VZCZCXRO4802
PP RUEHCN
DE RUEHHK #0733/01 0531016
ZNY CCCCC ZZH
P 221016Z FEB 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 5041
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 000733 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
MANILA PASS AMBASSADOR PAUL SPELTZ 
TREASURY FOR DAS DLOEVINGER AND OASIA-GKOPEKE 
USDOC FOR 4420 
 
E.O. 12958: DECL: 02/22/2031 
TAGS: PGOV ECON EFIN HK CH
SUBJECT: "GOOD TIMES" BUDGET PROPOSED 
 
REF: HONG KONG 687 
 
Classified By: EP Section Chief Simon Schuchat; Reasons: 1.4 (b/d) 
 
SUMMARY/COMMENT 
--------------- 
 
¶1. (C) A dearth of newsy initiatives in Financial Secretary 
Henry Tang's February 22 budget speech reflects continued 
cyclical good times.  There appears to be broad agreement 
here that there are no big new problems requiring short-term 
changes to economic policy or a significant redirection of 
government resources.  Tang, however, will likely find 
himself criticized for the speech on two counts.  First, his 
offer of only very limited tax concessions will disappoint 
the one-third of salaried workers who pay income taxes to 
begin with and would like to see some relief from mortgage 
payments that have risen rapidly with local interest rates. 
Second, Tang's laying out of tangible steps towards a 
consumption tax will be politically unpopular with just about 
everyone -- except the very few who have contemplated the 
HKG's existing volatile revenue structure and consider a 
consumption tax a necessary step towards addressing it.  END 
SUMMARY/COMMENT 
 
A TINY TAX CUT 
-------------- 
 
¶2. (C) Financial Secretary Henry Tang's February 22 budget 
speech -- a "second reading" to the legislature of the 
Appropriations Bill for 2006 -- revealed a small revenue 
surplus for the 2005-06 budget period, the second in a row, 
thanks to recently strong economic performance -- 8.6 percent 
GDP growth in 2004 (revised upward today) and 7.3 percent in 
2005 (released today).  Anticipation of the surplus had 
fueled hopes from the middle and upper classes for an income 
tax cut; these taxpayers find themselves increasingly 
squeezed by higher payments linked to their adjustable-rate 
mortgages.  Tang, however, offered only token cuts, 
suggesting a shaving of one percent off the marginal rate for 
the upper three tax brackets.  He also proposed extending the 
deduction period for interest on mortgages from seven to ten 
years. 
 
¶3. (SBU) Tang did not comment on lowering or rationalizing 
the duties on alcoholic beverages.  Several diplomatic 
missions in Hong Kong, including our own, have over the years 
pressed for a revision of the duties, especially for wine 
(presently 80 percent). 
 
CONCRETE STEPS TOWARDS A CONSUMPTION TAX 
---------------------------------------- 
 
¶4. (C) Tang said the HKG would announce details in mid-2006 
of a plan for a consumption tax (Goods and Services Tax, or 
GST), and that this will be followed by public consultations. 
 He did not specify whether the proposed GST would be revenue 
neutral.  Tang did state an intention to offer GST tax 
refunds to visitors and to provide relief to lower-income 
residents.  Deputy Finance Secretary Martin Glass told a 
Consular Corps briefing that the GST would be low, simple, 
and broad-based.  Glass acknowledged that this initiative 
would be hard to sell to the public, which is already showing 
signs of a "knee-jerk reaction."  He pointed out that only 
one-third of Hong Kong's work force presently pays income 
taxes.  A GST, by contrast, affects everyone, and is 
naturally unpopular.  While today's move towards a 
consumption tax was tangible, JP Morgan Greater China 
Economist Daniel Hui pointed out that the underlying 
mechanics involved suggest that such a levy will not be 
implemented before 2010. 
 
¶5. (U) A consumption tax, however, is important in the longer 
term for Hong Kong as a way to stabilize government revenue 
flows, in the view of Government Economist K.C. Kwok, who 
also chaired the Consular Corps briefing.  We note that HKG 
revenue sources are highly volatile according to economic 
conditions.  The tax base remains narrow, with income taxes 
and various fees accounting for most government revenue, and 
yields from these sources move up and down with economic 
performance and property value swings.  Further, around 20 
percent of fiscal intake over time has come from highly 
volatile non-tax sources such as land sales and interest 
rate-sensitive returns on accumulated surpluses.  Because of 
Hong Kong's USD-pegged exchange rate and lack of any capital 
controls, the HKG must be careful not to slip into projected 
 
HONG KONG 00000733  002 OF 003 
 
 
chronic deficits that would draw on the accumulated reserves 
necessary for maintaining the currency link. 
 
