ELEC3PF-MODULE-1-LESSON-1.pdf

1 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue 0 2 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue PROGRAM OUTCOMES By the time of graduation, the students of the program shall be...

1 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue 0 2 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue PROGRAM OUTCOMES By the time of graduation, the students of the program shall be able to: 1. articulate and discuss the latest developments in the specific field of practice; 2. effectively communicate orally and in writing using both English and Filipino; 3. work effectively and independently in multi-disciplinary and multi-cultural teams; 4. act in recognition of professional, social, and ethical responsibility; 5. preserve and promote "Filipino historical and cultural heritage"; 6. perform the basic functions of management such as planning, organizing, staffing, directing and controlling; 7. apply the basic concepts that underlie each of the functional areas of business (marketing, finance, human resource management, production and operations management, information technology, and strategic management) and employ these concepts in various business situations; 8. select the proper decision making tools to critically, analytically and creatively solve problems and drive results; 9. express oneself clearly and communicate effectively with stakeholders both in oral and written forms; 10. apply information and communication technology (ICT) skills as required by the business environment; 11. work effectively with other stakeholders and manage conflict in the workplace; 12. plan and implement business related activities; 13. demonstrate corporate citizenship and social responsibility; 14. exercise high personal moral and ethical standards; 15. analyze the business environment for strategic direction; 16. prepare operational plans; 17. innovate business ideas based on emerging industry; 18. manage a strategic business unit for economic sustainability; 19. conduct business research; and 20. participate in various types of employment, development activities, and public discourse particularly in response to the needs of the communities one serves. COURSE TITLE ELEC 3 – PUBLIC FINANCE COURSE OUTCOMES (CMO) At the end of the semester, the students have the ability to: 1. interpret the fundamentals of public finance and the concept of Philippine Public Reveneu; 2. analyze the impact of public debt to the Philippine Finance; 3 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue 3. correlate the nature of public expenditure and the theories that evolved overtime; 4. criticize the Philippine budgeting system; and 5. apply public finance in the local government through a case analysis. MODULE 1 Introduction to Public Finance INTRODUCTION Public Finance is the branch of economics that studies the taxing and spending activities of government. The term is something of a misnomer, because the fundamental issues are not financial (that is, relating to money). Rather, the key problems relate to the use of real resources. For this reason, some practitioners prefer the label public sector economics or simply public economics. Public finance encompasses both positive and normative analysis. Positive analysis deals with issues of cause and effect, for example, “If the government cuts the tax rate on gasoline, what will be the effect on gasoline consumption?” Normative analysis deals with ethical issues, for example, “Is it fairer to tax income or consumption?” This module is composed of only one lesson: Lesson 1 – Fundamentals of Public Finance and Public Revenue. This lesson tackles the concept of Public Finance and how the government earn income to suffice the needs of the public. SPECIFIC LEARNING OUTCOMES In this lesson, you should be able to: 1. define the goal of having a good public financial management; 2. relate the division of public finance in the real-world setting; 3. analyze the importance of maintaining a liquid public income; 4. criticize the Philippine Tax System; PRE-ASSESSMENT Instructions: True or False. Write TRUE if the statement is true and FALSE if the statement is not true. UNDERLINE what makes the statement false. 1. _______ A minimum corporate income tax (MCIT) of two percent is imposed on the gross income of both domestic and resident foreign corporations, on an annual basis. 2. _______ Dividends distributed by a resident company are subject to withholding tax at 25 percent; those distributed to non-residents are taxed at 15 percent, provided the country of the non-resident recipient allows a tax credit of 15 percent. 4 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue 3. _______ The corporate income tax rate is 25 percent. Domestic micro, small, and medium-sized companies will directly benefit from a preferential rate of 20 percent (businesses with taxable income of up to PHP 5 million (US$85,611) and not exceeding PHP 100 million (US$1.7 million). 4. _______ Asset securitization is a financial process where a company takes its loans or other receivables (such as mortgages, credit card debts, or auto loans) and pools them together. 5. _______ Non tax revenue include income from state owned corporation, central bank, income, fine, rates, capital received as external loan from international financial institutions. 6. _______ Public revenue is concerned with the income of the government through various sources. 7. _______ The government of an underdeveloped country protects its infant industries against foreign competition through various public finance activities like imposition of heavy tariff duties on imports, putting restrictions on imports, giving subsidies to keep the cost low etc. 8. _______ Public finance plays a pivotal role in influencing economic development and ensuring the effective utilization of public resources 9. _______ Maintaining fiscal discipline to achieve a balanced budget while meeting the diverse needs of society is a significant challenge. 10. _______ The principle of maximum social advantage implies that public expenditure is subject to diminishing marginal social benefits and taxes are subject to increasing marginal social costs. LESSON MAP Role of the Public Government Revenue Public FInance Tax System The process of understanding Public Finance must start with understanding the fundamentals of public finance, the role of the government, and start their learning with concept of Public Revenue especially the main source of income, the Tax System. CONTENT ENGAGE The Transition and the Changing Role of the Government Instruction. Summarize the Transition and the Changing Role of the Government. Answer Sheet: https://docs.google.com/document/d/1fLpM0EM1U9O22kmAh2JwB0UYxLXpb1ZABmL4y60RITw/edit?usp=s haring 5 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Content Total Points Enumerate and narrate the Style of Writing What are the levels of issues that drived the Conclusion (25.00) transition 100.00 transition. (25.00) (25.00) (25.00) EXPLORE DEFINING MODERN PUBLIC FINANCE Modern public