Deficit
Encyclopedia
A government budget deficit is the amount by which some measure of government revenues falls short of some measure of government spending.
If a government is running a positive budget deficit, it is also said to be running a negative budget surplus (and conversely, a positive budget surplus is a negative budget deficit).
on goods and services and total current revenue from all types of tax
es net of transfer payment
s. The total deficit (which is often called the fiscal deficit or just the 'deficit') is the primary deficit plus interest payments on the debt.
Therefore, if
is a timeframe, 
is government spending and 
is tax revenue for the respective timeframe, then the primary deficit is
If
is last year's debt, and 
is the interest rate, then the total deficit is
Finally, this year's debt can be calculated from last year's debt and this year's total deficit, as follows:
Economic trends can influence the growth or shrinkage of fiscal deficits in several ways. Increased levels of economic activity generally lead to higher tax revenues, while government expenditures often increase during economic downturns because of higher outlays for social insurance programs such as unemployment benefits. Changes in tax rates, tax enforcement policies, levels of social benefits, and other government policy decisions can also have major effects on public debt. For some countries, such as Norway, Russia, and members of the Organization of Petroleum Exporting Countries (OPEC), oil and gas receipts play a major role in public finances.
Inflation reduces the real value of accumulated debt. If investors anticipate future inflation, however, they will demand higher interest rates on government debt, making public borrowing more expensive.
At the lowest point in the business cycle
, there is a high level of unemployment
. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The additional borrowing required at the low point of the cycle is the cyclical deficit. By definition, the cyclical deficit will be entirely repaid by a cyclical surplus at the peak of the cycle.
The structural deficit
is the deficit that remains across the business cycle, because the general level of government spending exceeds prevailing tax levels. The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus.
Some economists have criticized the distinction between cyclical and structural deficits, contending that the business cycle is too difficult to measure to make cyclical analysis worthwhile.
The fiscal gap, a measure proposed by economists Alan Auerbach and Laurence Kotlikoff
, measures the difference between government spending and revenues over the very long term, typically as a percentage of Gross Domestic Product. The fiscal gap can be interpreted as the percentage increase in revenues or reduction of expenditures necessary to balance spending and revenues in the long run. For example, a fiscal gap of 5% could be eliminated by an immediate and permanent 5% increase in taxes or cut in spending or some combination of both. It includes not only the structural deficit at a given point in time, but also the difference between promised future government commitments, such as health and retirement spending, and planned future tax revenues. Since the elderly population is growing much faster than the young population in many countries, many economists argue that these countries have important fiscal gaps, beyond what can be seen from their deficits alone.
, the deficit could only be financed with loans from private investors or other countries. A prominent example of this was the Rothschild
dynasty in the late 18th and 19th century, though there were many earlier examples.
These loans became popular when private financiers had amassed enough capital to provide them, and when governments were no longer able to simply print money
, with consequent inflation
, to finance their spending.
However, large long-term loans had a high element of risk for the lender and consequently gave high interest rates. Governments later began to issue bonds that were payable to the bearer, rather than the original purchaser. This meant that someone who lent the state money could sell on the debt to someone else, reducing the risks involved and reducing the overall interest rates. Examples of this are British Consols
and American Treasury bill bonds.
hypothesis, named after the English political economist and Member of Parliament David Ricardo
, states that because households anticipate that current public deficit will be paid through future taxes, those households will accumulate savings now to offset those future taxes. If households acted in this way, a government would not be able to use tax cuts to stimulate the economy. The Ricardian equivalence result requires several assumptions. These include households acting as if they were infinite-lived dynasties as well as assumptions of no uncertainty and no liquidity constraints. Also, for Ricardian equivalence to apply, the deficit spending would have to be permanent. In contrast, a one-time stimulus through deficit spending would suggest a lesser tax burden annually than the one-time deficit expenditure. Thus temporary deficit spending is still expansionary. Empirical evidence on Ricardian equivalence effects has been mixed.
US-specific
Hong Kong
Finland
If a government is running a positive budget deficit, it is also said to be running a negative budget surplus (and conversely, a positive budget surplus is a negative budget deficit).
Primary deficit, total deficit, and debt
The meaning of 'deficit' differs from that of 'debt', which is an accumulation of yearly deficits. Deficits occur when a government's expenditures exceed the revenue that it generates. The deficit can be measured with or without including the interest payments on the debt as expenditures. The primary deficit is defined as the difference between current government spendingGovernment spending
Government spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...
on goods and services and total current revenue from all types of tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es net of transfer payment
Transfer payment
In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...
s. The total deficit (which is often called the fiscal deficit or just the 'deficit') is the primary deficit plus interest payments on the debt.
