27. I now turn to the second part of my speech in which I shall review our current situation and the prospects for the year ahead.
28. For 1996, I forecast that GDP will grow by five per cent in real terms. This represents an improved performance from last year, to a level in line with the medium-term trend. I also expect inflation, as measured by the CPI(A), to ease appreciably further, to an annual rate of 7.5 per cent. The moderating trend in both domestically-generated and imported inflation that has emerged in the latter part of last year is expected to carry over into the current year. The level of unemployment will continue to depend primarily on the labour supply. On current indications it seems unlikely that the unemployment rate will revert quickly to the very low levels to which we are more accustomed. However, I believe that the better economic prospects that I am forecasting will bring a gradual improvement.
29. The general external environment for our trade looks favourable. Economic growth in our major overseas markets, including the United States, Europe and Japan, is generally improving. The recent easing in interest rates is helpful in this respect. In the Asia-Pacific region, growth continues to be dynamic, and trade liberalisation is gathering momentum, though one cloud on the horizon remains the annual threat to China's most-favoured-nation status in the US market. The APEC initiatives on trade liberalisation are now winning wider support. A key objective of China's Ninth Five Year Plan is to ensure steady growth and to keep inflation in check. This should provide a solid foundation for the continuing healthy development of our trade and other economic links with China.
30. Overall, I forecast our total exports of goods to grow this year by ten per cent in real terms. I expect a growth of only 0.5 per cent in domestic exports but a 12 per cent growth in re-exports. For our exports of services, I forecast continued robust growth also at ten per cent in real terms. Overall, the surplus on invisible trade would be enough to offset the deficit on visible trade.
31. Domestically, the business prospects also look favourable. Wages and salaries are rising more moderately, and property prices and rentals are unlikely to rebound sharply. Together with the recent substantial investment in machinery and equipment, all this promises well for holding down our costs of doing business and enhancing our competitiveness. On domestic consumption, my forecast is for an accelerated growth in consumer spending to four per cent in real terms for 1996 as a whole, with probably a stronger pick-up in the second half of the year. Consumer sentiment is expected to turn better following the rebound in both the stock and the property markets. This will be helped further by the recent easing in interest rates. On domestic investment, construction work on our Airport Core Programme will peak this year, while private sector building activity is expected to bottom out. On the other hand, expenditure on machinery and equipment is likely to rise at a more moderate pace after two consecutive years of substantial growth. I forecast the growth in our fixed asset investment to be slightly less rapid than last year, at around six per cent in real terms.
32. Overall then, our immediate economic prospects remain good. But I cannot ignore what has been called the "feel bad" factor: the concerns about unemployment and persistent inflation and the cautious attitude on consumption, even though the situation has improved somewhat. The economic statistics of higher GDP, lower inflation, stabilised unemployment rate, rising exports and increased investment are of little comfort to those who have lost their jobs or to businesses under pressure as consumers hold back spending. In his Policy Address last October, the Governor announced a series of measures aimed at tackling directly the problems of unemployment and low incomes. Let me assure Members of this Council and the community that this Budget makes provision for funding all the measures announced by the Governor. Where possible, I shall be proposing that we go even further in improving and expanding these programmes.
Getting People Back to Work
33. The first priority is to get the unemployed back to work. As I explained earlier, a major challenge is matching skills to jobs. In 1992, we set up an Employees Retraining Scheme to provide retraining for displaced workers. To date, the Employees Retraining Board has provided over 100,000 places on its courses, teaching workers new skills or helping them to upgrade their existing skills. In 1992, we made a grant of $300 million to the Board as its reserve. But its primary source of income is the levy imposed on employers of imported workers admitted under the various importation of labour schemes. The freeze since April 1995 on the allocation of quotas under the General Importation of Labour Scheme has reduced the income of the Board from its levy. Consequently, the Board has begun to draw down the $300 million reserve, which now stands at $186 million. The General Scheme has been replaced by the Supplementary Labour Scheme. This provides for the entry of a limited number of imported workers, which will further reduce the income available from the levy. I propose to inject another $300 million into the Board's reserves to ensure that it has the financial resources to expand its programmes.