finance focuses on the microeconomic functions of government, how the government does and should affect the allocation of resources and the distribution of income. For the most part, the macroeconomic functions of government—the use of taxing, spending, and monetary policies to affect the overall level of unemployment and the price level—are covered in other fields. THE CONCEPT OF PUBLIC FINANCE Public finance includes administering a nation’s income, debt burden, and spending through various quasi-governmental and governmental entities. This field evaluates the financial activities of public authorities, including government revenue and expenditure. Public finance examines how government actions impact economic stability, resource allocation efficiency, and income distribution among citizens. It involves managing both revenue generation and spending across all sectors involving the public of the nation. Public finances play a critical role in fostering economic development by ensuring the efficient use of funds. This field underscores the government’s function and impact on an economy’s functioning and growth. Objectives of Public Finance Public finance must meet the nation’s basic needs comprehensively. Creating employment opportunities to bolster workforce participation and economic productivity. Preserving the currency’s value in international markets, thereby ensuring economic stability and competitiveness. 1. Addressing Public Needs. The primary objective of public finance is to manage essential public needs such as food, shelter, healthcare, infrastructure, and education. These responsibilities fall under the government’s purview to meet fundamental public requirements, thereby contributing to economic development. 2. Promoting Economic Development. Effective management of public finances fosters economic development, ultimately driving the nation’s overall growth trajectory. 3. Reducing Inequality. Public finance endeavors to reduce inequality through the equitable allocation of resources. This involves implementing measures such as progressive taxation to assist disadvantaged segments of society, thereby promoting social cohesion and fairness. 4. Ensuring Price Stability. Public finance strategies also focus on maintaining price stability by employing various mechanisms and initiatives to control inflation and foster sustainable economic growth. Component of Public Finance Through the collection and payments of funds collected from the public, the public finance theory has a series of responsibilities and functions that must be fulfilled, both in the fundamental sense and for a larger purpose; management of income and expenditure by optimum utilization of the resources; managing the growth and price stability in the economy; providing the necessary needs and infrastructure to the public; take initiatives for the development of the people, which can contribute to the nation’s development; maintaining the transparency of the policies and the records 6 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue of income and expenditures; compare the actual position with the budgets and accordingly alter the policies and manage the economy; monitor the functioning and effectiveness of the financial policy; and preparing the economic policies for the nation’s development and the economy. 1. Revenue Generation. Public finance relies heavily on revenue collection, primarily through taxation, which serves as the government’s main income source. Examples of taxes include income tax, sales tax, and property tax. Additionally, revenue is generated through tariffs on imports, duties, and other government services. 2. Expenditure Allocation. Governments allocate funds for essential sectors such as education, healthcare, infrastructure, and social welfare programs. These expenditures are aimed at improving the well-being and quality of life for society as a whole. 3. Budget Planning. Each fiscal year, governments create budgets that outline planned expenditures and revenue sources. Budgets serve as a roadmap for financial activities and resource allocation. 4. Deficit and Surplus Management. A deficit occurs when government spending exceeds revenue collection for a given period, resulting in a financial shortfall. Conversely, surpluses occur when expenditures are lower than tax revenues. 5. National Debt. Governments may incur deficits by borrowing money to cover budget shortfalls, leading to national debt issuance. The national debt represents accumulated borrowing over time, reflecting the government’s financial obligations. Significance of Public Finance 1. Encourages Investment. Public finance management fosters investment by implementing diverse policies and incentive packages like free trade zones and trade agreements. 2. Efficient Resource Allocation. Public finance management plays a pivotal role in effectively allocating natural and human resources, optimizing their usage for national development. 3. Nation’s Advancement. The effective administration of public finances contributes significantly to the progress and advancement of the nation, fostering economic growth and societal well- being. 4. Upholding Price Stability. Public finance management aids in maintaining price stability, mitigating the adverse effects of inflation and unemployment on the economy. 5. Policy Framing and Innovation. Through public finance, governments can frame policies and make informed decisions that encourage innovation, thereby bolstering overall economic development and competitiveness. ROLE OF PUBLIC FINANCE Satisfaction of social wants comes under the domain of public finance and satisfaction of private wants. Therefore, we must know the characteristics of social wants and private wants comes under the domain of private finance. Further, we must note that the goods which satisfy the social goods are public goods and the goods which satisfy private wants are known as private goods. Private Goods A private good is a product that must be purchased to be consumed, and consumption by one individual prevents another individual from consuming it. In other words, a good is a private good if there is competition between individuals to obtain the good and if consuming the good prevents someone else from consuming it. Economists refer to private goods as rivalrous and excludable and can be contrasted with public goods. 