CHAPTER 3

FISCAL POLICY
Lecturer: PhD. Hoang Huong Giang
 CONTENTS
• Overview on fiscal policy
• Tax and Fee

• Government expenditure

• Grand
Vietnam’s expenditure and tax collection in 2023 (exp.)

Tổng thu NS: 1.620.744 tỉ VND Tổng chi NS: 2.076.244 tỉ VND
Nguồn: Bộ Tài chính (2023)
 OVERVIEW OF FISCAL POLICY
• Concept
• Classification
• Principles
• Balanced fiscal
 OVERVIEW ON FISCAL POLICY
• Fiscal policy is the use of government spending and taxation to influence the economy.
Governments typically use fiscal policy to promote strong and sustainable growth and
reduce poverty. - IMF
• Measurements:
• Taxes and Fees
• Government spending
• Grand
• Approaches of fiscal policy
• Expansionary fiscal policy
• Contractionary fiscal policy
• Neutral fiscal policy
 OVERVIEW OF FISCAL POLICY
• Classifications:
• Based on the impact degree
• Auto-stabilizer: taxation and expenditure depend on the fluctuation of business cycle
• Discretionary fiscal policy: the government may suddenly change tax and spending
policy which do not depend on business cycle.
• Based on impact methods
• Pro-Cyclical: the government will pursue expansionary policy in booming period and
vice versa.
• Counter-Cyclical: the government will apply expansionary policy in recession period
and vice versa.
 OVERVIEW OF FISCAL POLICY
q Keynes’ opinion:
§ Keynes supports counter-cycle policy:
• Stimulus fiscal: applying for recession and high inflation rate, expansionary policy is
for prevention of worsen economy
• Distractionary fiscal: applying for the booming period, the policy is for prevention of
overheated economy
§ Limitations:
• Keynes’s advice is rather difficult to apply in every situations as:
• Time lag, moral issue and political problems?
• In recession, the government is overspending - is it reasonable?
• In booming, high growth rate, why have we have to constrain?
• IMF advice: in order to be rescued economies must sterilize
 OVERVIEW OF FISCAL POLICY

Counter cycle

Pro-cycle
 Why do emerging economies pursue pro-cycle fiscal
policy?
Frankel, Vegh, and Vuletin (2013):
• Being limited to to access international capital market
• Political reason: weak institution leading to overspending in booming period.
 FISCAL PRINCIPLES
• The EU: Maastricht treaty (1992)
• Budget deficit ≤ 3% GDP
• Public debt ≤ 60% GDP
• The US: Gramm-Rudman-Hollings (1985, 1987)
• Code on fiscal balance for urgent deficit budget passed in 1991 then revised in 1993
• Australia: Transforming from deficit to surplus fiscal strategy
• Controlling annual real expenditure at the level of 2% when the economy recovers steadily
• When budget surplus achieves and the economy still grows steadily, the government still
restrict annual spending by 2% till gets the minimum budget surplus equivalent to 1% of
GDP
 FISCAL PRINCIPLES
• Singapore: Budget must be balanced during the governmental term
• Indonesia:
• Central and local debts are not permitted over 60% of GDP
• consolidated budget deficit is not higher than 3% of GDP
• Chile: Balancing structure orientation: government expenditure depends on tax
collection - the 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
 FISCAL PRINCIPLES - VIETNAM
• Ceiling public debt: 65% of GDP (controversial!)
• Annual budget deficit is determined by the assembly
• Overall Deficit (= Gov. income - Gov. expenditure) vs Primary deficit (=
Gov. income - Gov. expenditure, excluding interest payment)
• Local budget deficit is permitted by the assembly
• Mid-term budget planning - transparency and accountability
 FISCAL POLICY
• Surplus vs deficit
• If T > G, Surplus = (T – G)
• If T < G, Deficit = (G – T)
• If T = G, Balance
• Rel balance sv. Structural balance based on the adjustment of business cycle
• Do the governments pursue budget balance?
• Governments finance budget deficit by:
• Issuing bonds
• Printing money
• Selling national asset
• International borrowing
 TAX AND FEE
• Concepts
• Characteristics
• Classification
• Functions of Tax and Fee
• Effect of Tax on economic growth
 TAX AND FEE
• Concepts
• “A tax is a charge imposed by a government on an individual or a corporate entity.” –
Article No.3, Law on Tax Management, 2019
• A fee is a fixed price charged for a specific service which can be imposed either by
state agencies or private organizations.
 TAX AND FEE
q Characteristics:
• Legal framework:
• A tax is regulated by laws
• A fee is regulated by:
• Law on Fees, 2015 and other regulations such as: governmental degrees, resolutions and local regulations for
public services
• Private organizations for specific service such as fee for late charge applied in commercial banks (for this course
- it is excluded)

