HKCE Macroeconomics

HKCE Macroeconomics • Chapter 6: Public Finance By Mr. LAU san-fat

Major Ideas • sources of government revenue • principles of taxation • types of taxation • effects of taxation • sources and socio-economic implications of public expenditure • kinds of budget and its effects • major proposals in the current budget speech By Mr. LAU san-fat

Meaning of Public Finance • Various ways of raising and spending money by the government for achieving certain goals of an economy, e.g. income distribution & stimulating production. By Mr. LAU san-fat

Sources of Government Revenue • Tax revenue • Direct tax vs. indirect tax • Progressive, proportional and regressive taxes • Non-tax revenue • In HK, direct tax is the major source of government revenue By Mr. LAU san-fat

Non-tax Revenue • Fines, forfeitures and penalties • Revenue from properties • Provisions of public services(utilities) • Fees and charges • Land transactions, sales and interest • Fund revenue • from loan repayments, interest of some government funds By Mr. LAU san-fat

Four Principles of Taxation 1. Equity • Everyone should pay taxes in proportion to his income 2. Certainty • A taxpayer should know well what his taxes are, when and how to pay 3. Economy • The administration cost of tax collection should be small in proportion to its yield By Mr. LAU san-fat

Four Principles of Taxation 4. Convenience • The way of collecting tax payments should be convenient to both taxpayers and the government • Tax in HK could be settled by electronic payment, or paid by phone, by bank ATM, by post, via the internet or in person. • Exercise 1: Textbook/P.146-7/MCQs 1&2 By Mr. LAU san-fat

Classification of Taxes • Direct taxes • Tax burden cannot be shifted to a third party • A tax on income/revenue • Including salaries (or income) tax, property tax, profits tax and estate duty By Mr. LAU san-fat

Salaries Tax in HK • Income arising in or derived from Hong Kong is subject to salaries tax • After deducting personal allowances and other allowances,and deductions, the remainder of one's annual income, which is known as taxable income, will be taxed. By Mr. LAU san-fat

Salaries Tax Assessment (04/05) • *NCI =Total Income – Deductions – Allowances • **Tax rate = tax payment/taxable income By Mr. LAU san-fat

Salaries Tax Assessment (04/05) • Standard Rate of Tax(SR) • Tax charged shall not exceed the standard rate of tax applied to the net total income without allowances, i.e. total assessable income less total deductions only. • Standard rate =16% for 2004/05. • Tax payment = (gross) income x SR By Mr. LAU san-fat

Direct Taxes in Hong Kong • Property tax • In accordance with the standard tax rate on the actual rent received • Allowance of 20% for repair & maintenance • Profits tax • 16% on profits of unincorporated business • 17.5% on profits of incorporated business (limited companies) By Mr. LAU san-fat

Indirect Taxes in Hong Kong • Indirect tax: • Tax burden can be shifted to a third party • A tax on goods and services • Sales tax, duties, rates, stamp duties, betting duty, hotel accommodation tax, first registration tax, and royalties. • Exercise 2: Textbook/P.148/Q7.1 By Mr. LAU san-fat

Indirect Taxes in Hong Kong • Duties • Hydrocarbon oil, alcoholic beverages, methyl and ethyl alcohol, tobacco • Rates • 5% of the rateable value (i.e. expected annual rent) • Stamp duties • On assignments of leases, sales of immovable property & shares contracts By Mr. LAU san-fat

Indirect Taxes in Hong Kong • Betting duty • On bets & the proceeds of Mark Six lotteries • Hotel accommodation tax • 3% of hotel accommodation expenditure • First registration tax • On newly imported cars • Royalties • On business units for exclusive rights By Mr. LAU san-fat

Progressive Taxes • Taxes that take an increasing proportion or percentage of one's (taxable) income as one's (taxable) income increases. • The higher the (taxable) income, the higher the tax rate, vice versa; ceteris paribus. By Mr. LAU san-fat

Progressive Taxes: An Example By Mr. LAU san-fat

Proportional Taxes • Taxes that take the same proportion or percentage of one's (taxable) income as one's (taxable) income increases. • The tax rate remains unchanged, regardless of one's (taxable) income, ceteris paribus. By Mr. LAU san-fat

Proportional Taxes: An Example By Mr. LAU san-fat

Regressive Taxes • Taxes that take a decreasing proportion or percentage of one's (taxable) income as one's (taxable) income increases. • The higher the level of one's (taxable) income, the lower the tax rate, vice versa; ceteris paribus. By Mr. LAU san-fat

Regressive Taxes: An Example By Mr. LAU san-fat

Classification of Taxes-Diagrams • Progressive Proportional Regressive By Mr. LAU san-fat

Classification of Taxes-Diagrams • Progressive Proportional Regressive • Exercise 3: Textbook/P.150-1/MCQ 4 & Q7.2 & Q7.3 By Mr. LAU san-fat

Is Salaries Tax Progressive? • Exercise 4: Textbook/P.152/MCQ 5 & Q7.5 TB/P.152 Closer Look By Mr. LAU san-fat

Taxes in HK – A Summary By Mr. LAU san-fat

Effects of Taxation • On general price level • Direct taxes (salaries tax) reduce one's disposable income and hence lower aggregate demand for products, resulting in a lower general price level • Indirect taxes (sales tax) raise production cost and thus increasing the general price level. Inflation may exist. • Exercise 5: Textbook/P.154/News online 7.2 By Mr. LAU san-fat

