PF - QnA

 

Question 1 (20 marks)

A. The government of Malaysia announced that minimum wage should be increased from RM1,200 to RM1,500. How might you expect each of the following to react to such announcement?

i. Someone with an organic conception of the state

Organic concept of the State refers to Individual that is a part of the community and the State is more powerful than them. The common good of the society matters, hence it also determines the good of the individual. State makes the decision that the goals are to attain the societal goals and common goods. For someone with an organic conception of the State, the announcement that the minimum wage should be increased from RM1,200 to RM1,500 will receive positive feedback. This is because this person believes that since the State is powerful and common goods are the goals, thus whatever that the State decides is the best for its people. The increase of the minimum wage will help the society to earn better income and improve their standard of living

ii. A libertarian

A libertarian is a person who strongly emphasize the people ' s liberty whereby he or she believes that people should be free to think, act and decide as they want. The State should not come in between and limit the people ' s liberty. For a libertarian, the announcement that the minimum wage should be increased from RM1,200 to RM1,500 will receive backlashes. Libertarian has a strong value in individual freedom- that seeks to minimise the Government' s power and that the wage rate should be determined by the supply and demand in the labour market instead of by the Government. Libertarian views the minimum wage that sets as a benchmark as a major problem that causes unemployment rates to rise as it makes harder for especially low skilled people to enter the employment.

iii. A social democrat

A social democrat is a person that advocates social democracy in such a way that he/she promotes direct intervention of the Government in the economy. For a social democrat, the announcement that the minimum wage should be increased from RM1,200 to RM1,500 will receive positive feedback. He/she would view this effort as a mean that enables income to be redistributed better which could ensure both the general interest of the people and the Government' s welfare being accommodated. With the policy, inequality and gap between the rich and the poor can be reduced.

 

 

 

 

 

 

 

 

B. What are the main issues and challenges in the Malaysian fiscal policy and according to your view how it could be addressed?

(Note: Provide 3 issues and how these could be addressed?)

 

Answer:

Main issues and challenges	How it could be addressed
1)The fiscal deficit. It happens when the government expenditures exceed their revenue. The emergence of new COVID-19 variants, which is more virulent and contagious has spread over the world. The outbreak has caused high deaths rate globally, let alone the huge number of people loss their job during pandemic. Hence, the percentage of people who need to pay income tax would also decrease, resulting the decline in GDP.  In 2021 Budget, it has been stated that fiscal deficit was reduced to 5.4% of GDP based on the assumption of steady economic recovery in the 2nd half of 2020 and spill over to 2021.   Since there was a reduction in the number of people who have a job (income taxpayers), there would be a significant drop in national income. Hence, there were high expenditure costs due to the implementation of the Movement Control Order (MCO) and the assistance package to regenerate and revival the economy.	Government regenerates the economy in a more orderly and controlled manner. Adding development and infrastructure projects by creating business opportunities as well as generating new employment opportunities encourage foreign investment. Also, government needs to expand the vaccination program.
2) Burden of the debt increasing. §  The burden of the debt is the redistributive effect of debt financing. §  It shifts the burden of taxation from the current generation to future generation, therefore reducing the living standards of future generations. §  While the current generations enjoy a higher utility, the tax burden falls on future generations - they have to pay tax for the debt interest. §  To pay interest on the debt and return the principal, the government usually increases taxes on future generation. §  Taxpayers in the future generation would need to undergo reductions in consumption or saving. §  The future generation will undergo a real reduction of income because they have to pay more in taxes to repay interest, implying a reduction in future living standards. §  In this sense, the burden of the debt does fall on the future generation. §  The burden of the debt is therefore a reduction in welfare for future taxpayers.	To solve this issue, the point below need to be highlighted: §  i. The current generation increase saving. ii. The revenue obtained from the issuance of public debt is used to finance projects that yield future benefits. §  It is efficient to transfer the burden of present expenditures to future generations if the tax shift benefits them. §  Therefore, it is legitimate to finance projects that yield the bulk of their benefits in the future through borrowing. §  In this sense, the postponement of taxes as a result of debt issue is often referred to as “pay-as-you-use” finance.
3) Narrow tax base. Following the replacement of the Goods and Services Tax (GST) by the Sales and Services Tax (SST) in 2018, Malaysia's tax base is reported to be narrow.   This is because when the indirect tax base shrinks, the direct tax rate somehow doesn't rise to pre-GST levels.	We need to reform of indirect taxes on goods and services by implementing GST to our country. By doing this, we can minimize the classification issues and at the same time, we may increase our in tax productivity.

