PUBLIC FINANCE

(International version)

June 2015

Examination Guide

The Examination Guide contains all questions from the June 2015 examination paper
together with the marking scheme answers and comments from the examiner.

The answers detailed below show some but not all possible answers that were
accepted by the marking team. Marks were awarded for other valid answers that
might not be included in this guide.

The Examination Guide has been created and should be used as a study aid.

© 2015 Chartered Institute of Public Finance and Accountancy

PUBLIC FINANCE

(International version)
10 June 2015
Reading time: 10 minutes
Writing time: 3 hours

Instructions to candidates

There are five questions on this question paper

Answer four questions in total

Answer TWO compulsory questions from Section A

Answer TWO from three questions from Section B

All questions carry 25 marks each

All workings should be shown. Where calculations are required using formulae, calculators may
be used but steps in the workings must be shown. Calculations with no evidence of this (for
example, using the scientific functions of calculators) will receive no credit. Programmable
calculators are not permitted in the examinations room.

Formula sheets, pro forma booklets, statistical tables, graph paper and cash analysis paper are
available from the invigilator, where applicable.

Where a question asks for a specific format or style, such as a letter, report or layout of
accounts, marks will be awarded for presentation and written communication.

In this paper the unit of currency used is the pound (£), however the currency itself does not
affect the calculations, and no knowledge of the UK currency or currency market is required.

© 2015 Chartered Institute of Public Finance and Accountancy

 IPFM PF Examination Guide June 2015

SECTION A (Compulsory – answer BOTH questions)

1
Hamchester is a large city based in a unitary state. Hamchester Municipal Authority (HMA) has
responsibility for certain local issues, including local transport and car parking. HMA are keen
to reduce congestion in the city centre. HMA are concerned that if visitors find it too difficult to
get into Hamchester, they will visit other nearby towns or shopping centres instead. In order
to attempt to reduce congestion without reducing the number of visitors, HMA has introduced
a “park-and-ride” scheme. The scheme allows visitors to park outside the city centre. A bus
regularly runs from the park-and-ride car park to take visitors into the city centre. The park-
and-ride scheme is significantly cheaper for drivers than parking in the city centre itself.

HMA’s elected councillors were dismayed to discover that congestion and demand for the city
centre car park had not been noticeably reduced during the first two years of the park-and-
ride scheme. HMA has recently reduced the price of park-and-ride and increased the price of
the city centre car park in an attempt to address these concerns. Throughout this time,
residents’ associations, which represent people living in Hamchester, have campaigned for
better city centre parking. Residents have argued that while the park-and-ride is good for
visitors from outside the city, it is not convenient enough for city residents to use on a regular
basis. Residents’ associations have criticised HMA for prioritising visitors and tourists and
profiting from local people, who don’t have any real choice about parking in the city centre.

The following table shows information on pricing and revenue for the park-and-ride and the
city centre car park (all values are in £, the unit of currency of the unitary state):

Park-and-ride City centre car park

2011 2013 2011 2013
£ £ £ £
Price per day 4.00 2.50 9.00 13.00
Daily revenue 2 400.00 2 162.50 6 525.00 8 580.00

Requirement for question 1

(a) Calculate the price elasticity of demand (PED) for both the park-and-ride
scheme and the city centre car park, clearly stating whether PED is elastic,
inelastic or unit elastic. (6)

(b) Using your results from part (a) discuss possible reasons for the differences
between changes in demand for the park-and-ride scheme and the city centre
car park. (8)

(c) Councillors in Hamchester have long complained that the council struggles to
raise enough revenue to provide their services without significant support
from central government.

i. Explain why it may be appropriate for central government to fund a

significant proportion of local government activity. (4)
ii. Explain the problem this may create for local government when
attempting to raise more revenue from local sources of funding. (4)

(d) Local government in federal states, such as the United States of America, has
much greater legislative powers than local government, such as HMA, in
unitary states. This allows local government in federal states the power to
change some tax laws or the way public sector employees are remunerated.

(3)
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IPFM PF Examination Guide June 2015

Provide three examples of how local government in federal states have

increased taxes and charges or reduced expenditure in order to cope with
reduced funding from higher levels of government.

(25)

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 IPFM PF Examination Guide June 2015

2
Bonneland is a large, industrialised country. In common with many developed countries, as
Bonneland’s economy has strengthened over time, life expectancy for its population has
increased. At the same time, the birth rate in Bonneland has reduced.

Bonneland has a universal state pension system. In addition, Bonneland has a centrally
funded health care system which is free to its citizens at the point of use.

The following table shows information about the expenditure on certain public services in
Bonneland. All figures have been adjusted for inflation and are shown in millions of £ (the
currency of Bonneland).

