Budget Deficit: Causes, Effects, and Prevention Strategies

Budget Deficit

Investopedia / Joules Garcia

What Is a Budget Deficit?

A budget deficit occurs when government expenses exceed revenue. Many people use it as an indicator of the financial health of a country. It is a term more commonly used to refer to government spending and receipts 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 or cutting spending.

How Budget Deficits Work

Understanding Budget Deficits

When a budget deficit is identified, current expenses exceed the 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, resulting 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.

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:

  • A tax structure that undertaxes 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 terrorist 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.

Strategies Used 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.

What Is the Difference Between the Federal Budget Deficit and the Federal Government Debt?

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

When Was the Last Federal Budget Surplus?

The last time the U.S. government had a federal budget surplus was in 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 are a negative balance between a government's spending and revenues. When a government spends more than it collects in tax revenues, there is a deficit. Conversely, if there is more collected than spent, there is a surplus.

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

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

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

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