Economic Development - Fiscal Policy

Economic Development

Fiscal Policy

What is Fiscal Policy?

• Definition: Government use of taxes, spending, and borrowing to influence the economy.

• Tools:

  • Spending: Investments in infrastructure (roads, bridges, public transport), education (schools, universities, training programs), and healthcare (hospitals, clinics, health insurance).

  • Taxes: Collection of revenue through income tax, value-added tax (VAT), and tariffs on imports.

  • Borrowing: Issuance of domestic bonds to local investors and securing foreign loans from international institutions.

• Flow of Funds:

  • Taxpayers contribute taxes, which the government uses for public services, leading to economic growth:
    Taxpayers \rightarrow Government \rightarrow Public Services \rightarrow Economic Growth

Expansionary vs Contractionary Fiscal Policy

Philippine Fiscal Snapshot (2023)

• Revenue: ₱3.8T (15% of GDP).

• Spending: ₱5.3T (20% of GDP).

• Deficit: ₱1.5T (5% of GDP).

• Debt-to-GDP Ratio: 60%.

Philippine Revenues, Spending, and Deficit (2010-2024) in Trillions PHP

Philippine GDP vs. National Debt (2010-2024) in Trillions PHP

• Debt-to-GDP Ratio Formula: (National Debt / GDP) \times 100.

• 2024 Data: Projections based on the Medium-Term Fiscal Framework (MTFF).

• Real Data Sources: Bureau of the Treasury, PSA.

Sources of Philippine Revenue

• Tax Revenue (85%):

  • BIR: ₱2.5T (income tax, VAT).

  • BOC: ₱1T (tariffs).

• Non-Tax Revenue (15%): Fees, privatization (e.g., NAIA rehab).

Spending Priorities

Key Challenges

1. Tax Evasion: ₱300B lost annually.

2. Spending Delays: 25% of infra funds unspent (2022).

3. Debt Burden: ₱1.6T allocated to interest payments (2024).

4. Regressive Taxes: Poor pay 20% of income in VAT vs. rich (5%).

Recent Reforms

• TRAIN Law (2017): Lowered income tax but raised fuel prices.

• CREATE Law (2021): Corporate tax cut (30% → 20% for SMEs).

• Ease of Paying Taxes Act (2023): Simplified filing.

Case Study – COVID-19 Response

• Bayanihan Acts: ₱1.3T stimulus (health, cash aid, SMEs).

• Outcome: GDP recovery (5.6% growth in 2022) but debt surged to 66% of GDP.

• Timeline: 2020 (lockdown) → 2021 (vaccines) → 2022 (reopening).

ASEAN Comparison

• Tax/GDP: PH (15%) vs. Thailand (17%) vs. Malaysia (12%).

• Debt/GDP: PH (60%) vs. Indonesia (40%) vs. Singapore (150%).

Future Directions

• Digitalization: BIR e-invoicing (target: 50% evasion reduction).

• Green Finance: Climate bonds for solar farms.

• OFW Programs: Skills training for returning workers.

• Roadmap: 2024 (e-invoicing) → 2025 (green bonds) → 2028 (deficit target: 3%).

Conclusion

• Key Takeaway: Fiscal policy must balance growth, equity, and sustainability.

• Call to Action: Strengthen tax compliance, prioritize climate spending, empower OFWs.

References

• Department of Finance (DOF) Philippines.

• Bangko Sentral ng Pilipinas (BSP).

• World Bank Philippines Economic Updates.

Macroeconomic Problem & Fiscal Policy

Expansionary Fiscal Policy to Close a Recessionary Gap

• Expansionary Fiscal Policy Tools

  • Cut taxes

  • Increase government purchases

  • Increase government transfer payments

Contractionary fiscal policy

• Raise taxes

• Decrease government purchases

• Decrease government transfer payments

Illustrating Marginal Propensity to Consume

• Having won a lottery of 1000, you might decide to spend $750 today and save $250. In this example, your marginal propensity to consume is 0.75 (or 75 percent).

