People’s Republic of China-Hong Kong Special Administrative Region1: Selected Issues and Statistical Appendix

This Selected Issues paper analyzes the long-term fiscal policy in Hong Kong Special Administrative Region (SAR) and the anticipated structural changes in the economy. The paper examines the factors that contributed to the stability of the banking system in Hong Kong SAR by assessing the roles played by banks, equity markets, and debt markets. The study describes a procedure to extract the probability distribution of future exchange rate movements based on currency option data. The paper also provides a statistical appendix report of the country.


This Selected Issues paper analyzes the long-term fiscal policy in Hong Kong Special Administrative Region (SAR) and the anticipated structural changes in the economy. The paper examines the factors that contributed to the stability of the banking system in Hong Kong SAR by assessing the roles played by banks, equity markets, and debt markets. The study describes a procedure to extract the probability distribution of future exchange rate movements based on currency option data. The paper also provides a statistical appendix report of the country.

I. Long-Run Fiscal Policy in Hong Kong SAR1

A. Introduction

1. Hong Kong SAR’s fiscal policy has traditionally been conservative. The fiscal balance has been in deficit only twice in the last 15 years resulting in an accumulated surplus of about 35 percent of GDP. Also, fiscal policy has not been used countercyclically except during the Asian crisis.

2. However over the next two decades, the fiscal situation could be strained due to a confluence of structural changes, both external and domestic. On the expenditure side, the anticipated aging of the population will likely increase public spending on health care. Given Hong Kong SAR’s largely service-based economy, to maintain competitiveness, labor skills will need to be continuously upgraded, which would exert increased pressure on education spending. On the revenue side, there is concern that the existing tax base is narrow and some taxes, such as stamp duties, could be eroded due to competition from other regional financial centers. These pressures on public finances could also strain the fiscal principles enshrined in the Basic Law—Hong Kong SAR’s de facto constitution. The Basic Law exhorts the government to avoid deficits; keep spending increases in line with GDP growth; and maintain low tax rates.

3. This chapter aims to:

  • First, provide indicative estimates of how revenue and expenditure might evolve, reflecting the anticipated structural changes in the economy, in the next 20 years, under the baseline scenario which assumes unchanged tax and expenditure policies. These assumptions are hypothetical since they do not include government reaction to the changes in revenue and expenditure.

  • Second, estimate to what extent the projected revenue and expenditure developments under the baseline scenario of unchanged policies strain the fiscal principles of budget balance and expenditure growth as laid down in the Basic Law.

  • Third, gauge the degree to which potential countermeasures, for example, greater cost-sharing with the private sector in health, and new broad-based taxes such as a General Sales Tax, can alleviate the situation.

4. In practice, however, fiscal policy under the rules-based system will adjust automatically to meet these challenges. The government has traditionally acted promptly to any deterioration in the budget balance through consolidation efforts, including tax measures and expenditure cuts. Indeed, the authorities have already in the past two years introduced expenditure restraining measures and an array of public sector reforms—such as the Civil Service Reform and the Enhanced Productivity Program—in order to achieve efficiency gains and contain expenditure growth.

5. The baseline scenario in the simulations, however, is conducted under the assumption of unchanged policies and their feedback effects are not modeled. Instead, a number of alternative scenarios—some based on hypothetical changes in fiscal policy—are discussed. The baseline and alternative scenarios are designed to be illustrative of the extent of the adjustment that might be needed to avoid straining the fiscal situation in light of the anticipated changes. The usefulness of constructing a hypothetical scenario based on unchanged policies is that although the scenario departs from the fiscal principles enshrined in the Basic Law, it serves to illustrate the extent of the adjustment—either annually or over the projection period—that may be needed to avoid straining the fiscal situation in light of the anticipated structural changes. The alternative scenarios are designed to illustrate several policy options available to the government to address the deterioration of the fiscal situation that occurs under the baseline scenario and to ensure that the principles of the Basic Law are adhered to. Effectively, the alternative scenarios reflect some of the options already being considered by the authorities to address the potential fiscal stresses.