Year 1973 1993 2013

£m £m £m
Expenditure on social security transfers 105 116 128
Expenditure on health and social care 186 199 214

Requirement for question 2

(a) Explain the following theories which consider the growth of public expenditure
over time:

i. Baumol’s disease (4)

ii. Weak public sector incentives (2)
iii. Public sector supply of luxury goods (2)

(b) Calculate trends in each category of Bonneland’s expenditure over time and,
using the information provided in the scenario, explain the trends. (5)

(c) You are aware that Bonneland has a balanced budget at present. Assuming
no changes in either taxation policy or the level of GDP in Bonneland, explain
whether you would expect Bonneland to be in surplus or deficit in the year
2033. (3)

(d) Bonneland’s government is considering charging for some healthcare services

which are currently provided free at the point of use.

Discuss the reasons why a government may choose to charge for services
rather than fund them through general taxation. (4)

(e) Critics have argued that, rather than charge for services, Bonneland’s
government should target ‘immoral’ tax avoidance by large multinational
corporations.

Explain what is meant by “‘immoral’ tax avoidance by large multinational

corporations” and how the OECD plans to address such tax avoidance. (5)

(25)

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 IPFM PF Examination Guide June 2015

SECTION B (Answer TWO from three questions)

3
Public Private Partnerships have been an attractive method of funding infrastructure
investment in recent years. Governments, such as those in Italy and Spain, have favoured
Public Private Partnerships as a way of improving infrastructure without exceeding debt limits.

Requirement for question 3

(a) Explain what is meant by ‘Public Private Partnership’ (PPP). (1)

(b) The Private Finance Initiative (PFI) is a high-profile form of PPP, used by many
governments as a method of providing public sector assets or infrastructure.

Explain how an asset is procured under PFI, and explain how this differs from
traditional public sector procurement. (7)

(c) i. State three reasons why PFI has been introduced as an alternative to
traditional procurement. (3)

ii. State three criticisms or disadvantages of PFI. (3)

(d) ‘Ability to use to meet wider objectives’ is one criterion against which sources
of financing can be evaluated.

Identify four more criteria that can be used when evaluating sources of
financing and evaluate PPPs against these four criteria. (6)

(e) As an alternative to acquiring an asset through PPP, a public sector entity may
choose to lease an asset.

Using examples as appropriate, explain what is meant by leasing an asset and

differentiate between the two classifications of lease as defined in IAS 17
Leases. (5)

(25)

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 IPFM PF Examination Guide June 2015

4
During recent years, the global economic crisis has thrown a spotlight on different
governments’ attitudes to debt and borrowing. It is therefore important to understand
opposing views on government borrowing, as well as the mechanisms of borrowing.

Requirement for question 4

(a) Explain the difference between ‘automatic stabilisation’ and ‘discretionary

stabilisation’. (6)

(b) Explain why a government may have difficulty in implementing discretionary

stabilisation successfully. (4)

(c) Explain why monetarists would argue that control of inflation is the most
effective method of achieving growth in the economy. (3)

(d) In terms of debt instruments, distinguish between the primary and secondary
market and discuss the implications for liquidity if an instrument is not
tradable on the secondary market. (3)

(e) Define the following terms associated with borrowing:

i. Residual maturity (1)

ii. Euro bonds (1)
iii. Strips (1)
iv. Index-linked bonds (1)

(f) Describe the economic effects associated with a government using bills or
bonds to borrow from overseas. (5)

(25)

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 IPFM PF Examination Guide June 2015

5
While governments can borrow to fund expenditure, loans must ultimately be repaid through
taxation. As taxation is therefore key to supporting government expenditure, it is important to
understand how a government can design an effective tax system.

Requirement for question 5

(a) Define what is meant by a ‘tax base’, giving examples of two tax bases (apart
from income). (3)

(b) i. Explain why an increase in rates of taxation may not necessarily lead
to an increase in net revenue from taxation. (6)
ii. Give an example of a real-world situation where a reduced tax rate led
to an increase in taxation revenue. (2)

(c) Describe two forms of market failure that can be addressed using a tax on
tobacco or alcohol. Explain how taxation can help address both forms of
market failure identified. (5)

(d) Taxation is often justified by the need to correct market failure.

Describe two other reasons why the government has a need to charge
taxation. (4)

(e) Define the terms ‘excise’ and ‘customs duties’ and identify how each is used
to affect economic behaviour. (2)

(f) Higher tax rates are often cited as necessary to reduce a government deficit.

