Fiscal Deficit and Public Sector Debt

Fiscal Deficit and Public Sector Debt

I. Introduction
A. Definition of Fiscal Deficit

Interchanged with budget deficit, Fiscal Deficit results from the difference
between what the government spends and what it collects in taxes from a given
period. According to Investopedia (2016), fiscal deficit is when a government's
total expenditures exceed the revenue that it generates (excluding money from
borrowings). As deficits accumulate yearly, it increases the national debt of the
government.

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.

B. Current situation of the Philippines

Particularly over the last 40 years, the Philippine government has

generally spent more than it collected in revenue. When this occurs, the
government must borrow money to cover the difference. The government
borrows by selling securities such as Treasury bonds, then agreeing to pay
bondholders back with interest. Over time, this borrowing accumulates into the
national debt.

For 2016, the national budget is 3.002 trillion pesos. On the other hand,
the Bureau of Internal Revenue’s target collection amount to 2.524 Trillion pesos.
 Hence, there is a finance deficit of 478.33 billion pesos. This deficit is financed
through foreign and domestic loans, Open Market Operations, and an increase in
the reserve requirements.

According to Magkilat, B. (2016), GDP Forecast in 2016 will increase from

6.5% to 7.2% due to huge budget election spending. Asian Development Bank
(2016) stated that inflation will grow up to 5.8% due to El Nino , and there is a
high unemployment in the Philippines especially in the youth with 1 out of 4
people neither working nor training.

II. Problems and Proposed Solutions

A. Because of the huge budget allocated for Debt Servicing, it decreases the
budget of other sectors.

Debt Service is the cash that is needed in a certain time frame that will
pay off the interest and principal on a debt. According to Bangko Sentral,
Philippines has a $77,658,912,000 external debt as of the early 2016. This is the
debt the country owes to foreign or international creditors. The total Public Debt
under the Aquino Administration is $163,934,972,678. Due to the very high debts
a large amount of the government budget would be allocated to Debt servicing
which results to low budgets in the other sectors of the Philippines making it hard
for these sectors to develop. Having large budget allocations to debt servicing
will hinder the growth of the other sectors in the Philippines.

1. Eliminate the Priority Development Assistance Fund (PDAF)

One possible solution would be eliminating the Priority

Development Assistance Fund (PDAF); this is a discretionary fund in the
Philippines available to members of Congress. Its main purpose is to fund
small projects or infrastructures, which are not covered in the national
infrastructure program. This is commonly known as the “pork barrel”. What
happens in the pork barrel is that high-ranking government officials such
as senators and congressmen are given the budget to implement a
project. What should be done instead is to eliminate the Priority
Development Fund and just leave it to the National Infrastructure when it
comes to projects so that it will lessen the debt servicing.

2. Privatization
 Another way to lessen debt servicing would be privatization.
Privatization is when you turn over or transfer ownership of a government
owned company to a privately owned entity. By privatizing a business it
will generate more revenue to pay off debt. By privatizing a company it will
be more efficient and will have high returns. An example would be private
investors who were able to win the bid on MWSS were able to improve
their services and make it more efficient as well as agreeing to pay the
foreign debt of $1 Billion.

3. Broad based taxes

Another solution would be practicing broad based taxes. Broad

base taxing is tax is applied to almost all the goods and services rather
than just limiting the taxation. This would increase a greater revenue over
the narrow base taxation. Taxes are what generate government revenue
and since there are several cases where citizens do not file for tax
payments. Government should focus on Indirect Taxation as a source of
revenue. By implementing this there will be more revenue to pay off debts
and increase budget for other sectors.

4. Expansionary Monetary Program

Embarking in Expansionary Monetary Program would be another

solution to lessen debt servicing. What happens is that the government
will increase the money supply circulation this will allow the expansion of
economic activity which means there will be more investments, projects
and programs. In order for this to be possible the government must sell
bonds and securities to the central bank which the central bank in return
will give them the local currency. With that the government will be able to
use it for projects and investments that will generate more profit to pay off
debts and provide more budget for the other sectors.

