Deficit
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A budget deficit occurs when an entity (often a government) plans to spend 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 deficit over several years (or centuries) 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.
Contents |
Primary deficit, total deficit, and debt
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.[1]
Therefore, if 
is government spending and 
is tax revenue, then
Primary deficit 
If 
is last year's debt, and 
is the interest rate, then
Total deficit 
Finally, this year's debt can be calculated from last year's debt and this year's total deficit:
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, 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.[2] 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)
| Nation | GDP | Revenue | Expenditure | Exp ÷ GDP | Budget Deficit/Surplus[3] | Deficit ÷ GDP[3] |
|---|---|---|---|---|---|---|
| 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.
Data on the United States' federal debt can be found at U.S. Treasury website. Data on U.S. state government finances can be found at the National Association of State Budget Officers (NASBO) website. Data for most advanced countries can be obtained from the Organization for Economic Cooperation and Development (OECD) website. Data for most other countries can be found at the International Monetary Fund (IMF) website.
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.
Miscellaneous
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 strong modelling assumptions. For example, the result requires that households act as if they were infinite-lived dynasties. Empirical evidence on Ricardian equivalence effects has been mixed.
See also
- Balance of payments
- Balance of trade
- Current account
- Deficit hawk
- Deficit spending
- 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
References
- ↑ Michael Burda and Charles Wyplosz (1995), European Macroeconomics, 2nd ed., Ch. 3.5.1, p. 56. Oxford University Press, ISBN 0198774680.
- ↑ http://www.aarp.org/research/blueprint/overstatedproblem/the_fiscal_gap.html AARP article on the fiscal gap
- ↑ 3.0 3.1 In this column, a negative number represents a deficit, and a positive number represents a surplus.
External links
United States
- 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