You’ve probably heard the term “budget deficit” on more than one occasion, but do you understand what it means? In short, the budget deficit refers to the shortfall between the government’s spending and its revenue. Explore the topic in more detail with our comprehensive guide, starting with our budget deficit definition.
Budget deficit definition
What is a budget deficit? A budget deficit occurs when expenses exceed income (i.e., tax and other borrowed revenue), usually measured over a single financial year. The term tends to be reserved for governments, although it’s also possible for organisations, businesses, and individuals to run budget deficits. Each year, the deficit adds to the national debt (the total amount owed by the government accumulated over the years). Consequently, the national debt is a significantly higher figure.
So, what are the causes of budget deficits? It’s relatively simple. During an economic recession or a period of slow economic growth, the government loses money. If workers lose their jobs, they pay less taxes, which means that the government’s revenue takes a hit. Furthermore, excessive or irresponsible government spending – combined with low levels of taxation – can also lead to a budget deficit. It’s also possible for the government to deliberately create a fiscal deficit (referred to as a Keynesian fiscal deficit) to boost employment and aggregate demand.
What is a structural budget deficit?
When we talk about budget deficits, we need to distinguish the cyclical and structural elements. Put simply, the state of the economy influences the deficit. In a boom, taxes are high, and borrowing is low. In a recession, it’s the reverse. That’s what we refer to as the cyclical deficit. However, the structural budget deficit is the part of the deficit that isn’t related to the economy, and as such, it won’t disappear after the economy recovers. An example of a structural factor is an ageing population or a significant level of corporate tax avoidance. The structural budget deficit cannot be measured, which means you’ll have to estimate it instead.
Understanding the UK’s budget deficit
The budget deficit is a common topic of conversation in the UK. In 2019/20, the government’s revenue was £824 billion, whereas it spent £887 billion. As a result, the budget deficit was £63 billion. Currently (i.e., according to the latest figures), the net public sector debt is £1.8 trillion. Since the early 1970s, the UK government has had a budget surplus in just six years. We’ve seen substantial budget deficits in the early 1990s, as well as in 2009/10, after the financial crash. Soon, we can expect to see the coronavirus pandemic have a significant effect on the budget deficit.
How to calculate the budget deficit
There’s a simple formula that you can use to calculate the budget deficit:
Budget Deficit = Total Government Spending – Total Government Income
Income includes corporate taxes, personal taxes, and other receipts, whereas expenditure includes expenses on healthcare, defence, energy, etc.
Budget surplus vs. deficit: what’s the difference?
If the government’s revenue exceeds expenses, it creates a budget surplus (the opposite of a budget deficit). As such, the government will have extra funds to allocate for a wide range of uses, including paying off debts, reducing taxes, funding public programs, and so on. The additional capital can also be saved to spend in the future when another budget deficit occurs.
What are the implications of a budget deficit?
Budget deficits are complicated because the implications aren’t always negative – in some cases, they can lead to increased aggregate demand (thereby boosting the economy). Furthermore, if budget deficits are caused by increased government spending, there could be a wide range of benefits for the public sector, such as unemployment programs or public services. One of the key dangers associated with the budget deficit, however, is inflation.
How to reduce the budget deficit
Generally speaking, it’s only possible to reduce the budget deficit by increasing revenue or decreasing spending. This can be achieved by increasing the country’s economic growth rate or raising taxes. However, it’s a tricky tightrope to walk, since excessive taxes can slow growth. Cutting spending can also be a complicated issue, as deep spending cuts can slow down economic growth, reducing revenues and potentially creating an even larger budget deficit.
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