B. Structure of Hong Kong SAR’s Public Finances

6. Fiscal policy in Hong Kong SAR has aimed at maintaining a small government while fostering a competitive private sector. Underlying fiscal policy has been four broad principles: (i) maintain a simple tax system with stable and low tax rates (Box I.2); (ii) keep real government expenditure increases in line with real GDP growth; (iii) provide funding for core infrastructure projects; and (iv) provide an adequate level of fiscal reserves for contingencies.

7. Guided by these principles, the following fiscal structure has emerged:

  • Overall expenditure has generally grown in line with GDP growth (Chart I.1).

  • Education (19 percent) and health (12 percent) are the major areas of public expenditure.

  • Welfare spending has nearly doubled over the past decade, and now accounts for 10 percent of public expenditure, reflecting rising cash and housing assistance to the elderly, Mainland immigrants, and the unemployed.

  • The tax burden is low (Box I.2)—about 9 percent of GDP.

  • The tax base is narrow (Box I.2). Income taxes account for about 35 percent of all revenue, with the majority of the working population outside the tax net. There are no general consumption taxes nor any duty on imports.

  • Nontax sources account for about half of consolidated revenue, mostly proceeds from land sales and investment income.

  • The budget has generally been in surplus with accumulated fiscal reserves at 35 percent of GDP.

Chart I.1.

Hong Kong SAR: Fiscal Developments, 1985/86–1999/00

Sources: Finance Bureau; and staff estimates.

C. Factors Affecting Long-Term Fiscal Development

8. Over the next two decades, a confluence of structural changes could strain Hong Kong SAR’S public finances. This section discusses these changes and their implications.

9. Like other advanced economies, Hong Kong SAR faces the prospect of an aging population over the next several decades (Chart I.2). Official projections2 indicate that population growth is projected to slow to about a 1 percent average annual rate between 2000 and 2020, from about a 2 percent rate between 1977 and 1999. The overall dependency rate—the ratio of the dependent population under age 15 and over age 64 to the working age population—is projected to start rising within a decade. The acceleration of the elderly dependency rate will coincide with a decline in the youth population. One offset to the aging trend is a steady immigration flow from the Mainland. Over 50,000 mostly young immigrants arrived annually from 1996 to 1999, and future migration from the Mainland is estimated at just under 55,000 annually.3 Immigration is, however, not expected to fully offset the aging of the population.

Chart I.2.

Hong Kong SAR: Population and Labor Force, 1990–2020

Source: Hong Kong Population Projections: 1997–2029, Census and Statistics Department, Hong Kong SAR.

10. The aging of the population will accelerate public spending, especially on health and education:4

Breakdown of Public Expenditure

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  • Public health spending has grown rapidly since the late 1980s in part because of the demographic trends, and is now the third largest expenditure item, financing about half the economy-wide health care expenditure of 4.6 percent of GDP in FY 1996/97.5 Despite the existence of private health care services, the more expensive inpatient care services—with the elderly consuming a large share of hospital services—are largely government financed. Subsidies are quite extensive as user fees have not risen in line with costs. The government finances 97 percent of inpatient cost and 83 percent of outpatient expenses in public health care facilities. In total, user fees paid by patients finance less than 5 percent of total public health expenditures. On current population trends and industry structure, public health spending is projected to double to 4 percent of GDP by 2016 and may account for up to 21–23 percent of the government’s total budget.6

  • To address the issue of rising health care expenditure, the Government has proposed a host of specific reform initiatives to maintain and improve the long term financial sustainability of the health care system: cost containment measures, revamping of the fees structure and the introduction of an individual medical savings account.7

  • Education spending is the government’s single largest spending item, accounting for about 20 percent of total public expenditure. The government has launched several initiatives since 1997 to improve the quality and scope of education—reflecting the need to remain competitive and narrow the income gap among the skilled and unskilled workers that widened sharply during the Asian crisis.8

11. On the revenue side, there is concern that the tax base is too narrow. Moreover, some taxes, such as stamp duties, could be eroded due to competition from other financial centers, while certain nontax revenue sources, like land sales, increase more sluggishly than in the past.