34. But retraining is only part of the solution. When people have skills to offer which the market needs, workers have to be put in touch with potential employers. This is why our Job Matching Programme is so crucial. We have now extended the scope of this scheme to cover all job-seekers. Its success rate has been increasing steadily, and has now reached 71 per cent.
Safety Net
35. The Governor also presented the interim results of a review of the Comprehensive Social Security Assistance (CSSA) Scheme during his Address to this Council last October. Members will recall that, based on the findings from the first six-months data from the Household Expenditure Survey, he announced a package of major improvements to certain CSSA standard rates. The higher rates will come into force on 1 April, and they will cost about $300 million.
36. In announcing these increases, the Governor pledged that we would seek this Council's endorsement for any additional benefits recommended on completion of the CSSA review. We have now completed that review and identified areas in which further improvements in CSSA are necessary. This is not the place to spell out the detailed results of the review. The Secretary for Health and Welfare, together with the Director of Social Welfare, will be doing so on Friday. But I feel I should give Members this afternoon a brief summary of the main benefits we will provide, including our additional improvements to the CSSA Scheme which will cost an extra $200 million a year on top of the amount pledged by the Governor.
As I have said, the full details of the improvements will be announced on Friday. My purpose today has been to report progress on the initiatives announced by the Governor last October.
Care for the Elderly
39. We have been reminded in recent weeks that the elderly are particularly vulnerable members of our community. It is for this reason that we are providing substantial resources to meet their needs. For example,
41. As a new initiative, we will provide financial support for selected multi-service centres for the elderly to organise new services to reach out to elderly people at risk. The Director of Social Welfare is now examining how best to take this forward through voluntary agencies who will be encouraged to make full use of volunteers to supplement the efforts of professional social workers.
42. Finally, and as a direct result of our experience of the recent cold spell, the Director of Social Welfare is looking at ways to speed up the provision of special grants for such items as telephones for elderly CSSA recipients. In addition, we shall provide the resources needed to improve the facilities at temporary shelters operated by the Home Affairs Department.
43. Our programmes have been guided by a clear-sighted strategy. This is based on the landmark report in 1994 by the Working Group on Care for the Elderly chaired by the Honourable Elizabeth Wong when she was Secretary for Health and Welfare. The Working Group made a total of 71 recommendations. We have funded, and we are implementing, every single one of these recommendations. But we cannot afford to stand still when it comes to taking care of the elderly members of our community. Next month, we will launch an important follow-up study into the needs of the elderly. I want to make it plain to Honourable Members today that our commitment to providing resources for the services our elderly need will continue. Caring for the elderly is, and will remain, a major priority.
44. After this review of our initiatives on unemployment, support for those with low incomes and help for the elderly, I would like to summarise our plans for expanding our other social service programmes in the current year.
46. When account is taken of the additional spending initiatives which I have just announced, and others which I will detail shortly, I estimate that, in 1996-97, government expenditure (excluding payments from the Capital Investment Fund) will total $183.7 billion. This is an increase of $22.1 billion over the revised estimate for 1995-96. This increase is comfortably within the level of expenditure permitted under our expenditure guideline, that is that expenditure, over time, should grow at a rate no faster than the economy. Appendix A to the printed version of my speech demonstrates this clearly.
47. I turn now to my revenue proposals. I will start by restating the principles which are the foundations of the management of our public revenue. Let us call them the "seven heavenly virtues". We must:
48. From time to time, there have been calls for the Government to implement bold revenue measures in order to "stimulate the economy", to reduce inflation or to cut unemployment. I have no doubt that the motives of those making such suggestions are genuine, and we share their concerns. But do they make practical sense in Hong Kong's circumstances? Total public spending as a proportion of GDP is 18 per cent. Government spending itself is only about 14 per cent of GDP. In consequence, we have been able to maintain low taxes.