Effects of Taxation • On standard of living • Direct taxes (salaries tax) reduce one's disposable income, resulting in a lower standard of living. • Indirect taxes (sales tax) may cause inflation but allows higher nominal wage. The living standard will be lower if the increase in nominal wage rate is less than the inflation rate. By Mr. LAU san-fat

Effects of Taxation • On investment • Direct taxes (profits tax) reduce one's net profits and investment incentive, resulting in less investment. • Indirect taxes (stamp duty) may reduce investment incentives in the real estate market. By Mr. LAU san-fat

Effects of Taxation • On working incentive • Direct taxes (salaries tax) reduce one's working incentives, especially if salaries tax is progressive. • Indirect taxes (stamp duty) will not affect working incentive as it is not a tax on income. • Exercise 6: Textbook/P.155/Q7.7 By Mr. LAU san-fat

Effects of Taxation • On income distribution • Progressive taxesreduce inequality of an economy as the rich have to pay a larger proportion of their income as tax than the poor. • Regressive taxes will widen the income gap as the poor have to pay a larger proportion of their income as tax than the higher income group. By Mr. LAU san-fat

Effects of Taxation • On resources allocation • Regressive taxes (sales tax) raise production cost and reduce supply, thus re-directing the flow of resources away from that production. • Exercise 7: Textbook/P.156/MCQs 7 & 8 • Exercise 8: Textbook/P.156/Q7.8 By Mr. LAU san-fat

Effects of Taxation • On undesirable issues • Taxes may be used to check against undesirable social issues. • Example: duties on tobacco raise cigarette prices and thus lowering its consumption. • Exercise 9: Textbook/P.157/Q7.9 • Textbook/P.158/Close Look 7.3 By Mr. LAU san-fat

Effects of Taxation • On economic growth and employment • Salaries tax lowers people's disposable income and profits tax reduces investor's net profits, resulting in a slower economic growth and higher unemployment rate. By Mr. LAU san-fat

Effects of Taxation • On capital flow • The higher the profits tax rate, the more the capital outflow will be as investors' net profits get smaller, vice versa. By Mr. LAU san-fat

Effects of Taxation • On government revenue • Higher tax rates will bring in more tax revenue in the short run. • However, lower disposable income and net profits reduce future economic activities, resulting in less tax revenue in the future. • Exercise 10: Textbook/P.159/Q7.10 • Closer Look7.4: Textbook/P.159 By Mr. LAU san-fat

Public Expenditure by Nature • Capital expenditure • Expenses on capital works • Example: expenditure on infrastructures • Recurrent expenditure • Expenses with a regular nature • Example: wages to civil servants By Mr. LAU san-fat

Public Expenditure by Policy Area Group • Major items: • Education • Housing • Social welfare • Health • Others: • Economics, security, environmental & food, infrastructure and support. By Mr. LAU san-fat

Effects of Public Expenditure • On Economic Growth • Increasing public expenditure on infrastructure, investment on technology and innovation, and education and training will enhance economic growth; vice versa. • On Employment • Increasing public expenditure on public projects creates job and investment opportunities; vice versa. By Mr. LAU san-fat

Effects of Public Expenditure • On Living Standard • Increasing public expenditure on public utilities, social welfare and community services enhance people’s living standard; vice versa. • On Income Distribution • With progressive and proportional taxes, increasing public expenditure on social and welfare services may result in a more even income distribution; vice versa. By Mr. LAU san-fat

Effects of Public Expenditure • On Resources Allocation • Resources will be directed to a certain production if the government increases its public expenditure on that area; vice versa. By Mr. LAU san-fat

Methods to Finance Public Expenditure • Using past fiscal reserves • lesser reserves for future uses and emergency purposes • Printing money • inflation may result if there is too much money chasing too little goods • Increasing charges and fees • cost of living will increase By Mr. LAU san-fat

Methods to Finance Public Expenditure • Borrowing • interest will be a significant burden to the government or society • Increasing tax • increasing salaries tax will reduce people’s purchasing power and their working incentives • increasing indirect tax will raise the general price level By Mr. LAU san-fat

Public Sector • Public sector(PS) refers to public expenditure(PE) as a proportion of GDP • PS = (PE/GDP)x100% • The public sector of HK is small but on an increasing trend (from 17.8% in 1995-96 to 21.6% in 2001-02) By Mr. LAU san-fat

Public Sector • Reasons for increasing size of public sector: • growing population • increasing effort to boost the economy after the economic turmoil in the late 90s • increasing expenditure on shaping HK as an international city by expanding its infrastructure • Exercise 11: Textbook/P.164/MCQ 9 By Mr. LAU san-fat

The Government Budget • A budget is a financial statement giving an estimate of the expected revenue and expenditure of the government for the coming fiscal year. By Mr. LAU san-fat

Types of Budget • Deficit budget: • the estimated expenditure is greater than the estimated revenue • Surplus budget: • the estimated revenue is greater than the estimated expenditure • Balanced budget: • the estimated expenditure and the estimated revenue are equal By Mr. LAU san-fat

Remarks on Budget • Exercise 12: TB/P.166-7/MCQ 10 & Q7.11 • A surplus or deficit budget is only anestimation of the expected government revenue and expenditure. • A budgetary surplus is a review of a year’s actual financial situation of the total public expenditure and revenue. • Closer Look 7.6/TB/P.168 By Mr. LAU san-fat

HKCE Macroeconomics