7 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Social Goods or Public Goods The goods or services are collectively consumed are known as social or public goods. The best example of social or public goods is ‘defence’ and ‘police’. The goods called ‘defence’ which is produced by the government is collectively consumed by the society. There are certain distinct characteristics of social goods. a. Indivisibility. The goods which cannot be divided for consumption are invisible goods. In other words, when there are two persons in the society the consumption of the first person is equal to the second person, which is also equal to the total supply. Therefore, it is said that the social goods are supplies to satisfy the collective wants. b. Principle of Exclusion. No body in the society can be excluded from the consumption of social goods. Suppose an individual in the society is not interested to consume social goods. On principle, it is not possible. Example is ‘defence’ This is a distinct characteristic of social goods as compared to the private goods. In case of private goods, if a person does not want to consume, s/he can exclude themselves from the consumption. As such, public goods are produced by the government and every individual in the society is the beneficiary of the goods. c. Non-applicability of the Pricing Principle. The price of public goods is not determined by the principle of demand and supply. The point number two above states that, no individual in the society can exclude himself from consumption of public goods. Hence the traditional pricing principles are not applicable. In order to finance the supply of public goods the principle of public finance plays a crucial role. PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE The principle of Maximum social advantage is the ‘Principle of Public Finance’. It is the fundamental principle which should determine fiscal operations of the government. This principle is formulated and popularized by Dr. Dalton and Prof. Pigou. Dr. Dalton calls it as the principle of maximum social advantage and Prof. Pigou describe as principle of Maximum Aggregate Welfare. The principle provides guidance to the Govt. regarding public revenue and public expenditure or public finance operations so as to maximise social advantage or welfare. According to Dalton, the principle of maximum social advantage is the most fundamental principle lying at the root of public finance. Hence, the best system of public finance is that which secures the maximum social advantage from its fiscal operations. Maximum social advantage is the maxim for the states. The optimum financial activities of a state should, therefore, be determined by the principle of maximum social advantage. It is obvious that taxation by itself is a loss of utility to the people, while public expenditure by itself is a gain of utility to the community. When the state imposes taxes, some disutility or dissatisfaction is experienced in the society. This disutility is in the form of sacrifice involved in the payment of taxes — in parting with the purchasing power. As such, the maximum social advantage is achieved when the state in its financial activities maximise the surplus of social gain or utility (resulting from public expenditure) over the social sacrifice or disutility (involved in payment of taxes.) The principle of maximum social advantage implies that public expenditure is subject to diminishing marginal social benefits and taxes are subject to increasing marginal social costs. So it is necessary to get an equilibrium position where marginal social benefits of public expenditures are equal to the marginal social sacrifice of taxation to maximize social advantage. According to Dalton “Public expenditure in every direction should be carried just so far, that the advantages to the community of a further small increase in any direction is just counter-balanced by the disadvantage of a corresponding small increase in taxation or in receipts from any other sources of public expenditure and public income.” According to Hugh Dalton, "The best system of public finance is that which secures the maximum social advantage from the operations which it conducts." 8 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue This principle is however based on the following assumptions: 1. All taxes result in sacrifice and all public expenditures lead to benefits. 2. Public revenue consists of only taxes and no other sources of income to the a. government. 3. The government has no surplus or deficit budget but only balanced budget. 4. Public expenditure is subject to diminishing marginal social benefit and b. taxes are subject to increasing marginal social sacrifice. The 'Principle of Maximum Social Advantage (MSA)' is the fundamental principle of Public Finance. The Principle of Maximum Social Advantage states that public finance leads to economic welfare when public expenditure & taxation are carried out up to that point where the benefits derived from the MU (Marginal Utility) of expenditure is equal to the Marginal Disutility or the sacrifice imposed by taxation. Hugh Dalton explains the principle of maximum social advantage with reference to Marginal Social Sacrifice and Marginal Social Benefits. The principle of maximum social advantage has been criticized on various grounds. The main practical difficulties are as follows: (i) Difficulties in Measuring Social Benefits. The principle of maximum social advantage is theoretically explained with the help of the marginal utility analysis. The Marginal benefits of public expenditure and the marginal disutility on sacrifice of public revenue are concepts, the objective measurement of which is extremely difficult. (ii) Unrealistic Assumptions. It is unrealistic to assume that government expenditure is always beneficial and that every tax is a burden to society. For example, taxes on cigarettes or alcohol can provide benefit to society; expenditure on social overheads like health care will give rise to social benefit whereas unnecessary increase in expenditure on defense may divert resource from productive activities causing loss of welfare to society. (iii) Neglect of Non – Tax Revenue. The principle says that the entire public expenditure is financed by taxation. But, in practice, a significant portion of public expenditure is also financed by other sources like public borrowing, profits from public sector enterprises, imposition of fees, penalties etc. Dalton fails to take into account all such other sources. (iv) Lack of divisibility. The marginal benefit from public expenditure and marginal sacrifice from taxation can be equated only when public expenditure and taxation are divided into smaller units. But it is not possible practically. (v) Large Budget Size. The financial operations of the government involve collection of large sums of money from taxation and other sources and the disbursement of large amounts by way of public expenditure DIVISION OF PUBLIC FINANCE Management of public finance includes the methodologies, procedures, and strategies that governments employ to manage a country’s financial resources (public funds) effectively and efficiently. It revolves around the various components of public finance, the interactions among these components, and the government’s role within the financial cycle of public resources. The financial cycle starts with budget preparation and follows with activities such as revenue generation, expenditure, accounting, and financial reporting. Public Revenue Public revenue refers to the income collected from various sources by the government or public sector. It can be categorized into two main types: non-tax revenue and tax revenue. Non-tax revenue includes income from administrative fees, fines, penalties, special assessments, escheat, forfeitures, gifts, grants, and irrigation charges. Administrative revenue includes fees, fines, penalties, special assessments, escheat, and forfeitures. 