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CHAPTER 5 PUBLIC FINANCE (FISCAL POLICY) AZIZAH ISA 1 Fiscal Policy is a policy to influence the performance of the economy by using government expenditure and tax revenues collection for regulating the aggregate level of economic activities. by changing the G and the T to regulate the Aggregate Demand (AD) and Output (Y) level. AZIZAH ISA 2 TOOLS FOR FISCAL POLICY Government Expenditure, G 2 TOOLS Tax Revenue, T G and T are used to regulate the aggregate level of the economic activities, AD. AZIZAH ISA 3 OBJECTIVES Government tend to implement fiscal policy for the purpose to: maintain the stability of the economy - solve all macroeconomic problems, thus without inflation or recession. reach an efficient economy at fullemployment. have steady rate of economic growth. stabilise prices and interest rate in the economy. AZIZAH ISA 4 Composition of Government Expenditure 1. Operating Expenditure 2. Development Expenditure AZIZAH ISA 5 1. Operating expenditure includes expenditure for maintaining government services and facilities and its department: includes the payments for: emoluments, pension and gratuities, debt service charges, aid to states government, subsidies, maintenance, repairs and supplies to improve the provision of public services. AZIZAH ISA 6 2. Development Expenditure is meant to support government’s projects to boost-up economic growth. There are three (3) main components of development expenditure: social services; economic sectors development; security sector. AZIZAH ISA 7 HOW TO IMPLEMENT THE FISCAL POLICY? AZIZAH ISA 8 TYPES OF FISCAL POLICY DEFICIT BUDGET SURPLUS BUDGET G>T G<T BALANCED BUDGET G=T AZIZAH ISA 9 Budget Policy/ Fiscal Policy 1. EXPANSIONARY FISCAL POLICY (Deficit Budget) G>T 2. CONTRACTIONARY FISCAL POLICY (Surplus Budget) G<T 3. BALANCED BUDGET POLICY G=T AZIZAH ISA 10 NATIONAL INCOME EQUILIBRIUM (Y=E) AD=AS Expenditure,E (RM) Y1=AD1=C+I+G+(X-M) Inflationary Gap Deflationary Gap e0 45° Y0 e1 Yfe=ADf e =C+I+G+(X-M) Y0=AD0 = C+I+G+(X-M) ef -GDP Gap Yfe +GDP Gap AZIZAH ISA Y1 Real Output (National Income) 11 WHERE IT COMES BORROWINGS: Borrowings and use of government debts 14.2% Income Taxes 38.9% Social services 17.3% Export duties 1.9% Non-tax revenue and others 28.7% REVENUE Other indirect taxes 14.3% Emolument 17.9% RM134 mil RM134 mil Import duties 3.1% WHERE IT GOES DEVELOPMENT EXPENDITURE Other Economic expenditures 17.9% services Supplies and services 15.3% 14.7% Subsidies 3.2% OPERATING EXPENDITURE ECONOMIC OUTLOOK FAVOURABLE AZIZAHREMAINS ISA 12 1. Expansionary Fiscal Policy/ Deficit Budget Government collects less tax revenue but spends more on expenditure, there will be a larger positive effects on real output. Deficit Budget is implemented to raise-up the economic activities. Is to cure the problem of recession. AZIZAH ISA 13 To reduce Recession: with Deficit Budget Since recession is related to the downturn of an economy, therefore to reduce recession, economic growth has to be shoot-up. More government expenditure, G that increases the aggregate demand and closed-down the deflationary-gap, while the real GDP increases. AZIZAH ISA 14 2. Contractionary Fiscal Policy / Surplus Budget When government collects more tax revenue and spends less on expenditure, the net budget will be under surplus (T>G). Surplus budget will narrow down the effect on real output or national income (negative effect). Is implemented to overcome inflation problem. AZIZAH ISA 15 To reduce Inflation: with Surplus Budget Since inflation is related to the booming of an economy, therefore to reduce inflation, economic growth has to be slowed down. Less government expenditure, G reduces the aggregate demand and closed-down the inflationary-gap, while the real GDP falls. AZIZAH ISA 16 Contractionary Fiscal Policy to combat inflation. General Price Decreasing G will reduce AD and lower the price level. AS P0 P1 G The reverse will happen if were to reduce recession AD0 AD1 Y1 Y0 Y To reduce inflation by lowering G or increases T or both. AZIZAH ISA 17 3. Balanced Budget Policy Still can stimulate economic growth. - but increases the real output by the same amount of government expenditure only. since its multiplier is 1. Y = 1 . G still can stimulate the economy, since the spending multiplier effect is larger than the tax multiplier effect. AZIZAH ISA 18 Expansionary Effect from Balanced Budget, where multiplier =1. If G = 100mil and MPC = 0.75, Govt multiplier, mG = 1/MPS = 1/0.25 =4 ∆YG = 1/MPS X ∆G = 4 X 100mil = 400 mil For a Balanced budget, ∆G = ∆T =100 (Government spends