In my recent discussions with some members of the financial-services sector about the fiscal deficit, I found that they were not entirely clear about our public finances. In view of this, I would like to use this column to give a brief account of the fiscal position of Hong Kong - our home.

The basic concept of managing public finances is no different from that of family financial management. The proper way to run our home is to live within our means. If the income of a family is inadequate to cover its daily expenses, financial problems are bound to surface sooner or later.

Our fiscal reserves have shrunk from $457.5 billion at the end of March 1998 to $241.1 billion - which is equal to just about 12 months of government expenditure - at the end of September this year.

If we do not exercise prudence in the management of our public finances, the problem of fiscal deficit will persist or even grow. Will it be in the best interests of Hong Kong if we pass the problem on to our next generation?

I believe that many citizens do not have a clear picture about the state of Hong Kong��s public revenue. As this has direct implications on the amount of public expenditure that the Government can bear, I would like to talk about public revenue first.

Tax rates lower than most other developed countries

Hong Kong has in place a simple and low tax regime. Nearly half of the Government��s revenue comes from profits tax, salaries tax, property tax, rates and rents. Our tax rates are lower than those in many other places.

Take the profits tax rate as an example. The 17.5% rate after the adjustment from 16% as proposed in the 2003-04 Budget is still lower than those in many other areas such as the UK, the US, Australia, Japan, Thailand and Singapore.

Similarly, the highest marginal rate of our salaries tax is also much lower than many of these places.

Only 18% of population pays salaries tax

Our public revenue is beset by two major problems. First, the tax base is narrow. Only about 18% of the total population of 6.8 million - about 1.2 million - pay any tax on their salaries. Among them, only 100,000 contribute about 60% of the salaries tax.

Similarly, as few as 500 corporations, only about 1% of the total number of profit-making corporations, contribute 60% of the profits tax.

Revenue swings with the economy

The second problem is the stability of our revenue. Most of the existing taxes are easily affected by the ups and downs of the economy.

Owing to the economic downturn and deflation brought about by the financial crisis and the slump in the property market, our recurrent revenue has dropped from $201.6 billion in 1997-98 to an estimated $149.2 billion in 2003-04, representing a decrease of $52.4 billion, or 26%.

Yields from taxes have recorded a decline during this period, with stamp duty falling 73%, the biggest drop of all. Hence it is necessary to explore stable and broad-based revenue sources in the long term to improve the Government��s revenue structure, thereby laying down a solid foundation for our public finances.

Government spending increases sharply

In sharp contrast with revenue, public expenditure has substantially increased over the past six years. Government recurrent expenditure has surged from about $157.9 billion in 1997-98 to $207 billion in 2003-04, representing an increase of 31%.

Among the expenditure items, those having the biggest increases include social welfare (61%), education (34%) and health (22%).

Education represents largest portion of recurrent spending

By policy area, the largest item of recurrent spending in the 2003-04 budget is education ($49.3 billion or 23.8%), followed by social welfare ($32.8 billion or 15.8%) and health ($31.9 billion or 15.4%).

Spending on security is $25 billion, representing 12.1% of the total. These four expenditure items, together with the $14.8 billion on pensions for civil servants, are already marginally higher than our estimated recurrent revenue.

Spending cuts are necessary

To solve the deficit problem, containment of public expenditure is necessary. In this regard, government departments and subvented organisations will strive to ensure effective use of resources by reviewing their service priorities and streamlining structures.

We also hope that the community will understand the difficulties the Government faces.

If the problem of fiscal imbalance were to persist, the stability of the financial market might be undermined and the recovery of our economy hindered. Our success in tackling the fiscal deficit will depend very much on the understanding and support of the community.

In the long-term interests of Hong Kong as a whole, I hope that we can work together to eliminate the fiscal deficit.

In formulating specific measures, we will consider carefully the views of all sectors of the community and try our best to cater for the different needs of Hong Kong people.