Therefore, if
is a timeframe, is government spending and is tax revenue for the respective timeframe, then the primary deficit isIf
is last year's debt, and is the interest rate, then the total deficit isFinally, this year's debt can be calculated from last year's debt and this year's total deficit, as follows:
Economic trends can influence the growth or shrinkage of fiscal deficits in several ways. Increased levels of economic activity generally lead to higher tax revenues, while government expenditures often increase during economic downturns because of higher outlays for social insurance programs such as unemployment benefits. Changes in tax rates, tax enforcement policies, levels of social benefits, and other government policy decisions can also have major effects on public debt. For some countries, such as Norway, Russia, and members of the Organization of Petroleum Exporting Countries (OPEC), oil and gas receipts play a major role in public finances.
Inflation reduces the real value of accumulated debt. If investors anticipate future inflation, however, they will demand higher interest rates on government debt, making public borrowing more expensive.
Structural deficits, cyclical deficits, and the fiscal gap
A government deficit can be thought of as consisting of two elements, structural and cyclical.At the lowest point in the business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
, there is a high level of unemployment
Unemployment
Unemployment , as defined by the International Labour Organization, occurs when people are without jobs and they have actively sought work within the past four weeks...
. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The additional borrowing required at the low point of the cycle is the cyclical deficit. By definition, the cyclical deficit will be entirely repaid by a cyclical surplus at the peak of the cycle.
The structural deficit
Structural deficit
Structural deficit forms part of the public sector deficit. Structural deficit differs from cyclical deficit in that structural deficit exists even when the economy is at its potential....
is the deficit that remains across the business cycle, because the general level of government spending exceeds prevailing tax levels. The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus.
Some economists have criticized the distinction between cyclical and structural deficits, contending that the business cycle is too difficult to measure to make cyclical analysis worthwhile.
The fiscal gap, a measure proposed by economists Alan Auerbach and Laurence Kotlikoff
Laurence Kotlikoff
Laurence Jacob Kotlikoff is a William Warren FairField Professor at Boston University, a Professor of Economics at Boston University, a Fellow of the American Academy of Arts and Sciences, a Research Associate of the National Bureau of Economic Research, a Fellow of the Econometric Society, a...
, measures the difference between government spending and revenues over the very long term, typically as a percentage of Gross Domestic Product. The fiscal gap can be interpreted as the percentage increase in revenues or reduction of expenditures necessary to balance spending and revenues in the long run. For example, a fiscal gap of 5% could be eliminated by an immediate and permanent 5% increase in taxes or cut in spending or some combination of both. It includes not only the structural deficit at a given point in time, but also the difference between promised future government commitments, such as health and retirement spending, and planned future tax revenues. Since the elderly population is growing much faster than the young population in many countries, many economists argue that these countries have important fiscal gaps, beyond what can be seen from their deficits alone.
National budget deficits
Data are for 2004| Nation | GDP | Revenue | Expenditure | Exp/GDP | Budget Surplus (or Deficit) | Deficit/GDP |
|---|---|---|---|---|---|---|
| US (federal) | 11700 | 1862 | 2338 | 19.98% | -25.56% | -4.07% |
| US (state) | - | 900 | 850 | 7.6% | +5% | +0.4% |
| Japan | 4600 | 1400 | 1748 | 38.00% | -24.86% | -7.57% |
| Germany | 2700 | 1200 | 1300 | 48.15% | -8.33% | -3.70% |
| United Kingdom | 2100 | 835 | 897 | 42.71% | -7.43% | -2.95% |
| France | 2000 | 1005 | 1080 | 54.00% | -7.46% | -3.75% |
| Italy | 1600 | 768 | 820 | 51.25% | -6.77% | -3.25% |
| China | 1600 | 318 | 349 | 21.81% | -9.75% | -1.94% |
| Spain | 1000 | 384 | 386 | 38.60% | -0.52% | -0.20% |
| Canada (federal) | 900 | 150 | 144 | 16.00% | +4.00% | +0.67% |
| South Korea | 600 | 150 | 155 | 25.83% | -3.33% | -0.83% |
Early deficits
Before the invention of bondsBond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
, the deficit could only be financed with loans from private investors or other countries. A prominent example of this was the Rothschild
Mayer Amschel Rothschild
Mayer Amschel Rothschild was the founder of the Rothschild family international banking dynasty that became the most successful business family in history. In 2005, he was ranked 7th on the Forbes magazine list of "The Twenty Most Influential Businessmen Of All Time"...
dynasty in the late 18th and 19th century, though there were many earlier examples.
These loans became popular when private financiers had amassed enough capital to provide them, and when governments were no longer able to simply print money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
, with consequent inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
, to finance their spending.
However, large long-term loans had a high element of risk for the lender and consequently gave high interest rates. Governments later began to issue bonds that were payable to the bearer, rather than the original purchaser. This meant that someone who lent the state money could sell on the debt to someone else, reducing the risks involved and reducing the overall interest rates. Examples of this are British Consols
Consols
Consol is a form of British government bond , dating originally from the 18th century. The first consols were originally issued in 1751...
and American Treasury bill bonds.
