Investment Management

Reymar L. Uy
Graduate School University of Santo Tomas

Fiscal Policy
y In simple words, fiscal policy is that part of

government policy which is concerned with raising revenue through taxation, deciding on the level of public expenditure and public debt. y Fiscal Policy refers to the "measures employed by governments to stabilize the economy, specifically by manipulating the levels and allocations of taxes and government expenditures. y The term fiscal has been derived from the Greek word Fisc , meaning a basket to symbolize the public purse. Fisc, thus, refers to the Treasury.
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Broader Concept
y Broadly speaking, fiscal policy is a part of general

economic policy of the government which is primarily concerned with the budget receipts and expenditures of the government. y In short, fiscal policy refers to the Budgetary Policy. Thus, the term fiscal policy embraces the tax and expenditure policies of the government. Fiscal policy operates through the control of government expenditures and tax receipts.
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Revenues and Funding

y Tax Revenue y Income Tax y E-VAT y Tariffs and Duties y Non-Tax Revenue y The Bureau of Treasury y Privatization y Government-owned corporations

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Spending, Debt, and Financing

1. Government Spending and Fiscal Imbalance 2. Financing and Debt y External Sources:
y y y y y

y Domestic Sources:
y y y y y y

Program and Project Loans Credit Facility Loans Zero-coupon Treasury Bills Global Bonds Foreign Currencies

Treasury Bonds Facility loans Treasury Bills Bond Exchanges Promissory Notes Term Deposits

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FISCAL POLICY CHOICES

1. Expansionary fiscal policy: used to combat a recession. 2. Contractionary fiscal policy: used to combat demand-pull inflation, due to excess spending.

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EXPANSIONARY FISCAL POLICY

Expansionary fiscal policy is designed to stimulate the economy during or anticipation of a businesscycle contraction. A possible fiscal solution may be: a. Increase in government spending. b. Decrease in taxes. c. Combination of increase in Government spending and reduce in taxes. d. If the budget was initially balanced, expansionary fiscal policy creates a budget deficit.
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CONTRACTIONARY FISCAL POLICY

Contractionary fiscal policy is designed to restrain the economy during or anticipation of an inflationinducing business-cycle expansion. A possible fiscal solution may be: a. Decrease in Government spending b. Increase in taxes c. Combined government spending decrease and tax increase d. If the budget was initially balanced, a contractionary fiscal policy creates a budget surplus.
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TOOLS OF FISCAL POLICY

A. Discretionary fiscal policy refers to the deliberate

manipulation of taxes and government spending by Congress to alter real domestic output and employment, control inflation, and stimulate economic growth. Discretionary means the changes are at the option of the Federal government. Simplifying assumptions:
1. 2.

Assume initial government purchases don t depress or stimulate private spending. Assume fiscal policy affects only the demand, not supply, side of the economy.
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TOOLS OF FISCAL POLICY

A. Automatic Stabilizers, without specific new legislation, increase (decrease) budget deficits during times of recessions (booms). They enact countercyclical policy without the lags associated with legislative policy changes. Examples include: 1. Corporate Profits - Taxes on corporate profits go up substantially during boom times, and decline rapidly during times of recession. 2. Progressive Income Taxes - This pushes people into higher income tax brackets during boom times. 3. The Unemployment Insurance (UI) Program - This program provides payments to greater numbers of people as unemployment increases during times of recession.
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FINANCING DEFICITS
Budget deficit - government expenditures exceed government tax revenues. A. Financing deficits can be done 2 ways: 1. Borrowing: ( crowding out effect) The government competes with private borrowers for funds, and could drive up interest rates; the government may crowd out private borrowing, and this offsets the government expansion. 2. Money Creation: When the Federal Reserve loans directly to the government by buying bonds, the expansionary effect is greater since private investors are not buying bonds. (Monetarists argue that this is monetary, not fiscal, policy that is having the expansionary effect in this situation).
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DISPOSING OF SURPLUSES
Budget surplus government tax revenues exceed and government expenditures. B. Disposing of surpluses can be done in 2 ways: 1. Debt reduction is good, but may cause interest rates to fall and stimulate spending, which could then be inflationary. 2. Impounding or letting the surplus funds remain idle would have greater anti-inflationary impact. The government holds surplus tax revenues which keeps these funds from being spent.

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POLICY OPTIONS
Economists have mixed views about whether to use government spending or tax changes to promote stability, depending on their view of the government: 1. If economists are concerned about unmet social needs or infrastructure, they tend to favor higher government spending during recessions and higher taxes during inflationary times. 2. When economists think that government is too large or inefficient, they tend to favor lower taxes for recessions and lower government spending during inflationary periods.
y
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BUILT-IN STABILITY
Built-in stability arises because net taxes (taxes minus transfers and subsidies) change with GDP. Remember that taxes reduce incomes, and therefore, spending. It is desirable for spending to rise when the economy is slumping and to fall when the economy is becoming inflationary. 1. Taxes automatically rise with GDP because incomes rise and tax revenues fall when GDP falls. 2. Transfers and subsidies rise when GDP falls; when these government payments (welfare, unemployment, etc.) rise, net tax revenues fall along with GDP.
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BUILT-IN STABILITY
The size of automatic stability depends on responsiveness of changes in taxes to changes in GDP: The more progressive the tax system, the greater the economy s built-in stability. 1. Marginal tax rates on personal income can be changes to prevent demand-pull inflation. 2. Automatic stability reduces instability, but does not correct this economic instability.

