Chapter 19 Public Finance

19 Public finance

Chapter Nineteen

Public finance

Self-assessment Questions 19.1

Salaries tax is progressive for those taxpayers paying an effective tax rate below the standard tax rate. For these taxpayers, their salaries tax increases proportionately more than their taxable income as taxable income increases. Salaries tax is proportional for those tax-payers paying the standard tax rate (which is 15.5% of their gross salaries in 2003-2004 and 16% in 2004-2005).

19.2

Tax payment will certainly increase with income for progressive and proportional income tax. When income is low, tax payment will also increase with income for regressive tax (see the following diagrams). Tax payment

Tax payment

Progressive

Proportional

T2

T2

T1

T1

Taxable income

Y2

Y1

Tax payment

Y1

Taxable income

Y2

Regressive

T2

T1

Y1

19.3

Y2

Taxable income

The standard tax rate applies to the rich or the high income group. The 2% increase in standard tax will affect the rich but not the poor. Hence, income distribution tends to be more equal.

Multiple Choice Questions 1 6

B D

2 7

A A

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C 43

4

C

5

B

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19 Public finance

1

Reduction in the standard tax rate will not benefit those taxpayers paying an effective tax rate below the standard tax rate. Hence, option (A) is incorrect.

2

Indirect taxes tend to be regressive in nature, which means that the poor will pay relatively more of their income in tax. Hence, an increase in the ratio of indirect taxes in total taxation tends to make income distribution more unequal.

4

Reduction in indirect taxes tends to lower the general price level, helping to check inflation. So (2) is correct.

5

When the government runs into a deficit, it does not mean that it has planned that deficit. Option (A) is wrong.

Short Questions 8(a)

If there is inflation, the increase in indirect tax will only worsen the problem. On the other hand, raising direct tax can help alleviate the problem of inflation by lowering levels of investment and consumption. Direct tax would be the better choice.

8(b)

When there is a recession, the increase in direct tax will worsen the problem because investment and private consumption will be adversely affected. Indirect tax would be a ‘better’ choice.

Structured Essay Question 9(a)(i)

Direct tax is a tax in which the burden is borne by the party being taxed, i.e. it cannot be shifted to a third party. Indirect tax is a tax in which the burden can be shifted from the party being taxed to a third party, usually in the form of higher prices.

9(a)(ii)

Direct tax: (a) and (b) Indirect tax: (c) and (d)

9(b)(i)

Yes. Their tax payment is calculated according to the standard tax rate. They would benefit from a drop in the standard tax rate because it would lower their tax payment.

9(b)(ii)

No. As long as their tax payment is still calculated according to the standard tax rate, they will not benefit from the increase in tax allowances.

9(c)

A drop in profits tax rate raises both the incentive and abilities of firms to invest, so investment will increase. The increase in investment stimulates production and generates income. When people spend their income on goods, production will be further stimulated. This results in an increase in GDP.

9(d)

Taxes on gasoline are regressive because the same amount of tax paid by the poor takes up a larger percentage of their income than that for the rich.

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