The Financial Secretary's Budget for 2003-04 was notable in that it revealed the largest operating deficit in Hong Kong's history, at HK$66.25 billion, and for anticipating another huge shortfall in the fiscal year to end March 2004, at HK$61.12 billion.

In this fiscal year, there isn't much Financial Secretary Antony Leung can do to rein in spending. So the figures he presented was an honest assessment of where we stand and what the immediate future holds for Hong Kong. As such, this Budget should be applauded: there was no effort here, as there is in far too many other Asian economies, to sweep the bad news under the carpet.

Given that Hong Kong has about 170,000 civil servants, and a similar number of people with pay linked to civil service levels, the reduction will save some money. Other sectors of society -- salaries taxpayers, companies paying profits taxes, welfare recipients, domestic helpers and those using the airport or buying cars -- are asked to contribute far more than 3 percent, which should net the government an additional 10.5 percent in operating revenues in FY2003-04.

To truly address the revenues-and-spending issue, structural changes are required. First, the income side: Hong Kong's tax base is far to narrow, and needs to expand. As noted at the Chamber's "Business and the Budget Seminar" (see box on page 28), a small fraction of the salaries tax payers -- and a far smaller share of all employees -- pay most of this tax. Too, just 600 companies contribute over 60 per cent of all profits taxes.

In this regard, the most important statement in the Financial Secretary's Budget speech was this: "Besides controlling public expenditure, the government also considers that it is necessary in the long term to introduce a Goods and Services Tax (GST) to broaden the tax base and secure a stable source of public revenue."

Such as tax would ensure that the SAR's revenues are both stable year-to-year and predictable. As the public sector accounts return to balance, we would expect other taxes (particularly salaries and profits) to be reduced.

Part of the structural problem is that very few people pay salaries taxes. When incomes are falling and unemployment rising, as in Hong Kong, the number of taxpayers shrinks very fast. As we already have one of the narrowest tax bases in the world, reducing personal allowances (from HK$108,000 to HK$100,000) is simply a means of slowing -- not stopping -- the deterioration of the tax base. Hong Kong is unique among developed economies in that a family of four must earn nearly 40 percent more than the median household income to pay any salaries tax at all. This must change: the personal allowance must be steadily reduced over the next several years.

To ensure that the GST is not merely pocketed, and seen as a "solution" to financing governmental services, the size of our public sector needs to be seriously reconsidered. The total number of civil servants and employees of government-financed institutions such as the Hospital Authority is simply to large. The structural answer is to rethink what services the public needs, and whether those services are best provided by the public sector, the private sector or a combination of the two.

As such a rethink takes hold, the civil service establishment, or head count, must fall. Rather than being concerned that some civil service positions will be eliminated, the emphasis should be on securing for Hong Kong a sustainable, sensible sized government. To this end, comments such as those reported in the press in February, stating flatly that the government will not dismiss some 430 surplus staff-surplus because their Architectural Services Department jobs were to be out-sourced by 2007-do not help. As any business executive knows, outsourcing is designed to remove staff-and their associated costs-from the books. Outsourcing the work while retaining the workers is expensive.

In great contrast to his first Budget last year, Mr Leung took a fine-edged knife to government spending. Moreover, he laid out strict targets for slimming the public sector's potbelly in the Medium Range Forecast (MRF), out to FY2007-08.

Total public spending will rise nearly five times faster than nominal GDP this year. Among the sectors receiving smaller envelopes than in FY2002-03 are health care (-1.5 percent) and housing (-7.3 percent), which together account for 21 percent of total spending. Economic services such as the labour, financial services and commerce and industry departments will receive 16.4 percent more this year, education 11.2 percent and infrastructure 8.4 percent.

As a result, the fiscal reserves will fall from last year's HK$300 or so billion to HK$240 billion for FY2003-04, and to HK$185 billion in FY2005-06, before rising to around HK$200 billion toward the end of the five-year forecast period. On the principle that reserves should equal one year's spending (and the intent to eventually reduce spending to HK$200 billion), the draw-down is not out of line.