Budget Deficit

Philippine Institute for Development Studies Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas March 2004

Economic Issue of the Day

Volume IV Number 1

Budget deficit

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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 two, one where it is spending too much. Whichever way it is regarded, it points to the same outcome—the deficit has to be financed.

Deficit per se, however, is not bad. The problem starts when the deficit continues or is sustained at an increasing pace.

Overview of the Philippine deficit In 2002, the budget deficit of the Philippine government reached P211 billion from a low of P16 billion ten years ago. Various factors accounted for the surge such as increasing salaries and wages of government employees, building-up of infrastructure and modernization programs, continuing interest payments and wavering revenue effort. The more than ten-fold increase in the deficit emits fear that the economy would not be able to prosper since the deficit is too large. But how does one assess the size of the deficit and decide that it is detrimental to the economy?

An appropriate way to assess the fiscal health of the government is to get the ratio of the deficit to output (proxied by gross national product, GNP).1 When viewed as such, the picture does not look as depressing but still alarming. The deficit/GNP picture (Figure 1) shows that the government was able to keep the deficit within a managed range of 2-3 percent of GNP with a few episodes of going over board such as in 1986 when it registered at 5.31 percent.

A major government activity is tax collection. Over 80 percent of government revenue 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 2

The GNP approximates the paying capacity of the country.

Tax effort is calculated as tax revenue over gross national product.

Budget deficit Budget deficit is defined simply as the difference between what the government spends and what it collects in taxes in a given period. If one is interested in the government's spending and taxing behavior, this is academically referred to as the fiscal policy (also known as budget policy). Budget deficits have to be financed either through local or foreign borrowing. Either way, government borrowing has its consequences, foremost of which is the increase in interest rates. This in turn acts as disincentives for private firms to borrow and invest in profitable ventures, thereby slowing down the economy's growth.

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Economic Issue of the Day March 2004

Volume IV Number 1

BUDGET DEFICIT

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 dissemination outlet aims to define and explain, in simple and easy-to-understand terms, basic economic concepts as they relate to current and everyday economics-related matters.

This Issue was written by Ma. Teresa S. DueñasCaparas, Supervising Research Specialist at the Institute. She acknowledges the valuable comments of Dr. Rosario G. Manasan, Senior Research Fellow at PIDS. The views expressed are those of the author(s) and do not necessarily reflect those of PIDS.

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Philippine Institute for Development Studies

NEDA sa Makati Building, 106 Amorsolo Street Legaspi Village, Makati City Telephone Nos: 8924059 and 8935705 Fax Nos: 8939589 and 8161091 URL: http://www.pids.gov.ph

Source: Bureau of Treasury

government expenditure, total output will increase by more than P1. Consider an increase in government salary. The additional income earned by the government employee will be used to buy more goods effectively increasing its demand for products. This in turn will have a favorable effect on private firms producing these goods. Additional profits will be earned which in turn can be passed on to the firms' laborers in terms of better benefits.

The higher income of the government employee, together with the increased corporate profit, will improve the government's tax revenue base. The cycle will go on until new changes are introduced in the economy.

Deficit and debt: soulmates?

When the government needs to spend but does not have enough in its pocket, it borrows either through foreign or local sources. Almost all governments incur a deficit, and borrow— 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 consequences. The occurrence of sustained and increasing deficit of a government can be compared to a person smoking—the cigarette might relieve him of some stress in the short run. But once his cigarette consumption increases and becomes a habit, the substance in the cigarette will make him unhealthy and could kill him in the end. ❋

_____________________ 3

Also referred to as debt service.