5. Increasing gas taxes

Increasing gas taxes would be another way to generate new

revenue. The revenue that these taxes will make could go to the public
sector of the Philippines. Knowing that everyone purchases gas will raise
the budget for public infrastructures, roads and etc.
B. Debt burden, as a result of high government expenditure, will lead to higher
debt interest payment.

Debt burden means the cost of servicing debt or interest payments on

debt. In the case of the Philippines, the government cannot reduce indebtedness
through time. Due to huge debt burden, the government would have to enforce
higher taxes in the future in order to combat future budgets. Having higher tax
will reduce the employee’s incentives to work. Also, the danger is that if taxes
are increased too early and too quickly, it could damp down the recovery and
cause a further downturn.

1. Increase tax rates

One solution for debt burden is to increase tax rates. Some

of the employees were having tax exemption such as imposing Tax
Holiday on some workers. With this, they don’t need to pay tax, it
will attract investors, but it decreases revenue. Increasing tax rates
will increase in prices that will lead in Inflation.

2. Reduce the number of tax brackets

Another solution for debt burden is to reduce the number of

tax brackets. According to Investopedia (2016), tax bracket is the
rate where a person is taxed based on income levels. It is also
serves as cutoff points for each given tax rates. The purpose of
having tax brackets is for the individuals to pay the tax based on
their income. Another purpose is to encourage economic activity for
the lower and middle classes. In the Philippines, the old tax bracket
has 15 tax rates that the lowest rate is 0% and the highest rate is
35%. The current tax bracket has decreased to 8 tax rates, 0%
being the lowest rate and 32% the highest rate. Currently, the
government proposed to decrease the tax 4 tax rates, 0% being the
lowest rate and 30% the highest rate.

3. Income tax

Income Tax is a levy on good that imposed on individuals

with income. Income Tax in the Philippines is from 5% to 32%. In
business enterprises, it is tax based on their net income.
Paglomutan (2004) said that proposed gross income tax will
 understate revenues or overstate expenses. With this, it will adjust
of having tax to the business enterprises.

4. Tax on text messages

People in the Philippines usually use electronic gadgets

such like cellphones. They usually use cellphone for texting as a
form of communication to other people. Paglomutan (2004) stated
that it will capture more taxpayers about 23 million cellphone users.
With this, the higher income individuals have, the higher the text to
consumption levels. The taxes generated should fund priority
programs in the educational sector in order to be acceptable to the
public.

5. Tax for Overseas workers

Their families enjoy the benefits of public services,

particularly education, security, roads and other social services.
The OCWs enjoyed these services before and when they are in the
country, and the government provides some services for them
abroad. Restoring income tax for overseas contract workers will
encourage them to pay tax.

C. Extreme depreciation of the Philippine Peso further puts the Philippines in

larger debt

Labeled the “perverse effect,” high interest rates lead to bankruptcies that
in turn lead to a higher country risk premium. The fiscal policy stance may also
influence the direction of interest rates. Since the Philippines is experiencing that
of a fiscal deficit, it needs to finance its existing budgetary requirements by
borrowing from the domestic market or from abroad. The higher is the fiscal
deficit, the stronger the demand to borrow again in order to finance the greater
gap created (Central Bank of the Philippines, 2015). This exerts upward pressure
on domestic interest rates, particularly if the government borrows from a
relatively less liquid domestic market. Thus, this induces capital flight and would
further lead to subsequent deterioration of the exchange rate (Furman and
Stiglitz, 1998).

