HKCE Macroeconomics
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Chapter 6: Public Finance
CH6-Public Finance
By Mr. LAU san-fat
Major Ideas
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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 Finance
By Mr. LAU san-fat
Meaning of Public Finance
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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 Finance
By Mr. LAU san-fat
Sources of Government Revenue
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Tax revenue
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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 Finance
By Mr. LAU san-fat
Non-tax Revenue
1.
2.
3.
4.
5.
6.
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
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CH6-Public Finance
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
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CH6-Public Finance
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
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CH6-Public Finance
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
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CH6-Public Finance
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.
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CH6-Public Finance
By Mr. LAU san-fat
Salaries Tax Assessment (04/05)
On the 1st
On the next
On the next
Net Chargeable
Income*
30,000
Rate**
Tax
2%
600
30,000
30,000
8%
14%
2,400
4,200
Remainder
20%
 *NCI =Total Income – Deductions – Allowances
 **Tax rate = tax payment/taxable income
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CH6-Public Finance
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
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CH6-Public Finance
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)
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CH6-Public Finance
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
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CH6-Public Finance
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
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CH6-Public Finance
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
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CH6-Public Finance
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.
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CH6-Public Finance
By Mr. LAU san-fat
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%
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CH6-Public Finance
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.
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CH6-Public Finance
By Mr. LAU san-fat
Proportional Taxes: An Example
Income
Tax payment
Tax 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%
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CH6-Public Finance
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.
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CH6-Public Finance
By Mr. LAU san-fat
Regressive Taxes: An Example
Income
Tax payment
Tax 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%
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CH6-Public Finance
By Mr. LAU san-fat
Classification of Taxes-Diagrams
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Progressive
Proportional
CH6-Public Finance
Regressive
By Mr. LAU san-fat
Classification of Taxes-Diagrams
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Progressive
Proportional
CH6-Public Finance
Regressive
By Mr. LAU san-fat
Classification of Taxes-Diagrams
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Progressive
Proportional
Regressive
 Exercise 3: Textbook/P.150-1/MCQ 4 & Q7.2 &
Q7.3
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CH6-Public Finance
By Mr. LAU san-fat
Is Salaries Tax Progressive?
TB/P.152
Closer Look
 Exercise 4: Textbook/P.152/MCQ 5 & Q7.5
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CH6-Public Finance
By Mr. LAU san-fat
Taxes in HK – A Summary
Progressive Proportional Regressive
Taxes
Taxes
Taxes
Direct
Taxes
Salaries
tax
below the
standard tax
rate
Estate duty
Salaries
tax at
the standard
tax rate
Profits tax
Property tax
Duties
Indirect
Taxes
Sales
taxes
Rates
Stamp
duties
Betting duty
royalties
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CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On general price level
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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
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CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On general price level
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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
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CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On standard of living
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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 Finance
By Mr. LAU san-fat
Effects of Taxation
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On investment
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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 Finance
By Mr. LAU san-fat
Effects of Taxation
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On working incentive
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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
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CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On income distribution
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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 Finance
By Mr. LAU san-fat
Effects of Taxation
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On resources allocation
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Regressive taxes (sales tax) raise
production cost and reduce supply, thus redirecting the flow of resources away from that
production.
Exercise 7: Textbook/P.156/MCQs 7 & 8
Exercise 8: Textbook/P.156/Q7.8
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CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On undesirable issues
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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
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CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On economic growth and employment
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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 Finance
By Mr. LAU san-fat
Effects of Taxation
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On capital flow
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The higher the profits tax rate, the more the
capital outflow will be as investors' net profits
get smaller, vice versa.
CH6-Public Finance
By Mr. LAU san-fat
Effects of Taxation
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On government revenue
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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
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CH6-Public Finance
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
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CH6-Public Finance
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.
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CH6-Public Finance
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.
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CH6-Public Finance
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.
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CH6-Public Finance
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.
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CH6-Public Finance
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
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CH6-Public Finance
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
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CH6-Public Finance
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)
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CH6-Public Finance
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
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CH6-Public Finance
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.
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CH6-Public Finance
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
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CH6-Public Finance
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 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
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CH6-Public Finance
By Mr. LAU san-fat