AZIZAH ISA 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 the to regulate the Aggregate Demand (AD) and Output (Y) level.

G T

AZIZAH ISA 3

TOOLS

FOR

FISCAL POLICY

Government Expenditure, G

Tax Revenue, T

G and T are used to regulate the aggregate level of the economic activities, AD.

2 TOOLS

AZIZAH ISA 4

OBJECTIVESGovernment 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 BUDGETSURPLUS BUDGET

BALANCED BUDGET

G = T

G > TG < 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

Real Output (National Income)

Expenditure,E

(RM)

Y0=AD0 = C+I+G+(X-M)

Y1=AD1=C+I+G+(X-M)

(Y=E)AD=AS

45°

Yfe=ADf e =C+I+G+(X-M)

Y0 Yfe Y1

Inflationary Gap

Deflationary Gape0

e1

ef

-GDP Gap

+GDP Gap

AZIZAH ISA 12

RM134 milRM134 mil

WHERE IT COMES

WHERE IT GOES

BORROWINGS:

Borrowings and use of government debts 14.2%

REVENUE

Income Taxes 38.9%

Non-tax revenue and others 28.7% Other

indirect taxes 14.3%

Import duties

3.1%

Export duties1.9%

DEVELOPMENT EXPENDITURE

OPERATING EXPENDITURE

Other expenditures 17.9%

Emolument 17.9%

Economic services 14.7%

Social services 17.3%

Supplies and services 15.3%

Subsidies 3.2%

ECONOMIC OUTLOOK REMAINS FAVOURABLE

AZIZAH ISA 13

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 14

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 15

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 16

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 17

Contractionary Fiscal Policy to combat inflation.

Y

General Price

AD1

AD0

P0

P1

Y0Y1

AS

To reduce inflation by lowering G or increases T or both.

G

Decreasing G will

reduce AD and lower the price

level.

The reverse

will happen if were to reduce

recession

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 milFor 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

Sources of Government RevenueTax 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 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 .

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

Tax rate

Progressive

Proportional

Regressive

AZIZAH ISA 23

Structure of Tax Types of

Tax

Income (RM)

Progressive Proportional Regressive

1000

2000

3000

4000

Tax Rate

Total tax

Tax rate

Total tax

Tax rate

Total tax

6%

9%

12%

15%

60

180

360

600

6%

6%

6%

6%

60

120

180

240

6%

5%

4%

3%

60

100

120

120

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 taxE.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

A B C D

10,000 2,000 1000 1000 1000

20,000 2,000 2000 3000 1600

30,000 2,000 3000 6000 1800

40,000 2,000 4000 9000 2000

AZIZAH ISA 27

Direct Tax: Personal income taxSolutions: Tax rate for each country at each income levels

are as follows:

Country

Income

A B C D

10,000 0.20 0.1 0.10 0.10

20,000 0.10 0.1 0.15 0.08

30,000 0.07 0.1 0.20 0.06

40,000 0.05 0.1 0.23 0.05A: 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.

Income

Total Tax

RM 9 000 RM 6 000 RM 3 000

(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

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

Income

Total Tax

RM 9 000 RM 6 000 RM 3 000

(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 30

Answer to the Exercise 1:

Tax Income

Structure

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 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 LeakageGiven that the economy with;

C = 400m + 0.75 Yd, I = 500m and G = 1000.i) Determine the equilibrium national income.ii) 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 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

4To 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 + GY = 400 + 0.75 (Y – 1/4Y) + 500 + 1000Y = 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 collected from the rich) instead of indirect 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 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 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 quality of 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

forces without 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

8 main channels where the expenditure should be distributed:

DefenseLaw and orderPublic justicePublic administrationBasic need fulfillmentDakwah activitiesEnjoining right conduct and forbidding wrong.Fulfillment of such socially obligatory duties as the private sector fails to perform.

How Islamic Government Spends?

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-FalahA 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 51

That’s all for today!

THANK YOU FOR

LEND ME YOUR EARS