Fiscal and Monetary Policies as Constraints to Development: An Exhaustive Study Guide

Clarifying Fiscal and Monetary Policies

• While "fiscal and monetary policy" is often used as a single phrase, the two refer to different aspects of economic policy that have related but distinct impacts on a nation.

• Public Finance Defined: This refers to the income and outgo of a government in pursuit of national objectives. It is the process of generating financial inflows through taxes and revenue and managing outflows through expenditures for goods and services.

• The Public Finance Cycle: This consists of a five-step process:

  1. The formulation of fiscal policy.

  2. The generation of revenue from taxation and other sources.

  3. The expenditure of funds through the national budget.

  4. Public borrowings.

  5. Accountability.

• These processes have significant effects on the economy and can either constrain or accelerate development.

• Fiscal Policy Definition: This refers to the specific mix of policies regarding taxation, other revenue, expenditure, and borrowing intended to promote the stabilization and development of the economy.

• The National Budget: Historically and practically, the national budget is the embodiment of a country's development goals. It explains how these goals are attained through:

  • Identifying specific sources of revenue (tax and non-tax).

  • Specifying proposed expenditures for government programs and projects.

  • Indicating the level of borrowing required to close the gap between revenues and expenditure.

• In the context of the Philippines, the budget is the primary articulation of the national fiscal policy.

• Monetary Policy Definition: This is understood as policy that influences the level of money supply in the economy to attain economic and development objectives.

• Interrelation: Fiscal and monetary policies are different but closely interrelated and must be coordinated. Failure to synchronize them can result in the effects of one policy wiping out the goals achieved by the other.

Fiscal Policy as a Constraint and Historical Influences

• Fiscal policy areas are often dominated by orthodox theories that require significant rethinking regarding tax, revenue, expenditure, and borrowing.

• Stabilization and Structural Adjustment: Since the 1950s, fiscal and monetary policies have been crafted to meet the requirements of stabilization and structural adjustment programs (SAPs) negotiated with the International Monetary Fund (IMF).

• Presidential Decree No. 1177 (PD 1177): A major influence on current Philippine fiscal policy. Promulgated by the late President Ferdinand E. Marcos during his autocratic regime, this decree prescribes the budget process and provides for the automatic appropriation of debt service. It continues to dictate fiscal processes under the current democratic system.

• Freedom from Debt Coalition (FDC): This group wages ongoing opposition to fiscal policies premised on IMF influence and PD 1177.

The "Budget Surplus" Illusion and its Human Costs

• Orthodox View of Balanced Budgets: Standard economic theory holds that a balanced budget (surpluses rather than deficits) is desirable for a developing country. However, attaining a surplus for its own sake can entail extremely high human and development costs.

• The 1994 Surplus Claim: The government claimed a surplus of $P12.3\,\text{billion}$ in 1994, which received widespread praise in media and from commentators.

• The FDC Critique: During a Senate hearing, the FDC argued that this surplus was a "mirage." The purported surplus failed to reflect debt service payments for Central Bank (CB) liabilities that the national government had assumed. These expenditures were treated as "off-budget" items.

• The Real Fiscal Standing of 1994: If the $P21.3\,\text{billion}$ in Central Bank liability payments had been included as a budget item, the government would have incurred a deficit of $P9\,\text{billion}$ instead of the claimed surplus.

• "Failure Masquerading as Success": This description was used by Dr. Benjamin Diokno of the U.P. School of Economics and former Undersecretary of the Department of Budget and Management (DBM) to characterize the 1994 fiscal situation.

• Developmental Costs of Surplus Trajectories: Underspending on infrastructure and social services is unsustainable for countries with ambitious development targets.

• Public Investment Ratios: The ratio of public investment to Gross National Product (GNP) for the Philippines was 4.5% in 1994, compared to 8.5% for Newly Industrialized Countries (NICs). It was estimated that to reach the NIC level, public investments needed to hit $P40\,\text{billion}$ in 1994 alone. Consequently, social and economic development objectives were negatively impacted for the sake of an accounting surplus.

Budget Priorities and Infrastructure Shortfalls

• Real government priorities are declared in the national budget rather than in political speeches.

• Debt Service Priority: Debt service has remained the primary priority item in the Philippine budget, consistently exceeding allocations for economic and social services since 1983.

• Social Allocation Ratio: In 1993, the share of the social services sector in the national budget was 30.1%. This is significantly lower than the United Nations Development Programme (UNDP) target of 40% and lags behind many other Asian countries.

• Health Service Expenditures: While the government takes pride in health accomplishments, the per capita general government expenditure for health was $7.22\,\text{USD}$ in 1993. This falls far short of the $12.61\,\text{USD}$ estimated by the World Bank as the minimum required for a basic package of health interventions that same year.

Policies on Tax and Non-tax Revenues

• Major Revenue Sources:

  1. Tax Revenues: Divided into Direct Taxes (income, wealth, property) and Indirect Taxes (sales, excise tax).

  2. Non-tax Revenues: Include grants, user charges, income from Government Owned and Controlled Corporations (GOCCs), and proceeds from privatization.

• The Reality of Recent Increases: While total revenue has increased, targeted tax revenues have not been met. The Bureau of Treasury reported a tax revenue shortfall of $P1.58\,\text{billion}$ in 1994.

