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Philippine Institute Economic Issue of the Day for Development Studies Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas March 2004 Volume IV Number 1 Budget deficit I Budget deficit t is a common, albeit rebuked, knowledge that the Philippine government has, for quite sometime, been spending more than what it has been earning. This deficit can be viewed in two ways: one, a case where the government is not earning enough, and Budget deficit is defined two, one where it is spending too much. Whichever way it is regarded, it points to the simply as the difference same outcome—the deficit has to be financed. between what the govern- Deficit per se, however, is not bad. The problem starts when the deficit continues or ment spends and what it is sustained at an increasing pace. collects in taxes in a given period. If one is interested Overview of the Philippine deficit in the government's spend- In 2002, the budget deficit of the Philippine government reached P211 billion from a low of ing and taxing behavior, this P16 billion ten years ago. Various factors accounted for the surge such as increasing is academically referred to as the fiscal policy (also known salaries and wages of government employees, building-up of infrastructure and as budget policy). Budget modernization programs, continuing interest payments and wavering revenue effort. The deficits have to be financed more than ten-fold increase in the deficit emits fear that the economy would not be able to either through local or foreign prosper since the deficit is too large. But how does one assess the size of the deficit and borrowing. Either way, gov- decide that it is detrimental to the economy? ernment borrowing has its An appropriate way to assess the fiscal health of the government is to get the ratio of consequences, foremost of the deficit to output (proxied by gross national product, GNP).1 When viewed as such, the which is the increase in picture does not look as depressing but still alarming. The deficit/GNP picture (Figure 1) interest rates. This in turn shows that the government was able to keep the deficit within a managed range of 2-3 acts as disincentives for percent of GNP with a few episodes of going over board such as in 1986 when it registered private firms to borrow and at 5.31 percent. invest in profitable ventures, A major government activity is tax collection. Over 80 percent of government revenue thereby slowing down the economy's growth. come from collecting taxes. Revenues from tax collection reached P490 million in 2001 and P500 million in 2002. As impressive as these figures might convey, though, tax collection effort 2 has been decreasing since 1995 suggesting that revenue collection should be ❋❋❋ strengthened and improved. Increasing tax effort, however, does not necessarily mean increasing tax rates as revenue efforts could be improved through administrative and monitoring efforts. Government spending increases total expenditure of the economy and stimulates output growth through its multiplier effect. This means that for every P1 increase in _____________________ 1 The GNP approximates the paying capacity of the country. 2 Tax effort is calculated as tax revenue over gross national product. Economic Issue of the Day BUDGET DEFICIT March 2004 Volume IV Number 1 Figure 1. Deficit/GNP (in percent) The Economic Issue of the Day is one of a series of PIDS efforts to help in enlightening the public and other interested parties on the concepts behind certain economic issues. This dis- semination outlet aims to define and explain, in simple and easy-to-understand terms, basic economic concepts as they relate to Source: Bureau of Treasury current and everyday economics-related matters. This Issue was written by government expenditure, total output will increase by more than P1. Consider an increase Ma. Teresa S. Dueñas- in government salary. The additional income earned by the government employee will be Caparas, Supervising used to buy more goods effectively increasing its demand for products. This in turn will Research Specialist at the have a favorable effect on private firms producing these goods. Additional profits will be Institute. She acknowledges earned which in turn can be passed on to the firms' laborers in terms of better benefits. the valuable comments of The higher income of the government employee, together with the increased corporate Dr. Rosario G. Manasan, profit, will improve the government's tax revenue base. The cycle will go on until new Senior Research Fellow at changes are introduced in the economy. PIDS. The views expressed Deficit and debt: soulmates? are those of the author(s) and When the government needs to spend but does not have enough in its pocket, it borrows do not necessarily reflect either through foreign or local sources. Almost all governments incur a deficit, and borrow— those of PIDS. the Philippines is no exception. ❋❋❋ Budget deficits and debts are inseparable partners. The persistence of budget deficit over time has led to an accumulation of debts. Whether foreign or local debt, this has to be paid. Thus, the government annually allots a portion of its budget to pay for the interest and a portion of the debt incurred.3 Unfortunately, debt servicing eats up a significant portion of the government's expenditure and puts additional pressure on the government's already-depleted pockets. Thus, the build-up of debt caused by the persistence of budget deficit increases debt service, which in turn adds pressure on the current year's expenditure. This results to an even larger budget deficit. Clearly, it is a vicious cycle that has created a fiscal bind to the Philippine government. Managing the budget deficit is one big task of the government that focuses on revenue generation and spending activities. When the former is not enough to cover the latter, borrowing becomes a viable activity provided one has the ability to pay. But it has its Philippine Institute consequences. The occurrence of sustained and increasing deficit of a government can be for Development compared to a person smoking—the cigarette might relieve him of some stress in the short Studies NEDA sa Makati Building, run. But once his cigarette consumption increases and becomes a habit, the substance in 106 Amorsolo Street the cigarette will make him unhealthy and could kill him in the end. ❋ Legaspi Village, Makati City Telephone Nos: 8924059 and 8935705 Fax Nos: 8939589 and 8161091 URL: http://www.pids.gov.ph _____________________ 3 Also referred to as debt service.
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