CH6-Public FinanceBy Mr. LAU san-fat 1 HKCE Macroeconomics Chapter 6: Public Finance

CH6-Public FinanceBy Mr. LAU san-fat 2 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

CH6-Public FinanceBy Mr. LAU san-fat 3 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.

CH6-Public FinanceBy Mr. LAU san-fat 4 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

CH6-Public FinanceBy Mr. LAU san-fat 5 Non-tax Revenue 1.Fines, forfeitures and penalties 2.Revenue from properties 3.Provisions of public services(utilities) 4.Fees and charges 5.Land transactions, sales and interest 6.Fund revenue from loan repayments, interest of some government funds

CH6-Public FinanceBy Mr. LAU san-fat 6 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

CH6-Public FinanceBy Mr. LAU san-fat 7 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

CH6-Public FinanceBy Mr. LAU san-fat 8 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

CH6-Public FinanceBy Mr. LAU san-fat 9 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.

CH6-Public FinanceBy Mr. LAU san-fat 10 Salaries Tax Assessment (04/05) Net Chargeable Income* Rate**Tax On the 1 st 30,0002%600 On the next30,0008%2,400 On the next30,00014%4,200 Remainder20% *NCI =Total Income – Deductions – Allowances **Tax rate = tax payment/taxable income

CH6-Public FinanceBy Mr. LAU san-fat 11 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

CH6-Public FinanceBy Mr. LAU san-fat 12 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)

CH6-Public FinanceBy Mr. LAU san-fat 13 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

CH6-Public FinanceBy Mr. LAU san-fat 14 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

CH6-Public FinanceBy Mr. LAU san-fat 15 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

CH6-Public FinanceBy Mr. LAU san-fat 16 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.

CH6-Public FinanceBy Mr. LAU san-fat 17 Progressive Taxes: An Example IncomeTax paymentTax rate = (tax/income)x100% $10 000$1 000$(1 000/10 000) = 10% $20 000$3 000$(3 000/20 000) = 15% $30 000$6 000$(6 000/30 000) = 20%

CH6-Public FinanceBy Mr. LAU san-fat 18 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.

CH6-Public FinanceBy Mr. LAU san-fat 19 Proportional Taxes: An Example IncomeTax paymentTax rate = (tax/income)x100% $10 000$1 000$(1 000/10 000) = 10% $20 000$2 000$(2 000/20 000) = 10% $30 000$3 000$(3 000/30 000) = 10%

CH6-Public FinanceBy Mr. LAU san-fat 20 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.

CH6-Public FinanceBy Mr. LAU san-fat 21 Regressive Taxes: An Example IncomeTax paymentTax rate = (tax/income)x100% $10 000$1 000$(1 000/10 000) = 10% $20 000$1 500$(1 500/20 000) = 7.5% $30 000$1 800$(1 800/30 000) = 6%

CH6-Public FinanceBy Mr. LAU san-fat 22 Classification of Taxes-Diagrams Progressive Proportional Regressive

CH6-Public FinanceBy Mr. LAU san-fat 23 Classification of Taxes-Diagrams Progressive Proportional Regressive

CH6-Public FinanceBy Mr. LAU san-fat 24 Classification of Taxes-Diagrams Progressive Proportional Regressive Exercise 3: Textbook/P.150-1/MCQ 4 & Q7.2 & Q7.3

CH6-Public FinanceBy Mr. LAU san-fat 25 Is Salaries Tax Progressive? Exercise 4: Textbook/P.152/MCQ 5 & Q7.5 TB/P.152 Closer Look

CH6-Public FinanceBy Mr. LAU san-fat 26 Taxes in HK – A Summary Progressive Taxes Proportional Taxes Regressive Taxes Direct Taxes Salaries tax below the standard tax rate Estate duty Salaries tax at the standard tax rate Profits tax Property tax Indirect Taxes Duties Sales taxes Rates Stamp duties Betting duty royalties

CH6-Public FinanceBy Mr. LAU san-fat 27 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

CH6-Public FinanceBy Mr. LAU san-fat 28 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

CH6-Public FinanceBy Mr. LAU san-fat 29 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.

CH6-Public FinanceBy Mr. LAU san-fat 30 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.

CH6-Public FinanceBy Mr. LAU san-fat 31 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

CH6-Public FinanceBy Mr. LAU san-fat 32 Effects of Taxation On income distribution Progressive taxes reduce 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.

CH6-Public FinanceBy Mr. LAU san-fat 33 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

CH6-Public FinanceBy Mr. LAU san-fat 34 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

CH6-Public FinanceBy Mr. LAU san-fat 35 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.

CH6-Public FinanceBy Mr. LAU san-fat 36 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.

CH6-Public FinanceBy Mr. LAU san-fat 37 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

CH6-Public FinanceBy Mr. LAU san-fat 38 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

CH6-Public FinanceBy Mr. LAU san-fat 39 Public Expenditure by Policy Area Group Major items: Education Housing Social welfare Health Others: Economics, security, environmental & food, infrastructure and support.

CH6-Public FinanceBy Mr. LAU san-fat 40 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.

CH6-Public FinanceBy Mr. LAU san-fat 41 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.

CH6-Public FinanceBy Mr. LAU san-fat 42 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.

CH6-Public FinanceBy Mr. LAU san-fat 43 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

CH6-Public FinanceBy Mr. LAU san-fat 44 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

CH6-Public FinanceBy Mr. LAU san-fat 45 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 to 21.6% in )

CH6-Public FinanceBy Mr. LAU san-fat 46 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

CH6-Public FinanceBy Mr. LAU san-fat 47 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.

CH6-Public FinanceBy Mr. LAU san-fat 48 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

CH6-Public FinanceBy Mr. LAU san-fat 49 Remarks on Budget Exercise 12: TB/P.166-7/MCQ 10 & Q7.11 A surplus or deficit budget is only an estimation 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