Define the terms ‘public deficit’ and ‘public debt’, explaining the relationship
between them. (3)

(25)

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IPFM PF Exam Guide June 2015

Marking Scheme for question 1

(a)

PED (Park-and-ride):

2011 2013
L£ L£
Price per day 4.00 2.50
Daily revenue 2 400.00 2 162.50

Daily demand (= revenue/price) 600 865 ½

½
Percentage change - L£ (= £1.50/L£4.00) -37.5%

½
Percentage change - demand (= 265/600) 44.2%

PED (= 44.2%/37.5%) 1.18 ½

With a PED of 1.18, demand for the park-and-ride scheme is elastic. 1

PED (city centre car park)

2011 2013
L£ L£
Price per day 9.00 13.00
Daily revenue 6 525.00 8 580.00

Daily demand (= revenue/price) 725 660 ½

½
Percentage change - L£ (= L£4.00/L£9.00) 44.4%

½
Percentage change - demand (= 65/725) -9.0%

PED (= 9.0%/44.4%) 0.20 ½

With a PED of 0.20, demand for the city centre car park is inelastic. 1

(6)

(b) Demand for the city centre car park is inelastic. That is, demand does not drop in
proportion to an increase in price. Demand for the park-and-ride is elastic. That is,
demand increases more than proportionately to a reduction in price.
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IPFM PF Exam Guide June 2015

(2)

PED theory suggests that demand will be inelastic when there is a lack of close
substitutes. According to residents’ associations, local people who use the city centre car
park value its convenience so highly that they do not see the park-and-ride as a viable
alternative. However, visitors to Hamchester do have alternatives. There are several
nearby towns and shopping centres to visit instead of Hamchester. It is likely that the
reduced price of the park-and-ride has attracted visitors in who otherwise were visiting
other places.

(up to 3 marks for a strong discussion of substitutes)

PED theory also suggests that demand will be inelastic for goods that are considered
essential. Local people are likely to have some need to visit their own city centre that
can’t be avoided (for example, to complete small shopping trips that are too small to
practically be conducted elsewhere). Therefore, their demand for the car park is likely to
remain constant in spite of the price change. However, visitors, who are more likely to
use the park-and-ride, are less likely to have a pressing need to visit Hamchester.
Therefore, when the cost of the park-and-ride is too high, they simply won’t visit, leading
to elastic demand for the park-and-ride.

(up to 3 marks for a strong discussion of essential vs. luxury goods)

Finally, PED theory suggests that demand will be inelastic when decisions are not price-
related. For local people who need to get into the city centre regularly, the additional
time it would take to drive away from the city centre to the park-and-ride then wait for a
bus back into the city centre is likely to be off-putting. Locals will continue to use the city
centre car park regardless of price to save time. However, visitors, who make the
journey less often, are less likely to find the extra time taken to use the park-and-ride an
issue since it will not interrupt their plans regularly.

(up to 3 marks for a strong discussion of non-price related decisions)

Maximum of (8)

(ci) The reasons in support of central government funding for local government include:

• the support of certain services, for example education, which are of importance to
the country as a whole;
• to enable local authorities to provide a similar range and standard of service across
the country as a whole without large variations in local taxation;
• redistribution of funds from the more wealthy parts of the country to the less
wealthy;
• to subsidise local tax payers from general taxation;
• to influence local government spending on some services;
• to allow implementation of central government policy; and
• to ‘pump prime’ local activity by providing targeted support to new projects while
they are being established.

1 mark per point to maximum of (4)

(cii) Heavy reliance on central government will create the Gearing Effect. Central government
grant receipts will typically be fixed. Where a local authority wishes to raise more
revenue, this will need to be raised locally. This can mean that a relatively small
percentage increase in the overall budget for the local authority is only achievable by a
large increase in locally raised funds, such as charges in the case of Hamchester.

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IPFM PF Exam Guide June 2015

Such an increase can prove problematic for local councillors as the local population may
criticise the authority for additional taxes or charges without understanding that the
increase is necessary due to the inflexible amount of central government grant. That is,
local politicians may be criticised for central government policy.

Up to 2 marks for explanation of gearing effect, up to 2 marks for discussion of problematic

nature (4)

(d) Examples include:

• Levies on hotel room stays in Las Vegas and New York;

• Increased charges for refuse collection in Detroit;
• Reduced public sector benefits (e.g. health insurance and pensions) in Detroit;
• Redundancies in Harrisburg.

Other valid examples, including examples from other countries, are acceptable.
1 mark per example to maximum of (3)

(25)

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IPFM PF Exam Guide June 2015

Examiner’s comments on question 1

All candidates attempted this question, but on average it was the worst answered question,
largely due to part b.

Part a was well attempted, with many candidates receiving full marks. The most common error
was for candidates to attempt to find the percentage change in demand using the revenue
figures, rather than dividing revenue by price to find demand first.