• Roles:
• Tax:
• The most important financial resource of state budget.
• The financial resource for the performance of state agencies
• Fee
• Another source of state budget
• As a compensation for state agencies’ operating costs
 TAX AND FEE
q Characteristics (cont.):
• Application scope:
• Tax: nationwide
• Fee: both nationwide and local (eg: car-keeping fee, health care fee)

• Compensation:
• Tax: indirect compensation for the government via his investment in infrastructure construction or welfare
improvement
• Fee: direct compensation for service providers (both state/local or private providers)

• Collectors:
• Tax: state agencies assigned by the government
• Fee:
• State agencies assigned by the state and local government
• Private service providers
 TAX AND FEE
• Classification:
• Based on tax payer:
• Income tax: individual income tax, corporate income tax

• Consumption tax: VAT, excise tax

• Property tax: tax on property

• Based on the nature of tax:

• Direct tax: tax on property or income possessed for individuals or organizations

• Indirect tax: tax on commodities on sale, the end users are taxpayers. eg: VAT
 TAX AND FEE
• The functions of tax

• The main income of the government

• The most important income of state budget
• Used for social-economic development targets

• A measure of the government to regulate the economy

• To stimulate or constrain domestic production or consumption in each
specific period of social-economic development
 TAX AND FEE (fiscal expansion in small country)
• The effect of tax on the economy (closed economy)
Aggregate supply: Y = F(K,L) - K,L are constant in short term
Aggregate demand: Z = C(Y-T) + I(r) + G
When the economy at the equilibrium: Y = Z
Y = C(Y-T) + I(r) + G
G, T are fixed by policy
Y is fixed by factors of production
r is based on the economic situation -> flexible for Demand - Supply intersection/balance
Y - C- G = I(r)
Y - T - C + T - G = I(r)
(Y - T - C): Private saving
(T - G): Public saving
 TAX AND FEE (fiscal expansion in small country)
• (Closed economy) A reduction in saving,
possibly the result of a change in fiscal policy
(tax reduction or Gov. expenditure
increasing), shifts the saving schedule to the
left. The new equilibrium is the point at which
the new saving schedule intersects the
investment schedule. A reduction in saving
lowers the amount of investment and raises
the interest rate. Fiscal-policy actions that
reduce saving are said to crowd out
investment.
 TAX AND FEE (fiscal expansion in small country)
• A Decrease in Taxes
• A reduction in taxes (-ΔT) ->
increase in disposable income ->
increase in consumption:
ΔC = MPC*ΔT
• As Y = constant, G = constant ->
an increase in C will reduce I
• For the reduction of I -> r must
raise
 TAX AND FEE (fiscal expansion in small country)
• The effect of tax on the economy (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 depends on tax and government expenditure
• I depends on interest rate
• NX depends on I and S
 TAX AND FEE (fiscal expansion in small country)
• The effect of tax on the economy (open economy)
• A lower T -> raises disposable income (Y−T) -> increase in C as MPC>1
ΔC = ΔT*MPC >ΔT -> reduction in S.
• NX=S−I
• As S reduces -> NX falls correspondingly
 TAX AND FEE (fiscal expansion in small country)
• A reduction of T increases C
or the raise of G reduces
national saving (Y−C−G) ->
shifts the saving from S1 to
S2.
• Because NX = (S - I) ->
reduces NX.
• A change in fiscal policy
(fiscal expansion) that
reduces national saving leads
to a trade deficit
 GOVERNMENT EXPENDITURE
• Government expenditure:
• Regular spending: salary for servants, army and security forces for their
public services
• Spending for development: Public investment
• By the end of 2021: Vietnam’s public debt accounted for 43,1% of GDP,
government debt was 39% of GDP, foreign debt was 38,4% of GDP
