PART II THE DEVELOPMENT OF PUBLIC FINANCE

OBJECTIVES: To trace the evolution of public finance both the macro & micro development
of public finance.

INITIAL SUMMARY: This part deals with the factors that stand out in the development of
public finance & the macro and micro evolution of public finance.

A. The Semantics:

1. Development. It is the process to enhance economic, social and political life

of the poor in defined areas. (by Dionisia Rola)

2. Development. It is the process through which rural poverty could be

alleviated by sustained increases in production and incomes of low income
people. (by the World Bank)

B. Two Factors that Stand Out in the Development of Public Finance:

1. Warfare – a tribute or strife which was almost the only cause of public
expenditure during those times. Here, the exploits of a ruler were expensive
that he had to get financial support that from his personal treasure.

2. Growing Scope of Government Activities - the beginning and

establishment of the government of which necessitated some form of taxation
in order to function has brought about the development of public finance and
its changing nature.

C. Evolution of Public Finance

1. Macro: Beyond the Philippine Setting

1.1 Ancient Finance: The Slave Societies

The beginnings of public finance started from the creation of the state.
The state was created by the necessity to protect and promote the welfare of
man. Basically, the state was comprised of the government, the people,
territory and sovereignty. Public Finance was supposed to preserve the state
and promote the goals of society. In particular, it financed the activities of the
government.

Expenditures: The role of public finance became inextricably linked with

the functions of the government.

1. Protection of the people, territory and sovereignty from

outside aggression. The provision and maintenance of armies and
navies were basic allocations of the public pursue. Writers claim that
public finance started with war activities which was the largest single
item of expenditures then.

2. Preservation of internal peace, order and security and the

administration of justice. Majority of the population were slaves
who might rebel anytime, so peace and order for the ruling minority
was the primary concern and the administration of justice was for the
free citizens and not for the slaves.
3. Maintenance of state religion. In slaves’ empires, the rulers were
considered gods and goddesses and they were looked upon as human
 manifestations of deities (god of war) and were considered religious
and temporal leaders, hence, state religions and massive temples
were erected.

4. Maintenance of the king and his household. It was the people’s

obligation to provide the king with revenues and to spend such for
anything he deemed good for the public welfare.

5. Building and maintenance of public works. Roads, canals,

irrigation systems, pyramids were considered public concerns to be
financed from public resources.

6. Provision of limited free goods and services. Distribution of free

grains in times of famine (as in Rome) public recreation and physical
education.

Revenues: To finance government expenditures, the state had to impose and

collect revenues. The usual sources of revenues at that time were:

1. lootings & tributes = these were imposed on non-citizens of the

state or on conquered people or provinces.

2. donations or gifts = these were collected from wealthy citizens of

the state.

3. revenues from public domain = these were mainly from

agriculture and mines.

4. poll taxes = were levied on Egyptian male population and on

non-Roman citizens engaged in business.

Budgeting: Budgeting was already exercised because of the need to

allocate public revenues for the several functions of the government. However,
there were no distinction between the public and the king’s private
expenditures because the public budget was merged with the king’s pursue.

Auditing: Ancient public finance was limited to tax and expenditure aspects,
so state audit was primarily concerned with the maintenance and inspection of
financial records to ensure the regularity of accounts and the legality of
expenditures. Ancient audit activities were commonly performed by
executive-judicial bureaucracies.

1.2 Medieval Public Finance (395 A.D – 1500)

The development of medieval public finance closely followed the weakening

of the central government and the subsequent fragmentation of public
authority resulting in the system of feudalism.

Feudalism = the system of economic relationship based upon land tenure,

among the king, the lord and the vassals. One important feature of the feudal
system is the suzerain-lord relationship, which implied the responsibility of the
feudal lords to support the king with revenues for the king’s public
expenditures.

 In medieval times, most of the traditional functions and prerogatives of the

king were assumed by the feudal lords. The feudal lords provided basic
services and collected most of the taxes. The king was mainly involved in
national wars. His power to exact contributions was severely curtailed. The
feudal system and its mode of taxation were transported by European
countries to their colonies like Spain which superimposed the encomienda
system in the Philippines. The feudal lord collected a wide range of taxes, fees,
licenses and tolls. While impositions increased, limited concerns of the state
remained the same but taxation emerged as the major source of public
revenue.

1.3 The Rise of Central Government (1300 – 1500). The emergence

of central governments particularly in Europe, brought significant changes in
public finance. These changes were:

1. income tax emerged as the major source of national revenue.

2. introduction of a wide variety of indirect taxes.
3. integration into the tax system, the principle – “That taxes
cannot be imposed without consent.”
4. development of auditing and accounting in the course of
increased demands for accountability.
5. public borrowing was the major activity in public finance.

1.4 Beginnings of Capitalism: During this time, prosperous merchants

and craftsmen began to go against communal restraints. Factories were
established to provide goods for increasing population. Technological
advances enabled man to explore other hands for raw materials and food. This
development demanded new political and social systems which could
accommodate the increased scope and complexities of modern life.

Capitalism – a system of economic organizations wherein privately owned

funds, properties and property rights are privately invested with the purpose of
gaining profit.

Three Schools of Thought (under the Era of Capitalism)

1. Mercantilism. It refers to those policies to enrich a great nation by

trade and manufactures done by the improvement and cultivation of
land rather than by industry of the towns. The mercantilist state was
primarily concerned with the strengthening of the central machinery of
government. This entailed the formulation of national policies
providing for the regulation of industry and trade, elimination of feudal
restrictions and the minting of national coinage.