9 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Commercial revenue includes income from tolls, postage, borrowed funds, electricity payments, and other commercial activities. Tax revenue comprises income generated from progressive taxes, regressive taxes, degressive taxes, direct taxes, indirect taxes, specific taxes, and ad valorem taxes. Public Debt Public debt refers to the total amount of money that a government owes to the public as part of its development funds. When combined with any previous deficits, it is referred to as public debt. This debt can be categorized into various types: Internal and External Debt. Internal debt is incurred when the government borrows money domestically, often from banks, business firms, and individuals within the country. In contrast, external debt refers to borrowings from foreign entities, such as international organizations like the World Bank and the Asian Development Bank. Compulsory and Voluntary Debt. Compulsory debt includes obligations that the public is required to pay, such as taxes. Voluntary debt, on the other hand, includes debts where commercial banks voluntarily subscribe to securities issued through government loans. Productive and Unproductive Debt. Productive debt refers to loans that generate revenue for the government and are self-liquidating. In contrast, unproductive debt burdens the community and requires additional taxes for repayment and servicing. Redeemable and Irredeemable Debt. Redeemable debt is repaid by the government after a specified period, often involving the sale of securities to the public. Irredeemable debt, however, lacks a promised repayment date and is not reported by the government. Public Expenditure Public expenditure refers to the total spending by the government on various goods and services to fulfill its responsibilities and meet the needs of the public. It plays a crucial role in the functioning of an economy as it impacts economic growth, social welfare, and public services. Here are some types of public expenditure: Current Expenditure. This includes day-to-day expenses such as salaries of government employees, maintenance of infrastructure, subsidies, and administrative costs. Capital Expenditure. Capital expenditure is used for long-term investments in infrastructure projects like roads, bridges, schools, hospitals, and other public facilities. These investments are aimed at improving the economy’s productivity and quality of life for citizens. Financial Administrator Financial administration in public finance involves managing government budgets, revenue, and expenditures efficiently. This includes: Budgeting and Planning. Estimating revenue, allocating funds, and setting financial goals. Financial Reporting. Transparently presenting financial information to stakeholders. Revenue Management. Collecting taxes and optimizing revenue streams. Expenditure Control. Monitoring spending, preventing waste, and evaluating program effectiveness. Debt Management. Issuing and managing government debt to maintain financial stability. Policies and Regulations. Establishing controls, audits, and risk management frameworks. Performance Evaluation. Assessing the efficiency and impact of government expenditures. MANAGEMENT OF PUBLIC FINANCE Managing public finance economics is a specialized job of a team of experts and professionals who not only concentrate on spending the amount collected towards public welfare but also concentrate on the collection of funds from every individual and organization under different tax slabs. 10 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue 1. Management of Income and Expenditure. Public finance largely involves public money; hence management and transparency in the records play the most important role. 2. Managing Debt and Investments. The role of government is wide as it manages various aspects like managing and repayment of the timely debt, managing the assets, and the investment by the government to decide the value of holding and benefit from it. The proper management of public finance ensures the growth of the nation. It encourages investment through various policies and packages. Preparation, implementation, evolving with the change in technology and the policies framed by the government for the development of the economy at large. It helps to maintain price stability and reduce inflation and unemployment. It is also important in terms of allocating natural and human resources. CHALLENGES WITHIN PUBLIC FINANCE Public finance plays a pivotal role in influencing economic development and ensuring the effective utilization of public resources. Let’s explore some of the key challenges and issues encountered within this domain: Fiscal Discipline and Budgetary Constraints. Maintaining fiscal discipline to achieve a balanced budget while meeting the diverse needs of society is a significant challenge. Political pressures, unexpected events (such as economic downturns or natural disasters), and competing demands for public spending can strain fiscal discipline and lead to budgetary deficits. Revenue Generation and Taxation Issues. Efficiently mobilizing revenue through taxation is crucial for funding public services and infrastructure projects. However, challenges such as tax evasion, an informal economy, outdated tax systems, tax avoidance schemes, and a narrow tax base can impede revenue generation efforts. Public Expenditure Management. Effectively managing public expenditures involves budget planning, allocation, execution, monitoring, and evaluation. Challenges include inefficient spending practices, lack of transparency, corruption in procurement processes, project implementation delays, and inadequate financial management capacity within government agencies. Emerging Challenges. Globalization, technological advancements, and climate change present new complexities in public finance management. Regulatory questions arise with the emergence of digital assets like cryptocurrencies. Post-pandemic corporate solvency remains a concern, highlighting the need for adaptive financial strategies. PUBLIC REVENUE Public revenue refers to the total amount of money that is collected by a government from various sources to finance its expenditures and operations. This can include various forms of taxation (such as income tax, sales tax, property tax, etc.), fees and fines, and other sources of income such as grants, subsidies, and revenue from government-owned enterprises. The collected funds are used to pay for public goods and services, such as national defense, infrastructure, education, health care, and welfare programs, among others. According to Dalton, “The term public income has two senses, wide and narrow. In the wider sense it includes all the income or receipts which a public authority may secure during any period of time". In the narrow sense, however it includes only those sources of income of public authority which are ordinarily known as revenue resources, to avoid ambiguity, thus the former is termed as public revenue.” 