Part b provided the most disappointing answers of the paper; candidates’ ability to apply
knowledge to a scenario appeared weak. Candidates seemed unable to identify the clues in the
scenario that would help them here, such as residents’ complaints that the park and ride is not
convenient enough, or the fact that there are alternative places for visitors to go if the park
and ride is too expensive. Candidates preparing for future exams are strongly advised to
practise more of this style of question.

Part ci was well answered; part cii less so. Within cii, some candidates made valid points
without mentioning the gearing effect, including the lack of buoyancy of typical local taxes.
However, to perform well in this requirement, candidates did need to identify the problems
caused by the gearing effect. Many candidates correctly identified the gearing effect as
relevant, but far fewer explained why the gearing effect would be problematic (e.g. local
politicians criticised unfairly). Candidates should make sure that they pay attention to the mark
allocation. Two sentences are not going to be enough for four marks.
Part d was reasonably well attempted. Although we were expecting to see real life examples
given here, marks were awarded for more generic suggestions as the requirement did not
specifically ask for “real world” examples. We would recommend that candidates do try to
make use of the real life examples given in the learning materials and wider experience when
responding to a question like this.

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IPFM PF Exam Guide June 2015

Marking scheme for question 2

(ai) Baumol’s disease explains that the cost of supplying public services may increase over
time. Baumol argued that productive activities can be divided into technologically
progressive (TP) or non-technologically progressive (NTP).

(1)

Technologically progressive activities are typically capital intensive. As technology

improves, it is possible for TP activities to become more productive over time. Wages are
likely to rise in response to the increase in productivity.

(up to 2 marks for a discussion of TP)

Conversely, non-technologically progressive activities are labour intensive. As such, it is

not likely that productivity can increase over time (tutorial note – Baumol gave the
example of a string quartet. It will take four players the same amount of time to perform
a piece now as it would have done 200 years ago). However, wages in NTP activities will
rise in line with wages in TP activities, otherwise staff would simply leave NTP work to
obtain high paid jobs in TP activities. Baumol argued that the public sector was
disproportionately non-technologically progressive, therefore over time faces a higher
wage bill with no corresponding increase in productivity.

(up to 2 marks for a discussion of NTP. 1 mark for conclusion)

Maximum of (4)

(aii) Weak public sector incentives can increase the cost of supplying public services over
time. It is argued that the public sector does not face competition or the need to
generate a profit. Therefore, public sector entities do not have an incentive to control
costs. As a result, public sector activity can become more expensive over time.

1 mark per point to maximum of (2)

(aiii) As an economy develops and citizens have more disposable income, demand for luxury
goods increases. It is argued that luxury goods are disproportionately provided by the
public sector (e.g. libraries, universities, leisure services). As voters demand more
luxuries from the public sector, the cost of public services increases over time.

1 mark per point to maximum of (2)

(b)

Trends in social security expenditure:

1973 1993 2013

Expenditure on social security transfers 105£ 116£ 128£
Growth on 1973 - 10.48% 21.90%
OR Growth on the previous period - 10.48% 10.34%

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Trends in health and social care expenditure:

1973 1993 2013

Expenditure on health and social care 186£ 199£ 214£
Growth on 1973 - 6.99% 15.05%
OR Growth on the previous period - 6.99% 7.54%

1 mark per pair of percentages calculated to maximum of (2)

Bonneland’s expenditure on social security transfers has increased over time. This
increase is likely to have partially been caused by the ageing population, since this
category of expenditure will include pensions. As life expectancy increase, there is a
greater demand for pension payments.

(½ mark for identification of trend, 1 mark for explanation)

Bonneland’s expenditure on health and social care has also increased over time. Again,
this is likely to be due to the ageing population. As people age, they are more likely to
need health and social care.

(½ mark for identification of trend, 1 mark for explanation)

Maximum of (3)

(5)

(c) Assuming no changes in taxation or economic growth, Bonneland would be expected to

be in deficit in the year 2033. As noted above, Bonneland’s ageing population is
increasing pressure on public expenditure – this would be expected to continue as life
expectancies continue to grow. At the same time, as the birth rate is low, there will be
fewer people of working age than at present. Therefore, tax revenues are likely to fall as
the workforce declines.

1 mark per point to maximum of (3)

(d) A government may decide to charge for certain services for the following reasons:

• Equity – relating payment to benefits. If there is a charge for a service, non-users

will not be expected to contribute to the service through general taxation. Only those
using the service have to pay for it.
• Economy. Charges discourage wastage. Users are more likely to be careful/less
wasteful with a service they have to pay for than for a service which is free at the
point of delivery.
• Rationing. If users must pay to use a service, only those who truly value the service
will use it. Providing services free at the point of use can lead to oversupply.
• Accountability. If a user has to pay for a service, the user is more likely to hold the
provider to account for poor service delivery.

