A constitutional crisis is looming over whether Tung Chee-hwa's successor, following the former chief executive's mid-term resignation two weeks ago, should serve only the remainder of his tenure, even though the Basic Law stipulates that the term of the chief executive is five years. If a clearly worded provision should spark such a row, then imagine the chaos that could arise if the government were sued for failing to heed the mini-constitution's far more ambiguous clauses on public finance. For example, while Article 108 provides that Hong Kong shall have a 'low tax policy', it does not specify what tax rates will be deemed low. Article 107 says the government 'shall follow the principle of keeping expenditure within the limits of revenues in drawing up its budget, and strive to achieve a fiscal balance, avoid budget deficits and keep the budget commensurate with the growth rate of its gross domestic product (GDP)'. But the provision begs the question of how much revenue the government should raise and how much it should spend. The required correlation between the budget and GDP growth rate is aimed at preventing public expenditure from rising at a pace faster than the rate at which the economy expands. Economists usually measure public spending as a percentage of GDP. But the article has not stipulated what that figure should be. Nor does it specify whether the GDP growth rate should be measured in nominal or real terms. The lack of clarity in these clauses is yet more evidence that the Basic Law is full of holes that could spark unconstructive rows over its precise meaning. The community may not gain from any legal challenge over these provisions, but should benefit from a proper debate on their underlying assumptions. It is interesting to note that in his maiden budget for 2002-03, then financial secretary Antony Leung Kam-chung pointed out that 'the share of public expenditure in the economy averaged around 16 per cent in the mid-1980s, about 17 per cent in the mid-1990s, but rose to 22 per cent in 2001-02'. He did not refer to the period between 1995 and 2001, when Donald Tsang Yam-kuen, now acting chief executive, was financial secretary. A dig into the archive reveals that Mr Tsang's policy was that public expenditure should form 20 per cent of GDP. As the Basic Law was drafted in the mid-1980s, could the drafters have intended that the post-1997 government should spend no more than 16 per cent of GDP? If that was their legislative intention, then Mr Tsang might have breached Article 108. Even Mr Leung might have committed the same error, as his pledge to reduce public spending to '20 per cent of GDP or below by 2006-07' was still short of the prevailing rate when the Basic Law was being drafted. Quietly, however, incumbent Financial Secretary Henry Tang Ying-yen has made it his target to trim public spending back to 16 per cent of GDP. The figure first appeared as a projection in an appendix to the 2004-05 budget. In his 2005-06 budget released last week, he forecast that 'a surplus of $25.6 billion will be recorded in 2009-10'. He did not say the projection assumed there would be continuous spending cuts to trim public spending to 16 per cent of GDP; again, the figure appeared only in a table. But why 16 per cent of GDP? Mr Tang has not provided an answer. In a research paper published last year, however, the International Monetary Fund has shown how Mr Tang might have explained his fiscal constraints to the community. The IMF notes that Hong Kong's tax base is very narrow, with neither general consumption taxes nor import duties, and the majority of the working population outside the tax net. Our simple tax system produces revenues that amount to just 9 per cent of GDP. Almost half of total government income comes from non-tax revenues, mainly from the proceeds of land sales and investment income. Between 1990-1991 and 2002-03, total fiscal revenues averaged 17 per cent of GDP. The fund's conclusion is that public spending would need to be 'adjusted significantly if Hong Kong intends to maintain its tradition of low taxes'. If no new taxes were levied, and assuming property and stock-related revenues returned to their levels of the 1990s, the IMF says public expenditure would need to be trimmed back to 15 per cent of GDP. But spending could go up to 16 per cent if a goods and services tax (GST) were introduced. No wonder the IMF has praised Mr Tang's latest budget, as he is following its recommendations. Where he differs with the IMF is on the reasons for introducing a GST. While the IMF report implies that the new tax should be introduced as an additional source of revenue, Mr Tang has said he does not want to increase the tax burden. In his 2004-05 budget, Mr Tang said that after a GST was imposed 'there might even be some scope for reducing other taxes, such as salaries tax and stamp duty'. In various public statements since then, he also stressed that the tax was aimed at providing a steady source of income, not increasing revenue. The question that the IMF has not asked is why the Hong Kong government should be taxing and spending relatively little, compared with other countries with similar levels of affluence. It notes, however, that 'the notion of affordability of a particular public service in Hong Kong should be analysed within the institutional setting of a small government rather than of a welfare state'. How much tax a government should collect is founded on the social contract it has reached, explicitly or implicitly, with its citizens. At a recent seminar on tax reform, a former government official noted that it had not been the Hong Kong tradition to levy taxes to achieve social and political objectives. He was right in so far as Hong Kong does not have a democratic system that allows politicians who could potentially form the government to put that option to the public. Instead, we are endowed by history with a system in which the unelected leaders of our government have achieved wonders by sticking to a formula of free trade, low taxes, minimal social security, and generous provision of social services in kind, including housing, education and health. As Mr Tsang pointed out in his 1997-98 budget, this formula had succeeded in lifting Hong Kong's standards of living. Between 1986 and 1996, for example, per capita GDP at current prices increased by about three times, from $56,558 to $191,022. As economic growth generated more revenue, much of it through high land prices, Hong Kong was able to spend more and more on social services. But the dramatic turnaround in the state of our economy after 1997 exposed the danger of relying too heavily on property revenues, which are essentially non-recurrent incomes that could plunge or even dry up in lean years. Drastic cuts have since been ordered by Mr Tsang's successors to reduce total public expenditure from 20 per cent of GDP to 16 per cent, a level that could be sustained by our simple and low tax regime. But there are clearly vocal calls on the government to do more from various sectors of the community, although they have typically failed to suggest how their pet programmes might be funded. What if our government put to the community that a GST should be introduced as a means of raising additional revenue so that, for example, our children would study in smaller classes, pre-school education would become free, and the needy would have their cash benefits raised? This is not such a preposterous proposition, as there is no reason why the target of public spending forming 16 per cent of GDP should be treated as a sacred cow. As long as sustained revenues could be raised to fund socially desirable programmes that the government is in the best position to provide, it does not appear that raising public expenditure to, say, 17 or 18 per cent of GDP would have disastrous effects on the economy, as our Organisation for Economic Co-operation and Development counterparts have shown. The proper share of the public sector in the economy and its relation to taxation is a subject that should form the crux of the forthcoming consultation on GST. If that discussion could form the basis for amending the Basic Law to remove ambiguities in its provisions on public finance, so much the better.