from what is collected from revenue) Tax multiplier, mT = MPC/MPS = 0.75/0.25 = 3 ∆YT = MPC/MPS X ∆G = 3 X 100mil = 300 mil Net increase in Y = (400 300)mil = 100 mil AZIZAH ISA 19 Just Relax for a moment LETS HAVE A BREAK AZIZAH ISA 20 Sources of Government Revenue Tax Revenue Non-tax Revenue consist of: 1) Direct tax: where the burden (incidence) of tax is paid by the person being imposed by tax, i.e. the taxpayer & the burden of tax cannot be shifted to others. e.g: income tax, petroleum income tax, profit tax, stamp duty, road tax and real property gains tax. 2) Indirect tax: where burden of tax is shifted to the third party. e.g: expenditure tax, sales tax, service tax, consumption tax, export duty, import duty, custom duty, excise duty and tariff. Taxes are the most important source of government revenue. AZIZAH ISA consist of: 1) Revenue receipts such as from licenses, permits, service fees, regulation fees, interest and returns(income) from investment. 2) Non-revenue receipts include refunds of overpayment, grants and aid, contribution from the federal government . 21 Structure of Taxes 1) Progressive tax: tax rate increases as income rises. 2) Proportional tax: tax rate is constant as income rises. 3) Regressive tax: tax rate decreases as income rises. income Proportional Progressive Regressive AZIZAH ISA Tax rate 22 Structure of Tax Types of Tax Income (RM) 1000 2000 3000 4000 Progressive Tax Rate 6% 9% 12% 15% Proportional Total tax 60 180 360 600 Tax rate 6% 6% 6% 6% AZIZAH ISA Total tax 60 120 180 240 Regressive Tax rate 6% 5% 4% 3% Total tax 60 100 120 120 23 Tax Rates and Taxpayers Progressive tax falls heavily on people with high income earners but Regressive tax falls relatively more on the poor. AZIZAH ISA 24 Examples Progressive tax - personal income tax Regressive tax - sales tax (tax on consumption expenditure) - property tax . Proportional tax - corporate income tax (with a flat rate percentage of tax rate) AZIZAH ISA 25 Direct Tax: Personal income tax E.g.: The income tax paid by the individuals at various income level in a country is shown in the schedule below. Which country is implementing the regressive, proportional and progressive tax structure? Country Income 10,000 20,000 30,000 40,000 A B C D 2,000 2,000 2,000 2,000 1000 2000 3000 4000 1000 3000 6000 9000 1000 1600 1800 2000 AZIZAH ISA 26 Direct Tax: Personal income tax Solutions: Tax rate for each country at each income levels are as follows: Country Income 10,000 20,000 30,000 40,000 A B C D 0.20 0.10 0.07 0.05 0.1 0.1 0.1 0.1 0.10 0.15 0.20 0.23 0.10 0.08 0.06 0.05 A: regressive B: proportional C: progressive D: regressive AZIZAH ISA 27 Exercise1: Given the amount of taxes as follows. Classify each tax structure i, ii and iii. Income RM 9 000 RM 6 000 RM 3 000 Total Tax (i) RM 1 800 RM 1 200 RM 600 (ii) RM 2 700 RM 1 500 RM 600 (iii) RM 1 350 RM 1 200 RM 1 200 AZIZAH ISA 28 Exercise1: Given the amount of taxes as follows. Classify each tax structure i, ii and iii. Income RM 9 000 RM 6 000 RM 3 000 Total Tax (i) RM 1 800 RM 1 200 RM 600 (ii) RM 2 700 RM 1 500 RM 600 (iii) RM 1 350 RM 1 200 RM 1 200 AZIZAH ISA 29 Answer to the Exercise 1: Tax Structure Income RM 9 000 RM 6 000 RM 3 000 (i) Proportional 20% 20% 20% (ii) Progressive 30% 25% 20% (iii) Regressive 15% 20% 40% AZIZAH ISA 30 The purpose of taxation - Why collect tax revenue? To develop a country. To redistribute the income and close the income- gap between the rich and the poor. To protect local and infant industries. To correct the adverse balance of payment. To solve inflation problem. To improve the unfavourable terms of trade. To reallocate resources. AZIZAH ISA 31 Exercise 2: Injection and Leakage Given that the economy with; C = 400m + 0.75 Yd, I = 500m and G = 1000. i) ii) Determine the equilibrium national income. If the income at full-employment is RM 8500mil., find the spending by government to achieve this full-employment. iii) Now assume tax is impose at ¼ Y and at the same time government spends RM 1700m. Find the new equilibrium income. iv) Is it the government implement a surplus or deficit budget?AZIZAH ISA 32 Solution(i) Y = C + I + G, Yd = Y. Y = 400 + 0.75Y + 500 + 1000 Y = 1900 + 0.75Y 0.25Y = 1900 Y = 1900/0.25 = 7600m AZIZAH ISA 33 Solution(ii) Y = 8500 –7600 = 900 Y = mG. G Y = G X (1 / MPS) 900 = G X (1 / 0.25) G = 900 = 225 4 To reach the full-employment, Government needs to spend another RM225 mil. AZIZAH ISA 34 Solution (iii) Y=C+I+G = 400 + 0.75 (Y – 1/4Y) + 500 + 1700 = 2600 + 0.75 (3/4Y) = 2600 + 0.56Y 0.44Y = 2600 Y = 5909.1 AZIZAH ISA 35 OR Solution (iii) can be solve