Budget Deficit: Causes, Effects, and Prevention Strategies

Budget Deficit

Investopedia / Joules Garcia

What Is a Budget Deficit?

A budget deficit occurs when expenses exceed revenue and can indicate the financial health of a country. The term is commonly used to refer to government spending rather than businesses or individuals.

Budget deficits affect the national debt, the sum of annual budget deficits, and the cumulative total a country owes to creditors. 

Key Takeaways

  • A budget deficit occurs when expenses exceed revenue.
  • Certain unanticipated events and policies may cause budget deficits.
  • Countries can counter budget deficits by raising taxes and cutting spending.
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How Budget Deficits Work

Understanding Budget Deficits

When a budget deficit is identified, current expenses exceed the amount of income received through standard operations. To correct its nation's budget deficit, often referred to as a fiscal deficit, a government may cut back on certain expenditures or increase revenue-generating activities.

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. When a surplus occurs, revenue exceeds current expenses and results in excess funds that can be further allocated. When the inflows equal the outflows, the budget is considered balanced.

In the early 20th century, few industrialized countries had large fiscal deficits, however, during the First World War, deficits grew as governments borrowed heavily and depleted financial reserves to finance the war and their growth. These wartime and growth deficits continued until the 1960s and 1970s when world economic growth rates dropped.

$726 Billion

The U.S. federal government ran a deficit of $726 billion for fiscal year 2022, an improvement of approximately 71%, from the deficit of $2.5 billion that was recorded for fiscal year 2021.

What Causes a Budget Deficit?

Both levels of taxation and spending affect a government's budget deficit. Common scenarios that create deficits by reducing revenue and increasing spending include:

• Tax structure that under taxes high-wage earners but overtaxes low-wage earners.

• Increased spending on programs like Social Security, Medicare, or military spending.

• Increased government subsidies to targeted industries.

• Tax cuts that decrease revenue but provide corporations with funds to increase employment.

• Low GDP, or gross domestic product, results in lower tax revenue.

Budget deficits may occur as a way to respond to certain unanticipated events and policies, such as the increase in defense spending after the September 11 terror attacks.

Effects of a Budget Deficit

Budget deficits affect individuals, businesses, and the overall economy. As the government takes steps to improve the deficit, spending for programs such as Medicare or Social Security may be curtailed. Improvements to infrastructure may also be affected.

To increase revenue, tax hikes may occur for high-income earners or large corporations which may affect their ability to invest in new business ventures or hire new employees.

A looming concern of a budget deficit is inflation, which is the continuous increase of price levels. In the United States, a budget deficit can cause the Federal Reserve to release more money into the economy, which feeds inflation and continued budget deficits can lead to inflationary monetary policies, year after year.

Strategies to Reduce Budget Deficits

Countries counter budget deficits by promoting economic growth through fiscal policies, such as reducing government spending and increasing taxes. Determining the best strategies regarding which spending to cut or whose taxes to raise are often widely debated.

To pay for government programs while operating under a deficit, the federal government borrows money by selling U.S. Treasury bonds, bills, and other securities. This strategy carries the risk of devaluing the nation’s currency, which can lead to hyperinflation.

Reduced regulations and lower corporate income taxes improve business confidence, stimulate further employment, and promote economic growth leading to higher taxable profits and an increase in income tax revenue.

What's the Difference Between the Federal Budget Deficit and the Federal Government Debt?

A federal budget deficit occurs when government spending outpaces revenue or the income drawn from taxes, fees, and investments. Deficits add to the national debt or federal government debt. If government debt grows at a faster pace than gross domestic product (GDP), the debt-to-GDP ratio may balloon, possibly indicating a destabilized economy.

How Does War or Military Spending Affect the Budget Deficit?

Budget deficits may occur with an increase in defense spending such as in the war in Afghanistan. At the end of George W. Bush's presidential term in 2009, the total amount spent reached over $900 billion. This sum increased the deficit to approximately $1.4 trillion by 2009 during the Obama Administration.

When Was the Last Federal Budget Surplus?

The last time the U.S. government had a federal budget surplus was 2001. In every year since, there has been a federal budget deficit.

What Can the Government Do About a Budget Deficit?

The government can work to cut back the budget deficit by using its fiscal policy toolbox to promote economic growth, such as scaling back government spending and raising taxes.


What Causes a Budget Deficit to Improve?

Budget deficits, reflected as a percentage of GDP, may decrease in times of economic prosperity, as increased tax revenue, lower unemployment rates, and increased economic growth reduce the need for government-funded programs such as unemployment insurance.

The Bottom Line

Budget deficits occur when expenses exceed revenue and for a nation, they can lead to economic instability, such as inflation. Using fiscal policy to promote economic growth to increase tax revenue and decrease spending can decrease a deficit.

Article Sources
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  1. International Monetary Fund. "Confronting Budget Deficits," Page 2.

  2. U.S. Treasury. "National Deficit."

  3. Brown University. "United States Budgetary Costs and Obligations of Post-9/11 Wars Through FY2020: $6.4 Trillion," Pages 1-2 and 7.

  4. Federal Reserve Bank of St. Louis. "Quantitative Easing Explained," Pages 1-2.

  5. Congressional Budget Office. "Federal Budget Deficit Totals $1.4 Trillion in Fiscal Year 2009."

  6. Congressional Research Service. "The Cost of Iraq, Afghanistan, and Other Global War on Terror Operations Since 9/11," Pages 14 and 19.

  7. U.S. Department of the Treasury. "Data Lab: Federal Deficit Trends Over Time."