1 mark per point to maximum of (4)

(e) ‘Immoral’ tax avoidance refers to the practice of some multinational corporations of
exploiting variations in tax law in different jurisdictions to minimise tax payments. Such
practices can involve creating offshore companies to take advantage of low-tax countries
while recording expenses and losses in high-tax countries. While technically not illegal,

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IPFM PF Exam Guide June 2015

this behaviour has been criticised for giving large companies an unfair advantage over
small companies. Multinationals that adopt such practices have been accused of
undermining the international tax system and paying an unfairly low amount of tax.

(Up to 3 marks for discussion of “immoral” tax avoidance, including marks for appropriate
examples)

The OECD has reported on this issue. The report, Addressing base erosion and profit
shifting, called for governments and businesses to quantify how much is lost through tax
avoidance. The OECD did not, however, recommend an optimal corporation tax rate.

(2)

Maximum of (5)

(25)

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IPFM PF Exam Guide June 2015

Examiner’s comments on question 2

Though not all students attempted this question it was on average better answered than
question 1.

Part a was well attempted. In particular, we saw many excellent explanations of Baumol’s
disease. Candidates would do better by concentrating on the wording of the requirement. For
example, many candidates explained in part aii how the public sector has weaker incentives
without linking this to growing public expenditure. Similarly, in part aiii candidates were able to
explain why expenditure on luxury goods is growing in general, but few linked this to public
sector expenditure.

Answers to Part b were more mixed. Most candidates produced accurate calculations.
However, a worrying minority of candidates stated that expenditure on social security
decreased from 1993 to 2013 (due to 10.34% being lower than 10.48%). Candidates should
be clear that these figures indicate growth, albeit at a slightly lower rate than between 1973
and 1993. The explanations were the worst handled aspect of this question. This question was
testing whether candidates knew how expenditure would be classified according to the IMF;
very few candidates were aware that a pension payment would be classified as a social benefit.

Part c required candidates to use their initiative. Most candidates seemed uncomfortable with
this, again probably because application of knowledge was required. The clues were in the
scenario; with a growing elderly population (and the associated health and pension costs) and
a lower birth rate (therefore a smaller working population to pay tax in 2033), a deficit would
be expected. Once again, we would recommend that candidates prepare with application style
questions as well as knowledge-based questions.

Part d was well attempted.

In part e, many candidates were able to discuss the concept of tax avoidance, and what might
make this “immoral”. Fewer were able to discuss the OECD’s response. Again, we would advise
candidates to make the most of the real life case studies, for example from the learning
materials, when preparing for this paper.

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Marking scheme for question 3

(a) ‘Public Private Partnership’ refers to collaborative activity between public and private
sector organisations. The focus of PPPs is often to bring private finance and knowledge
into public service provision.
(1 mark)

(b) Under PFI, an asset is procured as follows:

• The public sector entity sets out the outputs required from the asset.
• The private sector entities proposed ideas to achieve the required outputs.
• The best idea is selected using value for money criteria.
• The private sector designs, finances and builds the asset.
• The private sector retains responsibility for (and may operate) the asset.
• The public sector entity makes an annual payment for the use of the asset.

This differs from traditional procurement in the following ways:

• In traditional procurement, the public sector outline the asset that is required, rather
than requesting suggestions or ideas from the private sector;
• In traditional procurement, the public sector make payments for the asset as it is
built rather than annually following completion;
• In traditional procurement, the public sector takes responsibility for the asset once it
is completed.

Up to 4 marks for explanation of PFI, up to 3 marks for differences with traditional

procurement. Maximum of (7)

(ci) PFI was originally introduced for the following reasons:

• The involvement of private sector entities was intended to create efficiencies and
economies of scale, due to fewer restrictions on procurement and reduced
bureaucracy in the private sector.
• PFI can allow private sector knowledge and expertise to be utilised in the building
and construction of a public sector asset.
• PFI can allow risks of a project to be shared across the public and the private sector.

(1 mark per point, up to a maximum of 3. Marks will be awarded for other reasonable
suggestions.)

(cii) PFI has been criticised for the following reasons:

• A lack of transparency. As assets and liabilities are off-balance sheet, it is difficult to

assess the liabilities faced by the public sector.
• A lack of value for money. PFI arrangements make it difficult to establish the level of
profits made by the private sector.
• Risk transfer. Public sector entities have often found they have paid a high premium
to transfer risks to the private sector. Experience has shown that, in the event of a
failure of a private sector entity, the public sector is still exposed to risks. Therefore,
it can provide poor value for money to pay an excessive premium to transfer risks
from the public sector to the private sector.

(1 mark per point, up to a maximum of 3. Marks will be awarded for other reasonable
suggestions.)