  • As discussed in Box I.2, Hong Kong SAR’s tax base is very narrow. Moreover, over the last five years, salary and profit tax revenues have been declining as a fraction of GDP, though part of the decline was due to the tax relief measures introduced in FY 1998 and FY 1999. In the coming years, it is unlikely that the profit base will rise sharply given the prospects of increased competition in the service-based industries, and with extensive tax allowances for salaried workers, salary tax base will not expand markedly.

  • Stamp duties, which have been a key revenue item since the early 1980s, could erode in the future. Increased competition among regional financial centers may force the Hong Kong SAR government to reduce stamp duties (many regional stock exchanges have eliminated such duties).

  • The real-estate boom from 1990 to 1997 created an earnings windfall, and in the subsequent crash, land revenues plummeted—from 13 percent of total revenue in 1996 to 9 percent of total revenue in 1998. Most observers regard the pre-Asian crisis runup in property prices as a speculative bubble, and expect more stable prices in the future.9 Thus, the share of land-related revenue could fall in the coming years.

D. Long-Term Baseline Fiscal Projection

12. This section describes a hypothetical simulation exercise—based on unchanged policies—to assess the potential impact of population aging in the absence of additional tax revenue measures or/and expenditure cutting efforts on expenditure and revenue and the fiscal balance over the long term.10

13. Hong Kong SAR’s consolidated budget consists of the General Revenue Account GRA)—the government’s main budget—and a set of Funds. Among the largest of these Funds is the Capital Works Reserve Fund, which finances public works program, land acquisitions, and receives income from land transactions. The remaining statutory funds are: the Loan Fund, the Disaster Relief Fund, the Civil Service Pension Reserve Fund, the Capital Investment Fund, the Innovation and Technology Fund, and the Land Fund.11 The fiscal reserves are the cumulative total of all previous consolidated budget balances. Fiscal reserves are held with the Exchange Fund, with investment income proportionately divided among the GRA and Funds based on their respective asset holdings.

14. The assumptions used in simulating GRA revenue and expenditure items were:

Assumptions Underlying Fiscal Mode

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  • Labor force: Official population projections and historical averages of labor force participation rates between 1984 and 1998 were used to generate annual estimates of the labor force by age groups.

  • GDP growth: Most recent medium-term forecast (SM/01/13,1/16/01)) for real GDP growth are used till 2005. Real GDP growth beyond 2005 was kept at the potential rate of 4 percent.

  • Inflation: Most recent medium-term forecast (SM/01/13, 1/16/01) for inflation was used till 2005. Thereafter, annual inflation rate is expected to converge to trading-partner inflation of 3 percent.

  • Stamp duties for property transactions: Total property market turnover value was forecast using historical data on the total annual value of turnover (sum of value assignments and value agreements for sale and purchase of land) and the property index for domestic premises. For each year, an “implicit” quantity index (total turnover value/price index) was constructed to generate a proxy for quantity turnover. In the baseline scenario, property volume turnover was fixed to its 1993 value (fiscally neutral base year) while the real property price index is assumed to grow at 6 percent, its average growth rate between 1984 and 1999.12 The real values were converted to nominal terms using the projected GDP deflator.

  • Stamp duties for stock market transactions: Equity prices were assumed to grow at a fixed “real” rate. In the baseline scenario, the real rate was set equal to 10 percent, about 2 percentage points below its average real growth rate between 1984 and 1998. “Implicit’ turnover volume was fixed at its 1993 value throughout the projection period. The real values were subsequently converted to nominal terms using the projected GDP deflator.

  • Land premium: The price index for domestic premises was taken as proxy for price movements of government land sales, and the volume of land sales fixed at its average between 1984 and 1999 rather than its 1993 value—a value that was by historical standards unusually high.

  • Investment income: Projected real investment income was determined by multiplying the real fund balance at the end of the previous fiscal period by the assumed real rate of return on all assets of the Exchange Fund. In the baseline scenario, the real rate earned on these was set at 5 percent, around 3½ percent below the historical average between 1984 and 1998. The real values were subsequently converted to nominal terms using the projected GDP deflator.


