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The unbalanced budget

There are many ways to look at a Government Budget. In the short space available here, I shall attempt to analyse it from an accountant's viewpoint; a political perspective and then also from the standpoint of the middle income group.

True and fair view
Accountants take the 'true and fair view' concept very seriously. We also try to make predictions and forecasts as accurately as possible based on reasonable assumptions. Being financial experts, an accountant would always try to control expenditure in time before heavy losses had been incurred. The outcome of the 2002/03 Budget completely blew its forecast, ended up with an unacceptably high deficit of $70 billion and failed in the control of the run-away public expenditure. It is hard for an accountant to endorse a set of accounts in this shape without the most sober qualifications.

In the Budget Debate of 1999, I have already foretold that the Government was heading for a serious structural deficit and urged the Administration to take steps to control expenditure in way of public sector reforms. I also warned the Financial Secretary in last year's Budget Debate about the high systemic risks of his forecasts with regard to the unconventional estimates in the civil servants pay reduction, optimistic economic growth and ambitious land and assets sales. When the government pushed for the one-off legislation last year to establish a one percent cut in civil services pay, I urge them not to waste time but to embark straight away on a fundamental review in pay levels. I advocated the immediate consultation and legislation to establish a fair mechanism on a permanent basis to enable the adjustment of civil servants pay both downwards and upwards. I can only hope that the Government has now learnt a lesson from these past mistakes.

Not a 'true' political balance
In the last decade or so, the Government has succeeded year after year to forge a broad political consensus with major political parties in the formulation of its Budget proposals. This year's Budget has clearly deviated from this practice and is far more aggressive than any proposal put on the table. It is clear that the Government is taking some risks in trying to drive this unpopular Budget through a very grudging LegCo. If the past few Budgets can be described as financially imprudent, then this year's Budget can be described as politically heedless.

Although the Hong Kong community accepts that we should all share some responsibilities in alleviating the gigantic deficits, we all differ in our views on who shall bear the greater burden. I was first to propose, during a public forum organised by Ming Pao in 14 December 2002, a 1:2:3 split in addressing the $70 billion deficit by new revenue, economic recovery and public expenditure cut respectively. The Government now comes up with a 2:3:2 split. Therefore, it is my view that the Budget levies too much new taxes; relies too heavily on the fatalistic economic recovery and is far too weak in the internal efforts to cut its own towering expenditure.

The 2003/4 Budget is also taking risks in the financial arena. In my view, it is unscientific and unsafe to simply wish that $30 billion recurrent deficits would disappear as the result of the natural process of economic recovery. I have argued many times before that the territorial based tax system is already outdated. As more and more taxable economic activities are being moved outside the territory, the economic recovery in terms of GDP growth is unlikely to generate revenue quickly. The Government also counts on $7 billion in cost reduction through cuts of 10 per cent headcount among civil servants. In this calculation, 8 per cent (2 per cent per year from 2003/4 to 2006/7) of the cut would come from natural wastage e.g. retirement. However, natural wastage is not the best form of human resources management. In any case, the outsourcing and privatization exercises of the Government may require a very different group of young civil servants to lose jobs before savings can be realised. A mismatch of manpower is therefore going to be a likely scenario in the coming years. The third risk factor is the ambitious plan to sell $100 billion income bearing assets. Even if we managed to fetch such good prices for these assets within such a short timeframe in this weak financial market, I estimate that in the year of 2007/08 the loss in the recurrent investment income will be $15 billion or more each year. The next Financial Secretary will again have to find more ways to make up for this new income shortfall.

Not 'fair' to the middle class
The Government aims to raise $20 billion annually from new revenue measures by 2006/07. When we compare this to the existing base of about $50 billion in profits tax and $30 billion in salaries tax, the size of this additional $20 billion tax increase seems an impossible extra burden on the existing narrow tax base. It is so unfair to expect the slightly over one million higher-middle income group to bear the brunt of this incredible tax hike.

Although the Government has finally refrained from announcing immediately a full $20 billion tax increase, the first phase - a $14 billion new tax package is already large enough to send shock waves through the entire social stratum of the community. The aggressive revenue measures also resulted in revolts amongst the Government's own backbenchers. The two political parties led by Executive Council members are planning to modify the new tax measures in defiant of the collective responsibility rule.

As for your LegCo representative, I have pledged support to the extent that one sixth of the $70 billion deficit could be met by new revenue measures i.e. $11.7 billion. The present $14 billion package is already in excess of what I consider as a fair share. Noting that nearly half of the $14 billion tax increases come from salaries tax, it is clearly the priority area that I shall be looking at to see if some of that burden can be reduced.

A better balance is possible
I believe a better balance can be achieved if the Government does not bind itself to such unrealistically rigid rules. I see no valid economic reason to set 2006/07 as the deadline for balancing the Budget. I cannot understand how the Government can make a promise not to involuntarily retire a single civil servant. I believe that a fundamental reform of the revenue base is necessary rather than simply piling more tax onto the existing narrow tax base. I consider it extremely important for the taxpayers to see hope at the end of the tunnel before they are asked to contribute more.

Stability and preservation of financial strength
If we put the Budget under the microscope, there are many faults to be found in the details. However, it has achieved perhaps the two most important objectives of maintaining stability in our financial system and preserving the financial strength of the Government.

Despite the grave rigidity of our dinosaur Civil Service pay adjustment system. The Government has, at long last, shown the will to start tackling the problem. The Budget has also appeased the international financial community and spared Hong Kong from a credit downgrade. For the time being, we are also saved from a speculative attack on the dollar link, which may cause a serious systemic shock to our financial structures. As a legislator, our power to change the Budget is almost non-existence. It is a take it or leave it approach. Under the circumstances, we might just have to live with an imperfect solution and give it a chance to work.

Dr Eric Li is the LegCo Accountancy Functional Constituency Representative. For more information, refer to his website at http://www.ericli.org 

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