11 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue IMPORTANCE OF PUBLIC REVENUE Public revenue has not only occupied an importance place in financial operation of a state, but also been an issue of study in academic arena around the world. How important public revenue is can be described on some few grounds, which are as follows Protection to Infant Industries The government of an underdeveloped country protects its infant industries against foreign competition through various public finance activities like imposition of heavy tariff duties on imports, putting restrictions on imports, giving subsidies to keep the cost low etc. Planned Economic Development Public finance valuable help in the planned economic development of a country. The planning authorities fix the priorities of expenditure for the plan period and raise the necessary funds to implement the plans through various fiscal measures. Regulating Consumption Habits Public revenue regulates the consumption habits of the people. It imposes taxes on items of consumption, the use of which is to be discouraged such as wine, cigarettes etc. and allows concessions and rebates in taxes if it likes to encourage the consumption of any commodity. Reducing Inequalities Public revenue also plays a vital role in reducing social inequalities, through its fiscal policies. The Government can levy heavy taxes on the richer sections of the society and spend the incomes so received on providing various facilities to poor sections of the society such as providing free medical facilities, education, cheap housing, cheap rations through fair price shops Fund Public Goods and Services Public revenue is used to fund a wide range of public goods and services, such as education, healthcare, infrastructure, and national defense. These goods and services are deemed essential for the well-being of society and are not provided by the private sector.( Shill,2019) SOURCES OF PUBLIC REVENUE Public revenue is concerned with the income of the government through various sources. Public revenue is the income by realized the government for purpose of financing in public administration. The government collect money through various forms of tax and nontax revenue. The government collects money from various sectors to run the country. This money is again spent by the government for the welfare of the people. For the overall development of the country, to meet the basic needs of the people, to continue the administrative activities, the government receives revenue from various individuals, institutions, organizations and natural resources etc. Tax Revenue Tax revenue is the result of the application of a tax rate to a tax base. Total tax revenue as a percentage of GDP indicates the share of the country's output collected by the government through taxes. Tax revenue can be regarded as one measure of the degree to which the government controls the economy's resources. Taxes are divided into two types: direct tax and indirect tax. Direct tax is the tax that is paid directly to the government by the person or company on whom it is levied. Income tax, wealth tax, corporation tax and property tax are some examples of direct tax. An indirect tax is a tax levied on goods and services, rather than on income or wealth. The tax is paid by the consumer when they purchase the goods or services, and it is typically passed on to the government by the producer or retailer. Indirect taxes are indirect in the sense that the tax is not directly paid by the person who bears the economic burden of the tax. Examples of indirect taxes include value-added tax (VAT), sales tax, excise duty, and customs duties. Non-Tax Revenue 12 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Non tax revenue include income from state owned corporation, central bank, income, fine, rates, capital received as external loan from international financial institutions. Foreign aid is major and rarely the only source of revenue for developing country. Some non-tax revenue are given below. Fee It is also compulsory payment made by those who obtain a definite service in return. It is never more than the cost of service. For-example birth registration fee, Passport fee etc. Rates Rates are levied by local bodies. The government are generally levied on immovable property of the residents but not necessarily for any special improvement. Example: The money available for leasing various government infrastructures, rivers, ponds etc. Fines Fines are imposed as penalty for breaking in law. For- example: Penalty for non-registration of motorcycle. Forfeiture If an under trial jumps a bail or party to contract fail to carry his part of the contract, the money deposited is forfeited. For Example: If the contractor breaks the promise, the money is fined to the government. Tributes & Indemnities These are paid by foreign country. Tributes are paid by conquered countries and indemnities for any damage done to the country. THEORIES OF PUBLIC REVENUE There are two theories that the surrounds the revenue of the public; Dalton’s and Taylor’s Classification Theory. Dalton provides a very systematic, comprehensive and instructive classification of public revenue. In this opinion, there are two main sources of public revenue — taxes and prices. Taxes are paid compulsorily whereas prices are paid voluntarily by individuals, who enter into contracts with the public authority. Thus, prices are contractual payments. Taxes are sub-divided into: (i) Taxes in the ordinary sense; (ii) Tributes and indemnities; (iii) Compulsory loans, and (iv) Pecunary penalties for offènces. Prices are sub-divided into; (i) Receipts from public property passively held such as rents received from the tenants of public lands; (ii) Receipts from public enterprises charging competition rates; (iii) Fees or payments charged for rendering administration services, such as birth and death registration fees, and (iv) Voluntary public debt. To these two groups must be added another group to make the classification exhaustive. Under this group, the following items are included: (i) receipts from public monopolies, charging higher prices; (ii) special assessments; (iii) issue of new paper money or deficit financing: and (iv) voluntary gifts. 13 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Taylor explained the most logical and scientifically based classification of public revenue. He divides public revenue into four categories: (i) Grants and Gifts (ii) Administrative revenues (iii) Commercial Revenues (iv) Taxes ASSET SECURIZATION Asset securitization is a financial process where a company takes its loans or other receivables (such as mortgages, credit card debts, or auto loans) and pools them together. These pooled assets are then packaged into a new financial product called an "asset-backed security" (ABS). These securities are sold to investors, who receive the cash flows from the underlying assets, like the repayments on the loans. 