Stamp Duty Revenue versus Turnover Value on HKSE

(In HKS millions)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001

15. Three different methods were used to project the revenue and expenditure items in the GRA depending on the availability of data and explanatory variables.13 For most variables (Tables I.1 and I.2) projections were done based on the historical behavior of a variable of interest as approximated by a linear regression model (see Appendix). For some variables, the historical behavior was mimicked using a first or second order Taylor expansion of the fiscal variable around a cyclically neutral value. Lastly, some variables were projected as a constant proportion of GDP. This approach was used when adequate data on likely explanatory variables were not available or regression results indicated structural breaks.

Table I.1.

Revenue Model

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3-F First order. Taylor approximation.3-S Second order. Taylor approximation.

Dependent variable is ratio to GDP.

Portion excluding interest.

Real interest income is the (real) balance of general revenue account for previous period times the real interest rate.

Table I.2.

Expenditure Model

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F: first order. Taylor approximation.S: second order, Taylor approximation.P: modeled with xt = log(x/x(–1)) and y1 = log(y/y(–1)), i.e., percentage changes rather than levels.

Dependent variable is per member of the population aged 5 to 14.

Dependent variable is per capita.

Two lagged values of the dependent variable are included.

2001/02 is mean ratio of expenditure to GDP from 1984–98, and grows at nominal GDP growth thereafter.

16. For the statutory Funds, a less elaborate method was used to derive projections for their annual balance:

  • All the Funds other than the Capital Works Reserve Fund were assumed to achieve a balanced budget every fiscal year throughout the projection period. In addition, each Fund was assumed to transfer all investment income that it earned on its asset holdings with the Exchange Fund to the GRA.

  • The Capital Works Reserve Fund was assumed to achieve a zero balance every fiscal year throughout the projection period, excluding interest income and land premiums earned. While interest income was transferred to the GRA, land premium was transferred only to the extent necessary to maintain a non-negative balance in the GRA. Otherwise, land premium was added to the Capital Works asset holdings.

E. Policy Analysis

17. The baseline projection shows, in an unconstrained fiscal spending scenario and in the absence of additional tax measures, Hong Kong SAR could experience a deterioration in its public finances. The consolidated budget balance (reflecting the net budget position of the GRA and all funds) is projected to turn negative around FY 2015 (equivalent to a negative 0.3 percent of GDP)1 largely because uncontrolled expenditure growth outpaces revenue growth over the projection period. At that point, net government assets would amount to about 28 percent of GDP. Subsequent deficits would be financed by running down the government’s assets. By FY 2020, the deficit would have widened to 1¾ percent of GDP and assets would have declined to 13 percent of GDP. For illustrative purposes, extending the projections beyond 2020, the government’s asset holdings could be depleted within about 9 years (around 2024). By then, the government would have to resort to debt financing. The rapid pace of the asset rundown reflects the large dependence of investment income to finance expenditure.


Baseline Scenario Budget Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001


Baseline Scenario Government Assets

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001

18. While several revenue components, are expected to slow down, revenue overall is projected to grow in line with GDP. The slower trend growth in stamp duty and profit taxes, due to anticipated structural changes, will be offset by higher salary revenue and bets and sweeps which are projected to grow somewhat faster than their average annual growth rate in the 1990s. Overall, however, consolidated revenue grows on average in line with GDP growth over the projection period, with the revenue-to-GDP ratio roughly the same at the end of the projection period.


Baseline Scenario" Revenue Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001

Real Revenue Growth Rates

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19. On the expenditure side, although some components are expected to grow slower than in the last decade, together they are expected to outpace the rise in revenue. For example, despite the aging in the population, real expenditure on health grows slower than in the 1990s, reflecting the substantial catch-up in public health expenditure in the 1990s. Only social welfare spending is projected to accelerate in the second half of the projection period, largely due to rising share of those out of the workforce. However, consolidated expenditure growth exceeds GDP growth by an average annual rate of 1¾ percent over the projection period. Clearly, if expenditure growth could be kept under control (in line with GDP growth) the fiscal balance would not deteriorate as projected under the baseline scenario.

Real Expenditure Growth Rates

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20. Under the baseline scenario, two fiscal tenets enshrined in the Basic Law appear to be violated: first, a sustained fiscal deficit emerges from 2015 onwards, and second, expenditure grows faster than GDP from 2004 onwards.

