De La Salle University

BUDGET DEFICIT OF THE PHILIPPINES (2008)

In Partial Fulfilment of the Requirements

For FIMACRO Class to be passed to
Ms. Madeleine Balane of the
Economics Department

Caringal, Karen Marie

Reyes, Mary Grace
Rubio, Maria Rheza Mae
Venzon, Maybelene

FIMACRO K31

December 13, 2010

TABLE OF CONTENTS

I. Summary of the News Article

II. Macroeconomic Theories and Concepts

a. What is budget deficit?
b. Economic effects of budget deficit

III. Policies and Recommendations

IV. Bibliography
I. Summary of the News Article
10-month Budget Deficit Hits P62.3 B
A budget deficit of Php62.3 billion in the first ten months of the year 2008 was
experienced before the full-year program of Php75 billion. The Department of Finance will
remain the Php75 billion programmed deficit for this year having the confidence that the budget
deficit will not exceed in this manner. The DoF officials are expecting to raise Php25 billion
from the sale of government’s 40-percent shares in Petron Corporation by selling its shares for a
reasonable price until this year ends. Aside from this, the government is still launching a bond
issuance this year (Chipongian, 2008).

II. Macroeconomic Theories and Concepts

What is Budget Deficit?
The government incur two kinds of expenses. These are the revenue expenses and capital
expenses. Revenue expenses are the money spent by the government for paying off the salary of
their staffs while capital expenses are the money used for building schools, hospitals, and other
programs for the country’s citizens. On the other hand, the revenues earned by the government
are classified into: (a) revenue by direct and indirect taxes and (b) revenue by non-tax which
includes dividends from public sector companies, fees, fines, recovery of loans, and borrowings
of the government. All these factors affect the standing of the national budget except for the
government’s borrowings.
Budget deficit, also known as fiscal deficit, exists when the government’s expenditures
surpass the revenue it generates (exclusive of the borrowings it made). This may sound bad but
sometimes this does not only impose negative effect. For example, John Maynard Keynes, a
well-known economist, believed that undergoing fiscal deficits help and stimulate the economy
during times of recession. If there is recession, there will be a fall in taxation and higher
government spending which will cause a budget deficit. To solve this, the first thing that the
government might do is increase the taxes imposed to the people and products. This would
further deflate the economy leading to a lower growth and higher unemployment. Worse is if this
would have a negative multiplier effect which may increase the deficit even more. Thus, a deficit
is beneficial sometimes during recession. Another good side of budget deficit is that it increases
productivity. For example, there is a market failure in the economy. Of course the first thing that
the government will do is to increase their spending; hence, increasing the chance of having a
budget deficit. But this will just be for a short time since higher spending may lead to higher rate
economic growth and then more taxes can be collected.
On the other hand, the fiscal conservatives feel that government should avoid this since
they should focus on having a balanced budget. Besides, in exchange for this good side of budget
deficit is a very serious downturn. This downturn is debt. To finance all these deficits most of the
time, the government borrow money from banks, financial institutions, and investors in form of
loans, bonds or other financial instruments. This in turn might lead to bankruptcy especially if
large amounts of debt are accumulated.
Economic Effects of a Budget Deficit
Whenever a country, like the Philippines, experiences a budget deficit it would normally
impose a lot of economic effects in the country. Some of these are:
 Increase Aggregate Demand
Government spending is positively related to the Gross Domestic Product (GDP).
Therefore, an increase in the government expenditures leads to an increase in the
aggregate demand and may lead to higher GDP.
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 Higher Taxes or Cost-cutting

One way to finance the budget deficit is to increase taxes or cost-cutting.
Between the two, cost-cutting may look more applicable since if taxes are increased, it
would mean that people have to pay more. But according to Stiglitz and Orsza (2001), an
increase in taxes would have a better impact than a decrease in government spending.
For example, if taxes increase by $1, consumption may fall by 90 cents and saving may
fall by 10 cents. Since an increase in tax does not reduce consumption on a dollar-for-
dollar basis, its negative impact on the economy is satisfied in the short run. Unlike in
cost-cutting, it would reduce demand in the economy on a dollar-for-dollar basis and
hence would be more harmful to the economy.

