Fiscal Policy

Overview

Approach

Classification

Measurement

Tax

gov spending

Grand

Expansionary

Contractionary

Neutral

Impact degree

Impact method

Auto-stabilizer: depend on fluctuation of business cycle

Discretionary: suddenly change tax and spending, not depend on business cycle

Pro-cyclical: expansionary in booming period

Counter-cycle: expansionary in recession period

Keynes' opinion

support counter-cycle policy

limitations

stimulus fiscal

apply for recession and high inflation rate

expansionary policy to prevent of worsen economy

distractionary fiscal

apply for booming period

prevent overheated economy

time lag, moral/political issue

If in recession the gov overspend - is it reasonable?

If in booming with high growth rate - why have to constrain?

IMF advice: must sterilize to be rescued economies

Why emerging economies pursue pro-cycle policy

Being limited to access international capital market

Weak institution leading to overspending in booming period

Principles

The EU: Maastricht treaty (1992)

Budget deficit ≤ 3% GDP

Public debt ≤ 60% GDP

The US: Gramm-Rudman-Hollings (1985, 1987)

Australia

Transforming from deficit to surplus fiscal strategy

Controlling annual real expenditure at the level of 2% when the economy recovers steadily.

When there is budget surplus and the economy still grows steadily, the gov still restrict annual spending by 2% till the min budget surplus is equal to 1% of GDP

Code on fiscal balance for urgent deficit budget passed in 1991, then revised in 1993

Sing

Budget must be balanced during the gov term

Indo

Central & Local debts < 60% GDP

Consolidated budget deficit < 3% GDP

Chile

balancing structure orientation

gov expenditure DEPEND ON tax collection - output at potential level

2001-07: 1% GDP; 2008: 0,5% GDP; 2009: 0%; 2010-14: targeting to get structural deficit at 1% of GDP in 2014

Vietnam

Ceiling public debt=65% GDP - controversial

Assembly determines annual budget deficit, local budget deficit

Overall deficit = gov income - gov expenditure

Primary deficit = gov income - gov expenditure WITHOUT interest payment

Midterm budget planning

Transparency

Accountability

Surplus vs Deficit

Surplus Thặng dư=T-G

Deficit Thâm hụt=G-T

Banlance T=G

Gov finance budget deficit

Issuing bonds

Printing money

Selling national asset

International borrowing

Real balance vs. Strutral balance

based on adjustment of business cycle

Do govs pursue gov balance?

Tax & Fee

Concept

A tax is a charge imposed by a gov on an indv/corporate entity

A fee is a fixed price charged for a specific service, imposed by state agencies/private org.

Characteristics

Legal framework

A tax is regulated by laws

Fee is regulated by laws

gov degrees, national/local resolutions for public services

private org for specific service: fee for late charge in comm. banks

Role

Tax

The most important financial resource of state budget

The financial resource for the perfomance of state agencies

Fee

Also source of state budget

Compensation for state agencies' operating costs

Application scope

Tax: nationwide

Fee: nationwide & local

car-keeping fee

health care fee

Compensation

Tax: indirect compensation for the gov via investment in infra construction or welfare improvement

Fee: direct compensation for service providers

Collectors

Tax: Sate agencies assigned by the gov

Fee

Sate agencies by local

private service providers

Classification

on tax payer

Income tax

individual

corporate

Consumption tax

VAT

excise tax: thuế hàng hóa

Property tax

on nature of tax

Direct: tax on property/income possessed

Indirect: tax on commodities on sale, the end users are taxpayers

Function of tax

Main income of gov

most important income of state budget

used for social-economic development targets

A measure to regulate economy

Stimulate/constran domestic production/comsumption in each period of socioeconomic development

fiscal expansion in small country

Effect of tax on closed economy

Aggregate supply

Y = F(K,L) - K, L constant short term

Aggregate demand

Z = C(Y-T) + I(r) + G

When the economy at equilibrium: Y = C(Y-T) + I(r) + G

G,T are fixed by policy

Y is fixed by factors of production

r based on economic situation -> flexible for Demand - Supply

Y - C - G = I(r)

(Y - T - C) + (T - G) = I(r)

Y - T - C: private saving

T - G: public saving

A fall in saving by tax reduction or gov expenditure increase

Saving schedule to the left

Saving (T-G) giam -> Investment I(r) giam -> interest rate tang

reduction in tax, increase disposable income

public agency invest more, make it not profitable for private -> create crowd out effect

increase consumption

Investment dem di gui ngan hang lam r tang

Y, G constant -> C increase lam I reduce

r must raise

Effect of tax on open economy

C = C(Y-T)

Y = C(Y-T) + I(r) + G + NX

NX = Y - C(Y-T) - G - I(r)

NX = S - I(r)

S depend on tax and gov expenditure

i depend on interest rate

NX depend on I and S

Lower T -> Higher disposable income (Y-T) -> C increase

as MPC > 1

ΔC = ΔT*MPC >ΔT -> reduction in S.