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IPFM PF Exam Guide June 2015

(d)

Criteria Evaluation of PPP

Financial cost PPPs should offer value for money and
therefore should appear attractive on
financial cost. However, many have raised
concerns about the long term cost of PPPs
(particularly PFIs), as lack of transparency
can hide the amount of profit made by
private partners.
Flexible in use PPPs are only suitable for large capital
projects, therefore lack flexibility in use.
Flexible in availability Negotiation around PPPs can ensure that
financing can be used flexibly.
Administrative complexity PPPs can be highly complex in terms of
establishing the PPP and monitoring
ongoing PPPs.
Political attractiveness Political attractiveness may vary depending
on the organisation’s stance. However, as
PPPs and PFIs begin to appear more
expensive, it is likely they will become less
politically attractive.

(½ mark per criteria identified, up to 1 mark per point on evaluation of PPP. 6 marks
maximum)

(e) When leasing an asset, an organisation makes a series of payments for the right to use the
asset. The organisation may or may not obtain the legal title to the asset at the end of the
lease term.

The two classifications of lease per IAS 17 Leases are finance lease and operating lease. A
finance lease is a lease where substantially all the risks and rewards of ownership of the
asset are transferred to the lessee. For example, the lessee may be responsible for
insuring or maintaining the asset. Situations that would normally lead to a lease being
classified as a finance lease include:
• Ownership of the asset transfers to the lessee at the end of the lease term;
• The lessee has the option of purchasing the asset or continuing the lease for a reduced
rate at the end of the lease term;
• The present value of the minimum lease payments are substantially all of the fair value
of the asset at the inception of the lease.

A lease that does not transfer significantly all the risks and rewards of ownership to the
lessee would be classified as a finance lease.

1 mark per point to maximum of (5)

(Total available: 25)

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Examiner’s comments on question 3

This was the least popular question on the paper, attempted by only 52% of students.
However, on average it was generally well answered. It would only be advisable to attempt
this question if the candidate felt they knew the process for procuring an asset, both
traditionally and using PFI. Candidates appeared to sense this; we saw some excellent answers
to part b of this question.

Part c was reasonably well attempted. Where candidates lost marks it was more often than not
due to a lack of detail in their answer. Candidates are advised to be realistic when responding
to a question like this – we did see some candidates suggest that PFI is beneficial due to its
lack of bureaucracy. While it may be true that private sector companies enjoy less bureaucracy
than a public sector entity, we were unconvinced that this inherently means that PFI lacks
bureaucracy.

Part d was the lowest scoring requirement within this question for most candidates. Many
candidates were able to suggest four criteria. However, very few were able to evaluate PPP
against these criteria. Some candidates simply defined the criteria and did not attempt to
evaluate PPP, others attempted to explain how the criteria could be satisfied (for example,
stating that a PPP should be politically attractive before being accepted, rather than evaluating
whether PPP is politically attractive). Once again, we would recommend that candidates read
the requirement carefully and respond to what is being asked.

Part e was generally well attempted. The most common error was to insist that ownership of
an asset must transfer to the lessee at the end of the lease term in order for the lease to be a
finance lease. If ownership does transfer, it is likely that the lease will be a finance lease.
However, transfer of ownership is not a requirement for a lease to be classified as a finance
lease.

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Marking scheme for question 4

(a) Automatic stabilisation occurs naturally. As an economy grows, more people are
employed and consumer demand is higher. As a result, the government receives more
income through taxation. At the same time, fewer people are unemployed, therefore
government expenditure on benefits is lower. With higher taxation and lower government
expenditure during a period of growth, automatic stabilisation automatically acts as a
brake on growth. The opposite is true during a period of downturn in the economy.

(up to 3 marks for a discussion of automatic stabilisation)

Discretionary stabilisation occurs when the government attempts to use fiscal policy to
exacerbate the effect of automatic stabilisation. That is, the government will deliberately
attempt to increase taxation and reduce expenditure during a period of growth in an
attempt to smooth the economic cycle. The opposite is true during a recession. During a
period of growth, the government may increase tax rates. During a downturn in the
economy, the government may reduce tax rates and increase expenditure on benefits or
infrastructure projects.

(up to 3 marks for a discussion of discretionary stabilisation)

Maximum of (6)

(b) Governments may have difficulty implementing discretionary stabilisation successfully for
the following reasons:

• It can be difficult to know exactly where the economy is in terms of upturns and
downturns, therefore difficult to decide whether it is the correct time to tax or spend.
• It can be difficult to predict the outcome of a particular change in fiscal policy.
• Politically, a government may feel unable to adopt what it feels is the correct fiscal
policy at a particular point in time. For example, a government may feel it cannot
increase tax to control a boom in the run-up to an election.
• Excessive government borrowing to fund fiscal policy could lead to inflation.