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 Increase Interest Rates

Another way of solving budget deficit is by implementing contractionary
monetary policy. Here the government will sell more bonds in the market. When this
happens, the demand for bonds will decrease, leading to a decrease on its price. Since
price and interest rate are inversely proportional to each other, this contractionary
monetary policy will lead to an increase of interest rates. They would have to increase the
interest rates in order to attract investors to buy the extra debt.

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 Increase Borrowing and Interest Payments

Normally when the government exceeds its expenditures over its revenues, it will
have to borrow money from banks and financial institutions like World Bank (WB) and
International Monetary Fund (IMF). This will lead to higher amount of principal and
higher interest payments. Again, there might be an accumulation of debt which may lead
to bankruptcy.

III. Recommendations
For the recommendation, we would like first to raise these issues that were
mentioned in the given articles:
1. The government failed to achieve its goal for a balanced budget in year 2008 due to low
revenues, sudden changes in the external environment and their plan to surge economic
growth.
2. The government didn’t want to rely on sale of assets to generate more revenues.
There are several economic policies that can help address the budget deficit issue.
The government may choose to decrease spending, raise funds through selling government
securities or increase taxes.
However, the group found the first choice as not ideal. Decreasing government
spending is not really the best move for an emerging country like the Philippines. Developing
countries must be aggressive in spending for investments that will help in the growth of the
economy such as development projects like construction of infrastructure and utilities all over
the country. Holding back in spending will just push the country backwards and it is not
something we would like to happen.
Selling government securities on the other hand can pose threats to the Philippine
economy more so with a financial crisis endangering the global economy. Sale of securities in
the market will raise interest rates (prices decline) as money supply decreases and demand stays
at the same level and this will in turn lower investments as financing cost is high. Also, if
borrowing cost will be high, people will be weary of their spending. Contractionary monetary
policy may fight inflation however this will slow down economic activity as well as growth
which is not ideal with the global financial crisis posing threat to economies in the world. Selling
securities may not also be good since selling means borrowing. This will also raise the country’s
debt.
And so, we are recommending an increase in taxes as a solution for the problem in
the budget deficit of the country. Raising taxes may appear unappealing and even antagonistic.
Who would want to pay more when you receive less in return? Corruption is at large in the
country. But setting aside social issues, economically speaking, raising taxes is the most ideal
way to increase government revenues.
We will not confine this increase in tax among the income tax paid by
employees/workers but we will also tap other kind of taxes such as sin-taxes—taxes charged to
cigarettes, liquors, etc.
For the income tax, our first suggestion will be to adjust the income tax brackets and
fairly charge taxes accordingly to an individual’s income. Here we hope to get reasonable or an
increase in tax returns from the more capable individuals—people who are earning more than
enough that an increase in tax will not hurt. Or charge a higher tax on corporations.
Another suggestion will be based on the ability of the government in collecting taxes.
The government is obviously forgoing a large sum of money due to inefficiency in collecting
taxes. Most of the country’s tax revenues are coming from indirect taxes such as VAT which are
automatically charged and paid whenever people purchase. Given that, we may increase the 12%
VAT and in exchange lower the income tax charged.
 There are also revenue opportunities with sin products. The demand for sin products
in the country is very high and charging higher tax will be beneficial for the country. We may
say that this can help people stay away from vices or it is an opportunity to earn from these “sin
products” and use the revenue for health care projects.