MPC: the fraction of additional income that is spent on consumption. MPC 0.8 means every extra dollar of income, 80 cents are spent on consumption and 20 cents are saved

As S reduces -> NX falls correspondingly

T giam lam C tang/G tang

reduce national saving (Y-C-G)

shift the saving from S1 to S2

NX = S - I, S giam lam giam NX

Fiscal expansion lam giam national saving -> trade deficit

Gov expenditure

Regular spending

salary for servants, army and security forces aka public services

Public investment: to develop

Vietnam debt by 2021

public debt 43% GDP

gov debt 39% GDP

foreign debt 38% GDP

assume the economy is in difficulty

Yr < Y potential, I = ̅I

Y = Z = C + I + G

∆Y = ∆C + ∆I + ∆G = MPC∆Y + ∆G = (1/MPC)∆G

Multiplier: impact of a change in g. spending on the economy

Based on the initial gov expenditure, the spending and GDPr increased after a period thanks to multiplier effect

GDPr increased to 200USD (induced increases in consumption spending) with initial gov expenditure of 100USD

High Multiplier Value

economy has plenty of spare capacity

Low Propensity to Import and Tax

Labor and capital are underutilized.

Low Multiplier Value

Economy is close to capacity limits

Rising demand causes rising inflation

Higher inflation causes rising interest rate

Size of fiscal multiplier

gov capital investment -> higher multiplier effects

Economists calculate long-run multiplier

1.5 for developed countries

1.6 for developing countries

Why Multiplier > 1

initially ∆Y = ∆G.

Y increases => C raise ⇒ Y raise => C raise...

Finally, the increase of Y is larger than the increase of initial ∆G.

Does The increase in Government spending lead to the raise in output (promote economic growth)?

Crowding out effect

ICOR

Policy lag

disbursement of gov support 62 ty vnd

late to have statstics

not able to forecast covid victim

difficult to account for informal labor

disbursement of gov package for corporates

only 0.26%

ICOR Incremental Capital Output Ratio

lower ICOR means higher productivity of capital

VN's ICOR increase year by year -> inefficient

Subsidies

Forms

Direct gov expenditures

Tax incentives

equity infusion

soft loans

gov provision of goods with favorable terms and price support

tax creditors

reduced tax rates

lower interest rate than commercial loans

Motivation

environmental externalities

policy measures

gov subsidies to basic R&D

Farming subsidies to preserve natural ecosystems

Credit subsidies for SME

Social targets

too costly for banks to assess creditworthiness

safety net for the poor

income redistribution policies

broad-based employment policies

Example subsidies for the poor

give consumers coupons to buy bread, bakeries present the coupons to the gov, the gov pays for the coupons to incentivize bread baking

fix price of bread artificially low

pay bakers to compensate for their losses

require banks provide loans to bakers

gov absord all failed loans

provide cash to bakers to buy flour/ flour millers buy wheat

Allow flour mills preferential access to scare Forex if they use it to buy wheat

Restrict exports wheat, push price down in domestic, in turn lower price of bread

Outcomes

In the absence of market failures or externalities, they drive a costly wedge between prices and production costs

The costs of subsidy-induced distortions can be substantial: the effects of fossil fuel subsidies

Subsidies may distort trade and invest, disrupt other economies

Global supply chains are changing the impact of subsidies: support for upstream inputs or processes can lower input costs for downstream producers

Subsidies might interfere with each other and other measures: firm recieves tax incentives, whose financial apperance stronger than warrant

increase in expenditure/tax reduction

theorectically, the increase of output is at least equal to the increase in expenditure/tax reduction

create crowding effect

Tăng thâm hụt ngân sách -> tăng lãi suât thực

giảm đầu tư khu vực tư

vốn từ bên ngoài đổ vào

đồng nội tệ lên giá

giảm xk ròng

increased gov spending stimulate demand -> higher production & employment w/o inflation

The marginal propensity to import (MPM) is the change in imports induced by a change in disposable income

A low MPM means that an increase in income leads to a relatively small increase in imports

low marginal propensity to tax means that an increase in income leads to a relatively small increase in tax revenue

less of additional income is "leaked" out of economy through imports or taxes

High Propensity to Consume Extra Income

The marginal propensity to consume (MPC) the proportion of an additional unit of income spent on consumption

high MPC: when income increases, a large portion of it is spent on consumption -> increase in AD, stimulate economic activity