as: Y = mGt. G Y = (1 / MPSt ) X G Y = 1 X (1700 – 1000) (1 – b + bt ) Y = 700 / [1 – 0.75 + (0.75)(0.25)] Y = 1590.91 Y=C+I+G Y = 400 + 0.75 (Y – 1/4Y) + 500 + 1000 Y = 1900 + 0.75 (3/4Y) = 1900 + 0.56Y 0.44Y = 1900 Y0 = 4318.18 Therefore, new Y = 4318.18 + 1590.91 = 5909.1 AZIZAH ISA 36 Solution (iv) To confirm weather G is larger or smaller than T. G = 1700mil. T = 1/4Y = 1/4 (5909.1) = 1477.28 Therefore, G > T where, 1700 mil. > 1477.28 mil. So, budget is a DEFICIT. AZIZAH ISA 37 THAT’S ALL FOR TODAY THANK YOU! BUT DON’T FORGET TO DO THE REVISION FOR NEXT CLASS: READ GOVERNMENT REVENUE AND SPENDING IN ISLAMIC ECONOMICS AZIZAH ISA 38 SOURCES OF GOVERNMENT REVENUE IN ISLAMIC ECONOMICS i) Taxation major source of government revenue. to ensure it does not de-motivate the taxpayers from working harder. to preserve justice - minimize the tax burden of the poor. to concentrate on direct taxes (usually collected from the rich) instead of indirect taxes which are normally borne by the poor. AZIZAH ISA 39 ii) Zakat is collected from a full one-year possession of wealth which reaches to the Nisab. the coverage of zakat institution is very wide, ranging from sheep and cattle, up to bonds and equity shares. establish a proper body to enable the zakat be collected centrally. In Malaysia, is collected by Pusat Pungutan Zakat (PPZ) under Jabatan Agama Islam with close supervision by Baitul-Mal. AZIZAH ISA 40 iii) Jizzyah tax levied on non-Muslim citizens living in the Islamic state. Indeed, is the duty of the Islamic government to protect their lives and property like any other Muslim citizen. As Holy Quran states: “…… until they pay the Jizzyah with willing submission, and feeling themselves subdued….” ( 9 :29) AZIZAH ISA 41 iv) Kharaj an agricultural land tax levied on the producer of the landed property owned by the non-Muslims in the Islamic state. The rate will mainly depend on the quality of the land, fertility, irrigation requirements, etc. AZIZAH ISA 42 v) Ushr an agricultural land tax levied on the producer of the landed property owned by the Muslims, Charged at the rate of 10% if it is through natural rainfall or 20% if the water is supplied through irrigation. As Holy Quran states: “ ….. and render the dues that are proper on the day that the harvest is gathered ……” AZIZAH ISA 43 Khums and Fay’ vi) Khums: Muslim army gets as booty (Ghanimah) after fighting, war with enemies and gaining victory over them. It is used for the welfare of the nation. Vii) Fay’: - property captured from the enemy forces without fighting any battles with them. Such property, the acquired will go to the central funds of the Baitul-Mal. AZIZAH ISA 44 Ushur dan Waqf viii) Ushur: revenue collected from trade and business carried out by all the citizens of the Islamic state irrespective of their religions and beliefs. The revenue will also goes to Baitul-Mal. ix) Waqf: these are the religions trust and the proceeds from these trust goes to the Baitul- Mal. AZIZAH ISA 45 Kira al-Ard & Amwal al Fadilah x) Kira al-Ard: is the income generated from the services provided by the government. xi) Amwal al Fadilah: is the income received from the government owned natural resources. AZIZAH ISA 46 Infaq Fi Sabillillah (Sadaqah) is a voluntary charity given by individuals over and above the payment of the compulsory zakat to relieve the problems and suffering of fellowhuman being. According to Al-Hadith, sadaqah must be given in such a way that even the left hand (the donor) must not know what the right hand gives. AZIZAH ISA 47 How Islamic Government Spends? 8 main channels where the expenditure should be distributed: Defense Law and order Public justice Public administration Basic need fulfillment Dakwah activities Enjoining right conduct and forbidding wrong. Fulfillment of such socially obligatory duties as the private sector fails to perform. AZIZAH ISA 48 Priorities given based on hierarchy of needs: priorities should be given on expenditures based on the hierarchy of needs for four types of goods, that is: Dharnniat - Basic Necessities Hajiat - Complements Kamaliat and - Luxuries Thasiniat. - Haram/Forbidden AZIZAH ISA 49 To achieve Al-Falah A Muslims country’s objective for the use of government expenditure is to achieve AlFalah (the success in this world and the hereafter). How this Al-Falah is achieved is based on the foundation of At-Tauhid; which has the relationships of: Hablumminallah (the relationship between man with Allah) and Hablumminannaas (the relationship of man with his mankind). AZIZAH ISA 50 That’s all for today! THANK YOU FOR LEND ME YOUR EARS AZIZAH ISA 51