Hong Kong Budget Overview February 2018

Friday 02 March 2018

Introduction

The 2018/19 Budget is the first in which Mr Chan can be considered the true architect, given that he had only been in the job four weeks before delivering last year’s financial blueprint, which marked the 10th that was drawn up by his predecessor, John Tsang. This is also the first Budget prepared under the administration of Chief Executive Carrie Lam-Cheng Yuet-Ngor, who was sworn in on 1 July 2017.

Main themes 

As such, big themes are laid out early on in this year’s Budget, with Mr Chan referencing global trends and how he views emerging threats to Hong Kong’s economy. Among them, he spoke of the “unstoppable wave” of innovation and technology, the emergence of China and Southeast Asia as the single biggest driver of global economic growth, and rising protectionist movements that undermine globalisation.

The change of political leadership was referenced by Mr Chan in a section entitled ‘New Fiscal Philosophy’. Whereas the previous Financial Secretary was known for conservatism and saving fiscal surpluses for a rainy day, Mr Chan spoke of a policy U-turn in the current-term Government to ‘adopt forward-looking and strategic financial management principles in optimising the use of surplus to invest for Hong Kong’. Mr Chan indicated last year he would try to be more assertive in using the fiscal surplus for investment. This year, he left no doubt he was on board with Ms Lam’s thinking, telling Hong Kong lawmakers, ‘I agree entirely with her view.’

In fiscal year 2017/18, Hong Kong managed a budget surplus of HK$138 billion (US$17.6 billion), or about eight times the original estimate of HK$16.3 billion. Government revenues for the year were 20% higher than forecast, rising to HK$612.4 billion. Revenue from land sales was 62% higher than forecast, at HK$163.6 billion. 

By 31 March 2018, the fiscal reserves are expected to reach a historical high of HK$1,092 billion, while a Housing Reserve should rise to HK$78.8 billion. The 2018/19 budget is generally considered forward-looking in investing for the future, as the Financial Secretary indicated that 40% of the projected surplus will be redirected back to the community and 60% will be invested in the future. Furthermore, the Government proposes to spend more, as public expenditure as a percentage of GDP will rise to more than 21 per cent, breaking with a tradition of capping spending below 20 per cent of GDP. Notably, Mr Chan also announced HK$50 billion in funding to encourage Innovation and Technology, adding to HK$10 billion that was announced in last year’s Budget. He added that legislation was in process for a proposal to provide companies with a 300% deduction for the first HK$2 million in R&D expenditure, a policy announced in the Chief Executive’s Policy Address last year.

In the section on medium-term outlook, Mr Chan says he is cautiously optimistic, forecasting GDP growth of between 3 to 4%the year ahead. But he also cautioned of impacts on the global economy from interest rate normalisation. In a direct warning to property investors, he referenced underlying change in key factors that have propelled local housing prices, with supply of new homes set to increase as the ultra-low interest rate environment winds down.

Having said that, we would refer again to the risks that stem from an overly narrow tax base due to highly cyclical property tax-related revenues and direct taxes. The Financial Secretary conceded profits tax, salaries tax, stamp duties and land premium accounted for about 74% of total Government revenue in 2017-18. It was recognised that, among them, land premium and stamp duties fluctuate the most, and they account for 27% and 15% of the total revenue respectively (i.e. 42% in total). 

Notwithstanding this, it would appear the Government is still uncertain and undecided about how to resolve the problem of a narrow tax base and the concentration of the revenue sources from real estate. Mr Chan made no mention of the introduction of a goods and services tax (GST) or value-added tax (VAT) to resolve this long-standing problem, a reluctance that was also shared by his predecessor.

As such, we continue to question the Government’s emphasis on short-term measures to stimulate the economy. It continues to reduce tax burdens on individuals at the expense of a more meaningful effort to diversify the tax base and foster long-term investment and planning to limit the vulnerability to a structural deficit of the Government revenue. More specifically, the Budget laid out a wide range of relief measures, including a 75% reduction in profits and salary tax (capped at HK$30,000), a waiver on Government rates for four quarters (capped at HK$2,500 per property), and a number of beefed-up allowances for taxpayers. Unavoidably, the vulnerabilities of such a model will surely come under increasing pressure when the property market cools.

In a departure, Mr Chan emphasised the need to ‘think outside of the box’ in a push to help diversify the economy. Furthermore, he expressed ‘we will maintain a simple and competitive tax regime as well as a transparent and efficient regulatory system, while encouraging investment and innovation’. Another positive is that the Government will continue its efforts in expanding the network of tax treaties with other jurisdictions, in addition to the existing 38. This is an initiative that we of course support, as double tax treaties contain various measures (e.g. the reduction in withholding tax rates) that will help to facilitate cross-border business investments involving Hong Kong.

It goes without saying that the Government must continue being assertive to address the said issues with proposals, in order to protect Hong Kong’s economic future in the coming years. At the moment, the Government’s focus appears to be on investing in targeted industries for returns and, again, the emphasis was on mostly the same initiatives including, among others, innovation and technology, asset and wealth management, and financial services. Broadly, it would appear that the same matters are continually under discussion without having had any major achievements yet.

Conclusion

In concluding his Budget speech, Mr Chan remarked, ‘Our country’s economic development has entered a new phase. This, coupled with the ever-changing global economic landscape, has created a very favourable external environment for Hong Kong. If we can capitalise on the opportunities, the wind beneath our wings will bear Hong Kong far and high.’

Despite these strong words, we must wait longer to see how this ‘New Fiscal Philosophy’ will be implemented.


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