 

 

 

 

 

 

 

 

Question 2 (20 marks)

A. From a public finance point of view, what are the implications of a government budget deficit or a budget surplus? Trace the implications of a government budget deficit/surplus on the following:

i. interest rates

ii. private investment

iii. economic growth

Answer:

Budget Deficit:

§  The mix and quantity of government services and investment depend on the means used to finance such government expenditures.

§  By borrowing rather than taxes to finance government activities, politicians can influence the willingness of voters to vote for increased spending.

§  As such, the political equilibrium quantity of government spending can be affected when we use deficit as opposed to tax finance.

§  Deficit can affect resource allocation the overall size of the government sector in the economy.

§  The initial equilibrium at point E, where the:-

o   interest rate: i1

o   the total quantity of funds borrowed: L1

§  The budget deficit is covered by borrowing and increase in the quantity of loanable funds supplied to the markets.

§  If the government do some borrowing to cover the budget deficit. The increase in demand for loanable funds shift the demand curve from D1 to D1 + ∆DG and increases market interest rates from i1 to i2.

§  The higher interest rate will reduce private investment, economic growth, and future living standards.

§  The increase in the market rate of interest causes the business firms to decrease their demand for quantity of loanable funds from L1 to L. This fund is then reallocated to finance the deficit.

§  Another part of the budget deficit L1 L2 is financed by an increase in the quantity of loanable funds supplied to the markets.

§  Therefore, the budget deficit can be represented by the distance BE’, which is the difference between private borrowing, L, and total borrowing, L2, after the government finances its deficit.

 

 

 

Budget Surplus

∆L

§  When the federal government's budget is in balance or in surplus, the government doesn't need to enter the credit market.

§  When the government has a surplus, it affects the supply of loanable funds available to be used for private investment.

§  If the budget is balanced, the demand for credit will be D and the market equilibrium interest rate will be i1[NABMN1] . ∆L

§  If the government has a surplus and uses it to pay off its existing debt, then the supply of credit will increase from S1 to S' , where S' is equal to S1 + ∆L and ∆L is the amount of government debt being retired.

§  The supply of loanable funds increased as the federal government exchanged bonds for cash.

§  The market equilibrium interest rate decreases from i1 to i2.

§  The quantity of loanable funds demanded for investment and other private borrowing increases from L1 to L2.

§  This helps increase the productivity of future workers and can improve future income and living standards.

 

B. Answer the followings.

i. What is Ricardian equivalence?

Answer:

§  Ricardian equivalence is an economic theory that says that financing government spending out of current taxes or future taxes (and current deficits) will have equivalent effects on the overall economy.

§  Attempts to stimulate an economy by increasing debt-financed government spending will not be effective, because investors and consumers understand that the debt will be paid for in the form of future taxes.

§  People will save based on their expectation of increased future taxes to be levied in order to pay off the debt, this will offset the increase in AD from the increased government spending.

 

ii. Why does it imply that budget deficits cannot influence interest rates?

Answer:

§  The initial equilibrium at point E1, interest rate is r1 and the total quantity of funds borrowed is L1.

§  Government increase borrowing to finance a deficit, increase demand of loanable fund, demand curve shift to the right (D1 → D1+ ∆DG), interest rate increase from r1 to r2. The new equilibrium point is E2.

§  If Ricardian equivalence prevails, increase in government borrowing, exactly offset by an equal reduction in consumption because households will saving to finance higher future taxes.

§  Taxpayer increase their saving to prepare for higher future tax. So, the saving shift the supply curve to the right (S1→S2).