Deficit spending
According to some economists, during recessions, the government can stimulate the economy by intentionally running a deficit.Ricardian equivalence
The Ricardian equivalenceRicardian equivalence
The Ricardian equivalence proposition is an economic theory holding that consumers internalize the government's budget constraint: as a result, the timing of any tax change does not affect their change in spending...
hypothesis, named after the English political economist and Member of Parliament David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
, states that because households anticipate that current public deficit will be paid through future taxes, those households will accumulate savings now to offset those future taxes. If households acted in this way, a government would not be able to use tax cuts to stimulate the economy. The Ricardian equivalence result requires several assumptions. These include households acting as if they were infinite-lived dynasties as well as assumptions of no uncertainty and no liquidity constraints. Also, for Ricardian equivalence to apply, the deficit spending would have to be permanent. In contrast, a one-time stimulus through deficit spending would suggest a lesser tax burden annually than the one-time deficit expenditure. Thus temporary deficit spending is still expansionary. Empirical evidence on Ricardian equivalence effects has been mixed.
Crowding Out Hypothesis
The crowding out hypothesis is the assumption that when a government experiences a deficit, the choice to borrow to offset that deficit draws on the pool of resources available for investment and private investment gets crowded out. This crowding out effect is induced by changes in the interest rate. When the government wishes to borrow, their demand for credit increases and the interest rate, or price of credit, increases. This increase in the interest rate makes private investment more expensive as well and less of it is used.Increase Taxes or Reduce Government Spending
If a reduction in a structural deficit is desired, either revenue must increase, spending must decrease, or both. Taxes may be increased for everyone/every entity across the board or lawmakers may decide to assign that tax burden to specific groups of people (higher-income individuals, businesses, etc.). Lawmakers may also decide to cut government spending. Like with taxes, they could decide to cut the budgets every government agency/entity by the same percentage or they may decide to give a greater budget cut to specific agencies. Many, if not all, of these decisions made by lawmakers are based on political ideology, popularity with their electorate, or popularity with their donors.Changes in Tax Code
Similar to increasing taxes, changes can be made to the tax code that increases tax revenue. Closing tax loopholes and allowing fewer deductions are different from the act of increasing taxes but essentially have the same effect.Reduce Debt Service Liability
Every year, the federal government must pay debt service payments on their overall public debt. These payments include principal and interest payments. Occasionally, the federal government has the opportunity to refinance some of their public debt to afford them lower debt service payments. Doing this would allow the federal government to cut expenditures without cutting government spending.See also
- Balance of paymentsBalance of paymentsBalance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
- Balance of tradeBalance of tradeThe balance of trade is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports...
- Current accountCurrent accountIn economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...
- Fiscal policyFiscal policyIn economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
- Generational accountingGenerational accountingGenerational accounting is a relatively new method of national accounting for measuring redistribution of lifetime tax burdens across generations from social insurance, including social security and social health insurance...
- Government spendingGovernment spendingGovernment spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...
- Government debtGovernment debtGovernment debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...
- Government budgetGovernment budgetA government budget is a legal document that is often passed by the legislature, and approved by the chief executive-or president. For example, only certain types of revenue may be imposed and collected...
- List of countries by current account balance
- Public financePublic financePublic finance is the revenue and expenditure of public authoritiesThe purview of public finance is considered to be threefold: governmental effects on efficient allocation of resources, distribution of income, and macroeconomic stabilization.-Overview:The proper role of government provides a...
- TaxTaxTo tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
US-specific
- Fiscal policy in the United StatesFiscal Policy in the United StatesFiscal policy is considered any changes the government makes to the national budget in order to influence a nation’s economy. The approach to economic policy in the United States was rather laissez-faire until the Great Depression...
- National debt by U.S. presidential termsNational debt by U.S. presidential termsIn the United States, national debt is money borrowed by the federal government of the United States. Debt burden is usually measured as a ratio of public debt to gross domestic product; the U.S. debt/GDP ratio reached a maximum during World War II near the beginning of President Harry Truman's...
- Deficit hawkDeficit hawkDeficit hawk is an American political slang term for people who place great emphasis on keeping the federal budget under control. Deficit hawks believe the best way to reduce the deficit, pay off national debt, and balance the budget is by a combination of increasing taxes and cutting government...
- Starve-the-beast
- United States federal budgetUnited States federal budgetThe Budget of the United States Government is the President's proposal to the U.S. Congress which recommends funding levels for the next fiscal year, beginning October 1. Congressional decisions are governed by rules and legislation regarding the federal budget process...
- United States public debtUnited States public debtThe United States public debt is the money borrowed by the federal government of the United States at any one time through the issue of securities by the Treasury and other federal government agencies...
External links
United States- U.S. Government Net Saving - Graph of Historical U.S. Government Net Savings
- Death and Taxes: 2009 A graphical representation of the 2009 United States federal discretionary budget, including the public debt.
- United States - Deficit versus Savings rate from 1981 Historical graphical representation of the 12 month rolling Fiscal deficit versus the Savings rate of the United States. (since 1981)
- Government deficit calculator from AARP
Hong Kong
Finland