2. Cameralism. It was concerned with how to make the state powerful

and wealthy through the development of a nation’s internal resources
through efficient administration and control of economic activities.
Cameralists, like Von Justi and Sonnefels, advocated the use of
public finance institutions like taxation to direct the economy towards
prosperity.

3. Physiocracy. The Physiocrats were generally concerned with

taxation and its stability and uncertainty. They agreed that the only
way to institute a stable system of taxation was to base it on a sector
which produced a net profit or surplus. To them. The agricultural
surplus which sustained the flow of income and goods in the economy,
was the best foundation for a lasting system of taxation.
Important Contributions to Public Finance During the Era of Capitalism:

1. Adam Smith (1723 – 1790)

A classical economist who laid the philosophical basis and

justification for free enterprises as ideal political and economic system.
He favored complete freedom for business enterprise and advocated
the policy of minimum government control on business activities called
laissez-faire.

He devoted to the subject of public finance an entire book called

BOOK V = where he viewed that government activities should be
limited to: defense, justice, education and care of highways. He
also discussed here the ways in which public revenues are to be
raised.

He also sets out his celebrated four (4) cannons of taxation =

equality, certainty, convenience and economy. He was against
deficit spending and he advocated the concept of a balanced
budget.

2. David Ricardo (1772 – 1823)

A British economist, who is known for his “Theory of

Distribution of Tax Burden,” where he applied the shifting and
incidence of taxes. His concepts were the bases for the institution of
equality and uniformity in modern taxation and the progressivity of tax
structure.

3. Adolf Wagner (1835 – 1917)

Another economist who ascribed to the state the function of

eliminating the inequalities of wealth through fiscal measures

4. John Stuart Mill (1806 – 1873)

He also advocated the principle of laissez-faire because he

strongly favors personal liberty but he justified however, that
governmental intervention is also necessary.

5. John Maynard Keynes

He advocated the concept of deficit financing and borrowing

which gave theoretical justification for the need to borrow.

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2. Micro: Development of Public Finance in the Philippine Setting

2.1 Pre-Spanish Period. The early Filipinos had a monarchial form

of government known as the Barangay which was independent and governed
by a ruler called datu or rajah = who enjoyed the unconditional loyalty of the
people. Here, the people paid tribute or buiz from the crops that they gathered
or raised. They also rendered personal services to the ruler by assisting him
with wars, exploits and in the cultivation of his land. In return, the ruler,
maintained peace and order and assisted the people to obtain necessities in
life. Nobles and freemen were exempted from paying tributes and from
rendering services to the datu except in case of war.

2.2 Spanish Period. The Spaniards upon arrival here in the Philippines,
imposed and levied taxes upon the Filipinos for their survival and benefits.
Taxes imposed and collected from were:

a) Tariff Duties:

a.1 specific duties on all imports

a.2 surtaxes
a.3 advalorem taxes on imports
a.4 consumption taxes
a.5 other export taxes

b) Internal Revenue Taxes:

b.1 industrial taxes

b.2 urbana taxes (income from rents)
b.3 stamp taxes
b.4 sale of certificates of registration
B.5 public domain

Land during this period remains essentially from taxation.

2.3 Coming of the Americans. During this period, the US continued

to levy taxes for the Filipinos. The US Income Tax Law enacted in 1913 –
brought to the Philippines, Income Taxation. The Philippine Income Tax Law
on March 7, 1919, embodied the rates and exemptions of the 1916 US Income
Tax law. On June 15, 1939, a Comprehensive Taxation came into the
Philippines with the enactment of the National Internal Revenue Code,

2.4 The Japanese Occupation. During this period, the Japanese

authorities imposed increased sales and luxury taxes and license fees but they
also printed Japanese war Notes in running the government in an amount
from P6.623B to P11.148B, whereas, before their arrival, the Philippine money
supply never exceeded P300M. So, the Philippines then suffered the worst
inflation.

But its national assembly which sponsored the Philippine Republic,

authorized the creation of a Central Bank which did not actually came into
being, because the Central Bank of the Philippines was only established on
June 15, 1948 but commences operation on January 3, 1949.

2.5 The Early Years of the Republic. The Tydings Mcduffie Act of
1934 which established the Philippine Commonwealth under the
Presidency of Manuel A. Roxas, provided for the surrender of all US rights
of sovereignty in and over the Philippines.

It was in this period that the Bureau of Treasury and the General Auditing
Office were created. The former was one of the oldest bureaus of the national
government charged with the duty of receiving deposits from all government
offices, while the latter was charged to examine, audit and settle all accounts
of the government.

2.6 Development During 1949-1951. Various development of public

finance during this period were follows:

a. imposition of import controls to check the drain on the

international reserve;
b. licensing of all imports;
c. imposition of selective credit control; and
d. adoption of a flexible system of exchange control.

2.7 Further Development 1960-1970

a. Decontrol Program – a program for the gradual lifting of

exchange and import controls launched by the Central Bank on
April 25, 1960.

b. CB Circular 289 (Export Tax Law) – provided for an 80%

retention scheme of the export proceeds at the old rate of P3.90
to $1 with remaining 20% of foreign exchange receipts to be sold
by the producers-exporters at the free market.

2.8 Current Strategies in Development Finance

a) The role of taxation. Available literature in public finance

places a great deal of importance on the role of taxation
development. It appears that this is the main instrument
which is relied upon for revenue generation.

b) Non-tax revenue. Revenue generated from sources

other than taxes and borrowings, appear not to be given
much importance by academicians, advisers or policymakers.
Non-tax revenue were very minimal.

c) Grants from multilateral and bilateral partners.

These are contributions from international institutions and
other countries that constitute a substantial portion of
government revenue.

d) Borrowings. It is considered as the core of development

finance since the fifties.

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