49. With the standard rate of salaries tax at 15 per cent and corporate profits tax at 16.5 per cent, our tax rates are among the lowest of any advanced economy in the world. Together they provide about 40 per cent of our total revenue. As a result, the Government's ability to directly influence the overall level of economic activity through fiscal means is very limited. In order to achieve any appreciable impact on GDP, taxes would have to be cut very substantially indeed. For example, to engineer an increase of one percentage point in GDP, we would have to slash taxes by over ten percentage points, throwing the Budget and our financial guidelines into serious disarray. This is simply unrealistic, especially considering there is no guarantee it would work and no guarantee that the money released would not go straight into savings instead of into spending. We do better - far, far better - in the long run to stick with our tried and tested formula of living within our means and keeping taxes low and predictable. We do best of all by maintaining our commitment to free markets and minimal government interference.
50. I mentioned earlier the need to maintain a rigorous user-pays principle for setting government fees and charges. Our policy on this issue is simple, practical and, I believe, fair. Where there are overwhelming social considerations, we subsidise heavily, providing services free or at a tiny fraction of their cost. This is the basis on which we provide hospital services, education and public housing. But for other services which the Government provides, where there is no overriding social need, we must maintain the principle of user pays and full cost recovery. Those who use these services, often for commercial purposes, should pay the full cost. I can see no case for taxpayers subsidising such services. The user-pays principle is an integral part of our system of public finances. It is part of the balance we have to strike if we are to go on providing heavily-subsidised services while, at the same time, keeping taxes low. Short-term gestures made at the taxpayers' expense would only jeopardise the fundamentals of our public finances.
51. There have also been calls for us to dip into our reserves. The appropriate level of reserves over the long run can be a matter for debate. But let me state unequivocally. This is not the time, with all its inherent uncertainties, to reduce the cushion of healthy reserves that Hong Kong at present enjoys. Our reserves underpin the soundness of our financial system and must be maintained. Following a recent visit by the International Monetary Fund, its report wholeheartedly endorsed our commitment to maintaining Hong Kong's long-established fiscal policies. Indeed they emphasised, and I use their words, the need to preserve the reserves for "torrential downpours not the mild showers" we are currently experiencing.
52. Let me turn next to my specific revenue proposals for the coming year. I shall start with those areas where I do not propose to make changes at present.
53. On tax enforcement, we have recently introduced legislation to counter the use of service companies to avoid or significantly reduce tax liability. We have also legislated to specify the minimum records which all businesses must keep for taxation purposes. I am confident that the new legislation is achieving its aims, and I do not propose any further measures for the time being.
54. Over the past three years, the Inland Revenue Department's investigation and field audit staff have tackled some 3,700 cases and collected about $3 billion in back taxes and penalties. In the coming year, we will step up our efforts in this area by establishing an additional field audit team, increasing the total to nine.
55. Some tax experts have proposed that I should introduce legislation to clarify the territorial source concept which underlies our tax system. In brief, this concept means that only those profits which originate in Hong Kong are liable to tax here. I have considered the arguments very carefully. I have concluded that legislation on this subject is unnecessary and would not even be helpful. Where further clarification is necessary, I believe we should rely on administrative measures, such as Practice Notes issued by the Commissioner of Inland Revenue.
Tax Relief for Housing-Related Expenditure
56. During the Budget consultations, some Members asked me to consider introducing an allowance for expenditure on mortgage interest or rental payments. Some others have suggested that we should at least provide concessions to first-time home buyers. I share their enthusiasm for encouraging home ownership. Indeed, the Government already does a great deal to provide decent homes for Hong Kong people.
57. My colleagues and I have considered these ideas very carefully. The total cost over five years of the various suggestions made by Members on this subject could be as high as $17.5 billion. This is a significant sum. Also, there would be serious difficulties in defining first-time home buyers without creating the potential for widespread abuse. I believe we should continue to invest in our existing housing programmes in order to provide direct assistance to those genuinely in need. Thus with great regret, I cannot agree to provide a concession of such a nature. However, I will later discuss one concession to further alleviate the burden on home buyers, one which I hope Members will agree is worthwhile and affordable.