In 1982, the Philippines turned to the IMF due to BOP difficulties and
increase in outstanding oil import credit by 85%. By 1983, the Philippines had
again racked up a debt of $24.4 billion (US) and was unable to meet its payment
obligations to the IMF and World Bank. With this, the government had
subsequently agreed to the IMF and World Bank conditions to be granted
another loan. During 1983, the debt-to-GDP ratio grew to 56% (compared to 35%
during 1980) as well as the debt service ratio with 38% (versus 21% during
1980). The government also called for emergency loans from the World Bank and
transactional commercial banks. With a depreciated peso, the loan originally
borrowed from IMF and World Bank further increases its capital and interest
value; for every one dollar we pay, we pay more than what we owe in the future.
Thus, depreciation of peso vis-a-vis foreign currencies further increases the
national debt and the finance deficit the country already has (Dohner and
Ponciano, 2012).

1. The Philippines should rely more on domestic debts

When borrowing money, interests are the costs of borrowing

money, and as far as they are concerned, it is most likely that debtors
would prefer low interest rates. According to the Central Bank of the
Philippines (2015), interest rates are prices paid for the use of money for a
period of time, expressed as percentage of the outstanding balance that is
either fixed or variable. Since peso is overvalued vis-a-vis US dollar, the
amount of the external debt, both principal and the interest expense, of the
Philippines increase its value over time.

Also, interest payments increase in amount when there is

depreciation. With this, the government should embark on a massive effort
to convert national debt from foreign to domestic by reducing dependence
on the former; the government must assume most of private debt.
Although higher interest rates are available in the Philippines, it would be
most efficient for the government to rely more on internal debts since
external debts are paid in their respective foreign currency; thereby,
increasing the risks for a fluctuating exchange rate.

2. Increased capital inflow, for example, leads to appreciation and lower

interest rates

When the Philippine capital markets are fully liberalized, increased

capital mobility induced by the liberalization will lead to inflows of foreign
money that will find their way into the stock market. Left unsterilized,
capital inflows will lead to appreciation and decline in interest rates.
 3. Decrease in price levels of goods and services

A big currency depreciation instantly hits consumer purchasing

power and reduces wages. Purchases of foreign goods quickly fall
because prices of foreign goods quickly soar. Since there is an overvalued
peso, it results to inflation. With this, the government needs to decrease
inflation. To decrease money supply, the government can either sell its
securities or increase Rediscount Rates, Special Deposit Rates and
Reserve requirements.

4. Sell government assets that are not profiting

Another way to lessen debt servicing would be privatization.

Privatization is when you turn over or transfer ownership of a government
owned company to a privately owned entity. By privatizing a business it
will generate more revenue to pay off debt. By privatizing a company, it
will be more efficient and will have high returns. With this, the transfer of
public offices or functions to the private sector for cost-cutting and
efficiency considerations can help finance the debt. Clearly that the private
sector is superior to the government in the operation and maintenance of
public facilities. In order to improve such sector, the Privatization Council
(PrC) should further strengthen its policies and general guidelines on
privatization issues, identifying disposable assets, monitoring the progress
of privatization activities and approving the sale or divestment of assets with
respect to price and buyer.

5. If PDAF will remain in the budget, proper auditing should be implemented.

One way to reduce spending is by eliminating Priority Development

Assistance Fund (PDAF), which is a discretionary fund in the Philippines
available to the members of the legislative department. Its main purpose is
to fund small projects or infrastructures, which are not covered in the
national infrastructure program. By the word discretionary, no information
can be given out as to where the budget went. With this, the government
must record the said transactions and implement proper auditing. This
would increase reliance with the government and would encourage people
to pay correct taxes.

