Budget deficits and surpluses
the government budget
As we have seen, an important tool of government fiscal policy is public spending. But where does the government get the money to spend? The government collects its tax revenue of various kinds. The most important taxes (in terms of revenue generation for the government) are the personal income tax and the corporate income tax. The government budget represents the relationship between government spending and the revenue it collects.
There are three possibilities. Abalanced budgetIt is when the government spends an amount equal to what it collects in taxes. Abudget deficitis when the government spends more than it collects in taxes. Abudget surplusis when the government collects more taxes than it spends. While for the last two years the government has been running a widely reported budget surplus, for most of the last 40 years the government has been running a budget deficit.
The graph below shows the US budget deficit or surplus for each year since 1940.
There were relatively large budget deficits during the 1940s as a result of the United States' involvement in World War II. The budget was more or less in balance each year during the 1950s. There were relatively small deficits during the 1960s and 1970s. During the 1980s, budget deficits increased greatly. These large budget deficits were primarily the result of President Ronald Reagan's policies, which involved cutting personal and business income taxes while increasing government spending (mainly for military purposes). Increased government spending at a time when income taxes are cut leads to budget deficits. Budget deficits existed in the 1990s, although they have decreased (but the government still spent more than it collected in taxes). In 1998, however, the government collected more taxes than it spent. Budget surpluses continued for several years, largely because the economy was growing rapidly: as incomes rose, people paid more income taxes and government tax revenue increased. Deficits arose again in 2002.
How big were the government budget deficits? The most useful way to measure the size of a budget deficit or surplus is to compare it to the size of the economy (ie GDP). The graph below shows budget deficits and surpluses as a percentage of GDP.
Measuring the budget deficit or surplus as a percentage of GDP clearly shows the size of budget deficits during World War II. The 2005 and 2006 budget deficits, while the largest ever in dollar terms, are much smaller relative to the size of the economy than the budget deficits of the 1940s and the deficits of the Reagan-Bush years. .
Are budget deficits bad?
The question that arises is the following: are budget deficits bad? Are budget surpluses good?
Here is a snippet of the answer. Remember that the government uses spending and taxes to drive fiscal policy. Fiscal policy is a way to reduce unemployment or inflation. For example, we know that if the economy is in a recession, the appropriate fiscal policy is to increase government spending or reduce taxes. But what does increased public spending do with the government budget? What does a tax cut do to the government budget? Both increased spending and reduced taxes will tend to increase the government's budget deficit.
The point is that a budget deficit is exactly what we need during a recession. The government should run a budget deficit to get us out of the recession.
Likewise, during a period of inflation, the government must run a budget surplus: During inflation, the government must reduce Aggregate Demand by cutting spending or raising taxes. Both a cut in public spending and an increase in taxes will tend to increase the government's budget surplus. A surplus is exactly what we need during inflation.
So, in a sense, budget deficits and surpluses are neither inherently good nor bad. Good or bad depends on the state of the economy. Deficits are what we need during a recession; surpluses are what we need during inflation.
Unfortunately, there is a bit more.
Budget deficits and interest rates
A government budget deficit means that the government is spending more than it takes in in taxes. How is that possible? How can the government spend more money than it has? Just like you would: When people buy a house, car, or some other big-ticket item, they usually don't shell out the full purchase price in cash. Usually what people do is borrow the money they need. And that's what the government does: if the government runs a budget deficit, it has to borrow the extra money it needs.
From whom does the government borrow? Borrow from banks, companies and individuals. The loan takes the form of government bonds, which are just government notes. If you have a government bond, it means you have lent money to the government.
Government borrowing can have a major effect. When the government borrows money, it joins all the other people and businesses that are trying to borrow money to buy cars or houses, take vacations, or build new factories. That is, the demand for loans increases. We now know that when demand for anything increases, the result will be a higher price. Thus, when the demand for loans increases, the price of loans rises. The price of the loan is the interest rate that lenders charge. After:When the government runs a budget deficit and borrows to cover that deficit, the interest rate goes up.
Okay, so a government budget deficit causes interest rates to rise. Y? What happens when the interest rate rises?
As interest rates rise, consumers will be less willing and able to borrow money to buy cars or houses. As interest rates rise, companies will be less willing and able to borrow to build new factories. Therefore, as the interest rate rises, consumer spending falls and so does business investment spending.