1. Risk Transfer. By securitizing assets, the original lender (credit originator) transfers some of the risks associated with these assets to the investors who buy the asset-backed securities. This allows the lender to reduce their exposure to these risks. 2. Improved Funding Access. The credit originators can often achieve higher credit ratings on the asset-backed securities than their own corporate credit ratings. This is because the securitized assets are seen as less risky on their own than the entire company's balance sheet. With higher ratings, the originators can borrow money at lower interest rates and access a wider range of investors. 3. Off-Balance-Sheet Financing. When assets are securitized and sold, they are removed from the originator’s balance sheet. This can lower the company’s debt levels and improve financial ratios. It also allows companies to better match their assets and liabilities, and reduce the risk of having too many similar types of credit (credit concentration). Benefits for Originators This process ultimately helps the originators to fund their operations more efficiently, diversify their sources of capital, and manage financial risks more effectively. Risk Management. They can transfer the risk of default on the loans to investors. Better Credit Rating. They can issue securities with higher credit ratings than their own, which can be cheaper to finance. Balance Sheet Management. By moving assets off their balance sheet, they can manage their finances more efficiently and potentially reduce regulatory costs. TAX SYSTEM Tax system is a principle-based set of interconnected parts (elements) in the field of taxation, which includes the tax solvency of the country’s citizens, the system of legally established laws and fees, the tax administration, and the methods of tax administration. the “tax system” scientific term is a social category, which is considered an open system that incorporates political, economic, and legal provisions, and is established with a view to ensuring the implementation of the tax (or tax mechanism) as a means of financial support for the activity of public territorial formations. DIRECT TAXES A direct tax is a tax that a person or organization pays directly to the entity that imposed it. Examples include income tax, real property tax, personal property tax, and taxes on assets, all of which are paid by an individual taxpayer directly to the government. This economic principle states that those who have more resources or earn a higher income should bear a greater tax burden. Some critics of progressive or ability to pay taxation see it as a disincentive for individuals to work hard and earn more money because the more a person makes, the more taxes they pay. 14 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Direct taxes are taxes paid directly to the party that levied them, such as the IRS. Common examples include income, capital gains, or property tax that a taxpayer pays to the government. INDIRECT TAXES An indirect tax is a tax passed off by the government on goods and services. It is collected by the manufacturers or sellers of goods and services from the consumer when they purchase an item or service and then paid to the government. They are often already embedded in the prices of goods and services. Indirect taxes are also known as consumption taxes, transaction taxes, or excise taxes. They are considered regressive since they are a fixed percentage rather than a percentage of income. Indirect taxes are not refundable. Types of indirect tax There are several examples of indirect tax, which typically fall into one of three categories: Sales and services taxes, custom and excise duties, and activity-based taxes. Sales and services taxes In the sales and service tax category, indirect taxes may be seen on the final bill of sale or receipt. (i) Value-added tax (VAT). Value-added tax (VAT) is added at each stage of manufacturing, production, or distribution of goods and services. This is the most common type of indirect tax globally. It is typically collected at each stage of the supply chain and may qualify for input tax credits at the early stages of the supply chain. The cost ultimately falls on the consumer or end user. Most European Union countries apply a VAT. (ii) Goods and services tax (GST). Goods and services tax (GST) is another consumption tax that is applied to the supply of most goods and services. It is designed to replace multiple indirect taxes. Like VAT the consumer bears the GST, and input credits can be applied at early stages. GST is commonly applied in Canada, India, Australia, and New Zealand. (iii) Sales tax. Sales taxes are applied at the final point of sale and not at each point of the supply and distribution chain. They are typically a percentage of the selling price of the goods or services. They can be applied at multiple levels of jurisdiction – country, state, and city. The U.S., for example, does not have a federal sales tax, but taxes may be applied at the state and regional levels. Customs and excise tax In the customs and excise duties category, there is a regulatory tone. (i) Import duties, also known as tariffs, can be a direct result of geopolitical relationships and are a tool for regulating trade and protecting domestic markets. The World Customs Organization has implemented a standardized coding system, the Harmonized System, for more than 5000 commodity groups as a foundation for unified classification on customs tariffs. Over 98 % of the merchandise in international trade is classified in terms of the HS. (ii) Excise duties. Governments use excise duties to regulate the consumption of certain types of products manufactured within their borders. Sometimes called a ‘sin tax’, they are applied to hazardous chemicals, alcohol, cigarettes, sugary drinks, and gambling. These taxes are typically aimed at influencing behaviors that have negative effects on people’s health and the taxes collected are applied toward the healthcare and support programs affected by these behaviors. (iii) Fuel excise tax (gas taxes). Fuel excise tax, or gas taxes, are collected by sellers at the point of purchase and included in the price. They can be applied by various levels of government resulting in federal and state fuel excise taxes being added to the price, a 15 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue clear example of indirect tax. In more recent years, the incorporation of carbon emissions fees into gas prices has broadened the scope of what an indirect tax is. Activity-based taxes The third category, activity-based examples of indirect taxes include environmental tax and financial transaction tax. Like excise duties, activity-based examples of indirect taxes are aimed at influencing behavior. (i) Environmental taxes. Environmental taxes are imposed on activities that have a negative impact on the environment. They are designed to discourage pollution and encourage sustainable practices. Examples