D. High lending interest rates causes private companies to pull out

investments.
 The Debt-to-GDP ratio is used by investors to measure a country's ability
to make future payments on its debt; thus, affecting the country’s borrowing costs
and government bond yields. During 1990 to 1993, the Philippines experienced
its all time high debt to GDP ratio of 74.90% (Trading Economics, 2016).
According to the Bangko Sentral ng Pilipinas (n.d.), the ratio of what the
Philippines owes from foreign creditors (external debt) to what it has been
producing (GDP) has gone through a significant growth from 61.6% in 1999 to
68.2% in 2001. With this, the administration should aim for low debt-to-GDP
ratios because such is an indicator that the economy is producing high enough
output to pay off its borrowings. As our Debt-to-GDP ratio increases, creditors
become more concerned about the country’s ability to repay its debt. When this
happens, they demand for higher interest rates in order to provide greater return
for greater risks. Thus, increasing the overall interest rates in the market. As
observed by De Dios (1993), the government’s pump-priming activities that led to
growth in the last half of the 1980 decade brought pressure on domestic interest
rates as these were financed mainly by domestic borrowings. At the same time,
persistent current account imbalances hounded the economy – high import bill
added to foreign debt service and sluggish export growth. Active interest rate
defense of the currency began in the middle of 1990.

When interest rates increase, cost of borrowing becomes more expensive.

As a result, it increases a company’s cost of production. As a result, this forces
companies to increase their prices to combat the expenses incurred. With this,
inflation or the general increase in prices would actually decrease the quantity
demanded by the consumers. Practically, consumers have lower purchasing
power when there is inflation. Since a smaller number of inventories are being
sold, the profits of the company lower. With what is happening, this situation
becomes a disincentive for other companies to invest in the country. To
conclude, an increase in interest rates would lead to inflation, and an increase in
prices would lower investments. With the increase in interest rates, the
construction industry was reported to have only provided 5.4% of the GDP in
1993 that only further decreased from the 6.2% in 1989. It operated in a boom-
and-bust cycle, characterized by low investment and a lack of stability.

Aside from high interest rates, investments decrease due to the decrease
in the pool of funds available to investors. In order to finance the budget deficit,
the government needs to create an incentive for the private sector to buy more
government bonds. If the private sector's purchase of government bonds does
not increase in proportion with the higher deficit, the government must borrow
more money, which leaves less money for financing private projects, such as
investment in residences or factory equipment.

Such scenario was evident when the agriculture sector suffered from a
lack of infrastructure and financing due to the lack of available funds in 1993.
Although government intervention to break monopolies was helping invigorate
the sector, the level of investment needed to improve the situation has not been
financially available to landowners (Nolan, 1996).

1. Set lower minimum wages

With the help of the regional wage board committee, the

government can opt to impose lower minimum wages. Since this would
lower their costs in the business, this would act as an incentive to
encourage them to go to invest in the country with earning higher profits in
the long run. However, the government should always need to take into
consideration the cost of living and inflation situation first before
decreasing the respective minimum wages.

2. Creation of a new money to finance public and private investments

By selling long-term bonds and securities to the Bango Sentral ng

Pilipinas, it will, in turn, issue a corresponding new local money. The new
local money thus created will be used to finance development projects
such as the construction and establishment of infrastructure and utilities all
over the country thereby catalyzing growth and expansion and creating a
more favorable business and economic climate for private businesses to
thrive in. Faced with such government assistance and more business
opportunities at hand, the private sector can thus itself expand and grow,
make more profits, employ more people and pay more taxes to the
government. The economy, while on a downturn, could then be buoyed
into expansion, thanks to government’s direct and active intervention
through investments and expenses from borrowed money secured against
future taxes. In short, government monetary expansion leads to economic
expansion.

3. The Bangko Sentral ng Pilipinas can use moral suasion to reduce level of
interest rates

One way to ask for a decrease in interest rates is moral suasion.

According to Investopedia, moral suasion is a persuasion tactic used by
an authority to influence and pressure banks into adhering to policy. The
 “moral” characteristic is for the moral responsibility the banks feel they
have. This is done to make banks operate consistently with the economy.
Since the government and the economy is the one directly needing the
change from the bank and the economy, it increases the possibilities of
the bank’s approval.

With this, the Bangko Sentral ng Pilipinas should implement a

reduction of interest rates to about 0.15-0.40%. Such reduction would
enable local financial institutions to lend money to businesses at a very
reasonable cost. This, then, would create more economic activities both
for the firms and the consumers. The reduction of interest rate would also
attract potential investors in the country. Hence, contributing to the
increase of the employment rate of the country and to economic growth.