FISCAL GOALS REACHED AHEAD OF TIME 
---------------------------------- 
 
¶6. (U) Kwok pointed out that the HKG has as of this year 
reached several fiscal targets three years earlier than 
planned.  Government expenditure stands below the HKD 200 
billion mark (USD 26 billion).  The HKG's consolidated as 
well as operating budgets are both now in balance, for the 
first time in eight years.  Government expenditure amounts to 
less than 20 percent of GDP. 
 
NEW INITIATIVES 
--------------- 
 
¶7. (C) Tang spoke at length about Hong Kong enhancing its 
value-adding capabilities and developing in a manner that is 
"win-win" with the mainland's own economic trajectory.  He 
described a city whose economic future depends on bolstering 
employee skills and expanding physical infrastructure, both 
of which are necessary to support Hong Kong's role as a 
regional business platform.  Tang touched on numerous 
elements of "soft infrastructure" such as investor 
protections, the beneficial free trade agreement with China, 
and a committee presently looking into the potential utility 
of a competition law.  He noted challenges such as labor 
market skills mis-match, avian influenza, environmental 
degradation, and the need to attract overseas talent.  All 
that said, Tang made few proposals of note for new 
expenditures or even low-cost pilot initiatives, merely 
offering tweaks in line with existing trends.  Some of the 
more noteworthy proposals, all of which are either small in 
scale or build on existing initiatives, include: 
 
o TALENT PROGRAM: A new program to attract mainland and 
overseas talent; DepSec Glass said in the briefing that the 
aim is to attract accomplished workers with impressive 
qualifications, and that a pre-existing job offer would not 
be required to obtain the right to stay in Hong Kong and look 
for work for up to one year. 
 
o INFRASTRUCTURE: A stated commitment to physical 
infrastructure, with an eye towards creating 14,000 jobs in 
the weak construction sector.  Plans are to earmark HKD 29 
billion (USD 3.7 billion) per year.  Specific projects still 
to be determined. 
 
o AID TO DISADVANTAGED: An increase of HKD 100 million per 
year (USD 13 million) to strengthen rehabilitation services, 
family support, and child development. 
 
o EMPLOYMENT: HKD 230 million (USD 30 million) over five 
years to assist the unemployed and help them achieve 
self-reliance. 
 
o "GREEN" TAXES: Intention to promote the "polluter pays" 
principle through tax policy, including programs to encourage 
the recovery of tires, reduce the use of plastic bags, and 
promote electric vehicles. 
 
WHERE THE MONEY COMES FROM 
-------------------------- 
 
¶8. (U) The figures below were provided to the Consular Corps, 
detailing anticipated 2006-07 revenue of HKD 257.3 billion 
(USD 33 billion). 
 
UNIT = PERCENTAGES 
 
CATEGORY                     2006-07 
 
Profits Tax                     27.5 
Land Premium                          11.9 
Salaries Tax                          16.1 
Rates (Property Related)       6.0 
Stamp Duties                   5.8 
Utilities/Fees/Charges         5.7 
Properties/Investments         6.2 
Betting Duty                   4.6 
Land Fund                      3.1 
Duties                         2.6 
Other Operating                3.9 
Other Capital                  6.6 
 
 
HONG KONG 00000733  003 OF 003 
 
 
WHERE THE MONEY GOES 
-------------------- 
 
¶9. (U) The figures below are percentages of budget 
allocations based on original estimates for 2005-06 and 
2006-07, provided to the Consular Corps.  The recurrent 
government expenditure in 2005-06 was HKD 247.8 billion (USD 
31.7 billion) and for 2006-07 was HKD 245.6 billion (USD 31.4 
billion). 
 
UNIT = PERCENTAGES 
 
CATEGORY                     2005               2006 
 
Education                    23.6               23.0 
Social Welfare               14.5               14.8 
Health                       13.0               13.2 
Security                     10.6               11.0 
Infrastructure               10.9                9.9 
Economic                      4.7                4.8 
Environment and Food          4.3                4.7 
Community/External Affairs    8.3                8.4 
Housing                       0.1                0.1 
Support (Operational)        14.9               15.1 
 
 
 
 
Sakaue