What is the budget deficit?
A budget deficit occurs when spending exceeds revenue and indicates the financial health of a country. The government generally uses the term budget deficit when it refers to spending rather than businesses or individuals. The accumulated deficits constitute the national debt.
How budget deficits work
The budget deficit explained
In cases where a budget deficit is identified, current expenditure exceeds the amount of income received through standard operations. A country wishing to correct its budget deficit may need to reduce some spending, increase its income-generating activities, or use a combination of the two.
Key points to remember
- A budget deficit occurs when current expenditure exceeds the amount of income received through standard operations.
- Certain unforeseen events and policies can lead to budget deficits.
- Countries can tackle budget deficits by raising taxes and cutting spending.
The opposite of a budget deficit is a budget surplus. When a surplus occurs, revenues exceed current expenses and result in excess funds which can be allocated at will. In situations where inflows are equal to outflows, the budget is balanced.
At the beginning of the 20th century, few industrialized countries had large budget deficits, however, during the First World War, the deficits increased as governments borrowed heavily and used up financial reserves to finance the war and their growth. These war and growth deficits continued until the 1960s and 1970s, when global economic growth rates fell.
The danger of budget deficits
One of the main dangers of a budget deficit is inflation, which is the continuous rise in price levels. In the United States, a budget deficit can cause the Federal Reserve to release more money into the economy, which drives inflation. Ultimately, a recession will occur, representing a decline in economic activity that lasts at least six months. The persistence of budget deficits can lead to inflationary monetary policies, year after year.
Strategies to Reduce Budget Deficits
Countries can tackle budget deficits by promoting economic growth through fiscal policies, such as reducing public spending and raising taxes. For example, one strategy is to reduce regulations and corporate taxes to improve business confidence and increase tax cash inflows. A country can print additional currency to cover payments on debt issuing securities, such as treasury bills and bonds. While this provides a mechanism for making payments, it carries the risk of devaluing the national currency, which can lead to hyperinflation.
Example from the real world
Budget deficits can arise in response to certain unforeseen events and policies. For example, increased defense spending after the September 11 terrorist attacks in the United States contributed to the budget deficit. While the initial war in Afghanistan cost about $ 30 billion, subsequent spending in Iraq cost $ 50 billion in fiscal 2003. When George W. Bush’s presidential term ended in 2009, the total amount spent reached $ 864.82 billion. This, combined with the costs accrued during Barack Obama’s 2009 to 2020 presidential term, increased the deficit to about $ 1.4 trillion in 2009. According to the Congressional Budget Office, “in late 2020, the amount of debt held by the public was equal to 78 percent of gross domestic product (GDP). “
Budget deficits, expressed as a percentage of GDP, can decrease during times of economic prosperity, as higher tax revenues, lower unemployment rates and higher economic growth reduce the need for government-funded programs such as as unemployment insurance and Head Start.