However, if there would be a reduction of interest, banks should put

limits since this may cause hyperinflation. Since people would be enticed
to borrow more, they would have more purchasing power. Also, if interest
is not reduced and the country borrows money, there would only be an
increase in debt; this is the case the country is trying to avoid.

4. Decrease corporate income taxes

A reduction in the amount of taxes on organization frees up that

capital to be used in other ways. For those leading the charge to lessen
the tax burden on businesses, hopes have been that that money will be
reinvested back into businesses, increasing hiring and creating more
output. In the Philippines, the current corporate tax is a standard 30%.
With this, the government can lower it to 25% without compromising the
need for a greater revenue to finance the said debt. With this, a decrease
in corporate tax encourages people to invest more into the country.

5. Removal of the negative list

Since interest rates are high, there would be low levels of

investment in the country. To solve such problem, the government opt to
increase the fiscal incentives be given to foreign companies. Other than
that, removing the negative list would enable more foreign companies to
own shares and increase their investment inside the country. Negative list
is an actual list where the government does not allow foreign companies
to acquire shares. Furthermore, government can set lower minimum
 wages to further encourage them to go to invest in the country since this
would lower their costs in the business.

E.) Only 1% of taxpayers are audited

Since fiscal deficit accumulates every year, the national debt also
increases. With this, the government must also further improve its tax collection
system in order to offset and finance the increased debt

In Philippines, 38 million Filipino citizens are employed. Only 17.9 million

employees are filed with income tax. 7.2 million employees only pay tax. The
problem is that the government will audit 1% of taxpayers randomly, which is
72,000 papers.

This auditing problem is an example of Tax Evasion. Tax Evasion is an

illegal activity to avoid paying taxes. According to Tax and Accounting Center
Philippines, tax evaders have been succeeded due to: arbitrary non-reporting of
income, over-declaration of expenses, fictitious expenses, claiming personal
expenses as business expense, borrowing of invoices and receipts, and non-
filing of returns.

1. Computerization

One solution for Tax Evasion is to provide budget for the

computerization since they are auditing the tax manually. It is efficient to
use computer in order to reduce the errors of the auditors when they audit
taxes.

2. Tax on payroll

Another solution is to have tax on the date of payroll. It is efficient to

impose a tax such as Witholding Tax Payable that will automatically
deduct on their salary.

3. Case against tax evaders

In order to reduce Tax Evasion, government should file case

against tax evaders because Tax Evasion is illegal, and government want
to file tax to employees for fairness.
 4. Set a date for Professionals to pay tax

Also, government must set a date for Professionals for their

payment of tax. These professions such as doctor, lawyer, accountant,
etc. have their own firm. Thus, they can make a fraud that they already
pay their taxes to the BIR.

5. Stricter penalties to tax evasion

Lastly, government should proper implementation by increasing

strict penalties when paying tax. Also reevaluation of tax assessors since
they are the ones who receive bribes on taxpayers. This should have
proper values and evaluation in order to have clean and fair auditing in
tax.

References

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website: http://www.adb.org/countries/philippines/economy

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the government website: http://www.bsp.gov.ph/statistics/spei_new/tab18.htm

Central Bank of the Philippines. (2015). Interest Rates. Retrieved from the
government webite:
http://www.bsp.gov.ph/downloads/publications/faqs/intrates.pdf
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Philippines: Philippine Institute for Development Studies and International
Development Research Center

Dohner, R. & Ponciano, I. (2012). External debt and debt management:

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http://www.investopedia.com/terms/f/fiscaldeficit.asp

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from the website: http://www.mb.com.ph/business-sees-better-economy-in-2016/

Nolan, J. (1996). Philippines Business: The Portable Encyclopedia for Doing

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Paglomutan, R. (2004). Solutions to Fiscal Problems. Retrieved from the website:

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