Budget Deficit

Loading the player...

What is a 'Budget Deficit'

A budget deficit is an indicator of financial health in which expenditures exceed revenue. The term budget deficit is most commonly used to refer to government spending rather than business or individual spending, but can be applied to all of these entities. When referring to accrued federal government deficits, the deficits are referred to as the national debt.

BREAKING DOWN 'Budget Deficit'

In cases in which a budget deficit is identified, current expenses exceed the amount of income being received through standard operations. In order to correct a budget deficit, a nation may need to cut back on certain expenditures or increase revenue-generating activities, or employ a combination of the two.

The counter to a budget deficit is called a budget surplus. When a surplus occurs, revenue exceeds current expenditures and results in an excess of funds that can be allocated as desired. In situations in which the inflows equal the outflows, the budget is said to be balanced.

In the early 20th century, few industrialized countries had large fiscal deficits. This changed during the First World War, a time in which governments borrowed heavily and depleted financial reserves. Industrialized countries reduced these deficits until the 1960s and 1970s, despite years of steady economic growth.

Shifts to Budgets

Budget deficits may occur in response to certain unanticipated activities. For example, increased defense spending after the 9/11 terror attacks in the United States contributed to the budget deficit. While the initial war in Afghanistan cost an estimated $33 billion, the later spending attributed to operations in Iraq cost $50 billion within the 2003 fiscal year. At the end of the George W. Bush presidency, the total spent reached $864.82 billion. Combined with the costs accrued during the Barack Obama presidency of $857 billion, the deficit increased approximately $1.8 trillion.

Budget deficits, reflected as a percentage of Gross Domestic Product (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 and Temporary Assistance for Needy Families (TANF).

If investors expect higher inflation rates, which would reduce the real value of debt, they are likely to require higher interest rates on future loans to governments.

Techniques to Reverse a Budget Deficit

Countries can counter budget deficits by promoting economic growth, reducing government spending and increasing taxes. By reducing onerous regulations and simplifying tax regimes, a country can improve business confidence, thereby prompting improved economic conditions while increasing treasury inflows from taxes. Reducing government expenditures, including on social programs and defense, and reforming entitlement programs, such as state pensions, can result in less borrowing.

If desired, a nation can print additional currency to cover payments on debts owed. This is done through the issuance of securities including Treasury bills and bonds. While this provides a mechanism to make payments, it does carry the risk of devaluing the nation’s currency.