FISCAL POLICY AND

TAXATION
An Economic Perspective

Basic Fiscal Policy (FP) Options

FP concerns itself with inflows (G) and
outflows (taxes) towards economic
stability and growth
S + T = I + G refers to a condition of
equilibrium and FP is the instrument in
reaching this
Fiscal Surplus G < T

Uses of Government Funds

Consumption Expenditures salaries &

wages, social investments

Capital Outlays public works
construction, infrastructure, new
equipment
Economic Services assisting particular
industries
National Security
Debt Servicing

Sources of Public Funds

Non tax revenues:
*interest earned from deposits in the BSP
or in commercial banks
**grants from foreign governments
*** grants from private foundations
****proceeds from the sale of public assets
Taxes : Main Revenue Source

What is taxation?
It is the principal source of revenues in
financing government operations
Tax revenues serves as the primary
control in determining the level of G
In the Philippines, taxes pay for more than
80% of G

The Principles of Taxation

FIRST : Towards equity or social justice
taxes withdraws purchasing power from
society members
Benefit Principle: those who pay the tax
should benefit from the uses for which the tax is
spent

Ability-to-pay OR Sacrifice Principle:

those who have greater income (or wealth)

should pay a greater proportion than those with
less income

Second Principle of Taxation

Administrative Ease of Tax
Tax measures should be devised so
that it can be implemented with ease and
at low cost

Third Principle of Taxation

Adequacy of Revenue
To be worth the effort, a tax should
yield sufficient revenue
A tax that collects less revenue than
the cost of administering it is a nuisance

Other Aspects
Some taxes are aimed at discouraging the
use of a commodity or a service
EXAMPLE: a high tax on tobacco
Some taxes act as a subsidy ( i.e., tax
relief) and act as an incentive to
encourage a particular activity

Keep in mind!!
Taxes affect the allocation of resources or
of a specific activity
Taxes not only add to public revenues but
have effects on economic activity and on
the redistribution of income in the
economy
Tax Revenue = Tax Rate x Base*
Base = Object of that Tax

What are the different types of

taxes?
A progressive tax increases as the base
increases

EXAMPLE: Income Tax & other personal and

business taxes

A proportional tax has a fixed proportion

on the base

EXAMPLE: the VAT

A regressive tax stays the same or

decreases as the base increases in value

What are the different tax systems?

A progressive tax system has an income
redistribution effect from high to lowincome groups
A regressive tax system requires the lowincome groups to pay a higher tax than
the high-income group
NOTE: Tax systems are described
according to its overall effect

Direct and Indirect Taxes

Direct Taxes are directly imposed on
people or on the incomes of businesses
the burden of the tax cannot be
passed on to others
EX: Income, Estate & inheritance,
Residence, Real Property

Direct and Indirect Taxes

Indirect Taxes are levied on goods,
services & transactions
the burden of the tax can be passed
on to others
EX. VAT, Excise, Import Duties, Fines &
Penalties

Fiscal Policy and Stability

How do taxes affect the level of national
income?
T = f (Y) more business activity will lead
to more collected taxes
K = 1 / 1 MPC
KT = 1 / 1 MPC + MPT*
* Marginal Propensity to Tax

Progressive Tax (PT) as an

Automatic (Built-in) Stabilizer
REMEMBER: PT collects taxes from those
who have more
PT can inhibit or limit the overheating
effects of an economy beyond full
employment
PT can boost the economy during periods
of decline taxes drop more than income
does and therefore can boost the
economy

Are Taxes and G Flexible?

Why must government be flexible with tax
collection and with G?
Functions of Government (in Fiscal Policy)
stabilization : towards a deficit when
the economy is under full capacity and
unemployment is high
towards a surplus when the economy
is overheating

Are Taxes and G Flexible?

G is rigid as spending for education, health

and the like are NOT cyclical

T relatively flexible
t s are increased OR new taxes are put in
place when private spending is overheating the
economy siphons off funds from the private
sector
t s are decreased OR inefficient taxes are
removed OR some taxes are temporarily
suspended when the economy is performing
below capacity businesses will have more
money to spend

The Fiscal Deficit

G>T
raises demand and output IN THE SHORT
RUN
Government can finance its deficit by:
borrowing from abroad
borrowing from the BSP
borrowing from the domestic money
market : open market operations

Fiscal Policy and Growth

G for education is investment in human
capital
debt servicing : lessen the amount of
available funds for necessary services and
infrastructure
must also be used to improve national
productivity ex. improved irrigation,
transport systems, telecommunications etc

END OF TOPIC
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