The reduction in consumer and business spending when government borrowing raises the interest rate is called the crowding out.
What is important about exclusion? There is a short term effect and a long term effect.
In the short run, when the government increases spending or lowers taxes, it is trying to increase aggregate demand. When the government increases spending or cuts taxes so that there is a budget deficit, the government will have to borrow. This loan raises interest rates. Higher interest rates reduce consumer and business spending. Cutting consumer and business spending reduces aggregate demand. Therefore, the government's attempts to increase aggregate demand are somewhat offset by the crowding-out effect.
Because of the crowding out, government fiscal policy may not be as effective in reducing unemployment or inflation as might be expected. The greater the crowding-out effect, the less effective the fiscal policy.
There is also a long-term crowding out effect. If companies borrow less today because of higher interest rates, they won't invest as much today in building new factories or buying the latest technology. As a result, companies will not be able to produce as much in the future as they otherwise would. And if companies don't invest in new technologies, our standard of living in the future will be lower than it would otherwise be.
How big is the hover effect?
Recent evidence suggests that it is not very large. It is not very large because government borrowing does not lead to a large increase in the interest rate. And the reason that government borrowing doesn't lead to a big increase in interest rate is that as soon as the interest rate starts to rise, people in other countries decide to borrow their money in the US. to lower those interest rates. . And this increased supply of money for loans prevents the interest rate from rising too high.
Of course, there are those who think that an increase in the supply of loans from people in other countries is not a good thing.
So: are budget deficits bad? It is not a simple matter. It really depends on whether we care about the short term or the long term. In the short term, budget deficits are good if the economy is in a recession. A budget deficit helps us out of the recession. But in the long run, budget deficits are a bad thing. Budget deficits raise interest rates, causing businesses to invest less today, which lowers our standard of living in the future.
When a government's expenditures on goods, services, or transfer payments exceed their tax revenue, the government has run a budget deficit. Governments borrow money to pay for budget deficits, and whenever a government borrows money, this adds to its national debt.What is an example of budget surplus? ›
For example, If a restaurant made a monthly revenue of $20,000 and its expenses only equaled out to $17,000, it has a surplus of $3,000.What is the difference between a budget surplus and a budget? ›
A budget surplus is when extra money is left over in a budget after expenses are paid. A budget deficit occurs when the federal government spends more money that it collects in revenue. A budget surplus is more beneficial to a government.What happens when the government has a budget deficit or surplus? ›
A budget deficit can lead to higher levels of borrowing, higher interest payments, and low reinvestment, which will result in lower revenue during the following year. The opposite of a budget deficit is a budget surplus.What causes a budget surplus and deficit? ›
For any given year, the federal budget deficit is the amount of money the federal government spends (also known as outlays) minus the amount of money it collects from taxes (also known as revenue). If the government collects more revenue than it spends in a given year, the result is a surplus rather than a deficit.What happens when a government runs a surplus or deficit? ›
Since government funds come from tax revenues, running a high surplus can mean excessive taxation. Running a surplus means less economic stimulus from government spending. Lower spending reduces the amount of money circulating in an economy, potentially causing deflation.What is budget deficit with example? ›
A budget deficit occurs when a government spends more in a given year than it collects in revenues, such as taxes. As a simple example, if a government takes in $10 billion in revenue in a particular year, and its expenditures for the same year are $12 billion, it is running a deficit of $2 billion.What is meant by budget surplus? ›
: more money than is needed to pay for planned expenses. The state currently has a $3 million budget surplus.What are examples of surpluses? ›
A surplus is when you have more of something than you need or plan to use. For example, when you cook a meal, if you have food remaining after everyone has eaten, you have a surplus of food. You can choose to throw the food out, stockpile it, or try to find someone else, like a neighbor, who wants to eat the food.Which is better budget surplus or budget deficit? ›
The government should have a budget deficit to bring us out of a recession. Likewise, during a period of inflation, the government should have a budget surplus: during inflation, the government should reduce Aggregate Demand, by cutting its spending or by raising taxes.
