What Is a Budget Deficit?
A budget deficit occurs when expenses exceed revenue, and it can indicate the financial health of a country. The government generally uses the term budget deficit when referring to spending rather than businesses or individuals. Accrued deficits form national debt.
- A budget deficit happens when current expenses exceed the amount of income received through standard operations.
- Certain unanticipated events and policies may cause budget deficits.
- Countries can counter budget deficits by raising taxes and cutting spending.
How Budget Deficits Work
Understanding Budget Deficits
In cases where a budget deficit is identified, current expenses exceed the amount of income received through standard operations. A nation wishing to correct its budget deficit may need to cut back on certain expenditures, increase revenue-generating activities, or employ a combination of the two.
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 allocated as desired. In situations in which the inflows equal the outflows, the budget is 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.
The Danger of Budget Deficits
One of the primary dangers 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. Continued budget deficits can lead to inflationary monetary policies, year after year.
Strategies to Reduce Budget Deficits
Countries can counter budget deficits by promoting economic growth through fiscal policies, such as reducing government spending and increasing taxes. For example, one strategy to increase Treasury inflows is to reduce regulations and lower corporate income taxes to improve business confidence and promote economic growth, generating higher taxable profits and more income taxes due to job growth.
A nation can print additional currency to cover payments on debts issuing securities, such as Treasury bills and bonds. While this provides a mechanism to make payments, it does carry the risk of devaluing the nation’s currency, which can lead to hyperinflation.
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. While the initial war in Afghanistan cost an estimated $22.8 billion, spending in Iraq cost $51 billion in the fiscal year 2003.
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. And the costs accrued during the 2009 to 2017 presidential term of Barack Obama pushed the deficit up further. According to the Congressional Budget Office, "At the end of 2018, the amount of debt held by the public was equal to 78 percent of gross domestic product (GDP)."
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 and Head Start.
What's the Difference Between the Federal Budget Deficit and the Federal Government Debt?
A federal budget deficit is what happens 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.
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.
The Bottom Line
Budget deficits happen when expenses exceed revenue. When incurred by nations, they can lead to problems such as inflation. For example, the U.S. incurred a deficit through wars in Afghanistan and Iraq under the Bush and Obama administrations. Using policy to promote economic growth can decrease a deficit. These deficits may also lessen during times of economic prosperity.