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

Y1 Y2 Taxable Y1 Y2 Taxable
income income

Tax payment
Regressive

T2

T1

Y1 Y2 Taxable
income

19.3 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 B 2 A 3 C 4 C 5 B
6 D 7 A
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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.

New Introductory Economics 3rd Edition 44 © Pearson Education Asia Limited 2003
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