CHAPTER 5 PUBLIC FINANCE

This chapter will focus on the governments expenditure and its revenue. GOVERNMENT EXPENDITURE Government expenses can be distinguished into two major types: i) management expenses ii) development expenses Management Expenses Management expenses refer to the current expenditure made by government. The expenses referred as management expenses include: a) b) c) d) e) Salary/Emolument Gratuity, Pension payment Allocation of State government Debt payment (Internal/External) Subsidy

Development Expenses Development expenses are the capital expenditure on socio economic project to upgrade the economy activities for the development of the country. These expenditures include: a) b) c) d) Administration Defense Social Economy

GOVERNMENT REVENUE The sources of government revenue are: 1) Tax Revenue 2) Non-Tax Revenue

Tax Revenue A fee charged ("levied") by a government on a product, income, or activity. If tax is levied directly on personal or corporate income, then it is a direct tax. If tax is levied on the price of a good or service, then it is called an indirect tax. The purpose of taxation is to finance government expenditure. One of the most important uses of taxes is to finance public goods and services, such as street lighting and street cleaning. Tax revenue can be divided into 2 categories: a) Direct taxes b) Indirect taxes Direct taxes -

A direct tax is direct. The tax falls directly on the person or the thing taxed. The one who is obligated to pay such a tax is not in a position to shift it to another.. Example : income tax, corporate taxes, petroleum tax

Indirect taxes - an indirect tax may either be avoided or shifted to another. - Example: sales tax, excise tax - A trucking company shifts the excise tax on fuel to the customer who ships his product by way of the trucking company. The excise tax on cigarette is avoided by choosing not to smoke.

Non-Tax revenue Examples of non tax revenue are license payment, compound, regulation fees.

Objective of Taxation 1. To collect government revenue 2. To protect local industry 3. To distribute the income equally among the citizen Tax Structure - shows the relationship between the amount of income and amount of tax rate Tax Rate = Amount of tax paid x 100 Amount of taxable income 3

Tax structure can be divided into 3 types: a) Progressive Tax b) Regressive tax c) Proportional tax a) Progressive Tax when income increase, the tax rate imposed to the tax payer also increase. Tax rate

Income

b) Regressive Tax when income increase, the tax rate imposed to the tax payer decrease.

Tax rate

Income

c) Proportional Tax 4

when there is a change in income, the tax rate are remain constant. Tax rate

Income

Example:

Amount of income ( RM ) RM 1000 RM 1500 RM 2000

Country A 100 150 200

Amount of tax paid (RM) Country B Country C 150 100 150 165 150 240

Country A RM 1000 100 x 100 1000 = 10 % 150 x 100 1500 = 10 % 200 x 100 2000 = 10%

RM 1500

RM 2000

Country adapt Proportional tax

Country B RM 1000 5 150 x 100 1000

= 15% RM 1500 150 x 100 1500 = 10 % 150 x 100 2000 = 7.5%

RM 2000

Country B adapted Regressive tax

Country C RM 1000 100 x 100 1000 = 10% 165 x 100 1500 = 11 %

RM 1500

RM 2000

240 x 100 2000 =12 %

Country C adapted Progressive tax

PUBLIC POLICY Balanced Budget Policy Deficit Budget Policy

Surplus Budget Policy 6

FISCAL POLICY

Balanced Budget Policy A budget in which government revenue equals government expenditure in a given time period. Surplus Budget Policy A budget in which government revenues exceeds government expenditures in a given time period. Deficit Budget Policy A budget in which government expenditures exceeds government revenues in a given time period. 2 types of fiscal policy: i) Expansionary Fiscal Policy An increase in government spending or a reduction in net taxes to increase aggregate expenditure. ii) Contractionary Fiscal Policy A reduction in government spending or an increase in net taxes aimed to decrease aggregate expenditure. Expansionary fiscal policy is used when economy is having deflation/ recession. Contractionary fiscal policy is used when economy is experiencing inflation.

MONETARY POLICY

EXPANSIONARY MONETARY POLICY

CONTRACTIONARY MONETARY POLICY

Expansionary monetary policy

An increase in the money supply aimed at increasing aggregate income. Expansionary monetary policy is implemented during recession. Contractionary Monetary policy A decrease in the money supply aimed at decreasing aggregate output. Contractionary monetary policy is implemented during inflation. Tools of monetary policy 1. 2. 3. 4. 5. 6. Discount rate Interest rate Required reserve ratio Open market operation Funding Qualitative control; moral suasion, selective credit control

Objectives of monetary policy: 1. 2. 3. 4. to maintain economic stability to achieve full employment to achieve economic growth to control inflation