(Source: MOT, 2023)
 GOVERNMENT EXPENDITURE
expenditure Z
Assume:
- the economy is in difficulty
- Yr < Y potential
- I = ̅I (exogenous)
Y = Z = C + I + G (45o line)
∆Y = ∆C + ∆I + ∆G
Income, output Y
∆Y = MPC*∆Y + ∆G
∆Y = (1/MPC)*∆G
GOVERNMENT EXPENDITURE - Multiplier
Based on the initial government expenditure, the spending and
GDPr have increased just after a period thanks to multiplier
effect.
The new spending and the increase of GDPr in specific period
measured by green areas, while previous spending is orange
areas.
The sum of green and orange areas is the accumulated spending
and GDPr
In general, GDPr will increase up to 200 USD with the initial
government expenditure of 100 USD
 GOVERNMENT EXPENDITURE - Multiplier
• Y = Co + MPC*(Y - T) + I + G
=> Y - MPC*Y = Co - MPC*T + I + G
=> Y*(1 - MPC) = Co - MPC*T + I + G
Y = [1/(1 - MPC)]*[Co - MPC*T + I + G]
• If I and G are constant:
∆Y = [-MPC/(1-MPC)]*∆T
• If I is constant:
∆Y = [-MPC/(1-MPC)]*∆T + [1/(1 - MPC)]*∆G
• If ∆G = ∆T then: ∆Y = ∆T = ∆G
GOVERNMENT EXPENDITURE - Multiplier
 GOVERNMENT EXPENDITURE - Multiplier
• Why Multiplier is larger than 1 unit
• Initially, the increase of G leads to Y will increase by: ∆Y = ∆G.
• When Y increases => C raise ⇒ Y raise => C raise...
• Finally, the increase of Y is larger than the increase of initial ∆G.
• Can be Multiplier smaller than 1 unit?
 GOVERNMENT EXPENDITURE - Multiplier
• The range of Multiplier is 0.4 - 1.5, based on calculation methods (Alesina
2012)
• Arin, Koray, and Spagnolo (2012):
• Multiplier is 2.907 in low growth rate period, 0.131 t in high growth rate
period (1949-2006)
• Tax multiplier is from -0.194 to -0.663, equivalent to low and high growth
rate periods
• Ramey (2011): Multiplier is from 0.6 to 1.2
• Romer and Romer (2010): Tax multiplier 3.0
• many others and many debates
 GOVERNMENT EXPENDITURE
• Does The increase in Government spending lead to the raise in output (promote
economic growth)?
• Crowding out effect
• ICOR
• Policy lag
 GOVERNMENT EXPENDITURE
I/GDPr (%) ICOR at constant • The disbursement of government’s support
price 2010 (*)
package of 62,000 billion VND: By the end of
2010 38.1 ..
5/2021, only 22% of the package was grand for
2011 32.8 5.5
vulnerable groups, due to:
2012 31.3 6.4
• Being late to have statistic figure
2013 31 6.5
• Not being able to forecast affected victims
2014 31.6 5.9
by Covid
2015 33.8 5.6
• Being difficult to get list of informal
2016 34.2 6 laborers
2017 34.7 6.1 • The disbursement of Government’s support
2018 34.6 5.7 package of 16,000 billion VND for
2019 34.6 5.8 corporates: only 0,26% because large
2020 34.8 14.3 number of businesses were affected,
2021* 34.1 15.5 inefficient measures
 SUBSIDIES
• Forms of Subsidies:
• Direct government expenditures
• Tax incentives (such as tax credits or reduced tax rates),
• Equity infusions (issue of equity shares against cash)
• Soft loans (lower interest rates than commercial loans)
• Government provision of goods and services and procurement on favorable
terms, and price supports.
 SUBSIDIES
• Motivations - clear-targeted orientation
• Environmental externalities, other externalities
• Policy measures
• Firms tend to underinvest in R&D - Gov.’s subsidies to basic R&D (IMF, 2021)
• Farming subsidies to preserve natural ecosystems
• Credit subsidies for small firms as banks find it too costly to assess their
creditworthiness
• Social targets: social safety nets for the poor, income redistribution policies, or broad-
based (non-firm-specific) employment policies.
 SUBSIDIES
• Subsidy mechanism for the poor ( Schwartz and Clemens, 1999) - examples
• Give consumers coupons to buy bread; bakeries present the coupons to the government,
which pays enough for the coupons to incentivize bread baking;
• Fix the price of bread artificially low and pay bakers to compensate their losses;