1 mark per point to maximum of (4)

(c) Monetarism argues that where a country has a lower inflation rate than its major
international competitors, its products would be relatively cheaper than products in other
countries. Therefore, exports would rise as other countries demand the relatively cheaper
products. Imports would fall as products from overseas become relatively more
expensive, leading to a fall in demand for products from overseas.

(up to 2 marks for an explanation of international impact of inflation)

Exporting more and importing less would mean domestic employment and economic
growth would rise.

(1)

Maximum of (3)

(d) The primary market is where new debt instruments are issued. The secondary market is
where existing debt instruments can be traded before they reach their maturity. The
liquidity of an instrument refers to the ease with which an instrument can be converted
into cash without incurring a significant capital loss.
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IPFM PF Exam Guide June 2015

(½ mark per definition, 1½ marks in total)

If an instrument is not tradable on a secondary market, it is much less liquid than a

transferrable asset. The holder is unable to sell the debt instrument, thus release cash,
before the instrument’s maturity date.

(Up to 1½ marks for implications for liquidity)

Maximum of (3)

(ei) Residual maturity is the period before an existing bond is due to be redeemed.

(1 mark)

(eii) Euro bonds are bonds issued in Euros. Strictly, Euro bonds should be issued in a country
in the Eurozone.

(1 mark)

(eiii) Strips are instruments where the coupon payments can be “stripped” and traded
separately from the redemption value. Each coupon payment can be sold separately.

(1 mark)

(eiv) Index-linked bonds are those where the coupon payments and redemption value of the
bond are uplifted in line with inflation.

(1 mark)

(f) The main economic effect of borrowing from overseas is the detrimental impact on the
exchange rate. In order to buy bonds or bills, overseas investors must first buy the
national currency. This increased demand for currency strengthens the exchange rate.

(1)

As a result, domestic suppliers will export less, due to their products becoming relatively
more expensive. Rather, the country will import more to take advantage of relatively
cheaper prices from overseas. This will slow down domestic economic activity.

(1)

In time, after a period in which exports fall and imports rise, the exchange rate will tend
to fall to a new equilibrium and address some of the imbalances. However, there is a risk
that the loss in domestic capacity is permanent, as some firms may go out of business
when export orders reduce.

(up to 2 marks for explanation of longer term effects)

The more minor impact of borrowing from overseas is the fact that interest payments
would go abroad.
(1)

Maximum of (5)

(25)

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IPFM PF Exam Guide June 2015

Examiner’s comments on question 4

Only 56% of students attempted this question, and on average it was the second worst
answered question.

Part a yielded many accurate, if brief, responses. Candidates are reminded that they should
match the detail in their answer to the marks on offer.

Part b was less well answered. This question was set to determine whether candidates
understood the reasons why governments have generally moved away from the Keynesian
approach to economics. As well as just learning the different economic attitudes and
approaches to debt financing, candidates are reminded that it is also important to understand
the context in which attitudes to debt evolved.

Part c was often well answered. The significant minority of candidates who did not score well in
this requirement seemed to have misread the question, and described how monetarists
attempt to control the money supply.

Parts d and e were well answered. However, part f seemed problematic for some. Candidates
with the correct answer often did not include enough detail in their response. A significant
minority of candidates attempted to explain the economic impact of issuing treasury bills or
bonds, ignoring the overseas aspect to the requirement. Again, candidates are reminded to
read the requirement carefully and make sure they’re answering the question that has been
set rather than the question they’d perhaps prefer to answer.

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IPFM PF Exam Guide June 2015

Marking scheme for question 5

(a) A tax base is an activity or event upon which tax is levied. Examples include:
• consumption, e.g. value added tax;
• gains on the disposal of property, e.g. capital gains tax.

1 mark per point to maximum of (3)

(bi) Increased rates of taxation may lead to reduced tax revenue for the following reasons:

• Higher rates of taxation create greater incentives for avoidance and evasion, which
reduce the amount of tax collected.

(1)

• This can include “capital flight”, where wealthy individuals or companies remove
themselves and/or their wealth to another jurisdiction where the tax rates are lower.

(1)

• Greater incidence of avoidance and evasion require the tax administration authorities to
engage in greater audit and investigation activities and to design more administrative
and statutory measures to counter avoidance and evasion. Such extra measures
increase administration costs and therefore reduce net tax revenue.

(2)

• Higher rates of taxation create disincentives for individuals and businesses to engage in
those activities that are taxed because of the reduction in the net benefit they receive.
This can result in a reduction in the size of the tax base, therefore less tax revenue is
collected.

(2)

• Where the costs of tax are passed on to the customer via an increase in prices, higher
tax rates may result in reductions in demand and so reduce tax revenues.

