CHAPTER 11

Public Finance

What is

Public Finance?

Public finance is the economics of the public sector regarding taxation, expenditure and barrowing.

It is the basic role of the government to guide, correct, and assist the operations of the economy in order to minimize the limitations of the market systems.

Example:
Only those who have money can acquire more goods and services. Precisely, this is the reason why the poor die of hunger or disease . Since the market or capitalist economy can not perform all economic functions, a government policy is needed to guide, correct, and assist the operations of the economy.

Fiscal functions
The word fiscal has been derived from the Latin word fiscus which means money bag. It pertains to public treasury or revenues.

The government collect revenues and spend these to satisfy the various sectors of the economy and society such as education, defense, public works, agriculture, health, and so forth.
Public money is allocated through the national budget system.

There are three major fiscal functions: Allocation function Distribution function Stabilization function

What is Allocation function?

Private goods like rice, soap or cake are allocated in market. Those who have money and they are willing to acquire such goods. However, in the case of most social goods it is not efficient to allocate them through market.

In the Philippines, there are also goods and services sold by the government at a lower price or even free. But these are limited due to our inadequate financial resources. One good example of social service is the LRT, those who like convenience and prompt travel; PGH also extends competent and free medical services to the poor

What is Distribution function?

The issue of fair distribution of wealth and income has been a problem from ancient times to modern times. This economic theory appears to be good but in countries where there is no just distributions of the factors of production (land, capital, labor, entrepreneur), only very few have incomes while the great masses have very low incomes.

Social reformers fight for distributive justice. They claim that the productive resources of society should be fairly distributed among its members. If this is done, the gap between the rich and the poor is narrowed.

What is Stabilization function?

One major goal of fiscal policy is the attainment of economic stability. When there are no problems of unemployment and inflation, the economy is said to be stable. The government through the fiscal tools of taxation, barrowings, and expenditures can minimize or eliminate the problems of unemployment and inflation.

What is fiscal policy?

Fiscal policy refers to the revenue and expenditure measures of the public budget. In formulating fiscal policies, the voters, the president and his cabinet (executive branch), and the legislative body (congress or general assembly) are involved.

The most important needs of the economy and the people are given top priority.

What are the objectives of fiscal policy?

Provision for social goods; Equitable distribution of wealth and income; Maintain high employment; Ensure price stability; and Sustain a satisfactory rate of economic growth

 The national budget contains specific provisions for the funding of projects and programs geared towards the attainment of the aforementioned policy objectives. 1986 national budget is with a social conscience. This means that the budget is focused towards the promotion of the welfare of the poor masses

Shortcomings of fiscal policies

Many government programs and projects are very good. They are always intended for the good people, especially the poor masses. However , when it comes to results, it is already different. Such projects are not properly managed or implemented. For example, the land reform program in most less developed countries is failure.

 Many people do not understand why the government should increase taxes and reduce government expenditures at a time when the economy is prosperous. They do not know such fiscal measures are designed to prevent inflation. So, for political expediency the government does not adopt such fiscal policies. Fiscal policies also suffers from several lags, just like monetary policies. A lag is a delay in solving a given problem.

Fiscal Policy and the Masses

Through its instruments such as taxation and government expenditures can be effective force in improving the social economic conditions of the poor. Since most of the people are poor in less developed country, the emphasis of a fiscal policy should be shifted towards the poor.

 A fiscal policy has both positive and negative fiscal effects on the individuals and the economy. Taxation can encourage or discourage investment, employment, production and savings.

The Politics of Public Finance

In democracy the preference for social goods by the people are expressed through their elected representatives.

Likewise, there are very powerful special groups with vested interests who also work for the approval or disapproval of certain proposed projects.

Public Expenditures
The expenditures of the government are reflected in the national budget which shows the specific programs and projects of the government. Public expenditures mirror the major goals of the government.

 The national government expenditures are allocated among the various sectors such as economic services, social services, defense and general public administration and debt service.

There are causes for such great leap in public expenditures: Inflation Growth of the Population Increase in the Price of Oil Massive Infrastructures of the Government

EVALUATING PUBLIC EXPENDITURES o to evaluate the efficiency of government programs or projects, we have to compare their respective benefits and costs. o economic profitability is not only the basis of judging whether a project is good or not.

o over and above everything else, social justice should be the first priority in estimating the benefits of government expenditures.

o a government should provide more funds to programs and projects w/c are principally designed to improve the social & economic conditions of the poor masses.

TAXATION
o is the means of raising funds for the operations of the government, especially its public services.

o taxes are very important

o they constitute the lifeblood of our economy and society

o they also alleged that there is graft and corruption in the administration of the tax program.

WHAT IS A GOOD TAX SYSTEM?

o The canons (criteria) of a good tax system according to Adam Smith are: o Equity o Certainty o Convenience o Economy

REQUIREMENTS OF A GOOD SYSTEM:

o The distribution of the tax burden should be equitable or fair o Taxes should not ruin an efficient market system o Taxes should serve as tools in facilitating economic stability and economic growth o Tax administration should be efficient o The cost of tax administration & the its compliance should be economical.

APPROACHES TO EQUITABLE TAXATION

o Taxpayers as good citizens have the responsibility to contribute a fair share to the cost of government.
o both such burden can be made less painful or reasonable by the government through the concepts benefit received &

ability-to-pay.

BENEFIT RECEIVED
People pay their taxes in accordance w/ the benefits they received from government projects.

those who do not receive benefits do not pay taxes. EX: postal services, use of roads & bridges w/ toll fees, entrance of a public recreation park w/ fee & so forth.

