The Hong Kong government budget has been widely labelled as "unimaginative" or "lacking of vision" by the local press. Many economists and social analysts have expressed their disappointment at the small tax concession to the middle class when the economy is showing definite signs of a sustained recovery.

But they are missing the point. As prescribed by the "positive non-interventionism" philosophy, government fiscal policy must be designed to accommodate the prevailing economic environment rather than influence it. While Hong Kong is emerging from a prolonged recession, a budget that is neither expansionary nor constrictive seems the best choice that the government can make.

A cautious approach in fiscal policy is of particular importance when the economic outlook is clouded by a possible outbreak of the bird-flu epidemic, rising energy prices and the search of a new role for Hong Kong in the future economic development on the mainland. The economic recovery, though sustainable under the present economic environment, is far from assured because the domestic economy lacks the breadth and depth to absorb sudden blows.

It is apparently for the same concern that Financial Secretary Henry Tang has kept a tight fist on tax rebates and concessions despite the revenue surplus, the first in nearly six years. Although the government has budgeted for another surplus for the fiscal year beginning April 1, 2006, it is prudent to maintain a margin of safety against any unexpected economic setback.

What's more, Hong Kong's income tax rates, even at current levels, are still lower by a significant margin than those in many other developed economies. Criticisms that the taxation system is structured in a way that puts most of the burden on the middle class may have some merits. But these critics seem to have ignored the fact that the people who fall into the tax net here are those who stand to gain much from the social and economic system that has made it possible for so many families to move up to the middle class from poverty within one generation.

Because of their relatively higher household incomes, most middle-class families are excluded from the host of social benefits, including government subsidized housing. Many of them have elected to buy their own medical insurance plans rather than going to the usually crowded public hospitals, even though they do provide excellent care at much lower cost than private hospitals.

Just as everyone else in Hong Kong, the middle class shares all the other less obvious, but possibly more important, benefits in the form of a highly efficient civil service that is relatively free of corruption, excellent infrastructure facilities, convenient transportation, an effective police force and an independent judiciary that is seen to dispense justice fairly and equitably without undue delays.

These are the essential elements that have created the free-enterprise environment that enabled Hong Kong to make the highly successful transition from a low-cost manufacturing base to a high-value-added services centre and an international financial hub in no more than 10 years in the 1980s. The confidence of the people, especially those in the middle class, which was built up at that time, was seriously undermined by the outbreak of the 1997 Asian financial crisis, which plunged Hong Kong into a prolonged economic downturn.

The problem in the following seven years or so was conveniently crystalized in the form of the enlarging government budget deficit arising from committed expenditure on ambitious social programmes devised in the pre-crisis years and the fall in revenue during the economic downturn.

The expansion of the annual budget deficit prompted many economists and business professionals to question whether the narrowly based tax regime could continue to satisfy the social needs of an economy as highly developed as that of Hong Kong. At that time, talks about a "structural" deficit as opposed to "cyclical" deficit, rapidly gained credence among academics and professionals, although nobody has ever produced any convincing figures to prove the case.

Among the most active proponents of the need to widen the tax base were the accounting firms, which produced numerous documents to support their calls for the introduction of a form of sales tax. Tang said in his latest budget speech that a public hearing would be held on the topic.

But the public is confused because the budget turned into a surplus as soon as the economy improved. It would seem the deficits of the past several fiscal years were "cyclical" in nature rather than "structural." If that is the case, why is there a need to meddle with the existing tax regime that has worked so well for Hong Kong for so long?

Email: jamesleung@chindaily.com.cn

(China Daily 02/28/2006 page4)