• Fix the price of bread artificially low and require commercial banks to provide loans to
bakers (with the government presumably absorbing the costs of failed loans);
• Provide a cash subsidy to bakers to buy flour or to flour millers to buy wheat;
• Allow flour mills preferential access to scarce foreign exchange if they use it to buy wheat;
• Restrict exports of wheat, pushing its price down in the domestic market, which in turn
could lower the price of bread.
 SUBSIDIES
• The outcomes of subsidies:
• 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 investment and disrupt other economies
• Global supply chains are also changing the impact of subsidies: support for upstream inputs
or processes can lower input costs for downstream producers (Lane, 2019; OECD, 2019a)
• Subsidies can interact with each other and with other measures: a firm receives tax
incentives, whose financial position can appear stronger than its performance would
warrant.
SUBSIDIES
SUBSIDIES
 SUBSIDIES
Public debt in selected countries in period of 2018-2021
Nguồn: OECD, 2022
 FISCAL POLICY
• Public debt crisis in the EU:
• Since the mid of 2009:
• Greece was the pioneer with budget deficit up to 13,6% of GDP, public debt was
236 was EUR, equivalent to 115% of GDP
• 11-2010: Ireland was officially the second victim
• 2011: Portugal represented the following member felt in crisis
• Italy and Spain were in the danger
• Italy: budget deficit in 2011 was 5% of GDP, but public debt was 120% of GDP
• Spain: public debt was 72% of GDP, while budget deficit represented up to 9% of GDP
 FISCAL POLICY
• Public debt crisis in the EU (cont.):
• Causes: unsustainable fiscal policy and unbalanced debt structure
• Greece: Budget deficit was 5%, while Eurozone were 2% in the period of 2001-2008
(IMF,2009) - not being able to meet the requirement of the standard of Economic and
Monetary Union (EMU) with ceiling budget deficit of 3% and external debt of 60% of
GDP, but 25/27 members could not meet the requirements. Tax evasion was popular.
• The cooperation among agencies to implement fiscal and monetary policies in
Eurozone: mainly to maintain the value of EUR, the limited cooperation in fiscal among
members (Eurozone)
• Fiscal policy crisis led to belief crisis of international financial institutions in countries
with expansionary fiscal policy
 FISCAL POLICY
• The effect of fiscal policy on the economy:
• Expansionary fiscal policy: increase in expenditure or tax reduction or both
• The increase of output is at least equal to the increase in expenditure or tax reduction
(theoretically)
• Crowding out effect (reduction in private investment)
• Being able to apply pro-cycle or counter-cycle policy
• Contractionary fiscal policy:
 FISCAL POLICY
• Many countries have not be successful for fiscal improvement to achieve high
growth rate as:
• When it is sunny, they feel it is not necessary to fill the hole in their roof.
• When it is stormy, they recognize that the hole is very dangerous, but it is
too late
• Most official forecast are over positive in booming period, which lead to
lack of early preventive and necessary actions.
• Policy makers often forget the mistakes in the past
 DISCUSSIONS
• Analysis the outstanding features of fiscal policy of the following countries and
its effects
• China’s fiscal in the period of 1978 -now
• Abenomic policy
• Korea’s fiscal policy in the period of 1990 -now
• Obama Care
• Trump policy on migration
• Fiscal policy 1977-1987 (Mrs. Thatcher - the UK)
• Việt Nam’s fiscal policy in the period of 1978 -now
 Discussions
By applying fiscal models, please evaluate the:
Public Debt in Greece and the governmental attempts
Public Debt in Portugal and the governmental attempts
Public Debt in Spain and the governmental attempts
Public Debt in Italy and the governmental attempts
Fiscal policy under Thatcher authority
Obama care for the poor: good for the US economy?