§  Interest rate go back to r1 and the new equilibrium is E3.

§  Changes in government borrowing will be offset by changes in private saving.

§  As a result, no increase in aggregate current spending, no effect on interest rates, no crowding out of private investment, and therefore no reduction economic growth.

 

 

 

 

Question 3 (20 marks)

A. On April 2015, the Government of Malaysia introduced Goods and Services Tax (GST) with a rate of 6%.

i. What type of tax is GST?

§  GST or VAT (Value added taxes) is a consumption tax. Consumers purchase goods with the GST or VAT included in the price.

§  It is a tax on consumption levied on the value added to intermediate products by businesses at each stage of production.

§  Value added is the difference between sales proceeds and purchases of intermediate goods and services over a certain period.

§  Value added =Total transaction – Intermediate transaction = Final Sales =GDP

§  Value added = Wages + interest + rents + depreciation

 

ii. Provide two more types of taxes which could be replace GST.

§  Retail Sales Tax (SST) and Excise.

§  On an ad valorem basis, a retail sales tax is imposed. Typically, the tax is included in the retail price of goods and services. It is only imposed on consumption at the end of the process, and it is collected from businesses that make retail sales. As a result, shops merely serve as go-betweens for consumers and the government when it comes to tax collection.

§  Excise taxes are a sort of tax that is imposed on specific types of consumer activity. Some excise taxes are used to raise money, while others are meant to discourage certain types of consumption. For example, tobacco taxes are enforced to promote a healthy lifestyle while also increasing government revenue.

 

 

 

 

 

B. A furniture manufacturer sells $500,000 worth of tables, chairs, and other items in a given year. The manufacturer earns a profit of $100,000 that year. His purchase invoices indicate that he bought $200,000 worth of lumber, varnish, nails, and other materials during the year. His labor costs were $150,000, and 5 he purchased $50,000 of new equipment that year. Calculate his tax liability under a 15 percent consumption-type value added tax (VAT).

 

Answer:

Given,

Sales = $ 500, 000

Profit = $ 100, 000

Purchase of lumber, varnish, nails, and other materials = $ 200, 000

Labour costs = $ 150, 000

Purchase of new equipment = $ 50, 000

t= rate of taxation = 15 % = 0.15

Hence,

Value added = Sales proceeds - purchases of intermediate goods and services

Value added = Total transaction – Intermediate transaction

= $ 500, 000 - ( $ 200, 000 + $ 150, 000 + $ 50, 000 )

= $ 500, 000 - $ 400, 000

= $ 100, 000

 

Tax Liability = (t) (Value added)

= (0.15) ( $ 100, 000 )

= $ 15, 000

 

Final answer: The furniture manufacturer's tax liability is $ 15, 000.

 

 

 

 

C. Why would replacement of income tax with a consumption tax result in a gain efficiency in investment market, yet a loss in efficiency in labour market?

 

Answer:

§  Income tax is a tax imposed on the income or profits earned by them. The interest in income tax is also taxable.

§  Consumption tax is a tax imposed on the final product of the retail price of goods and consumers need to pay the tax. Consumption tax does not impose a tax on interest.

§  Based on the graph, the income tax shows the net return below the gross return.

§  As the tax base is smaller under a consumption tax compared to income tax.

§  A substitute for consumption tax would make the amount of loan savings in the loanable market increase and make the interest rate lower from r*G to r*.

§  Correspondingly, it lowers the cost of borrowing and increases the investment from Q0 to Q1 to gain efficiency in FGE.

§  In the labour market, the tax base in consumption tax is much higher than income tax to raise the same amount of revenue.

§  Based on the graph, the efficient allocation in the labour market at point B where wages are W0 and labour hours at L1.

§  With the substitution of consumption tax of 125%, the workers need to pay 25% more taxes.

§  Consequently, wages decrease from W0 to W N1 and labour hours from L1 to L2 because it will reduce the incentive to work will cost a further decline in efficiency of labour market

§  The loss efficiency in ABC due to reduction in labour hours reflect back substitution of consumption tax that rise the excess burden in the labour market.

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