Deficit

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What is a 'Deficit'

A deficit is the opposite of a surplus: the amount by which a resource falls short of a mark. Most often used to describe a difference between cash inflows and outflows, it is synonymous with shortfall or loss – the amount by which expenses or costs exceed income or revenues.

BREAKING DOWN 'Deficit'

The term "deficit" is generally prefixed by another word to put it in context.

Trade Deficits

A trade deficit exists when when a nation’s imports exceed its exports. For example, if a nation imports $3 billion in goods, but only exports $2 billion, it has a trade deficit of $1 billion for that year. This means there is more coming into the country (being bought) than there is going out (being sold). As a result, the country owes more to other countries than is owed to it.

A trade deficit can cause a fall in a domestic currency’s value and send jobs beyond a nation’s borders. Some say trade deficits stem from global competition, which provides consumers a larger array of products.

Assume the small island of Yota has abundant resources.  It uses them to meet almost all of its citizens' needs. It also uses its resources to build a factory to make surfboards. This is the only item that Yota exports. The one resource Yota does not have is oil, and it needs oil to generate electricity for its citizens and the surfboard factory.  If Yota imports $1 million of oil in a year, but only exports $600,000 worth of surfboards, Yota will have a trade deficit of $400,000. 

Note that the only way for Yota to have this trade deficit is if other countries are willing to allow the island to borrow funds to finance the $400,000 debt.

Trade deficits are not always a bad thing. For instance, without a trade deficit, Yota would not be able to keep the surfboard factory operating and its workers employed. Having a trade deficit might also inspire the country to take positive actions that would ultimately eliminate the deficit while providing benefits.  For example, Yota’s government could encourage research and development in alternative energy to reduce its oil dependency. 

Budget Deficits

A budget deficit refers to the balance sheet of a business or, more commonly, a government. It indicates that the entity's revenues are lower than its expenditures. Let's say a small country has $10 billion worth of revenue for a year and its expenditures were at $12 billion for that same year. It would be running a deficit of $2 billion.

When governments and other entities experience budget deficits, they obviously have less money and fewer options for future endeavors; if they've borrowed money to cover the shortfall, they often must pay interest on loans or bonds, as well. It used to be that government budget deficits were financed exclusively by loans from private investors and foreign countries. These loans were often seen as holding a lot of risk for the lender, given that they were often both large and long-term. When governments began to issue bonds which could be payable to bearer, it enabled the original lender to sell the debt, reducing risk and interest rates.

Budget deficits aren't always inadvertent, however. Businesses may plan to run budget deficits to maximize future earning opportunities, such as retaining employees during slow months, to ensure an adequate workforce in busier times. Some governments run deficit to finance public projects and maintain programs for their citizens.

Income Deficits

An income deficit is a measurement used by the U.S. Census, representing the dollar amount by which a family’s income falls short of being at or above the poverty line. If the poverty line is $17,000 a year for a family of three, and the family income is at $15,000, then the family’s income deficit is $2,000. 

Measuring Deficits

Deficits can estimated in different ways. There are two ways to measure a government's deficit, for example.

  • Primary deficit refers to the shortfall without including interest payments on loans taken out to finance the operation of the government.
  • Total deficit does include the interest payments on loans.

Deliberately Running a Deficit

 During a recession, it’s not uncommon for a national government to intentionally run a deficit. It might do this by decreasing sources of revenue, like taxes, while maintaining or even increasing expenditures (say, on infrastructure) that provide employment and income. The theory is that these measures will boost the public’s purchasing power, which in turn stimulates the economy.

So, while it may be hard to find anyone who thinks it's a great idea to carry a budget deficit, there are times when a deficit can be expected. In fact, Keynesian economists argue that it is the responsibility of the government to assist the economy and smooth out the ups and downs in the business cycle. If doing so causes a government to go into debt, they consider this an acceptable level of deficit spending.

This tactic is by no means universally agreed upon. The Ricardian equivalence hypothesis, originally developed by British Parliament member and economist David Ricardo, argues that households will keep the money saved from tax cuts instead of spending it – possibly because they anticipate a future rise in taxes, brought on by the government debt!  However, for Ricardian equivalence to apply, the deficit spending would have to be permanent, as opposed to a one-time stimulus.