58. I do not propose to make any change this year in the level of corporate Profits Tax. Comparisons with other countries in the region continue to support my view that our level of Profits Tax is already very low. I note, too, that a recent survey of senior executives in 16 industries found that 93 per cent of them are happy with our current tax arrangements. In any case, the cost to the revenue of reducing the rate of Profits Tax would be substantial. A one percentage point reduction would mean $1.7 billion of revenue forgone in 1996-97 and over $11 billion up to 1999-2000. Nor do I consider that we should provide further tax concessions to encourage expenditure on research and development. Expenditure on scientific research is fully deductible. As Members will hear later, the Government can do more to stimulate research and development but the tax system would be the wrong vehicle.
59. Although I have said that I do not propose any changes to the rate of Profits Tax, I accept that other changes in the taxation regime for businesses are justified. I will be discussing these later when I come to talk about how we can improve the business environment to encourage future growth and development.
60. Last year, we asked the Board of Inland Revenue to review the classification of items that fall into the existing three categories for an annual depreciation allowance. The Board has largely completed its review. It has concluded that, on the basis of the estimated useful life of plant and machinery, the present classification is over-generous and should be changed for some items. The result would be to reduce the annual allowance for these items. I am grateful for the work of the Board. However, I accept that the change could affect investment in plant and machinery, in particular in the manufacturing sector. In consequence, I propose to ask the Board to examine how the rationalisation of the classification should best be implemented in order to ameliorate the impact on investment in plant and machinery. Any changes to be introduced as a result will be subject to approval by Members of this Council.
61. We reduced the stamp duty on stock transfers for three consecutive years from 1991 to 1993, from 0.6 per cent to 0.3 per cent for a complete transaction, where it stands now. In practice, the overall cost of stock transfers in the local market is largely the brokerage cost. This is not high compared with other markets in the region, and our market remains competitive. I do not propose to change the stamp duty on stock transfers for the time being. But I am prepared to review the issue next year if there are initiatives from the securities industry to reduce the brokerage cost in order to make our market even more competitive.
62. Rates are significant as a relatively progressive tax and a stable source of revenue. It is important that we should go on adjusting the rates charged to reflect the changing rental values of different types of properties and in different locations. We will conduct our routine three-year rates revaluation this year, with any changes coming into effect on 1 April 1997. I will also consider if it is necessary to introduce a suitable rates relief scheme to cushion the effect of the revaluation on those experiencing large increases in rateable values.
63. It is far better to make regular adjustments in the rates than to introduce substantial increases at less frequent intervals. In the concluding speech to the 1994-95 Budget debate, my predecessor said that we would look at the option of indexing rateable values between revaluation years, so as to soften the impact of any large increase immediately following a general revaluation. We have examined this issue. I have concluded that a better option might be to consider conducting a revaluation on an annual basis. I will seriously consider the feasibility of conducting annual revaluations after the completion of the forthcoming revaluation exercise.
64. We introduced a new simple ad valorem duty system on alcoholic beverages in April 1994. The new system has benefited ordinary consumers through the effects of greater competition, especially at the lower end of the market. There was a drop in duty revenue immediately after the introduction of the new system, as most products enjoyed a duty reduction. But I note that the situation has changed, and duty revenue from alcoholic beverages has gradually picked up. I do not propose any change to the duty system.
65. Having dealt with the revenue items where I do not intend to make any changes this year, I now turn to a limited number of areas on the revenue side where I believe modest increases in taxes and duties are justified for inflation and other reasons.
66. The anti-cigarette smuggling task force established in the Customs and Excise Department in April 1994 has proved to be extremely effective in tackling the problem of cigarette smuggling. There has been a substantial increase in seizures of contraband cigarettes, and the black market price of cigarettes has continued to increase. These are sure signs that we are hurting the smugglers at current rates of duty. I consider it appropriate that we should adjust the duty rate of tobacco broadly in line with the rate of inflation. This will preserve the deterrent effect on smoking habits whilst not providing a further incentive for smuggling. I propose to increase tobacco duty by nine per cent.
