(DP 2007-02) Economic and Fiscal Policy Determinants of Public Deficits: The Philippine Case

Benjamin E. Diokno


The large and unsustainable deficits of the early 1980s have reemerged in recent years. This paper aims to answer two questions: What has caused the poor fiscal performance of the Philippines in recent years? Is it the result of unfortunate events, macroeconomic shocks or misdirected fiscal policy? Using time series data and 2SLS estimation method, two measures of public deficits -- the national government account balance (NGAB) and the consolidated public sector financial position (CPSFP) -- were regressed against some macroeconomic and fiscal variables. An important result of the empirical work is that the broader measure, CPSFP, turned out to be the more useful and meaningful one both from the theoretical and policy standpoints. The statistically significant determinants of CPFSP are the following: economic growth rate, inflation, domestic liquidity, capital expenditure, intergovernmental fiscal transfer, and tax effort. Using the narrow deficit concept of NGAB as dependent variable, economic rate and intergovernmental fiscal transfer turned out to be statistically insignificant. 

Tax effort, defined as taxes as percent of GDP, is the most robust determinant of fiscal deficits, with higher tax effort associated with larger fiscal surplus or lower deficit. But tax effort was largely determined by two episodes to tax changes during the period under study. The contribution of the 1986 tax reform to tax effort is positive and highly significant while that of the 1997 tax reform is negatively and statistically significant. Looking forward, any package of reforms which aim to achieve fiscal sustainability in the Philippines should include a strong component for improving revenue effort. Such component should not only aim to correct existing weaknesses in the current tax system (such as, for example, the narrow tax base owing to the proliferation of fiscal incentives laws) but also improve tax administration.

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