Chapter 6

Government:
A body within any organization that has the

authority to make laws, regulations, or rules; and

the power to enforce them.
Typically, the government refers to a civil
government that includes, provincial, local, or
other national organizations.
In democratic process, people elect their
representative through voting to act and make
decisions on their behalf.

Fundamental purpose of government:

Maintenance of basic security and the public order

 Expanded Roles for Government

Military Defense
Security (Internal)
Economic Security
Social Security
Healthcare
Environmental Security
Education

Our focus here is on The role of the government sector in

the Macroeconomy:
How government spending influences the total

spending/aggregate spendingAS = C + Ig + G + Xn
How government spending through its
purchases of goods and services, transfer
payments and the taxes it collects influences
the direction of the economy.

 Magnitude of expenditures and taxes makes

government extremely important in the

functioning of the economy.
A decision made at the federal level to
initiate or cancel an interstate highway
project or defense system, or to increase or
decrease taxes, can have far-reaching
impact on the economy (level of output,
employment, income and also prices)
Similar effects are felt on the decision made
by the state level.

 Government Expenditures & Revenues

Categories of Government Expenditures:

Government purchases of goods & services
Government spending

on new goods and

services.
Public Good (Public parks, flood control

dams, lighthouse etc)

Goods or services provided for all of society.

Quasi-Public Good (education, an

ambulance haul)

Government-provided good that could also be

sold in a private market.

 Transfer Payments
Money

from the government for which no

direct work is required in return.

Interest paid on borrowed funds

Grants-in-aid to state and local

governments

Government Expenditures Categories

TABLE 6-2
Total, Federal, and State and Local Government Expenditures, and Total
Government Expenditures as a Percentage of GDP, Selected Years
1980-2005 (Billions of Dollars)

Government Expenditures Categories (cont.)

Table 6-3

Federal Government Expenditures (1970-2007)

Year

(RM Million)

GDP (RM
Million)

Total as a
% of GDP

1970

2,888

12,534

23.04

1980

17,762

54,286

32.72

1985

25,908

78,891

32.84

1990

35,714

119,081

29.99

1995

50,624

222,472

22.76

2000

84,487

342,612

24.66

2005

128,278

522,445

24.55

2007

158,045

641,864

24.62

Expenditures by sector (% of total)

Sectors

1970

1990

2005

Security

23.1

13.6

13.3

Social Services

28.7

27.8

32.1

Economic Services

19.6

25.2

17.5

General Administration
& Other Expenditures

28.6

33.4

37.4

Government Revenues
Sources of Government Revenues:
Social Insurance Program (e.g., PPF)
Contributions

from an individuals wages are

made to a fund from which that individual may
draw when eligible for benefits.

Taxes (direct & indirect)

Income taxes (personal, business)
Excise taxes (on the production of a specific product within
the country, or on the quantity of the product purchased, or tax
on goods produced for sale also called inland tax)

Customs (e.g. imports), estate, and gift taxes

Non-tax revenue (e.g., different types of fees)

Non-revenue receipts (typically in a form of
grants)

Malaysia: Federal Government Revenue,

1970-2007 (RM Million)
Years

Direct
Taxes

Indirect
Taxes

1970

685

1,155

1975

1,990

1980

Total Tax
Revenue

Non-Tax
Revenue

Non-Revenue
Receipts

Total
Revenue

1,840

529

31

2,400

2,67

4,257

796

64

5,117

5,495

6,565

12,060

1,675

191

13,926

1985

9,259

7,441

16,700

3,976

439

21,115

1990

10,402

10,842

21,244

6,946

1,331

29,521

1995

22,699

18,971

41,670

8,468

815

50,953

2000

29,156

18,017

47,173

14,093

598

61,864

2005

53,543

27,051

80,594

25,053

657

106,304

2007

70,117

26,080

96,197

44,734

859

141,790

 Types of Taxes: (Tax incidence)

Progressive
Proportional (Flat tax)
Regressive Taxes
Progressive Tax:
Tax reflecting a direct relationship between
the percentage of income taxed and the size of
the income.

