EF3461
The Economies of Mainland
China and Hong Kong
Tutorial 5
Hong Kong’s
Fiscal Policy
City University of Hong Kong
Dr. Isabel Yan
1. HK’s Fiscal Policy (Li(2003): Ch4)
Automatic income stabilizer vs discretionary fiscal policy:
Automatic income stabilizer:
The automatic mechanism built into the fiscal framework that can
reduce the fluctuation of disposable income in the economy.
e.g. progressive income tax system (economic upturn pushes individual
households into a higher tax bracket)
welfare benefit (welfare benefits limits the income reduction during
economic downturn)
However, automatic income stabilizer can only reduce part of the
income fluctuation but cannot eliminate the fluctuation entirely.
Discretionary Fiscal Policy:
Discretionary fiscal policy refers to the discretionary government
policy on government revenue and expenditure that are enacted by
the legislature (such as setting tax rates, welfare benefits) in order
to promote economic growth. Discretionary fiscal policy can be
expansionary or contractionary.
• Discretionary reduction in revenue:
Expansionary fiscal policy:
e.g. Reduce tax rate, less taxable items
• Discretionary increase in expenditure:
e.g. Increase urban constructions and building of
public utilities
Contractionary fiscal policy:
• Discretionary increase in revenue
• Discretionary reduction in expenditure
Discussion Question 1
1. Based on the revenue data in table 10.3,
answer the following questions.
1a. What is the most important source of revenue for the
HK government? Was there a significant decline in
this source during 2001-02?
1b. Which sources of revenue declined most drastically
since 1998? What do you think are the reasons for the
decline?
1c. What do you think is the major problem of HK’s
revenue structure? What recommendations will you
make to the HK government?
1
Main source
Large
decline
2
Answers:
1a. The earnings and profits tax (the main direct operating revenue) is the most
important source of revenue for the HK government. It accounted for 44.28% of
the total revenue in 2001-02.
Based on the data, this item remained steady since 1998. However, one
major problem of HK’s salary tax structure is that it is T-shaped, which means
that a few high income earners shoulder a large portion of the total salary tax.
This structure is very unstable because revenue base is too narrow.
1b. The revenue sources that are related to the property market declined most drastically
since 1998. These revenue sources include:
• Stamp Duty: a government tax levied on certain legal transactions including the
purchase of property. When the asset market declined, the revenue from stamp duty
dropped.
• The investment income from Land Fund: the revenue yield from the Land Fund.
• The Capital Work Reserve Fund: it finances the Public Work Program, land
acquisitions, capital subventions etc. Between 1986 and 1997, half of the proceeds
from land sales were credited to this account and the other half deposited to the
Land Fund. After 97, all income from land transacted is to be credited to this Fund.
These 3 revenue items (which heavily depend on the performance of the property
market) alone account for 30% of HK government’s total revenue in 1997-98.
Even in 2001-02, it account for 11% of the total revenue. This again indicates
that one problem is that HK’s revenue base is too narrow.
1c. The major problem of HK’s revenue structure is that the revenue base is too
narrow. The Advisory Committee on New Board Based Taxes has suggested
the following to widen the revenue base:
 A low rated but board-based goods and services tax (GST) is the best choice
for boarding the tax base
 Lower personal income tax exemptions are recommended
 A land and sea departure tax is cited as an additional option (The HK
government proposed to introduce a land departure tax in financial year 2003)
Discussion Question 2
2. Based on the expenditure data in table 10.4,
answer the following questions.
2a. What is the biggest expenditure item of the HK
government? What had the HK government done to try
to lower this expenditure item?
2b. What are the largest subvention items of the HK
government? Do you think this is consistent with HK
government’s goal of “investing for the future”?
1
Main expenditure
Expenditure on
education is the
largest subvention
item
2
Answers:
2a. The personal emolument is the largest expenditure item of the
HK government. It accounted for 21.7% of the total government
expenditure and 44.5% of the recurrent expenditure in 2001-02.
To lower this expenditure item, the civil servant’s pay was cut by
4.5% starting from October 2002.
2b. The largest subvention item of HK is education which means
that education and training occupies a high priority in
government expenditures. The is consistent with HK
government’s theme of “investing in future”. Better educated
workforce have better capacity to earn income and hence pay
tax.
Is HK’s Deficit a Structural Deficit
or a Cyclical Deficit?

Structural balance (Structural surplus or deficit)
the structural budget balance is the hypothetical balance we would
have under current fiscal policies if the economy were operating at
full employment (or potential output). The structural balance is
determined by the discretionary policy of the government (such as
setting tax rates, welfare benefits).

Cyclical balance (Cyclical surplus or deficit)
The deviation of the actual budget balance from its structural
balance due to fluctuations in the business cycle.
HK’s Actual and Structural Fiscal Surplus/Deficit
100
HK's Actual Balance
80
HK's Structural Balance (for
illustration only )
60
20
-40
-60
-80
2001/02
1999/00
1997/98
1995/96
1993/94
1991/92
1989/90
1987/88
1985/86
-20
1983/84
0
1981/82
Billion HKD
40
structural
cyclical
actual




HK’s Task Force on the Review of Public Finances had found
structural deficits in recent years which arose because of the
following structural deterioration in HK: (read the Press Release)
Poor performance of the property market resulted in low revenue
from land premium, stamp duties on property transaction and
profits tax.
HK’s direct tax declined because some of HK’s businesses moved
to the Mainland and elsewhere. This reduced HK government’s
tax revenue due to the territorial source tax principle practised in
HK (that is, only HK-sourced profits and salaries are liable to tax)
Investment income from fiscal reserves had fallen because the
persistent fiscal deficits lowered the fiscal reserves
The demographic trends raised the expenditure on health and
social security expenditure