The Hong Kong Special Administrative Region government last month rolled out a further HK$120 billion (US$15.4 billion) relief stimulus package to prop up the pandemic-ravaged economy and lift economic growth by 2 percent.

As a result, the budget deficit for the 2021-22 financial year is expected to reach HK$101.6 billion, accounting for 3.6 percent of the city's GDP, due to the countercyclical measures and the continued rise in recurrent expenditure.

The government also offered a list of "sweeteners", including HK$5,000 worth of electronic consumption vouchers for each eligible Hong Kong permanent resident and new arrivals aged 18 or above; cuts in salaries tax, capped at HK$10,000; a 100 percent reduction in profits tax, capped at HK$10,000, that will benefit nearly 130,000 enterprises; an extra half-a-month pay in welfare allowances; as well as low interest rate loans of up to HK$80,000 for the jobless.

Delivering the fourth budget of the current-term SAR government, Financial Secretary Paul Chan Mo-po also presented a revised record budget deficit forecast of HK$257.6 billion for the 2020-21 financial year, equivalent to 9.5 percent of GDP — far above the original forecast of HK$139.1 billion, but lower than an anticipated HK$300 billion deficit.

Hong Kong's fiscal reserves are expected to shrink to HK$902.7 billion by March 31 — down 22 percent from HK$1.16 trillion a year ago. The city's fiscal reserves have dwindled sharply in two years, from the equivalent of 23 months of government expenditure to 13 months.

The SAR saw a budget deficit of HK$37.8 billion, about 1.3 percent of GDP, for the 2019-20 financial year, ending a 15-year surplus streak. The last time the city had a budget deficit was from 2000 to 2003 on the heels of the Asian financial crisis and before the SARS outbreak.

Economic rebound expected

Sources said the government expects its operating account to be in the red for the coming financial years, but the consolidated account, after taking in consideration proceeds from bond issuances and investment returns of the Future Fund — the city's sovereign wealth fund — will remain balanced. The government will need time to tackle the thorny issue of budget deficits.

"If the economy can recover this year, I think government deficits shouldn't bother us too much," said Stephen Chiu, associate economics professor at HKU Business School. "There may be a budget surplus again for the 2022-23 financial year."

But revenue increases cannot be expected during the period even though the local economy is expected to recover this year, while government expenditure cannot be slashed and key revenue sources like salaries tax, profits tax, land premium income and stamp duties are tipped to remain stagnant in the 2021-22 financial year.

Maurice Tse, principle lecturer in finance at HKU Business School, said that the budget deficit for the 2021-22 year shouldn't lead to a recurrent budget deficit as COVID-19 is a rare global public-health crisis that drags down the economy. "When the domestic economy bounces back as the pandemic fades, government revenue will increase."

The government has forecast deficits between HK$11.8 billion and HK$18.1 billion for each year during the financial years from 2022-23 to 2024-25. Fiscal reserves will drop to HK$775.8 billion by the end of March 2026, representing 22 percent of GDP, or equivalent to 12 months of government expenditure.

"(The budget deficit) may not cause any structural change to the fiscal condition, but may avoid a fiscal cliff and set the basis for smooth and sustainable growth. Any resultant negative effect will likely be transitory, while the resultant stronger fiscal condition may have long-lasting benefits for the economy and society," said OCBC Wing Hang Bank economist Carie Li Ruofan.

Despite the anticipated economic rebound this year, economic and financial pundits have urged the government to explore more revenue streams to shore up the stability of its finances. The government estimates that GDP growth will be between 3.5 percent and 5.5 percent this year, while OCBC Wing Hang Bank sees the local economy expanding by 4.1 percent.

PwC Hong Kong Tax Partner Agnes Wong called for a "balanced approach" in spending to reserve resources for fresh challenges and measures to revive the economy in the medium-to-long term.

"In the longer term, the government will need to enhance sustainable economic growth and maintain Hong Kong's competitiveness in the Asia-Pacific region by continuing to attract overseas investment and create local job opportunities," said John Timpany, KPMG China's partner and Hong Kong head of tax.