(1)

Maximum of (6)

(bii) Tax cuts by the Reagan administration in the early 1980s led to an increase in taxation
revenues. A 25% across-the-board cut in personal marginal tax rates resulted in an
increase in tax revenues due to greater investment and economic activity, and an
increase in the proportion of personal taxes paid by the wealthiest members of the
population.

1 mark per point to maximum of (2)

(c) Tobacco and alcohol both create negative externalities. That is, tobacco and alcohol are
associated with negative side effects that are costs to society rather than the individual
consumer (for example, additional costs associated with health care). Taxation is used to
increase the cost of goods with negative externalities to discourage consumption and
contribute towards the social cost of the negative externality.
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IPFM PF Exam Guide June 2015

(½ mark for identification of negative externalities, up to 2 marks for discussion)

Tobacco and alcohol are also demerit goods. That is, the government considers the
consumption of the goods undesirable since the goods are harmful to the individual
consumer. At market prices, consumers would consume more tobacco and alcohol than is
desirable. Tax can increase the price of the goods and therefore reduce consumption.

(½ mark for identification of demerit goods, up to 2 marks for discussion)

Maximum of (5)

(d) Firstly, the government may use taxation to redistribute wealth. Households and
individuals with higher incomes are charged taxation, which is redistributed to lower
income households and individuals. Redistribution can reduce damaging inequalities in
society and reduce deprivation amongst vulnerable individuals and households.

Secondly, the government may use taxation to stabilise the economy. By charging
additional tax or increasing tax rates during a period of economic growth, the
government can calm the period of growth. This can avoid creating a “bubble” in the
economy.

Up to 2 marks for discussion of redistribution, up to 2 marks for discussion of stabilisation

to maximum of (4)

(e) Excise is an internal tax on the sale or production of a good. Excise is often used to
discourage the consumption of demerit goods or goods with negative externalities.

Customs duties apply to the import (or, rarely, export) of certain goods. Customs duties
are often used to discourage the import of goods in support of domestic producers.

1 mark per point to maximum of (2)

(f) The public deficit represents a shortfall (short or long term) between expenditure and
revenue. Any cash deficit will need to be made up by borrowing, otherwise the
government will be unable to finance its activities and honour its commitments. A cash
surplus on the other hand would allow cash reserves to be built up or debt redeemed.

(up to 2 marks for discussion of public deficit)

Public debt represents a stock of past borrowings that have yet to be repaid. Thus
government borrowing adds to outstanding public sector debt. The government pays
interest on the debt until it is repaid.

(1)

Maximum of (3)

(25)

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IPFM PF Exam Guide June 2015

Examiner’s comments on question 5

89% of candidates answered this question and it proved on average to be the best answered
question on the paper.

To perform better on a question like this, candidates should aim to include a little more detail
in their responses, but the level of knowledge shown was high.

Parts a, b and c were well attempted. Local examples were awarded credit in part bii. Several
candidates offered generic, rather than real world, examples in bii. These examples were not
awarded marks as the requirement specifically requested a real world example.

Part d provided the first major stumbling block in question 5 as a significant minority of
candidates simply offered two examples of market failure that hadn’t been mentioned in part
c. These examples were not awarded any marks as the question made clear we were looking
for reasons for taxation other than market failure.

Part e was well handled; where candidates lost marks it was generally because they hadn’t
explained why the tax was levied.

Part f was generally well attempted. However, many candidates undermined their own
response by suggesting that a deficit could be fulfilled by borrowing or taxation. This
undermined explanations that a deficit would exist if taxation was insufficient to fund
expenditure.

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IPFM PF Exam Guide June 2015

Summary

Performance was generally considered to be good on this paper. Comments below, designed to
encourage even stronger results in future, should be viewed in that context.

A number of candidates included mini-introductions in their answers (e.g. repeating or

rephrasing the requirement). Candidates should note that this is not required. Where
candidates did include mini-introductions, for which no marks are awarded, it was often clear
that the candidate was running out of time and therefore unable to make sufficient mark-
scoring points towards the end of their script. Candidates should get straight to the point when
answering requirements, which should help to reduce pressure on time.

While we were impressed at the overall quality of the work, there was a clear divide between
questions that asked candidates to simply recall information and questions that required
application of knowledge. Candidates’ level of knowledge appeared to be high, with some very
impressive answers to the knowledge-based requirements. Where candidates scored poorly on
knowledge-based requirements, it was usually due to a lack of detail in their answer rather
than a lack of knowledge. However, on the whole, candidates appeared to struggle when being
required to apply this knowledge to a scenario, for example in Question 1b or Question 2b.
Candidates should note that the ability to apply knowledge to a scenario is crucial, therefore
any candidates attempting this paper in the future should make sure they include plenty of
scenario-based question practice in their preparations.

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