PUBLIC FINANCE Macroeconomics ECO211

At the end of the courses, students should be able to know: 5.1 Concepts of public finance 5.2 Sources of conventional government revenue (tax and non-tax revenue) and expenditure 5.3 Types of government expenditure: operating and development 5.4 Types of tax structure 5.5 Types of government budget (deficit, surplus, and balanced budget) 5.6 Fiscal policy (types and tools) 5.7 Public finance in Islam 5.8 Sources of Islamic government revenue (zakat, wakaf, kharaj, ushr, jizyah, fai, ghanimah) and types of expenditure 5.1 Public Finance Is a field of economics concerned with paying for collective or governmental activities and with the administration and design of those activities. Sources of Conventional Government Revenue Tax acts as a government sources in providing the necessary administrative services to govern the country. There are two major sources of government revenue, which are: 1. Taxes revenue Taxes generate the financial resources that federal, state, and local governments use to provide public goods and to redistribute income. 2. Non-taxes revenue Selling of goods and services, grants from other countries, domestic loans and loans from overseas. 5.2.1 Taxes revenue It can be divided into two main types of taxes: a) Direct taxes the burden of taxes cannot be transferred to other parties. a) The main direct taxes are: Personal income tax for individual; b) Indirect taxes the burden of taxes can be passed on to other parties. a) The main types of indirect taxes are: Custom duties which are taxes on imported goods;

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 Corporate tax on excess profit; Petroleum revenue taxes; Property tax on assets like house, land and building; Inheritance tax for inherited property; Road tax on vehicles based on engine capacity Payroll tax on a employers based on the number of employees. Other taxes stamp duty, film rent duty.

Excise duties which are taxes on locally-produced goods (cigarettes, alcohol, tobacco ) Purchase / sales tax on the value of sales or gross earning; Services / entertainment tax on entertainment like nightclubs;

5.2.2 Non -Taxes revenue a) Non-tax revenues are revenues which arise from other sources besides tax b) Includes: Licenses and permits Treasury bills, bonds and loans from international organization like IMF and World Bank Petroleum royalty as well as gas Interest and return on investment- POS, MAS, KTMB Fees and penalties on traffic offenses, corruption, littering etc. Sales of goods and services postal services, health and education Rental revenue from federal territories. 5.3 Types of tax structure Taxes can be classified into three: 1. Progressive taxes This is where the rate of tax increases as income increase. It imposes a great portion of tax on higher income group than the lower income group. This is the most effective way of redistributing the income among the population. This form of tax is structure is practiced in personal income tax.

2. Regressive taxes A regressive tax is a tax rate which falls with an increase in income. The higher the income, the lower the percentage of tax. This structure will make the lower income group bear a higher proportion of tax than the higher income group does. An example of this structure is the payment of toll. A toll may be a small charge to a person whose income is RM5000 per month, but it can be a great burden to an individual whose income is RM900 per month.

3. Proportional taxes Also known as flat tax rate. The rate of tax remains constant regardless of the level of income. The example is the corporate tax. If the government announced the corporate tax as 28%, then it will take a fixed proportion of the companies profit, regardless of the amount of profit stated by the companies.

4.

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

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To solve inflation problem To improve the unfavorable terms of trade To reallocate resources

Types of government expenditure: operating and development There are two categories of government expenditure: a) Government Operating Expenditure Operating expenditure is the government expenditure allocated to cover the expenses of operating and administering government department. Operating expenditure consists of; Emoluments salary increment and bonus Debt service charges interest payment for domestic and external borrowings. Grants and transfer to state governments Supplies and services. Pension and gratuities. Subsidies. b) Government Development Expenditure Development expenditure is government expenditure for investment purposes to improve facilities in the basic physical infrastructure. Government development expenditure is focused on development projects that can boost economic growth. Development expenditure consists of: General administration computerization of governments administration and public utilities. Security purchase of military equipments. Social services educational and training, construction of low cost houses, building and upgrading hospital. Economics services upgrading roads, agriculture and rural development.

