Government budget balance

A budget deficit occurs when an entity spends more money than it takes in. The opposite of a budget deficit is a budget surplus. Debt is essentially an accumulated flow of deficits. In other words, a deficit is a flow, and debt is a stock.

An accumulated governmental deficit over several years (or decades) is referred to as the government debt. Government debt is usually financed by borrowing, although if a government's debt is denominated in its own currency it can print new currency to pay debts. Monetizing debts, however, can cause rapid inflation if done on a large scale. Governments can also sell assets to pay off debt. Most governments finance their debts by issuing long-term government bonds or shorter term notes and bills. Many governments use auctions to sell government bonds.

Governments usually must pay interest on what they have borrowed. Governments reduce debt when their revenues exceed their current expenditures and interest costs. Otherwise, government debt increases, requiring the issue of new government bonds or other means of financing debt, such as asset sales.

According to Keynesian economic theories, running a fiscal deficit and increasing government debt can stimulate economic activity when a country's output (GDP) is below its potential output. When an economy is running near or at its potential level of output, fiscal deficits can cause inflation.

Primary deficit, total deficit, and debt

Main article: Primary deficit

The government's deficit can be measured with or without including the interest it pays on its debt. The primary deficit is defined as the difference between current government spending and total current revenue from all types of taxes. The total deficit (which is often just called the 'deficit') is spending, plus interest payments on the debt, minus tax revenues.

Therefore, if $_{t}$ is a timeframe, $G_{t}$ is government spending and $T_{t}$ is tax revenue for the respective timeframe, then

Primary deficit $=G_{t}-T_{t}$

If $D_{t-1}$ is last year's debt, and $r$ is the interest rate, then

Total deficit $=G_{t}+rD_{t-1}-T_{t}$

Finally, this year's debt can be calculated from last year's debt and this year's total deficit:

${D_{t}}=(1+r)D_{t-1}+G_{t}-T_{t}$

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

Main article: Structural deficit

A government deficit can be thought of as consisting of two elements, structural and cyclical.

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 is too high for 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 Lawrence 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.

National budget deficits (2004)

United States deficit or surplus percentage 1901 to 2006

National Government Budgets for 2004 (in billions of US$)

Nation	GDP	Revenue	Expenditure	Exp ÷ GDP	Budget Deficit/Surplus	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%

Data are for 2004.

Early deficits

Before the invention of bonds, 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.

Ricardian Equivalence

The Ricardian equivalence 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 fiscal policy to stimulate the economy. The Ricardian equivalence result requires 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.

Deficit Spending

Main article: Deficit spending

Governments can attempt to stimulate the economy by intentionally running a deficit.

See also

• Balance of payments
• Balance of trade
• Current account
• Deficit hawk
• Fiscal policy
• Fiscal policy in the United States
• Generational accounting
• Government spending
• Government debt
• Government budget
• List of countries by current account balance
• Public finance
• National debt by U.S. presidential terms
• Starve-the-beast
• Tax
• United States federal budget
• United States public debt

External links

United States

• U.S. Congressional Budget Office
• Office of Management and Budget
• 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)

Other Countries or Entities

• Hong Kong Government Budget