As income increases, so too does the rate at which

that income is taxed, and vice versa.

Proportional Tax (Flat tax):

Also

called a flat tax.

Tax equal to the same percentage of income
regardless of the size of the income.
As income increases or decreases, the rate
at which that income is taxed remains
constant.
Regressive Tax:
Tax reflecting an inverse relationship
between the percentage of income taxes and
the size of the income.
As income increases, the rate at which that
income is taxed decreases, and vice versa.
Sales tax are considered to be regressive
tax.

 Tax Reform &

Issues

Tax Reform

Changes in tax policies and structures.

Tax Bracket Indexation

A policy of adjusting income tax brackets to account for

inflation.

Tax Base

Particular thing (e.g., income tax, the base is income) on which

a tax is levied.

Tax Rate

The amount that is levied on the base.

Tax Abatement (Tax relief)

A policy of reducing or eliminating a tax that would normally

be charged.

Fiscal Policy:
One of

the tools that a national government

uses to influence its domestic economy.
The term fiscal policy refers to the
expenditure a government undertakes to
provide goods and services and to the way
in which the government finances these
expenditures.
In other word, it refers to the use of
government budget to influence the economic
activities.
Fiscal Policy instruments:

Government expenditures
Taxation

Objective of Fiscal Policy

To influence the levels of aggregate output

and employment or prices (demand pull

inflation) through changes in federal
government purchases, transfer payments,
and/or taxes.

 Types of

Fiscal Policies/Options

Discretionary Fiscal Policy

Deliberate

changes in government
expenditures and/or taxes in response to a
problem with unemployment or demand-pull
inflation.
Non-discretionary/Automatic Fiscal Policy
Also called automatic stabilization.
Changes in government expenditures and/or
taxes that occur automatically as the level of
economic activity changes. It helps to control
unemployment or demand-pull inflation
automatically.

 Two Automatic Fiscal Policy Stabilizers

Transfer payment (e.g. unemployment

compensation)
Personal income tax

Fiscal Policy
Types of Fiscal Policies (cont.)

 Mechanics of

Fiscal Policy:
Expansionary fiscal policy

Unemployment due to a decline in spending

can be resolved by any or all of the following:
Increasing

government purchases of goods and

services
Increasing transfer payments
Decreasing taxes
Combination of the above

How it works? Multiplier effect..

EXPANSIONARY FISCAL POLICY

the multiplier at work...

$5 billion initial
increase in spending

Price level

AS
Full $20 billion
increase in
aggregate
demand

P1

AD1

$490

AD2

$510

Real GDP (billions)

 Contractionary fiscal policy

Demand-pull inflation (occurs from too

much spending) can be resolved by any or

all of the following:
Decreasing government purchases of
good and services
Decreasing transfer payments
Increasing taxes
Combinations of the above
How it works? Multiplier effect.

CONTRACTIONARY FISCAL POLICY

the multiplier at work...

$5 billion initial
decrease in spending

Price level

AS

P2

Full $20 billion

decrease in
aggregate
demand

P1

AD2

AD1

$510 $522

Real GDP (billions)

Government Budgets
What is budget?
Budget (from French baguette, purse) generally

refers to a list of all planned expenses and

revenues (of the government)
An itemized accounting of the payments received
by government (taxes and other fees) and the
payments made by government (purchases,
transfer payments, interest payments, and other
spending)
Important mainly in assessing government
influence in economic activity.

Types of Budgets:
Balanced Budget

Governments total expenditures equal its total

revenues.

Surplus Budget

Governments revenues are greater than its

expenditures.

Deficit Budget

Governments expenditures are greater than its

revenues.

Budgetary position, 1985-2008

FINANCING OF DEFICITS AND DISPOSING OF

SURPLUSES
FINANCING DEFICIT:
Borrowing
Borrowing From The Public
External borrowing

Money Creation
Selling of assets (e.g., land)
Consumption of reserves

DISPOSING SURPLUS :
Debt Retirement versus Idle Surplus

 Debt retirement:
Pay back some debt using surplus money

Reduce debt burden by buying back the bonds

from the market with surplus money

Idle surplus:
Hold back the surplus so that it can not circulate

in the economy. This will reduce inflation. This

one is more effective than the first one to fight
inflationary pressure.