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Objectives of Fiscal Policy

(1) Capital Formation. (2) Mobilization of Resources. (3) Problem of Unemployment. (4) Economic Stability. (5) Redistribution of National Income. (6) Price Stability.

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EVALUATING FISCAL POLICY

To evaluate the direction of discretionary fiscal policy, adjustments need to be made to the actual budget deficits or surpluses. The standardized budget is a better index than the actual budget in the direction of government fiscal policy because it indicates when the Federal budget deficit or surplus would be if the economy were operating at full employment. In the case of a budget deficit, the standardized budget: a. Removes the cyclical deficit that is produced by swings in the business cycle, and b. Reveals the size of the standardized deficit, indicating how expansionary the fiscal policy was that year.
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EVALUATING FISCAL POLICY

The effectiveness of our fiscal policy can be assessed from three angles: a) Fiscal policy and savings and capital formation, b) Fiscal policy and economic inequalities, c) Fiscal policy and inflation control.

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DRAWBACKS OF FISCAL POLICY

A. Problems of timing 1. Recognition lag is the elapsed time between the beginning of recession or inflation and awareness of the occurrence. 2. Administrative lag is the difficulty in changing policy once the problem has been recognized. 3. Operational lag is the time elapsed between change in policy and its impact on the economy.

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DRAWBACKS OF FISCAL POLICY

B. Political considerations: Government has other goals

besides economic stability, and these may conflict with stabilization policy.
1. 2. 3.

Voters are likely to respond more favourably to increases in government purchases and cuts in taxes A political business cycle may destabilize the economy. State and local finance policies may offset federal stabilization policies.

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DRAWBACKS OF FISCAL POLICY

4.
a)

The crowding-out effect may be caused by fiscal policy.

crowding-out may occur with government deficit spending. It may increase the interest rate and reduce private spending which weakens or cancels the stimulus of fiscal policy. Some economists argue that little crowding out will occur during a recession. Economists agree that government deficits should not occur at Full-Employment. It is also argued that monetary authorities could counteract the crowding-out by increasing the money supply to accommodate fiscal policy.
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b)

c)

DRAWBACKS OF FISCAL POLICY

C. Public Debt: 1. Public Debt - the total amount owed by the federal government as a result of its past borrowing 2. Public Debt Charges are the amounts paid out each year by the federal government to cover the interest charges on its public debt

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FISCAL POLICY IN AN OPEN ECONOMY

A. Shocks or changes from abroad will cause changes in

net exports which can shift aggregate demand leftward or rightward. B. The net export effect reduces the effectiveness of fiscal policy by offsetting its effects. For example: 1. Expansionary fiscal policy may increase domestic interest rates, which can cause the dollar to appreciate and exports to decline. 2. Contractionary fiscal policy may reduce domestic interest rates, which would cause the dollar to depreciate, and net exports to increase.
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History of Philippine Fiscal Policy

y Marcos Administration (1981-1985) y Tax system was generally regressive y Government expenditure for economic services peaked during this period, focusing mainly on infrastructure development. y The government became increasingly reliant on domestic financing to finance fiscal deficit. y The government also started liberalizing tariff policy.

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History of Philippine Fiscal Policy

y Aquino Administration (1986-1992) y Enacted the 1986 Tax Reform Program (TRP) y Introduction of the Value Added Tax (VAT). y The sale of sequestered assets of President Marcos and his cronies (totaling to about P20 billion). y Oil deregulation and privatization of Gov enterprises y Public debt servicing and interest payment on making up for the debt incurred by the Marcos administration y 1991 Local Government Code

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History of Philippine Fiscal Policy

y Ramos Administration (1993-1998) y The Ramos administration had budget surpluses for four of its six years in power. y Sale of government assets (continuation of 1986 TRP) y Invested on the power sector ad the country was beset by power outages. y Real estate boom and strong foreign direct investment. y Onset of the 1997 Asian financial crisis. y 1997 Comprehensive Tax Reform Program (CTRP) y Republic Act (RA) 8184 and RA 8240
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History of Philippine Fiscal Policy

y Estrada Administration (1999-2000) y Assumed office at the height of the Asian financial crisis and faced large fiscal deficit. y higher interest payments given the sharp depreciation of the peso during the crisis. y Paid P60 billion worth of accounts payables y Public spending focused on social services y To finance the fiscal deficit, Estrada created a balance between domestic and foreign borrowing.

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History of Philippine Fiscal Policy

y Arroyo Administration (2002-2009) y Poor fiscal position y Large fiscal deficits and heavy losses for monitored government corporations. y National debt-to-GDP ratio reached an all-time high. y Under-spending in public infrastructure and social overhead capital. y RA 9337 (E-VAT Law)

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Recent Philippine Fiscal Policy

y Benigno Aquino III (2010 Present) y No new tax. y Anti-corruption program y Remittance inflows from OFW. y Public-private partnerships (PPPs) y Privatization of Government Assets.

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THANK YOU
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