ABILITY-TO-PAY
people should pay their taxes (as

contributions to the cost of government) on the basis of their ability to pay. those who have more incomes or wealth pay more taxes than those w/ less incomes or wealth. more widely used as the basis in computing our tax payments. it is more accurate to measure income & wealth than benefits received.

TAX STRUCTURE

1.Progressive Tax the one whose rate increases as income increases. a taxable income of less P10,000 pays 3 percent while those taxable income between P10,000 & P15,000 pay 5 percent

2.Registered Tax when its rate decrease as income increases the main portion of our tax revenues comes from the indirect taxes.
3.Proportion Tax is one whose rate remains constant regardless of the size of the income

DIRECT TAXES
Income Taxes o corporations o individuals o fine and penalties Residence Tax Immigration Tax Real Property Tax Estate, gift and Inheritance Tax

INDIRECT TAXES
Amusement Taxes Customs Duties Privilege Taxes Sales Taxes Stabilization Taxes

EXEMPTIONS FROM TAXATION

o encourage & promote their growth, such as cooperatives, cottage industries, infant industries, and rural banks, among others.

o organizations or institutions w/c are engaged in non-profit undertakings, together w/ some specific financial benefits or incomes, are exempted by the Tax Code and special laws.

Examples: Corporations or associations organized and operated solely for religious, charitable, scientific, athletic, or cultural purposes.

Benefits received by members from GSIS. Social security benefits, retirement gratuities, pensions, & other similar benefits received by retired employees

 Prized received by winners from the Philippine Charity Sweeptakes Office. Benefits received from the U.S. government through the U.S. Veterans Administration Donations to social welfare, cultural & charitable institution

 Many claim our tax system is not progressive because the real burden of taxation falls on the poor. The poor are more honest in paying their direct taxes, such as their individual taxes. They have no connections or special tax consultant to help them avoid the payment of taxes. Another criticism is the unrealistic tax exemptions given to individual income tax payers.

likewise, beyond a certain point in the income bracket, individuals are discouraged to work because their income go mostly to taxes. they prefer to retire in their jobs or refuse to accept higher positions. Either way, their net income is higher. The big shots do not pay the right amount of taxes because of their connections.

 Furthermore, our tax collection is very inefficient. They say that if all taxes are really collected , there are enough to finance the expenditures of the government. Hence there is no more need to increase the rates of taxes and no tax on the other productive activities. This is the observation of not a few economists. They noted that tax administration in most less developed countries is not only inefficient but also corrupt.

 The debt of the poor countries is about 1.3 trillion. Such huge debts reflect the very bad economic conditions of the poor countries. In fact, many of them could not pay their debts to the World Bank. Our country has also accumulated a big amount of foreign loans. In fact based on 1988 record, it was no.8 among the biggest borrowers of the world. Of course, critics of the previous government believe that our economic recovery is just a farce.

The IMF has postponed rescue loans to many Latin countries for ignoring economic reforms set by the IMF like sharp currency devaluation, government spending cuts, and credit and import control. Such IMF-prescribe reforms have been intended to solve the extremely high inflation rate pervading in the region.

The biggest debtors are found in Latin America. These are Brazil, Mexico. Argentina and Venezuela. Despite the gigantic foreign loans that they received, still there has been no visible economic progress. Instead, their economies plummeted into the deepest level. Thus, people asked: Where did the money go? Some economic observer gave the ff. answers: 1. Costly construction of projects; 2. Rising cost of imported oil and interest payments; and 3. Most of it were stolen or lost, and perhaps onethird went into private banks in NEW YORK, LONDON, ZURICH and MIAMI.

Our government economic managers claimed that our foreign debt went up because of: 1. The increase in the prices of oil; 2. Increase in the interest rates of foreign loans; and 3. The decrease of our foreign exchange earnings due to economic recession among the industrial countries w/c bought our products.

Highly indebted developing countries:

*Argentina *Brazil *Columbia *Cote dIvoire *Jamaica *Morocco *Peru *Uruguay *Yugoslavia *Bolivia *Chile *Costa Rica *Ecuador *Mexico *Nigeria *Philippines *Venezuela

Most Creditworthy Countries

Based on March 1988 survey of 112 countries conducted by 100 international banks, Japan has maintained its credit rating as the most creditworthy country -- with the score of 94.6. The United States used to be no. 1. It moved down to no. 4 for the last several years. The Philippines moved up from no. 73 in 1987 to no. 71 in 1988. In 1979, our country was no. 3 among the lowest in Asia-pacific region. North Korea has remained the lowest in the credit rating ladder, with the score of 4.0.

The top 25 countries in credit rating were:

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Japan Switzerland West Germany United States Netherlands United Kingdom Canada France Australia Sweden Norway Finland Italy 14. Belgium 15. Taiwan 16. Singapore 17. Spain 18. Denmark 19. Australia 20. Hong Kong 21. Soviet Union 22. New Zealand 23. China 24. South Korea 25. Ireland

Strings Attached to Foreign Loans

For many years, the industrial countries have been extending billions and billions of dollars as foreign loans to the poor countries. How come they have even become poorer? Evidently, such enormous financial assistance have no positive effects on the economies of the poor countries. Nonetheless, it can be said that the poor countries do not know how to use their foreign loans properly. But above all, the conditions attached to foreign loans favor more the foreign creditors than the poor debtors. As a result, more economic benefits go to the lenders.

Foreign Loans for Progress

Credit is good as long as it is used for development purposes. Even the United States relied heavily on European financial Capital during its formative years, In later years, however, it developed its own capital Formation. Even the foremost Filipino nationalist, Claro M. Recto, was in favor of foreign loans. He said that when we borrow money from abroad for our economic development, we become the capitalists, And therefore retain the Profits.