include taxes on carbon emissions, landfill waste, and certain types of pollutants. In Environmental Taxation: A Guide for Policy Makers, the OECD delivers a comprehensive overview of how environmental taxes should be developed, applied, and implemented. (ii) Financial transaction tax (FTT). A Financial Transaction Tax (FTT) is a levy imposed on specific financial transactions such as stock trades, currency exchanges, or certain types of financial derivatives. A small percentage of the value is paid in taxes. The levy can be passed onto the buyer, seller, or intermediary. Despite being an indirect tax generating a large revenue stream for governments, FTTs are a topic of debate with almost as many countries abandoning FTTs as there are implementing them. TAX BASES The taxation policy in the Philippines is chiefly governed by the following Republic Acts: The Corporate Recovery and Tax Incentives for Enterprises Act (CREATE Act), Tax Reform for Acceleration and Inclusion (TRAIN) Law; Article VI, Section 28 of the Constitution; The National Internal Revenue Code; and Local Government Code of 1991. The country imposes a territorial tax system, meaning only Philippine-sourced income is subject to Philippine taxes. Corporate income tax The corporate income tax rate is 25 percent. Domestic micro, small, and medium-sized companies will directly benefit from a preferential rate of 20 percent (businesses with taxable income of up to PHP 5 million (US$85,611) and not exceeding PHP 100 million (US$1.7 million). The CIT of 25 percent is levied on net income on all sources. Non-resident companies are taxed only on their Philippine-sourced income. Domestic companies are taxed on their worldwide income. Ease of Paying Taxes (EOPT) Act The Ease of Paying Taxes Act, also known as Republic Act No. 11976, became effective on January 22, 2024. This law aims to modernize tax administration and streamline processes to encourage easier compliance for taxpayers. Notable changes include the new classification of taxpayers. Taxpayers are now categorized based on gross sales: Micro: Less than PHP 3 million (US$51,379); Small: PHP 3 million to less than PHP 20 million (US$342,529); Medium: PHP 20 million to less than PHP 1 billion (US$17.1 million); and Large: PHP 1 billion and above. Minimum corporate Income tax A minimum corporate income tax (MCIT) of two percent is imposed on the gross income of both domestic and resident foreign corporations, on an annual basis. It is imposed from the beginning of the fourth taxable year immediately following the commencement of the business operations of the corporation. The MCIT is imposed when the standard 20 percent CIT is lower than the two percent MCIT on the company’s gross income. Any excess of the MCIT over the normal tax may be carried forward and credited against the normal tax for the three immediately succeeding taxable years. 16 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue WITHHOLDING TAX Dividends Dividends distributed by a resident company are subject to withholding tax at 25 percent; those distributed to non-residents are taxed at 15 percent, provided the country of the non-resident recipient allows a tax credit of 15 percent. The withholding tax may be reduced under an applicable tax treaty. Interest Interest paid to a non-resident is subject to a 20 percent withholding tax unless otherwise stipulated under a tax treaty. Royalty Royalty payments made to a domestic or resident company are subject to a final withholding tax of 20 percent. A 25 percent withholding tax is levied on royalty payments to non-residents. FRINGE BENEFITS TAX Fringe benefits granted to supervisory and managerial employees are subject to a 35 percent tax on the grossed-up monetary value of the fringe benefit. Under new income tax regulations, fringe benefits mean any good, service, or other benefit granted in cash or kind, other than the basic compensation, by an employer to an individual employee. The benefits include, but are not limited to: housing, expense accounts, vehicles, household personnel, interest on loans at below market rate, club membership fees, expenses for foreign travel, holiday and vacation expenses, education assistance, and life or health insurance and other non- life insurance premiums. Fringe benefits tax, however, is not imposed when the fringe benefits are deemed necessary to the nature of your business. BRANCH PROFIT REMITTANCE TAX Branches of foreign companies in the Philippines, except those registered with the Philippine Economic Zone Authority, are subject to income tax at 30 percent of their income derived within the Philippines. A 15 percent branch profit remittance tax (BPRT) is levied on the after-tax profits remitted by a branch to its head office. After-tax profits remitted by a branch do not include income items that are not effectively connected with the conduct of its trade or business in the Philippines. Such income items include interests, dividends, rents, royalties, including remuneration for technical services, salaries, wages, premiums, annuities, emoluments or other fixed or determinable annual, periodic, or casual gains, profits, income, and capital gains received during each taxable year from all sources within the Philippines. IMPROPERLY ACCUMULATED EARNINGS TAX Income accumulated by closely held corporations with the purpose of avoiding tax attracts an improperly accumulated earnings tax (IAET) of 10 percent. The closely held corporation may refer to companies wherein at least 50 percent of the capital stock or voting power is owned directly or indirectly by not more than 20 individuals. The tax base of the 10 percent IAET is the taxable income of the current year plus income exempt from tax, income excluded from gross income, income subject to final tax, and the amount of net operating loss carry-over deducted. Corporations excluded from the ambit of the IAET include banks and other nonbank financial intermediaries; insurance companies; publicly held corporations; taxable partnerships; general professional partnerships; non-taxable joint ventures; and duly registered enterprises located within the special economic zones declared by law, which enjoy payment of special tax rate on their registered operations or activities in place of other taxes, national or local. The criteria to determine the liability for the IAET is the purpose of the accumulation of the income and not the consequences of the accumulation. That is, if a company allows its earnings or 17 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue profits to accumulate within its reasonable needs, then it would not be subject to the tax unless proven to the contrary. PERSONAL INCOME TAX The Philippines implements a progressive personal income tax rate of up to 35 percent. The TRAIN Act, which was passed at the end of 2017, stipulated provisions to reduce personal income tax on all taxpayers except those in the highest income bracket. Taxpayers in all income brackets below PHP 8 million (US$142,900) will therefore see between a two and five