5.4 Types of government budget It is various ways for the government to change the taxation system and the expenditure pattern to achieve the macroeconomics objectives. Budget is an annual statement of the expenditures, tax receipts and the surplus or deficit of the government. There are three types of budget: 1. Surplus Budget (T > G)

 Known as contractionary fiscal policy. The amount by which governments tax revenues (T) exceed governments expenditures (G) in a year. Generally, a government does not need to maintain a budget surplus. However, a government has to be careful about running a budget deficit to make sure that the means of financing the deficit do not cause too much of an interest burden. This policy implement during inflation period 2. Deficit Budget (T < G) Known as expansionary fiscal policy. The amount by which governments expenditures (G) exceed governments tax revenues (T) in a year. It is also called deficit or deficit spending. This budget is the opposite of budget surplus. This policy implement during deflation period 3. Balance Budget (T = G) A budget for which governments expenditures (G) are equal to governments tax revenue (T). Sometimes a budget for which expenditures are less than income is also considered balanced. The concept is often discussed in reference to the federal government. 5.5 Fiscal policy Is a policy to influence the performance of the economy by using government taxation & expenditure to influence the countrys spending, employment & price level. Also known as Budget Policy Government tend to implement fiscal policy for the purpose to: Maintain the stability of the economy Solve all macroeconomic problems, thus without inflation and recession Reach an efficient economy at full employment Have steady rate of economic growth Stabilize prices and interest rate in the economy Controlling the equitable distribution of income and wealth

There are three types of budget:

1. Contractionary Fiscal Policy (Surplus Budget) Is implemented to overcome inflation problem Increase Taxes to reduce spending Decrease government expenditure Increase public debt by selling treasury bills & bonds Decrease wages of government officials 2. Expansionary Fiscal Policy (Deficit Budget) Gov collect less tax revenue but spends more on expenditure, there will be a larger positive effects on real output (G>T) Deficit Budget is implemented to raise-up the economic activities Is to cure the problem of recession or unemployment. Since recession is related to the downturn of an economy, therefore to reduce recession, economic growth has to be shoot-up Decrease Taxes Increase government expenditure Decrease public debt by selling treasury bills & bonds Increase wages of government officials 3. Balance Fiscal Policy (Balance Budget) To increase economic growth Total government revenue equal total government expenditure 5.6 Public finance in Islam Zakat - it is collected from full one year possession of wealth which reaches to the nisab. Taxation - Islamic government must make sure that the imposition of taxes does not kill the working incentive of tax payer. There should not be any injustice involved with taxation policy in Islamic state. Major sources of government revenue in Islamic state Jizzyah - Annual tax levied on non-Muslim citizens living in the Islamic states. Just as the Muslim pays the compulsory zakat, the non-muslim pay. In return, it will be the duty of the muslim pay state to protect their lives and property like any muslim citizen. Kharaj (tax on land) - The agriculture land tax. Tax levied on the producer of the landed property owned by the non-muslim in the islamic state.

 Ushr - the taxation to be paid on the produce of the landed property of the Muslim at the rate of 10% if it through natural rain fall. But if the water has been supplied through irrigation, it will be at the rate of 20%. Ushur - The revenue collected from the proceeeds out by all the citizens of the Islamic state irrespective of their religions and belief. Fay - The property captured from the enemy forces without fighting any battles with them. Such property, will go to central funds of the Baitulmal Daraib - The general taxes which the Islamic state impose on its citizens to carry out some public welfare works or when the state needs funds in the events og emergency. Ghanimah - The wealth obtained during the wars, one fifth of which was deposited in the Baitulmal. 5.7 Government Expenditure in Islamic Economics The priority of the public expenditure in Islamic state should be based on the hierarchy of needs such as Dharuriyyat, Hajiyyat and Kamaliyyat. The main expenditure of Islamic state are: 1. Permanent heads of expenditure i) Defence ii) Law and order iii) Public justice iv) Public administration v) Basic needs fulfillment vi) Dawah activities vii) Enjoining right conduct and forbidding wrong 2. Essential expenditure i) Protection of the environment ii) Capital formation iii) Expenditure for stabilization purpose- Scientific research 3. Expenditure to organize additional activities @ public interest i) Improving the drainage system ii) School iii) hospital