67. There has been an increase in the smuggling and illegal use of diesel oil. We have provided resources to the Customs and Excise Department to set up additional investigation and enforcement teams in 1996-97 to tackle the problem. The situation should improve, and I consider it appropriate to increase the duty on petrol and other hydrocarbon oils by an amount broadly in line with the rate of inflation. I propose to increase fuel duty by nine per cent.
68. There has been no increase in Betting Tax since 1992. I consider that it is now appropriate to raise the tax from 11.5 per cent to 12 per cent for standard bets and 17.5 per cent to 18 per cent for exotic bets. This is a modest increase, and I have asked the Royal Hong Kong Jockey Club to absorb the cost of the increase by reducing its betting commission. There will be no reduction in the prize money pool, so this should not give any encouragement to the activities of illegal bookmakers. The increase should take effect from the beginning of the next racing season in September.
69. We reduced the Air Passenger Departure Tax from $150 to $50 in the 1994-95 Budget. Some Members in this Council felt that the reduction was excessive and unjustified, and criticised us. With hindsight, these criticisms had some validity. The reduction obviously affected revenue. But it did not achieve the intended purpose of encouraging transit passengers to leave the transit halls so as to enhance the business of our retail trade and alleviate congestion at the airport. Statistics also show that an increase or a decrease in the tax has no effect on passenger throughput. The current level of the tax at $50 is well below the average for the region. I propose to increase the tax to $100, which was the level when the tax was first introduced in 1983. This will bring the tax more in line with the level charged by other places in the region. I am aware of the concerns that the tourism industry might have at this point. Let me say now that it is not my intention to ignore their interests in my Budget, and I shall give details later of measures that the industry should welcome.
70. I must emphasise that the proposed increases in tobacco and fuel duties and betting and air passenger departure taxes are essential in order to allow us to fund the various revenue concessions that I propose to introduce in this Budget. They are an integral part of my Budget package.
71. Having set out the areas where I do not propose to make changes, and the very modest tax and duty increases I believe are necessary, I now turn to a number of tax concessions that I believe are justified.
72. I start with Salaries Tax. The last three Budgets have already provided substantial benefits to salaries taxpayers. As a result,
77. Last year, we revised the rates of Estate Duty to offset the effect of inflation. This year, I propose to further increase the level below which no duty is payable from $6 million to $6.5 million. Above that level, I propose that Estate Duty be payable at 6 per cent on estates between $6.5 million and $8 million; 12 per cent for estates between $8 million and $9.5 million; and 18 per cent on estates over $9.5 million. The width of the two bands will thus be increased from $1 million to $1.5 million. The cost of this proposal will be some $50 million in 1996-97 and $240 million up to 1999-2000.
Stamp Duty on Property Transactions
78. Many Members have suggested that I should make various changes to reduce the impact of Stamp Duty on property transactions in order to benefit home-buyers. I have examined these ideas with some sympathy but concluded that they are not feasible. It is more practical to focus on reviewing the structure of Stamp Duty rates in order to relieve the burden on the home-buyer. Accordingly, I propose to reduce the impact of Stamp Duty in a manner which will directly benefit buyers of lower and medium-value flats with property values of up to $3.5 million. This will be of particular assistance to buyers of Home Ownership Flats and Sandwich Class Housing Scheme properties. Let me explain the changes I propose, which will bring relief to home buyers, particularly at the lower to middle end of the market.
79. As a result of the proposed adjustments, the Stamp Duty paid on a typical $1.5 million flat under the Home Ownership Scheme will be halved, from $22,500 to $11,250. I estimate that about 54 000 property transactions will benefit from the proposal each year. These concessions will cost $550 million in 1996-97 and $2.7 billion up to 1999-2000. Details of the new schedule of stamp duty rates are set out in the supplement to the printed version of this speech.
