hkce macroeconomics

CH6-Public Finance By Mr. LAU san-fat1

HKCE Macroeconomics

Chapter 6: Public Finance


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


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.


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


Non-tax Revenue

1. Fines, forfeitures and penalties2. Revenue from properties3. Provisions of public services(utilities)4. Fees and charges5. Land transactions, sales and interest6. Fund revenue

from loan repayments, interest of some government funds


Four Principles of Taxation

1. Equity Everyone should pay taxes in proportion to

his income2. 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


Four Principles of Taxation

4. Convenience The way of collecting tax payments should b

e 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


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


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.


Salaries Tax Assessment (04/05)

Net Chargeable Income*

Rate** Tax

On the 1st 30,000 2% 600

On the next 30,000 8% 2,400On the next 30,000 14% 4,200Remainder 20%

*NCI =Total Income – Deductions – Allowances **Tax rate = tax payment/taxable income


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


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)


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



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 immovabl

e property & shares contracts



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


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.


Progressive Taxes: An Example

Income Tax payment Tax 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%


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.


Proportional Taxes: An Example


$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%


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.


Regressive Taxes: An Example


$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%


Classification of Taxes-Diagrams

Progressive Proportional Regressive




Exercise 3: Textbook/P.150-1/MCQ 4 & Q7.2 & Q7.3


Is Salaries Tax Progressive?

Exercise 4: Textbook/P.152/MCQ 5 & Q7.5

TB/P.152Closer Look


Taxes in HK – A SummaryProgressive Taxes

Proportional Taxes

Regressive Taxes

DirectTaxes

Salaries tax below the standard tax rateEstate duty

Salaries tax at the standard tax rateProfits taxProperty tax

IndirectTaxes

DutiesSales taxesRatesStamp dutiesBetting dutyroyalties


Effects of Taxation

On general price level Direct taxes (salaries tax) reduce one's dispo

sable 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


Effects of Taxation

On standard of living Direct taxes (salaries tax) reduce one's dispo

sable 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.


Effects of Taxation

On investment Direct taxes (profits tax) reduce one's net pro

fits and investment incentive, resulting in less investment.

Indirect taxes (stamp duty) may reduce investment incentives in the real estate market.


Effects of Taxation

On working incentive Direct taxes (salaries tax) reduce one's worki

ng 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


Effects of Taxation

On income distribution Progressive taxes reduce inequality of an ec

onomy 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.


Effects of Taxation

On resources allocation Regressive taxes (sales tax) raise productio

n 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


Effects of Taxation

On undesirable issues Taxes may be used to check against undesira

ble social issues. Example: duties on tobacco raise cigarette pri

ces and thus lowering its consumption.

Exercise 9: Textbook/P.157/Q7.9 Textbook/P.158/Close Look 7.3


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.


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.


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 pr

ofits 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


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


Public Expenditure by Policy Area Group

Major items: Education Housing Social welfare Health

Others: Economics, security, environmental & food,

infrastructure and support.


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.



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.



On Resources Allocation Resources will be directed to a certain

production if the government increases its public expenditure on that area; vice versa.


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


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


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)


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


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.


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


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

hkce macroeconomics

Documents

income tax

partya tax

tax revenuefines

registration tax

servicessales tax

tax payments

standard tax rate

hong kongindirect tax