CHAPTER 5

1. CHAPTER 5 PUBLIC FINANCE (FISCAL POLICY) AZIZAH ISA

2. 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 and theto regulate the Aggregate Demand (AD) and Output (Y) level. G T AZIZAH ISA

3. TOOLS FOR FISCAL POLICY Government Expenditure, G Tax Revenue, T 2 TOOLS G and T are used to regulate the aggregate level of the economic activities, AD. AZIZAH ISA

4. 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 full- employment. • have steady rate of economic growth. • stabilise prices and interest rate in the economy. AZIZAH ISA

5. Composition of Government Expenditure 1. Operating Expenditure 2. Development Expenditure AZIZAH ISA

6. 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

7. 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

8. HOW TO IMPLEMENT THE FISCAL POLICY? AZIZAH ISA

9. TYPES OF FISCAL POLICY DEFICIT BUDGET SURPLUS BUDGET G > T G < T BALANCED BUDGET G = T AZIZAH ISA

10. 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

11. NATIONAL INCOME EQUILIBRIUM Expenditure,E (Y=E) AD=AS (RM) Y1=AD1=C+I+G+(X-M) e1  Yfe=ADf e =C+I+G+(X-M) Inflationary Gap Y0=AD0 = C+I+G+(X-M) ef  Deflationary Gap -GDPGap e0 45° Real Output (National Income) Y0 Yfe Y1 +GDP Gap AZIZAH ISA

12. BORROWINGS: Borrowings and use of government debts 14.2% WHERE IT GOES DEVELOPMENT EXPENDITURE WHERE IT COMES Social services 17.3% Emolument 17.9% Income Taxes 38.9% Export duties 1.9% RM134 mil RM134 mil Supplies and services 15.3% Import duties 3.1% Other expenditures 17.9% Economic services 14.7% Non-tax revenue and others 28.7% Other indirect taxes 14.3% Subsidies 3.2% REVENUE OPERATING EXPENDITURE ECONOMIC OUTLOOK REMAINS FAVOURABLE AZIZAH ISA

13. 1. Expansionary Fiscal Policy/ Deficit Budget • Government collects less tax revenuebut 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

14. To reduce Recession: with Deficit Budget Since recession is related to the downturnof 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

15. 2. Contractionary Fiscal Policy/ Surplus Budget • When government collects more tax revenueand 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

16. To reduce Inflation: with Surplus Budget Since inflation is related to the boomingof 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

17. Contractionary Fiscal Policy to combat inflation. The reverse will happen if were to reduce recession General Price AS Decreasing G will reduce AD and lower the price level. P0 P1 G AD0 AD1 Y Y1 Y0 To reduce inflation by lowering G or increases T or both. AZIZAH ISA

18. 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

19. 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

20. Just Relax for a moment • LETS HAVE A BREAK AZIZAH ISA

21. 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. Non-tax Revenue consist of: 1) Revenue receiptssuch as from licenses, permits, service fees, regulation fees, interest and returns(income) from investment. 2) Non-revenue receiptsinclude refunds of overpayment, grants and aid, contribution from the federal government . Sources of Government Revenue AZIZAH ISA

22. 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 Tax rate AZIZAH ISA

23. Structure of Tax AZIZAH ISA

24. 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

25. 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

26. 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? AZIZAH ISA

27. Direct Tax: Personal income tax Solutions: Tax rate for each country at each income levels are as follows: A: regressive B: proportional C: progressive D: regressive AZIZAH ISA

28. Exercise1: • Given the amount of taxes as follows. Classify each tax structure i, ii and iii. AZIZAH ISA

29. Exercise1: • Given the amount of taxes as follows. Classify each tax structure i, ii and iii. AZIZAH ISA

30. Answer to the Exercise 1: AZIZAH ISA

31. 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

32. Exercise 2: Injection and Leakage • Given that the economy with; C = 400m + 0.75 Yd, I = 500m and G = 1000. • Determine the equilibrium national income. • If the income at full-employment is RM 8500mil., find the spending by government to achieve this full-employment. • Now assume tax is impose at ¼ Y and at the same time government spends RM 1700m. Find the new equilibrium income. • Is it the government implement a surplus or deficit budget? AZIZAH ISA

33. 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

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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 collectedfrom the rich) instead ofindirect taxes which are normally borne by the poor. AZIZAH ISA

40. 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

41. iii) Jizzyah • tax levied on non-Muslim citizensliving 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

42. 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 qualityof the land, fertility, irrigation requirements, etc. AZIZAH ISA

43. 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

44. 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 forceswithout fighting any battles with them. Such property, the acquired will go to the central funds of the Baitul-Mal. AZIZAH ISA

45. 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

46. 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

47. 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 fellow-human 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

48. 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

49. 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

50. To achieve Al-Falah • A Muslims country’s objective for the use of government expenditure is to achieve Al-Falah (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