Another theory, called crowding out, also warns that serious consequences could result from deficit-financed spending. Developed in the 1970s, this school of thought maintains that when a government borrows to offset the deficit it's running, interest rates tend to rise – which in turn decreases the incentive for business expansion and investment. Increased spending and lending by the government can create a "crowding out" effect by competing with private spending and financing, in other words.

Risks of Running a Deficit

If a deficit is large enough, it can over a number of years can wipe out equity for an individual or a company's shareholders. Although sovereign governments have a much greater capacity to sustain deficits, negative effects in such cases include lower economic growth rates (in case of budget deficits) or a devaluation of the domestic currency (in case of trade deficits).

However, the experience of governments that have run persistent deficits in the 20th and 21st centuries have complicated the Ricardian and neo-classical analyses of the effect of government debt on economic activity. The Great Recession, which drove up government deficits across the world from 2008 to 2013, led many neo-classical economists to speculate that government budgets would collapse under the weight of persistent spending deficits. In fact, Harvard economists Carmen Reinhart and Kenneth Rogoff predicted in 2010 that government debt above 90% of GDP would actively retard economic growth. (Researchers at the University of Massachusetts later discovered a coding error in the Excel spreadsheet Reinhart and Rogoff used that invalidated the pair's conclusion.)

The U.S. Budget Deficit

At times in history the U.S. budget deficit has been quite large, while at other times the budget has achieved a balance or run a surplus. The reasons for deficits vary over time, and there is constant debate over the need for them. But, given that they've become a regular fixture year after after year, the size of the current shortfall ($19,845,043,703,943, as of August, 2017), and its potential impact in our increasingly globalized economy, the deficit has become more of a polarizing issue than ever before.

Like a Loan, Only Bigger
Carrying a deficit balance on the U.S. budget is very similar to a long-term loan, but on a much larger scale. With a balanced budget, the government spends tax receipts and other sources of revenue in amounts roughly equal to what it receives. It is what the government strives for in a best-case scenario.

Unfortunately, it is difficult to carry a balanced budget, let alone a surplus, when the country needs to make payments for national services, programs, defense, and other domestic and foreign expenditures. If there is a shortfall, the government has several options. It can either print new currency or finance the debt with government bills, notes and bonds. Cutting spending and raising taxes are also options, but they are difficult to implement, especially when the spending needs that helped create the deficit in the first place are pressing. Issuing more money can create inflation, while issuing bills or bonds can widen the deficit as the cost of the debt payments mounts. While neither option is desirable, they both may be necessary to battle a deficit.

Sources of Spending
Chart 1 below represents the spending sources of the U.S. government. There is a clear correlation between the Treasury spending, which includes debt payments, and the level of total spending that leads to the deficit spending. (For the latest figures, see the Treasury's running daily total of the deficit.)

Source: http://www.federalbudget.com
 
Source: http://www.marktaw.com/culture_and_media/TheNationalDebt.html
Chart 2: This chart represents income and expenses of the U.S. Government from 1913 to 2008.

It is clear that, until the early 1980s, the U.S. government was able to spend approximately as much as it received from the following sources:

Source: http://www.marktaw.com/culture_and_media/TheNationalDebt.html
Chart 3

After the '80s, carrying a budget deficit became pretty routine, except for the period around 2000, when tax receipts were plentiful as the economy finished a growth spurt and spending was in check. After 2001 spending increased dramatically as defense expenses increased and receipts fell from tax revenues at both the corporate and individual level.

The Budget Process of the U.S. Government
Each year, the president presents the proposed budget to Congress for the next fiscal year. The U.S. Government works on a fiscal calendar ending on September 30. The House of Representatives and the Senate review the proposed budget, following the guidelines created by the Budget and Accounting Act of 1921. Then, the dance begins as appropriation committees propose spending limits and approve appropriation bills, which are sent to the President. The President can approve or veto the bills, with the goal of ultimately getting an approved overall budget. The President also has the option of requesting special and emergency funding to be used for a variety of uses, including defense and natural disasters. One recent example: the bailout packages provided by President Barack Obama following the sub-prime mortgage meltdown of 2008-2009.