percent reduction in personal income tax rate from January 1, 2023, onwards. VALUE-ADDED TAX The 12 percent value-added tax (VAT) rate is imposed on most goods and services that have achieved actual gross sales of over PHP 3 million (US$51,379). VAT exemption for exporters of local purchases The Philippines issued a value-added tax (VAT) exemption for registered exporters on their local purchases of goods and services through Revenue Regulations (RR) No. 21-2021. The VAT privilege covers the sale of equipment, supplies, packaging materials, and goods, among others, for a maximum period of up to 17 years. What services are subject to VAT exemption? The services performed by a VAT-registered person that is subject to VAT exemption are as follows: Sale of raw materials, packaging materials, supplies, inventories, and goods, to a registered enterprise and used in its registered activity; Sale of services, including the provision of basic infrastructure, maintenance, utilities, and repair of equipment, to a registered enterprise; Services rendered to persons engaged in air transport operations or international shipping, including leases of property, provided that these services are exclusively used for air transport operations or international shipping; The transport of passengers and cargo by domestic air or sea vessels from the Philippines to a foreign country; Sales to persons or entities who are exempted from direct and indirect taxes under special international agreements to which the Philippines is a signatory; 18 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue The manufacturing, processing, or repacking of goods for persons or entity that are doing business outside of the Philippines, and the said goods are subsequently exported and paid for by foreign currency; and The sale of power is generated through renewable resources such as geothermal and steam, hydropower, biomass, solar, and wind, among others. Newly registered export enterprises under CREATE can enjoy the VAT exemption for a maximum of 17 years starting from the date of registration. Meanwhile, for existing registered export companies located inside freeport zones and ecozones, the VAT exemption shall be until the expiration of the transitory period. A registered export enterprise is a corporation, partnership, or other entity established under Philippine laws and registered with an Investment Promotion Agency (IPA). They must also engage in manufacturing, assembling, or processing activities that result in the direct exportation of manufactured or processed products. TAX STRUCTURE Tax structures vary because countries have different economic structures and governments have diverse economic, social, and political objectives and varying abilities to use the tax system. During economic development the objectives of tax policy change, a wider range of possible tax bases becomes accessible, and the capability of countries to administer broad-based tax systems improves. Economic development changes the economic structure, the aims of economic policy, and the tax structure. In theory and practice, the development of tax structure means a rise in the share of direct taxes and thus an increase in the progressivity of the tax system. Progressive Tax A progressive tax is a tax in which the tax rate increases as the taxable base amount increases. The term “progressive” describes a distribution effect on income or expenditure, referring to the way the rate progresses from low to high, where the average tax rate is less than the marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability-to-pay, as such taxes shift the incidence increasingly to those with a higher ability-to- pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden increases as an individual’s ability to pay it decreases. Recessive Tax A regressive tax is a tax imposed in such a manner that the average tax rate decreases as the amount subject to taxation increases. “Regressive” describes a distribution effect on income or expenditure, referring to the way the rate progresses from high to low, where the average tax rate exceeds the marginal tax rate. In terms of individual income and wealth, a regressive tax imposes a greater burden (relative to resources) on the poor than on the rich — there is an inverse relationship between the tax rate and the taxpayer’s ability to pay as measured by assets, consumption, or income. Proportional Tax A proportional tax is a tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or decreases. The amount of the tax is in proportion to the amount subject to taxation. “Proportional” describes a distribution effect on income or expenditure, referring to the way the rate remains consistent (does not progress from “low to high” or “high to low” as income or consumption changes), where the marginal tax rate is equal to the average tax rate. EXPLAIN Exploring Concepts Instruction. Criticize the IMF Working Paper “Asset Securization and Structured Financing: Future prospects and Challenges for Emerging Market Countries”. 19 Module 1 – INTRODUCTION TO PUBLIC FINANCE Lesson 1 Fundamentals of Public Finance and Public Revenue Answer Sheet: https://docs.google.com/document/d/19Jgujlf3m8kVcVUmkC71AxIFCVINMYX1Fd5eI2lCdFo/edit?usp=sharin g Content Total Points Define the environment Style of Writing How would you able and concept of Asset Illustrate all issues faced (25.00) to resolve issues? 100.00 Securization (25.00) (25.00) (25.00) TOPIC SUMMARY At the end of this lesson, you have learned that: Modern Finance focuses on resource allocation. Public fiancé manages the national’s income, debt and spending. Public finance addresses the public needs, promote economic development, reduce inequality, and ensure price stability There are different tax collection in the country. The role of the government in maintain a healthy financial structure. REFERENCES College of Earth and Mineral Sciences, The Pennsylvania State University. "GEOG/EME 432: Energy Policy: Public and Private Goods / The Tragedy of the Commons." https://www.e-education.psu.edu/geog432/node/277 https://gyansanchay.csjmu.ac.in/wp-content/uploads/2022/04/Principle-of-Maximum-Social- Advantage-22-4.pdf https://www.occ.treas.gov/publications-and-resources/publications/comptrollers- handbook/files/asset-securitization/pub-ch-asset-securitization.pdf https://www.iejme.com/download/tax-system-the-concept-and-its-legal-content.pdf Internal Revenue Service. "Understanding Taxes: Direct and Indirect Taxes, https://apps.irs.gov/app/understandingTaxes/student/whys_thm04_les04-jsp." Constitution Center. "Direct and Indirect Taxes, https://constitutioncenter.org/interactiveconstitution/interpretation/article/clauses/757." Internal Revenue Service. "Historical Highlights of the IRS, https://www.irs.gov/newsroom/historical-highlights-of-the-irs." https://www.aseanbriefing.com/news/a-guide-to-taxation-in-the-philippines/ https://socialsci.libretexts.org/Bookshelves/Economics/Economics_(Boundless)/16%3A_Taxe s_and_Public_Finance/16.3%3A_Progressive_Proportional_and_Regressive_Taxes