  • Taking FY 2004 as starting point, to achieve balanced budget over the projection period so that an asset-to-GDP ratio of about 33 percent is reached in FY 2020, real total public expenditure would have to be cut by an annual average rate of 6½ percent (or an average of 1.1 percent of GDP per year).

  • Assuming that all the adjustment burden fell on areas outside of social spending, then total non-social spending, including housing, would have to decline by 13 percent per year in real terms. Many of these non-social spending areas are, however, already being squeezed, and further cuts could potentially undermine the quality of public services. Hence, reforms to social spending areas, such as public health, may be needed to bring expenditure growth under control.

  • While these cuts are sufficient to achieve balanced budget, they are not enough to satisfy the second tenet of the Basic Law, namely to bring expenditure growth in line with GDP. Instead, this would require cutting real expenditure by 14 percent in real terms over the projection period, equivalent to 2½ percent of GDP per year, and double the amount of expenditure cuts needed to achieve balanced budget.

21. The baseline scenario is sensitive to the assumptions underpinning the simulations.14 For illustrative purposes, four revenue-enhancing and one cost-cutting scenarios were examined. In all revenue-raising scenarios, while the requirement under the Basic Law of a budget balance over the projection period could be met, the second expenditure growth objective tenet remained violated since none of them entailed expenditure-cutting options. For that reason, an alternative option of allowing for greater burden sharing with the private sector to reduce health care expenditure was considered in order to achieve the expenditure growth objective.


Sensitivity Analysis: Property Prices.

(in percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001


Sensitivity Analysis: Real Growth

(in percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001


Sensitivity Analysis: Real Stock Prices

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001

  • Property prices. Increasing the growth rate in real property prices from the baseline rate of 6 percent to 8½ percent improves the long-term fiscal balance enough to achieve the asset target ratio of 33 percent.

  • Equity prices. The growth rate in real equity prices would have to more than double to 24½ percent from the baseline rate of 10 percent to reach the target asset ratio, as stamp duties from stock transactions account for only 3 percent of total revenue.

  • Growth rate. Raising the growth rate of the economy by 0.6 percent from its current baseline rate of 4 percent would be enough to achieve the target asset ratio of 33 percent. Higher productivity growth could come from the education reforms and the Mainland’s accession to the WTO, which should benefit HKSAR as trade creation is expected to exceed trade diversion.

  • Expanding the tax base. The impact of a 3 percent and 5 percent GST was simulated for illustration.15 Both rates are low by international standards. The tax base is assumed to amount to 38 percent of GDP.16 The 3 percent rate will raise the general price level by 1.9 percent, while the 5 percent rate will increase prices by 3.2 percent on a one-off basis. It is assuemed that the GST would be introduced in FY 2004/05 with ¾ of the price level impact occurring in 2004 and the remaining in 2005. The results suggest that a 3 percent GST could achieve the target asset-to-GDP ratio by 2020.

  • Greater burden sharing with private sector: Another option would be to reduce health care expenditure by allowing for greater cost sharing of health care expenditure. This could be achieved through higher user fees, introducing means-testing and encouraging more private insurance. It is estimated that to maintain the government’s share of health expenditure steady at its current share of 2½ percent of GDP over the projection period (compared to the baseline level of about 4 percent in 2020), and just enough to keep total expenditure growing in line with trend growth, health expenditure growth would have to be cut by 2½ percent on average and user fees would have to double to finance around 35 percentof public health expenditures from their current baseline rate of about 5 percent17


Sensitivity Analysis: GST

(in percent of GDP)

Citation: IMF Staff Country Reports 2001, 146; 10.5089/9781451807790.002.A001

F. Conclusion

22. The baseline projections suggest that the potential impact of demographic and other structural trends could be nontrivial. Clearly, the results are sensitive to the underlying assumptions and do not incorporate an equilibrium response by the private sector. That said, the factors that are driving the deterioration in public finances appear largely structural. In an unchanged policy scenario, the consolidated fiscal balance is expected to deteriorate, and turn negative around 2015. To be sure, accumulated fiscal reserves of the government are significant, and the authorities could arguably allow its balance sheet to deteriorate temporarily, financed by drawing down reserves. However, prolonged deficits would not be in the long-term interests of the Hong Kong SAR economy. They would conflict with Hong Kong SAR’s tradition of fiscal prudence, erode investor confidence and undermine the credibility of the currency board arrangement.