CPA Australia Greater China's Taxation Committee Co-Chairman Anthony Lau suggested that as Hong Kong faces long-term challenges, such as an aging population, a narrow and volatile tax base, as well as diminishing fiscal reserves, the government should overhaul its tax system to achieve "three Cs" — certainty, clarity and consistency.

New revenue sources

Besides cutting recurrent expenditure by 1 percent in the 2022-23 financial year and gradually reducing one-off relief measures in the medium term, the government is exploring new revenue sources by raising the stamp duty on stock transactions from August this year.

But experts argued that the administration should be more creative in mulling new revenue streams.

According to a CPA Australia tax survey among its members last year, raising taxes on tobacco, alcohol and hydrocarbon oil are the best options to broaden the tax base within three years.

Chiu proposed raising rates — a form of property tax which currently stands at 5 percent of a property's lettable value — to boost government revenue.

He recalled that property rates had been in the double digits for more than five decades — from 1931 to 1984 — before it came down to single digits. "The government can gradually raise rates, which are a very reliable income source as the number of properties and their lettable values are quite constant. The government could exclude rates increases for residents owning just one property. This is reasonable and equitable," he said.

"Although raising rates is theoretically sound and practical, it could stir political controversy. The government has to wait for the economy to recover to allow it to raise rates gradually."

Chiu also recommended raising profits and salaries taxes, saying this will not drastically affect lower income earners as higher salaries tax will mostly hit only those earning more than HK$2 million a year. But he's against imposing a sales tax, calling it a "regressive" type of tax, whereas low income earners will have to shoulder a heavier tax burden.

Besides hiking the equity market stamp duty, the government is strengthening various revenue streams, such as drawing from the fiscal reserves, bringing back the Future Fund's investment returns and the Housing Reserve of HK$25 billion and HK$23 billion, respectively, and tapping the annual proceeds of about HK$35 billion from the expansion of the Government Green Bond Program.

In addition to levying new taxes, managing fiscal reserves proactively and utilizing the bond market are also seen as effective ways to lift revenue, experts said.

Tse told China Daily the Hong Kong government could take a leaf from Singapore's Temasek Holdings — the island state's investment company that directly invests in sectors like financials, energy, agricultural, life sciences, pharmaceuticals and infrastructure which generate stable returns by adopting a global and diversified approach.

By implementing the Temasek investment model, he said the SAR government must be able to establish suitable investment teams to gauge the performance of private equity and venture capital funds in the long term.

Lau urged the government to expedite capital deployment in the Future Fund's Hong Kong Growth Portfolio and the Exchange Fund's Long-Term Growth Portfolio to make strategic investments in local companies in innovation and technology, as well as healthcare sectors to earn a required return from investment set by the government.

Leveraging Hong Kong's high credit ratings and a favorable interest-rate environment, the government should consider launching a large-scale international bond issue in the coming year.

"Such a bond issue should include, but not be limited to, an issuance of perpetual bonds and/or bonds with long-term maturity. We believe such a bond issue will not only increase fiscal liquidity, but also draw interest from investors around the world and help further promote Hong Kong as an international financial center," said Lau.

Although the government can find more revenue sources, it still needs to conduct a comprehensive review of the tax regime to fortify the sustainability of public finances in future, auditing advisory firm Ernst & Young says.

For years, most of the government's recurrent revenue has come from profits tax, salaries tax, stamp duties and land sales, which are vulnerable to economic cycles and external shocks. The pandemic has revealed the weaknesses of the existing tax system amid the economic turmoil.

The Hong Kong Institute of Certified Public Accountants said it's important having a holistic review of the local tax system in the past few years, and evaluating the public finance revenue model has become even more pressing following last year's developments.

"As COVID-19 persists, Hong Kong's fiscal reserves will decline faster. Without stable income sources, it'll be hard to replenish our fiscal reserves. The government should, therefore, review its public finance revenue model, address the problem of a narrow tax base, ease long-term public finance pressure and avoid persistent deficits," said Eugene Yeung, convener of the institute's Budget Recommendation Committee.