What Is Budget Deficit?
A budget deficit occurs when expenses exceed revenue and 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. 1:41
How Budget Deficits Work
Budget Deficit Explained
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.
- 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.
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 where 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.1
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.2 Ultimately, a recession will occur, which represents a decline in economic activity that lasts for at least six months. 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 is to reduce regulations and lower corporate taxes to improve business confidence and increase Treasury inflows from taxes. 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.
Real World Example
Budget deficits may occur in response to certain unanticipated events and policies. For example, increased defense spending after the September 11 terror attacks in the United States contributed to the budget deficit.3 While the initial war in Afghanistan cost an estimated $22.8 billion, subsequent spending in Iraq cost $51 billion in the fiscal year 2003. At the end of the presidential term of George W. Bush in 2009, the total amount spent reached over $900 billion.4 This sum, combined with the costs accrued during the 2009 to 2017 presidential term of Barack Obama, increased the deficit to approximately $1.4 trillion by 2009.5 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).”6
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.
Compete Risk Free with $100,000 in Virtual Cash
Put your trading skills to the test with our FREE Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own money. Practice trading strategies so that when you’re ready to enter the real market, you’ve had the practice you need. Try our Stock Simulator today >>« Back to Glossary Index