23. Against this setting, the government has already begun to address some of these problems. The government introduced a Civil Service Reform and an Enhanced Productivity Program aimed at controlling growth in expenditure and achieving cost efficiency gains in 1998. In additional Task Force on Review of Public Finances was established in 2000 to investigate the recent deterioration of the operational fiscal balance. An Advisory Committee to the Task Force has also been established to assess the merits of introducing different taxes, including a broad-based goods and service tax as means to broaden the tax base. Both bodies are expected to complete their work by the end of 2001. The government further commissioned a study in 1997 to assess Hong Kong SAR’s health care system and make recommendations to improve the financing and delivery of health care. Based on this study, the government is expected to introduce comprehensive health care reforms. Furthermore, the government conducts regular departmental reviews, which have led to reforms in welfare, pensions, and education, to contain costs and improve efficiency.

Fiscal Constraints on the Hong Kong SAR Government

1. The provisions of the Basic Law

The Basic Law of HKSAR, which went into effect on July 1, 1997, requires the government to abide by the principles of:

  • keeping expenditure within the limits of revenues when drawing up the budget;

  • striving to achieve a fiscal balance, and avoid deficits;

  • keeping the budget commensurate with the growth rate of GDP;

  • taking the low tax policy previously pursued in Hong Kong SAR as reference, enact laws on its own concerning types of taxes, tax rates, tax reductions, allowances and exemptions, and other matters of taxation;

  • maintaining the region’s status as a free port and not imposing any tariff unless otherwise prescribed by law; and

  • backing the issue of Hong Kong SAR currency by a 100 percent reserve fund.

2. The fiscal philosophy set out in previous budgets

The government of Hong Kong SAR has laid out its fiscal philosophy in previous budgets, including among them the following guidelines

  • The budgetary surplus should be managed in order to maintain adequate fiscal reserves over the long term. The general guideline is to maintain reserves within plus or minus 25 percent of the M1 money supply plus 12 months’ government expenditure.

  • Adherence to the principle of full cost recovery in setting user fees and charges for services provided by government.

  • A revenue scheme that features low tax rates, a flat tax profile, and that is drawn from only a limited number of sources.

  • A ceiling on total permitted expenditure is determined under the guideline that real budgetary expenditure growth be no faster than the forecast growth of potential GDP.

3. An implicit social contract between the government and the people

The unique history and traditions of the people of Hong Kong SAR and its government suggest a number of “implicit” guidelines which will limit the ability of the government to change taxes or government programs. These include:

  • Minimal government interference in the economy.

  • Only the most vulnerable members of society are eligible for social welfare (which is heavily means-tested). In return for this modest social safety net, income taxes are kept low, and are only levied on the wealthiest members of society.

Key Characteristics of Hong Kong SAR’s Tax System

Hong Kong SAR has the lowest level of taxation of any advanced economy. HKSAR’s tax revenue in 1998 amounted to 9 percent of GDP compared to 16 percent for Singapore, 21 percent for Korea, and 29 percent for Japan. Despite its conservative approach to taxation, Hong Kong SAR’s tax system has, over the past decade or more, continued to generate sufficient revenue to finance adequately all budgetary commitments and at the same time allow a substantial build up of fiscal reserves, which are currently estimated to amount to about 35 percent of GDP. Notable features of HKSAR’s tax structure are:

The tax structure is simple and the tax base is narrow. Profits are taxed at a flat rate of 16 percent on corporations and 15 percent on others. Salaries tax (with four marginal rates) is based on a sliding scale that progresses from 2 percent to 17 percent of income after the deduction of allowances. Total tax charged cannot exceed 15 percent of total taxable income before personal allowances. The current allowance is generous with more than half the workforce not subject to any income tax. Income tax is also limited to income derived from sources within HKSAR. Moreover, few taxes are levied. HKSAR has no consumption tax and as a free port, has no trade tax such as duties on imports. Interest and capital gains are also largely exempt from tax and dividends are not taxed.

