The Hong Kong government projects that the trend growth rate of nominal GDP over the medium term will be 4.5%. With rising consumption and investment and with increasing merger activities resulting from the launch of CEPA and booming tourism, 4.5% trend rate is likely to be achieved. However, the cyclical recovery will not help slash the structural budget deficits as over-spending in the public sector remains unsolved.

The fiscal deficit for FY2004/05 is forecast to be HK$42.6bn. While it is welcome to see the deficit narrowing, it must be pointed out that should the HK$20bn bond issuance is excluded, consolidated deficit will become HK$62.1bn. Whether the deficit disappears in FY2008/09 will mainly depend on the strong suppression of government expenditure.

While the salary cut of the civil service will continue next year, there are no imminent concrete measures to scale back government expenditure. The government should consider slash subsidies such as housing and overseas education allowances as well as outsourcing and privatisation. More important, the government will have to think about privatisation with the staff status change.

The tax base in Hong Kong is very narrow and more reliant on profit tax and salary tax which accounts for about 40% of total government revenue. 5% of the companies accounted for 80% of the revenues from profit tax, while a quarter of taxpayers accounted for 85% of the revenue from salary tax. The sources of revenue are thus highly vulnerable to cyclical economic changes. In the medium term, widening of the tax base via the implementation of sales tax will be needed. However, to ease public concerns and burden of taxpayers, it is appropriate to hold more public consultation and rationale explanation. That will be easy to be launched together with the reduction of income and profit tax.