Government Budgets (example)

Types of Budgets (cont.)

Government Budgets
Types of Budgets (cont.)

 Beyond the Budget Figures

Unified Budget

Budget that assembles all federal government

receipts and outlays, and the resulting overall
deficit or surplus, in one report.

Trust Fund

Restricted fund.
Payments from this fund are specified as to
recipients and/or uses.

Entitlement

Programs set up by the government to pay benefits

to people who meet the eligibility requirements of
the programs.

 Budget & Fiscal Policy: Tying them together

Surplus Budget (Contractionary Fiscal Policy)

Dampens aggregate spending and can aid in

managing demand-pull inflation.

Deficit Budget (Expansionary Fiscal Policy)

Increases aggregate spending and can help to

reverse a recession.

Balanced Budget

Can slightly expand the economy.

National Debt
National Debt Overview
Accumulated total debt of the federal government due to

deficit spending.

National Debt Overview (cont.)

National Debt, 1975-2007) (Malaysia)

Year

Total Debt
(RM Million)

Per capita
debt (RM)

National debt
as a % of GDP

1975

12,705

1,032.90

56.90

1980

28,614

2,061.65

53.68

1985

83,279

5,243.61

107.50

1990

115,891

6,401.97

97.32

1995

163,047

7,880.74

73.29

2000

267,870

11,508.90

75.16

2005

396,368

15,170.84

75.87

2006

402,499

15,108.72

70.15

National Debt as a Percentage of GDP, 1971-2006

160

140

120

100

80

60

40

20

0
1

11

13

15

17

19

21

23

25

27

29

31

33

35

 Financing the National Debt

Borrowing:
U.S. Treasury Security: (issued by the federal
government in return for funds lent to it)

T-bills (1 year or less)

Note (between 1 to 10 years)

Bond (10 or more years)

Largest portion of the national debt is held by

private investors, and the rest is owned by the
Federal Reserve Banks, government
agencies, and trusts.

Malaysia:
Borrowing:
Malaysian T-Bills (MTB: 91, 182 & 365 days) or 1 year or
less

Government Investment Issues (GII: 2 to 5

years)

Malaysian Government Securities (MGS: 3 to

20 years)

Main players:
- EPF, SOCSO, BSN, Banking institutions, Insurance etc.

 Assessing the National Debt

Debt Service (Cost of maintaining a debt)

Generally measured in interest costs.

Passes the burden of debt service to futures
generations
Redistribution of income from tax payers to
securities holders

 Effect of Government borrowing

Crowding-Out Effect
Borrowing by the federal government to
finance spending increases the demand for
fund (in money market) and hence the
interest rates
Increase interest rates reduces borrowing by
households and businesses.
Crowding out may retard economic growth
as the private sectors investment in buying
machinery and other productive equipment
necessary for growth may be postponed.

Expansionary fiscal policy increases aggregate demand from

AD1 to AD2, but this crowds out some private investment
spending that offsets the increase to some extent causing AD2
to decrease to AD3. this is shown in the graph below:

Zakat and its impact

What is zakat?
One of the five pillars of Islam
Multiple meaning (purification, growth, wealth
extension etc.,
A system that ensures a fair wealth circulation in the
society
Wealth flows from rich to those in need
Appears in the Quran along with solat at least 20 times

 Who should pay zakat and who deserve to receive it?

The Holy Quran (9:60) classifies the due recipients of zakat
under the following eight categories.
"Zakat is for the poor, and the needy and those who are
employed to administer and collect it, and the new
converts, and for those who are in bondage, and in debt
and service of the cause of God, and for the wayfarers, a
duty ordained by God, and Godis the All-Knowing, the
Wise".
Purpose of zakat
Economic & social impact.