The revenue structure relies largely on direct tax and nontax revenue. The main source of revenue is corporate and household income tax, accounting on average for 43 percent of total revenue between 1990 and 1998. The second largest source are stamp duties, related to stock and property transactions. Finally, the third largest source is capital income earned on die government’s asset holdings with the Exchange Fund. Overall, about one-third of total revenue in recent years is estimated to be land and property related.

GRA Revenue Structure

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HKSAR’s revenue system is highly volatile. The strong reliance on income tax revenue, asset-related revenue makes HKSAR’s revenue system vulnerable to cyclical downturn and asset price swings, as was evident during the Asian crisis. Indeed, revenues as shares of GDP are highly volatile. Total fiscal revenues averaged 17½ percent of GDP between FY 1983-FY 1998, with a standard deviation of 2 percent. Not surprisingly, among the components, land revenue and stamp duties are the most volatile revenue sources. Both these items are highly correlated with movements in property and stock prices, with the coefficient of correlation for both well above 0.9.

HKSAR’s revenue structure is also highly procyclical. The overall tax system is highly buoyant and highly sensitive to economic fluctuations: a 1 percent increase in GDP raises total revenue by 0.96 percent while a 1 percent increase in GDP growth rate raises total revenue by 1¾ percent. Capital revenue (mostly premia from land sales) and stamp duties are particularly elastic (a 1 percent increase in GDP will cause land revenue and stamp duty to grow by more than 5 percent). The high volatility in fiscal revenues makes it that much more difficult for the Hong Kong SAR authorities to use fiscal policy as an effective countercyclical tool. Cross-country comparisons confirm that HKSAR’s fiscal revenue is more volatile than economies of similar structure (small open economies such as Singapore, Korea, Denmark, Netherlands, and New Zealand). Only Singapore’s revenue displays strikingly similar revenue volatility.

Appendix Regression Results1

Revenue Category

Direct taxes

Property tax:


Salaries tax:


Profit tax:


Estate tax:

LEST = (LEST1993 + 86.1 – 0.05*1993) + 0.26*DELHKSE – 1.13*SQDELHKSE – 86.1 + 0.05*Year

Indirect taxes


LDUTY = (LDUTY1993 + 25.7 – 0.02*(1993)) – 2.26*DELPOP – 25.7 +0.02*Year

Bets and sweeps:

LBS = (LBS1993 + 120.6 – 0.06*(1993)) + 1.76*DELGDPPC – 120.6 +0.06*Year

Stamp duties from property transactions:


Stamp duties from stock transaction:


Air passenger departure:


Fines and penalties:

LFP = (LFP1993 + 95.6 –0.05*1993) + 0.59*DELGDPPC – 0.37*DELFP[-1]) –1.28*SQDELGDPPC + 0.92*SQDELFP[-1] – 4.61*(DELGDPPC*DELFP[-1]) – 95.6 +0.05*Year

Reimbursement and contributions:

LRECO= (LRECO1993 + 69.5 – 0.04*1993) – 3.90*DELGDP – 15.76*SQDELGDP – 69.5 + 0.04*Year

Fees and charges:

LFC= (LFC1993 + 56.6 – 3.03*1993) + 1.42*DELGDP + 3.43*SQDELGDP – 56.6 + 0.03*Year

Expenditure Category2

Personal emoluments:

LPE = (LPE1993 + 65.7 – 0.04*1993) + 0.54*DELPE[-1] + 1.191 *DELPOP[-1] – 65.7 + 0.04*Year

Other charges:

LOC = (LOC1993 + 118.6 – 0.064*1993) – 0.75*DELGDPPC + 1.09*DELPOP[-1] – 118.6 + 0.06*Year

Subvention education:

LSED = (LSED1993 + 109.0 – 0.06*1993) – 0.96*DELGDP[-1] – 3.76*SQDELGDP[-1] – 109.0 + 0.06*Year

Subvention medical (per capita medical expenditures)3:


Subvention welfare spending (expressed in annual percentage changes or log differences):

LSWS_pch = LSWS_pch1993 + 2.42*DELNILF[-1] + 7.01*DELNILF[-2] + 7.49*DELNILF[-3] + 199.4*SQDELNILF[-1] – 166.8*SQDELNILF[-2] – 42.8*SQDELNILF[-3] + 75.4*DELNILF[-1]*DELNILF[-2] – 90.4*DELNILF[-1]*DELNILF[-3] – 338.5*DELNILF[-2]*DELNIF[-3]

Subvention vocational training:


Subvention miscellaneous:


The term “country,” as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.