• The term marginal propensity has two parts

  • Marginal refers to the fact that you received an extra amount of disposable income—an addition to your income, not your total income

The Multiplier Effect At Work

• The multiplier effect is worked out for an assumed MPC of two-thirds.

• The initial 10 billion increase in government purchases causes both a 10 billion increase in aggregate demand and an income increase of 10 billion to suppliers of the inputs used to produce aircraft carriers.

• The owners of those inputs, in turn, will spend an additional 6.67 billion (two-thirds of 10 billion) on additional consumption purchases.

• A chain reaction has been started.

• The added 6.67 billion in consumption purchases by those deriving income from the initial investment brings a 6.67 billion increase in aggregate demand and in new income to suppliers of the inputs that produced the goods and services.

The Multiplier Process

• What is the total impact of the initial increase in purchases, after all the rounds of additional purchases and income have occurred?

• The multiplier is equal to 1 divided by 1 minus the marginal propensity to consume.

• Multiplier = \frac{1}{(1 – MPC)}

• Multiplier = \frac{1}{(1 – .66)}

• Multiplier = \frac{1}{(.34)}

• Multiplier = 2.94 = 3.00 rounded

• 10 Billion x 3.00 = 30 Billion rounded

The Crowding-Out Effect

When the government borrows money

1. to finance a deficit,

2. it increases the overall demand for money in the money market,

3. driving interest rates up.

4. As a result of the higher interest rate, consumers may decide against buying some interest-sensitive goods, and

5. businesses may cancel or scale back plans to expand or buy new capital equipment.

Changes In The MPC Affect The Multiplier Process

• Note that the larger MPC, the larger the multiplier effect, because relatively more additional consumption purchases out of any given income increase generates relatively larger secondary and tertiary income effects in successive rounds of the process.

• Multiplier = \frac{1}{(1 – MPC)}

• Multiplier = \frac{1}{(1 – .66)}

• Multiplier = \frac{1}{(.34)}

• Multiplier = 2.94 = 3.00 rounded

• 10 Billion x 3.00 = 30 Billion rounded

• Multiplier = \frac{1}{(1 – MPC)}

• Multiplier = \frac{1}{(1 – .75)}

• Multiplier = \frac{1}{(.25)}

• Multiplier = 4 rounded

• 10 Billion x 4.00 = 40 Billion rounded

Supply-Side Effects of Tax Cuts

• When policy makers discuss methods to stabilize the economy, the traditional focus has been on managing the economy through demand-side policies.

• But there are economists who believe that we should be focusing on the supply side of the economy as well, especially in the long run, rather than just on the demand side.

The Crowding-Out Effect

• AD Aggregate Demand

• RGDP = C Consumption + I Investment + G Government Spending + X Exports - M Imports Net Exports

The Crowding-Out Effect can Decrease Consumption

• AD Aggregate Demand

• RGDP = C Consumption + I Investment + G Government Spending + X Exports - M Imports Net Exports

The Crowding-Out Effect

An additional 10 billion of government spending on aircraft carriers, other things equal, would shift the aggregate demand curve right by 10 billion times the multiplier. However, as this process takes place, interest rates rise, crowding out some higher investment spending, shifting the aggregate demand curve to the left.

The Crowding-Out Effect

Critics argue that the increase in government purchases, particularly when the economy is severely recessive, may actually improve consumer and business expectations and encourage private investment spending. It is also possible for monetary authorities to increase money supply to offset the higher interest rate ( Monetary Policy) resulting from the crowding-out effect.

The Crowding-Out Effect

An additional 10 billion of government spending on aircraft carriers, other things equal, would shift the aggregate demand curve right by 10 billion times the multiplier. However, as this process takes place, interest rates rise, crowding out some higher investment spending, shifting the aggregate demand curve to the left.