

-20

0

20

40

2001-2002

2006-2007

2011-2012

2016-2017

2021-2022

% of GDP

Fiscal Balance Fiscal Reserve (Cumulative)

8

Causes for the alert

• Changes in the economy

• Changes in government revenue

• Changes in government expenditure

9

Changes in the economy: 1991-1997

• Upsurge of the asset markets

• Average real GDP growth 5.2% per annum

• Inflation：– average GDP deflator 6.9% per annum– average CCPI 8.5% per annum

10

Changes in the economy: 1998-2001

• Asian financial crisis

• Global economic downturn

• Average real GDP growth 1.9% per annum

• Deflation:– average GDP deflator –3.0% per annum– average CCPI –1.6% per annum

11

Year-on-Year GDP Growth Rates in Real and Nominal Terms

5.1

6.3 6.15.4

3.94.5

5.0

-5.3

3.0

10.5

0.1

14.8

16.6

15.2

12.6

6.6

10.7 11.1

-4.9

-2.6

3.2

-0.3

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

18

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

%

Real Growth Nominal Growth

12

GDP Deflator and Composite CPI

9.29.7

8.5

6.9

2.5

5.9 5.8

0.4

-5.4

-6.5

-0.5

11.6

9.68.8 8.8 9.1

6.35.8

2.8

-4.0 -3.8

-1.6

-8

-6

-4

-2

0

2

4

6

8

10

12

14

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

%

GDP Deflator Composite CPI

13

Changes in government revenue (1)A fundamental change has occurred in the proper

ty market since 1998/99

Land Premium

8.9 8.9

18.5 19.1 19.427

63.6

19.3

34.829.5

8.6

0

10

20

30

40

50

60

70

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

($bn)

14

Changes in government revenue (1)

A fundamental change has occurred in the property market since 1998/99

Stamp Duty

6.9

9.5

12.8

9.57.6

15.117.3

6.34.9 4.9 4.5

02468

101214161820

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

$bn

15

Changes in government revenue (1)

A fundamental change has occurred in the property market since 1998/99

6.79.7

13.0 13.7 14.5 14.3 14.012.1

7.9

4.0

5.8

7.0 7.18.0 8.7 9.0

5.8

5.3

0

5

10

15

20

25

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

$bn Property Sector Banking Sector

16

Changes in government revenue (2)Since 1997-98, investment income from the fiscal re

serves became a key operating revenue item. Its importance has been increasing.

Investment Income

3.0 1.83.4

4.9 5.9 5.6

15.0

31.6

36.8

19.5

0.00

5

10

15

20

25

30

35

40

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

$bn

17

Changes in government revenue (2)Since 1997-98, investment income from the fiscal re

serves became a key operating revenue item. Its importance has been increasing.

0%

5%

10%

15%

20%

25%

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

Investment income as a % of operating revenueInvestment income as a % of operating expenditure

18

Changes in government revenue (2)

• To finance increasing annual operating expenditure by investment income at a constant proportion, annual investment income will have to increase accordingly.

• To achieve the above objective, there are theoretically two means –– rate of investment return will have to increase year after

year; but this is not quite possible with the global trend towards low inflation

– alternatively, there needs to be fiscal surplus year after year to increase the fiscal reserves and in turn the investment income

19

Changes in government revenue (2)

• However, with the recent consecutive years of deficits, the level of fiscal reserves has been falling. From $430 bn on 1 April 2001, the reserves are projected to decrease to $369 bn by the end of the current fiscal year.

20

Changes in government revenue (3)

• Outreach of the Hong Kong economy to the Mainland and elsewhere, plus acceleration of economic globalisation may conceivably adversely affect direct tax revenue, particularly profits tax and salaries tax

• This is due to the territorial source-based tax system practised in Hong Kong

• With available data, the magnitude of the effect cannot be quantified at this stage

21

Changes in government expenditure (1)

• Higher differential price movements in government expenditure than that of the economy; government prices slower to adjust

• Partly due to the heavy weighting of the salaries and personnel-related component (eg pension) in government operating expenditure

• The effect will worsen in a deflationary environment because government wages have not adjusted downwards in line with prices in the economy in general

22

Changes in the GCE Deflator andGDP Deflator

10.410.0

10.9 10.9

9.2

6.5 6.4

2.7

-0.2

-1.7

2.1

9.29.7

8.5

6.9

2.5

5.9 5.8

0.4

-5.4

-6.6

-0.5

-8

-6

-4

-2

0

2

4

6

8

10

12

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

%

GCE Deflator GDP Deflator

23

Changes in government expenditure

(2) Ageing population, dependency ratio to increase sub

stantially in 2010s270

125

143155 157 158

185

227

0

50

100

150

200

250

300

1990 1995 2000 2005 2010 2015 2020 2025

per

'000

per

sons

age

d 15

-64

Actual Projected

24

Changes in government expenditure (3)

• Since 1998, Government has maintained growth of expenditure higher than growth of the economy in order not to exacerbate the economic downturn