Budget surplus: the positive budget balance when tax revenues exceed outlays. Budget deficit: the negative budget balance when outlays exceeds tax revenues. National debt: the amount of government debt outstanding- debt that has arisen from past budget deficits.What is the meaning of surplus and deficit? ›
Definition. A surplus is an amount of a resource or asset that exceeds the utilized portion. On the other hand, a deficit is a situation whereby a required resource, especially money, is less than what is required, hence expenses exceed revenues.What happens when the government runs a surplus? ›
Under a budget surplus, government revenues exceed spending. It usually happens when the economy is prospering where the economy is expanding. During this period, economic activity increased. Corporate profits increased as demand for goods and services strengthened.Why is a budget surplus good? ›
On the one hand, achieving a budget surplus is desirable. A surplus means that the National Debt (sum of all previous budget deficits minus any budget surpluses) can be reduced over time. This means that the opportunity cost of funding debt-interest repayments is reduced.What factors cause surplus? ›
Reasons for Surplus
A surplus occurs when there is some sort of disconnect between supply and demand for a product, or when some people are willing to pay more for a product than others.
A current account surplus means that a country has more exports and incoming payments than imports and outgoing payments to other countries.What are the advantages of budget deficit? ›
A budget deficit may be used to finance an expansionary fiscal policy, which involves lowering income and corporate taxes (therefore reducing revenue for the government) and increasing government spending on infrastructure and investments to attract foreign capital and boost economic growth.What is the formula of budget deficit? ›
Fiscal deficit = Total expenditure - Total receipts (excluding borrowings). Fiscal deficit = (Revenue expenditure + Capital expenditure) - (Revenue receipts + Capital receipts excluding borrowings).What is budget deficit equation? ›
There's a simple formula that you can use to calculate the budget deficit: Budget Deficit = Total Government Spending – Total Government Income. Income includes corporate taxes, personal taxes, and other receipts, whereas expenditure includes expenses on healthcare, defence, energy, etc.How do you calculate deficit and surplus on a balance sheet? ›
- In Reports, under Financial Statements - open the report parameters.
- Select the Format tab.
- Highlight the Detail section.
- Check the box next to "Print total net surplus/(deficit)" Note: For the Balance Sheet, mark "Print change in net assets (or fund balance).
- Print the report.
Try the 50/30/20 rule as a simple budgeting framework. Allow up to 50% of your income for needs. Leave 30% of your income for wants. Commit 20% of your income to savings and debt repayment.What are the three types of budget deficit? ›
Revenue deficit: Revenue expenditure as reduced by revenue receipts. Fiscal Deficit: Total expenditure as reduced by total receipts except borrowings. Primary Deficit: Fiscal deficit as reduced by interest payments.What are the causes of budget deficit? ›
The two main causes of a budget deficit are excessive government spending and low levels of taxation that don't cover expenditure. Tax cuts can cause declines in revenue can result in a budget deficit, or, a massive fiscal stimulus can increase government spending over and above the income it receives.What are the two types of budget deficit? ›
Types of Budget Deficits
They are explained follows: Fiscal deficit. Revenue deficit. Primary deficit.
An increase in the fiscal deficit, in theory, can boost a sluggish economy by giving more money to people who can then buy and invest more. Long-term deficits, however, can be detrimental for economic growth and stability.What is difference between fiscal deficit and budget deficit? ›
Fiscal deficit reflects the borrowing requirements of the government for financing the expenditure inclusive of interest payments. As against it, primary deficit shows the borrowing requirements of the government including interest payment for meeting expenditure.What is the formula for surplus? ›
Calculating Consumer Surplus
While taking into consideration the demand and supply curves, the formula for consumer surplus is CS = ½ (base) (height). In our example, CS = ½ (40) (70-50) = 400.
A surplus is when you have more of something than you need or plan to use. For example, when you cook a meal, if you have food remaining after everyone has eaten, you have a surplus of food.How do you calculate a surplus? ›
Total market surplus can be calculated as total benefits – total costs. Alternatively, we can calculate the area between our marginal benefit and marginal cost, constrained by quantity. This is the equivalent of finding the difference between the marginal benefits and the marginal costs at each level of production.What is the golden rule of budgeting? ›
The 50/30/20 rule is an easy budgeting method that can help you to manage your money effectively, simply and sustainably. The basic rule of thumb is to divide your monthly after-tax income into three spending categories: 50% for needs, 30% for wants and 20% for savings or paying off debt.
It includes fixed cost, variable cost, capital costs, and non-operating expenses.