• The Role of Privatization: The impressive revenue increase is largely due to privatization, not taxes. In 1994, while the tax effort improved by only 2.6% in nominal terms, privatization proceeds accounted for 53.8% of total revenues generated from new government measures.

• Sustainability Concerns: Dependence on privatization is not sustainable. Once government assets are sold off, this revenue source will dry up.

• Regressive Taxation: Philippine tax policy is traditionally dependent on indirect taxes. In 1994, indirect taxes accounted for 65.6% of total collections, with direct taxes only providing 34.4%. This regressive system is a legacy of the Marcos years and earlier, and it lacks popular support and commitment because it does not reflect equity or justice.

• Comparison with "Tiger Economies": These successful economies utilize progressive tax systems. While they may increase revenue from indirect taxes, they do so from a foundation that is already progressive. In contrast, the Philippines' imposition of Value Added Tax (VAT) and Expanded Value Added Tax (EVAT) on a system already dominated by indirect taxes enhances its regressiveness.

Monetary Policy as an Economic Constraint

• Monetary policy has been tailored to orthodox IMF requirements through stabilization programs and SAPs. Under these programs, money supply is monitored zealously to prevent inflation.

• The Downside of Monetary Ceilings: Rigid limits on money supply put upward pressure on interest rates. This causes productive investments to contract, hampering development.

• Disproving the Inflation Correlation: Recent studies indicate that high money supply does not necessarily correlate with high inflation in the Philippines:

  • 1992: Money supply growth was restricted to 11%, yet inflation remained high at 8.9%.

  • 1993: Money supply grew by 24.6%, yet inflation was lower at 7.6%.

Challenges to Government Reform

• Challenge 1: Breaking IMF Dependence. The government must extricate fiscal and monetary policies from the control of IMF stabilization programs. The FDC maintains the Philippines does not need these orthodox policies and requires flexibility for innovation in the 21st century.

• Challenge 2: Ending Anachronistic Policies. The government must repeal PD 1177, particularly the provision on automatic appropriation for debt service.

• Challenge 3: Democratizing Policy Formulation. Fiscal and monetary policy should not be the exclusive domain of technocrats. It is an indispensable part of the democratic process.

• The Herring Principle: E. Pendleton Herring (1938) stated that "formulation of fiscal policy lies at the dead center of democratic government." This emphasizes that citizens must participate in decisions regarding taxes, services, and debt burdens.

Rethinking Fiscal and Debt Policy Options

• If PD 1177 is repealed and IMF influence is reduced, the following options are proposed:

  1. Lower Domestic Interest Rates: As the largest domestic debtor ($P661\,\text{billion}$ in Q1 1994), a reduction in interest rates by 1% would reduce debt service by $P6.6\,\text{billion}$.

  2. Domestic Debt Restructuring: Since the bulk of domestic creditors are government financial institutions, the government can restructure this debt.

  3. Negotiate with Japan: Negotiate for the reduction of debt to Japan (the Philippines' #1 creditor), specifically regarding the increase in debt stock caused by currency revaluation, but not the original debt stock.

  4. Relax Fiscal Targets: Allow for higher magnitudes of expenditure and levels of deficit to prevent development expenditures from being "crowded out" by debt service. Expand social services to meet UN standards.

  5. Address Behest Loans: Pursue the issue of behest loans relentlessly and penalize those responsible for fraudulent debt to send a strong signal against corruption.

Orienting Public Spending and Tax Reform

• Correcting Urban Bias: Public spending must be redirected away from the National Capital Region (NCR) to rural areas. This includes implementing GATT safety nets.

• Rural Development Strategies:

  • Build mass transportation and telecommunications infrastructure.

  • Increase credit access by strengthening rural banks through capitalization.

  • Encourage cooperatives.

  • Resolve the irrigation backlog.

• Improving Tax Collection: Experts (Manasan and Llanto) suggest that if only half of existing tax evasion were stopped, the government could raise $P17.6\,\text{billion}$ yearly without new taxes.

• Progressive Tax Reform Agenda:

  • Expand the 20% excise tax on nonessential goods.

  • Implement a 2% affluent consumption tax on residential units worth $P5\,\text{million}$ or more and exclusive club memberships.

  • Impose a 25% land conversion tax on agricultural land converted to non-agricultural use.

  • Increase taxes on high-priced private motor vehicles.

  • Improve real property tax collections through better property valuation.

• Environmental Linkage: Implement higher taxes and penalties for industries that pollute or use energy inefficiently, while providing tax incentives for pollution-free technology and resource efficiency, similar to models used in Europe.

Challenges to Progressive Groups and Future Dialogue

• Progressive groups must also reevaluate their theories regarding budget deficits, money supply, and inflation. In some contexts, deficits may not be bad, and surpluses may not be good.

• Dynamic Debt Analysis: Alternative debt policies must be updated to reflect the changing national debt profile and global developments. The FDC, for example, expanded its framework in 1993 to include an analysis of SAPs.

• Monetary and Foreign Exchange Debate: Continued discussion is needed on foreign exchange (forex) rates, considering the large sector of Overseas Contract Workers (OCWs) whose dependents are affected by forex policy.

• Currency Strength: Groups must investigate if a "strong" currency necessarily denotes a strong economy, citing Japan's economic troubles as a counter-example.

• The Balance of Advocacy: Progressive groups must maintain analytical rigor while pursuing pro-people objectives, balancing technical feasibility with political correctness. The people who bear the cost of financing development must be heard and listened to as the country enters the new millennium.