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Using the IS/LM curve, the following figure will illustrate how increase in tax affects output.
As seen in the IS curve corresponding to the equilibrium in the goods market or ZZ
curve, an increase in taxes leads to a lower disposable income which causes people to decrease
their consumption. The result through the multiplier effect is a decrease in income and output
from Y to Y’. Moreover, after the increase in taxes, the IS curve will shift to the left from IS to
IS’. LM curve will remain the same, decreasing the new equilibrium from A to A’. Likewise,
from i to i’, interest rate decreases as a result of a decrease in income which reduces the demand
for money.
Increase in taxes may hurt the economy since output is pulled down, however since
interest rates are also decreased, investments might also increase in return which might benefit
i
the economy. On the other hand, investment does not depend on interest rates alone; output is
also a big factor for it. This is why we really cannot tell how the country can benefit from
investments after taxes are increased.
In general, increasing taxes to reduce budget deficit will decrease output and may lead to
a decrease in investment in the short run if it is executed on its own and unaccompanied by any
change in the monetary policy. However, the decrease in output could be prevented by using the
right monetary policy to correspond with the increase in taxes. Lowering interest rates by enough
amounts to offset government spending could be a way to solve budget deficit in the short run.
However, in the medium run, we can expect output to return to its natural rate.

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 As can be seen on the graph above, when we perform a contractionary fiscal policy,
in the short run output will be lower than the natural level as what we have mentioned earlier—
output decreased due to increase in taxes. We can see that as AD curve shifts to the left.
However, the economy will soon adjust itself in the medium run. Pe will be reduced as it is at a
level where P is less than Pe. AS curve will then shift to the right. This will result to a decrease in
the in wages as wage setters foresee this reduction in Pe. A decrease in wages will then decrease
actual price level and then in turn increase M/P which will decrease interest rates and finally
increase output until it reaches again its natural rate.

IV. Bibliography

Abs-cbn News (2010, June 28). Noynoy urged: Increase VAT, lower income taxes. Retrieved
December 11, 2010, from ABS-CBN NEWS: http://www.abscbnnews.com/business
/06/28/10/noynoy-urged-increase-vat-lower-income-taxes
Advantages of Budget Deficit - Economics Help. (n.d.). Economics Help - Helping to Simplify
Economics. Retrieved December 11, 2010, from
http://www.economicshelp.org/macroeconomics/fiscal-policy/adv-budget-deficit.html
Chipongian, L. (2008, November 18). 10-month budget deficit hits P62.3 B. Manila Bulletin
Newspaper. Retrieved from http://mb.com.ph/articles/192851/10-month-budget-deficit-
hitsp623-b
Economic Effects of a Budget Deficit - Economics Help. (n.d.). Economics Help - Helping to
SimplifyEconomics. Retrieved December 11, 2010, from
http://www.economicshelp.org/macroeconomics/fiscal-policy/effects-budget-deficit.html
John Maynard Keynes | Business economy news, business plan, web marketing, small business,
business elements, search engine optimization, business dictionary. (n.d.). Business
economy news, business plan, web marketing, small business, business elements, search
engine optimization, business dictionary | BusinessInEconomy.com. Retrieved December
11, 2010, from http://www.businessineconomy.com/tag/john-maynard-keynes/
Johnson, N. (2010, April 28) Budget Cuts or Tax Increases at the State Level
Which Is Preferable When the Economy Is Weak? Retrieved December 11, 2010 from
Center on Budget and Policy Priorities http://www.cbpp.org/cms/?fa=view&id=1032
Kanabat, R. (2009, February 23). Fiscal Deficits. Scribd. Retrieved December 11, 2010, from
http://www.scribd.com/doc/12752143/Fiscal-Deficits
Orszag, P. & Stiglitz, J. (2001, November 6). Center on Budget and Policy Priorities. Budget
Cuts vs. Tax Increases at the State Level: Is One More Counter-Productive Than the
Other During a Recession?.
Riley, G. (2006 September). Government Borrowing & Budget Deficit. Retrieved December 11,
2010, from http://tutor2u.net/economics/revision-notes/as-macro-government-
borrowing.html
Roxas, R. (2004, August 23). HE CAUSES, EFFECTS AND SOLUTION TO BUDGET
DEFICIT. Retrieved December 11, 2010, from News Flash http://www.newsflash.org/
2004/02/ht/ht004617.htm