• As a result, growth in government expenditure has far exceeded growth of the economy in money (or nominal) terms – one of the reasons for the strain on the fiscal system

25

Cumulative Growth Rate in Government Expenditure, Government Revenue and GD

P in Nominal Terms

0

50

100

150

200

250

300

350

400

450

500

1986-

1987

1987-

1988

1988-

1989

1989-

1990

1990-

1991

1991-

1992

1992-

1993

1993-

1994

1994-

1995

1995-

1996

1996-

1997

1997-

1998

1998-

1999

1999-

2000

2000-

2001

2001-

2002

%

Nominal Growth in Government Expenditure Nominal Growth in Government Revenue

Nominal Growth in GDP

26

Government Revenue, Government Expenditure and Public Sector

Expenditure as a Percentage of GDP

17.2 17.4

18.6

17.4

19.0

13.8

14.5

16.4 16.2

17.0

15.314.7

18.1

21.7

13.8

17.7

21.2

17.117.5

16.7

19.0

18.319.0

21.1

22.0

21.2

17.7

17.7

15.8

17.8

16.4

17.3

16.2

10

12

14

16

18

20

22

24

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

% of GDP

Total Government Revenue Total Government Expenditure

Total Public Expenditure

27

Budget Model

• Economic parameters

• Demographic parameters

• Revenue and expenditure parameters

28

Budget Model Economic parameters

Calender Year 2002 2003 - 2006 2007-2021

% % %

Real GDP Growth Rate 1.0 3.5 3.0

GDP Deflator -1.5 0.9 2.0

Nominal GDP Growth Rate -0.5 4.4 5.1

29

Budget Model Revenue and expenditure parameters

• Revenue– each major revenue item aligned with an economi

c driver– eg. In the longer term,

• profit tax yield = 9.3% of gross operating surplus of previous year

• salaries tax yield = 5.0% of compensation of employees of previous year

30

Budget Model Revenue and expenditure parameters

• Expenditure– current expenditure control guideline, growt

h of government expenditure aligned to trend real growth of economy

– addition of 80 basis points on top of GDP deflator to reflect government expenditure price rigidity

– social consequences of ageing population

31

Budget Model Projections• To achieve consolidated balance in five years' time, revenue increase and/or

expenditure cut measures averaging $35 billion per annum, about 12.3% of annual government expenditure, will be required from 2002-03 to 2006-07 under medium growth assumptions

• Beyond 2006-07, revenue increase and/or expenditure cut measures will need to increase to:

$89 billion in 2011-12, being 21.9% of government expenditure*

$141 billion in 2016-17, being 26.0% of government expenditure*

$215 billion in 2021-22, being 29.7% of government expenditure*

* Revenue increase and/or expenditure cut has already taken into account amount of measure in previous period.

32

Budget Model Projections•Assuming that the level of fiscal reserves should be maintained at 18 months of government expenditure starting in 2016-17 and thereafter, the revenue increase and/or expenditure cut measures will be:

$127 billion in 2011-12, being 31.3% of government expenditure*

$186 billion in 2016-17, being 34.3% of government expenditure*

$236 billion in 2021-22, being 32.6% of government expenditure*

* Revenue increase and/or expenditure cut has already taken into account amount of measure in previous period.

33

Budget Model Projections

• Assuming that the level of fiscal reserves should be maintained at 12 months of government expenditure 2007-08 and thereafter, the revenue increase and/or expenditure cut measures will be:

$107 billion in 2011-12, being 26.4% of government expenditure*

$159 billion in 2016-17, being 29.3% of government expenditure*

$235 billion in 2021-22, being 32.4% of government expenditure*

* Revenue increase and/or expenditure cut has already taken into account amount of measure in previous period.

34

Annual Revenue and/or Expenditure Measures Required under Different Scenarios

(Medium Growth)

* Revenue increase and/or expenditure cut has already taken into account amount of measure in previous period.

35

76

118

183

35

110

161

203

35

93

137

202

0

50

100

150

200

250

2002-03 to2006-07*

2007-08 to2011-12*

2012-13 to2016-17*

2017-18 to2021-22*

$bn

Consolidated Balance Scenario

18-Month Fiscal Reserves Scenario

12-Month Fiscal Reserves Scenario

35

Fiscal Reserves Levelsunder Different Scenarios

(Medium Growth)

* Revenue increase and/or expenditure cut has already taken into account amount of measure in previous period.

309 309 309 309309

508

813

1,088

309406

542

725

0

200

400

600

800

1,000

1,200

2002-03 to2006-07*

2007-08 to2011-12*

2012-13 to2016-17*

2017-18 to2021-22*

$bn

Consolidated Balance Scenario

18-Month Fiscal Reserves Scenario

12-Month Fiscal Reserves Scenario

36

Conclusion

• Change fiscal “lifestyle”

• Expenditure: reinforce existing guideline by having regard to trend GDP growth in money (or nominal) terms in addition to GDP growth in real terms

• Revenue: consider views of Advisory Committee on New Broad-based Taxes and others