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Budget deficit


									   Philippine Institute
                                         Economic Issue
                                           of the Day
     for Development
  Surian sa mga Pag-aaral
         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

        The GNP approximates the paying capacity of the country.
        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.
    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
   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:         _____________________
                                             Also referred to as debt service.

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