Motor Vehicle First Registration Tax
80. There are now over 40,000 private vehicles which are ten or more years old. Most of these vehicles run on leaded fuel and are not fitted with catalytic converters. They are a significant source of pollution. I propose to introduce a scheme to encourage owners to scrap their old vehicles. If the owner of a private vehicle of ten or more years old decides to scrap his old car and replace it with a new one, he may enjoy a reduction in First Registration Tax of 20 per cent of the tax payable or $30,000 whichever is the lower amount. This initiative is designed to help to improve air quality by reducing the number of old vehicles without increasing the total vehicle fleet. We have devised a number of measures to safeguard against abuse of the scheme. The scheme will only apply to private vehicles. Commercial vehicles seldom have an economic life exceeding ten years, and, in any case, they pay a much lower First Registration Tax. We will review the effect of the proposed scheme after 12 months.
81. While still on vehicles, it has become apparent that some motor vehicle dealers have been manipulating their First Registration Tax liability. They artificially suppress the retail price of the standard motor vehicle and over-declare the value of tax exempted items like vehicle accessories and distributor's warranties. I intend to stop this abuse and ensure that all vehicle dealers can operate on a level playing field. I will introduce an amendment Bill into this Council within this legislative session so that we can set a reasonable ceiling value for these tax exempted items. The excess of the value of these items over the ceiling value will be subject to First Registration Tax.
Refurbishment Allowance for Hotels
82. Finally, I propose to adjust the taxation of refurbishment expenditure incurred by hotels. At present, such expenditure is subject to a commercial rebuilding allowance of just two per cent, meaning that it can only be written-off over 50 years. I recognise that, for a hotel, refurbishments have only a limited life before the hotel has to be renovated again to maintain quality and standards. Our tourist industry needs good hotels. I propose the introduction of a specific allowance to enable hotels to deduct refurbishment expenditure over a five year period using an annual 20 per cent write-off. The cost of this proposal is estimated to be $2 million in 1996-97 and $100 million up to 1999-2000.
83. The proposed increases in Tobacco Duty and Fuel Duty come into immediate effect under a Public Revenue Protection Order issued today. Under similar authority, my proposals on Estate Duty, Stamp Duty and Air Passenger Departure Tax will come into effect on 1 April this year. My proposals on Salaries Tax and Profits Tax will take effect from the year of assessment starting on 1 April 1996, and my scrapping incentive to replace old private vehicles will be implemented as soon as the necessary legislative and administrative measures have been put in place.
Overall Financial Position 1996-97
84. After taking account of the revenue and spending proposals I am making today, including those to be mentioned later in my speech, I expect that we will see a surplus in 1996-97 of $1.6 billion. This is lower than my predecessor forecast in his 1995 Budget. Nevertheless, as he predicted, we will have drawn on our reserves only in 1995-96 when our investment in the Airport Core Programme has been at a peak. In 1996-97, we will see a return to a surplus, albeit a very modest one.
85. I have published my Medium Range Forecast in Appendix A to the printed version of this Speech. This is our forecast of revenue and expenditure over the next four years. I must emphasise that this is a forecast only. It has been prepared to reassure ourselves that the proposals which I have put forward today are affordable both in the context of the next financial year and over the medium term. It does not impose any commitment on the future Special Administrative Region Government.
86. After taking account of the revenue proposals which I have announced this afternoon, I am making the following forecasts.
87. Our fiscal reserves at the 31 March 1997, three months before the change of sovereignty, are expected to stand at a healthy $150 billion. By the end of the forecast period in March 2000, total reserves including the SARG Land Fund are forecast to be in excess of $365 billion.
88. In presenting these figures, I must point out that one of the probable calls on these funds will be the need for capital injections into the KCRC and perhaps the MTRC towards the cost of the priority railway development projects. At the present time, the precise cost, timing and mode of financing of these projects are uncertain. In the circumstances, I have made no allowance for any such payments in my Medium Range Forecast.
89. The economic growth I am forecasting for the period up to March 2000, and the corresponding growth in our expenditure, will enable us to go on enjoying the fruits of our success. As I have explained earlier, these increases in our real expenditure and the benefits that they bring, can and will be funded from the Government's share of the wealth that our successful economy will generate.
[1996-97 Budget Speech]