This chapter was prepared by Jeanne Gobat (ext. 34413). The simulation model was constructed by Jonathan Millar, when he was a Summer Intern at the Fund in 2000.


Hong Kong Population Projections: 2000–29, Hong Kong Census and Statistics Department.


This estimate accords with a mutual agreement between Hong Kong SAR and the Mainland that took effect in 1995, which places a daily quota of 150 arrivals.


Aging of the population also affects welfare spending, but in Hong Kong SAR income support for the elderly is not expected to rise sharply as it is mostly means-tested.


After education, housing is the second largest public spending item. Although housing is integral to the government’s social policy agenda, it is not included in social spending in this paper. For details on housing policy, see Dubravko Mihaljek, “1998 People’s Republic of China—Hong Kong Special Administrative Region—Recent Economic Developments,” IMF Staff Country Report No. 98/41.


The consultancy report—“Improving Hong Kong’s Health Care System: Why and For Whom?” Harvard Consultancy Report, 1999, Health and Welfare Bureau, Hong Kong SAR prepared by the government also projected a similar figure.


These reform measures were released in the Consultation Document on Health Care Reform on December 2000.


Among these initiatives are: formulating a five-year strategy to promote the use of information technology in schools; building additional schools to raise the percentage of students in whole-day primary schools; introduce a comprehensive school curriculum reform; and enhance support for teacher training. At the tertiary level, efforts are being undertaken to substantially expand education opportunities at the sub-degree level, improve innovation and promote Hong Kong SAR as regional education center.


The government launched a new land policy in 1998 aimed at helping stabilize prices.


It should be noted, however, that the exercise was conducted on a partial equilibrium basis and did not take into account the economy-wide impact of the structural changes on aggregate savings, capital accumulation, participation rate, and factor productivity, and the subsequent feedback effects of these variables on the budget.


The consolidated budget records expenditure by the statutory funds and the GRA. A broader measure of public expenditure would include quasi-governmental bodies such as the Housing Authority and trading funds. Expenditure by these bodies is only included to the extent of their subventions from the GRA. Expenditures by institutions where the government has an equity stake (e.g., the Airport Authority) are not included.


The projected stamp duties are highly sensitive to the assumptions about whether volume turnover rises or not. The historical data shows large swings and no discernible pattern in volume turnover.


The coefficients estimated to project tax revenue (salary and corporate taxes) may be somewhat biased since they fail to take into account the effect of recent tax relief measures.


Participation rates were left unchanged. Also, no changes were made to the official projections of demographic developments, which are based on official estimates of fertility and mortality rates, and immigration flows.


For simulation purposes the proceeds from a GST was taken on a net basis, i.e., administrative costs were excluded from the exercise. In practice, the set-up and subsequent administrative costs will have to be taken into account to assess the net impact of the tax.


Based on the consumption of goods and services (especially financial) that are taxable.


User fees are assumed to differ by income group with the burden of absorbing the increase in health care costs expected to be borne by higher income groups.


A11 variables are expressed in real values and are logged. Values in parenthesis denote t-values. Del indicates that the log real variable has been time-detrended and then differenced against the 1993 fiscal neutral base year. DEL variable can be understood as the cyclical deviation of the variable of interest from its 1993 neutral base year. SQ—used where variables are modeled based on a second order Taylor approximation—is the square of the deviation from the base year (or the variance).


In the model, medical subvention per capita grows in line with population, growth.

People’s Republic of China-Hong Kong Special Administrative Region1: Selected Issues and Statistical Appendix
Author: International Monetary Fund