After a long week at work, payday is here! How will you budget the money you just earned? Will you take out a loan to buy a car? Will you save it so you don't owe money to anyone? Believe it or not, these questions are all asked by our own government! The government budget requires government officials to be fiscally responsible with the government's income — just like you! To learn more about the government budget and how it affects you, keep scrolling!
Government Budget Meaning
The Government Budget is a document written by government officials that estimates their spending and revenues for the fiscal year. In the U.S. it runs from October 1st to September 30th. Spending is seen through government purchases and transfers such as infrastructure, education, and healthcare. Revenue is seen through the government collecting taxes such as income tax, corporate tax, and capital gains tax. We can get a deeper understanding of the spending and revenue with the following budget balance equation:
What does the budget balance equation above tell us? If the government collects more in tax revenue than it spends, then savings will be positive. If the government collects less in taxes than it spends, savings will be negative. If revenue is higher than spending, then the federal budget is in a surplus. If spending is higher than the revenue, then the federal budget is in a deficit. If the federal revenue and spending equal one another, then it is a balanced budget.
The government budget is a document written by government officials that estimates their spending and revenues for the fiscal year.
Budget deficit occurs when government spending exceeds revenues.
Budget surplus occurs when government revenues exceed spending.
Balanced budget occurs when government spending and revenue are equal.
Government Budget Deficit
Let's go into more depth on a government budget deficit. To do so, we need to take a deeper look at the budget balance equation.
Government Budget Deficit: Equation and Example
Let's look at the budget balance equation once more:
What does the budget balance equation above tell us? A federal budget deficit will occur if tax revenue is less than the combined total of government spending and transfers — this will result in a negative budget balance. Let's look at a brief example below where we need to determine whether the budget is in a surplus or a deficit:
Government Budget Deficit: Causes
Depending on the fiscal policy, a government may be more likely to be in a federal budget deficit for the fiscal year. Expansionary Fiscal Policy tends to increase federal budget deficits and decrease federal budget surpluses due to its high spending and low taxes.
Government spending also means government borrowing — governments do not just have billions of dollars lying around! Borrowing billions of dollars seems like a scenario that the government wants to avoid. Why might the government put itself in a federal budget deficit?
The government may deficit spend during a recession. A recession prompts expansionary fiscal policy to close the negative output gap. The government may choose for the spending to increase and taxes to decrease — potentially putting the government in a federal budget deficit. Another potential cause is the government investing more in infrastructure such as roads, buildings, and bridges. This helps the supply-side of the economy, but is very expensive and can likely cause the federal budget to be in a deficit.
Fig. 1 - U.S. Budget Deficits. Source: DataLab1
The chart above looks at the United States' budget deficit from 2001 to 2021. As you can see, the United States has only been in a budget surplus once in two decades! Also noteworthy is how large the deficits are when there are large downturns in the economy — 2008 and 2020 respectively.
Debt Limit in the United States
There is actually a longstanding rule in Congress that can help prevent deficits and debts from getting out of control — the goal is to maintain a relatively balanced budget.
The debt limit can be used to limit the amount of borrowing for the fiscal year. The government can shut down if borrowing exceeds the debt limit without approval from Congress. The last time the United States shut down its government was in 2018. In total, the United States has shut down its economy 21 times. Government shutdowns are detrimental to an economy and should always be avoided!
Learn more about government spending in our article - Government Spending
Government Budget Surplus
Understanding the government budget deficit will make understanding the federal budget surplus easier. We can start with the budget balance equation once more.
Government Budget Surplus: Equation
What does the budget balance equation above tell us? A budget surplus will occur if tax revenue is greater than the combined total of government spending and transfers — this will result in a positive budget balance. Let's look at a brief example below where we need to determine whether the budget is in a surplus or a deficit:
Government Budget Surplus: Causes
Depending on the fiscal policy, a government may be more likely to be in a federal budget surplus for the fiscal year. Contractionary Fiscal Policy will tend to increase federal budget surpluses and decrease federal budget deficits due to its lower spending and higher taxes.
A government may prefer a federal budget surplus during "good times" — unemployment is low, production is high, and competition is rampant! The government is increasing its output and revenues during this time. Here, the government will want to spend less since its revenues are so high. This can offset a future federal budget deficit that may be prompted during a recession. A federal budget surplus can also increase trust from other governments since federal budget surpluses are perceived as fiscally responsible. Maintaining trust in a government's financial institutions is very important — who will engage in trade or loan with the United States if no one trusts them?
Balanced Government Budget
Our last application of the government budget will come in the form of a balanced budget.
Balanced Government Budget: Equation
Let's take one final look at our budget balance equation:
What does the budget balance equation above tell us? A balanced budget will occur if tax revenue is equal to the combined total of government spending and transfers. Let's look at a brief example below:
Balanced Government Budget: Causes
There is no specific policy that will perfectly balance the budget, but properly utilizing fiscal policy can help governments come close to doing so. In contrast, improper use of fiscal policy will make it difficult to balance the budget. Contractionary fiscal policy during a recession may make things worse!
The cause for a balanced budget is not as clear as a surplus or deficit. Economists tend to agree that a balanced budget is not the most desirable outcome for a government long term since it undermines automatic stabilizers. Economists generally believe that a budget should only be balanced on average, leaving room for deficits in "bad times" and surpluses in "good times." Everything in moderation!
Fig. 2 - Calculating a Budget
Impacts of Government Budget on the Economy
The impact of government budget on the economy is grand. In particular, prolonged federal budget deficits can cause problems for an economy. We will discuss two potential issues here.
Impacts of Government Budget on Economy: Crowding Out
Crowding Out can occur when a government borrows excessively to cover its spending. High government borrowing will make it more difficult for private businesses and individuals to borrow since they are competing for loans — this will cause interest rates to rise. This can lower private investment which can inhibit long-term growth, defeating the purpose of government spending. While the government's actions are sincere enough, there is a danger to prolonged government spending in an economy.
Impacts of Government Budget on the Economy: Defaulting on Debt
There are two options when the government borrows money: pay it off through tax revenue and lower spending, or continue borrowing on your debt. Of course, paying off debt is the obvious option, but what if the government is going through a major recession and they continue to borrow on their debt? What are the potential impacts?
The National Debt is the accrued federal borrowing from the previous fiscal years. If the government continues borrowing at high rates, it keeps adding to the national debt year after year. Adding to the problem are interest payments; interest payments will increase if the debt accrued is substantial. This vicious cycle continues until the government is burdened with a glut of debt. Eventually, the government will have no choice but to default on its debt, causing immense harm to its economy.
The national debt is the total debt outstanding for a nation. That is, the total amount borrowed minus the total amount repaid, over time.
Argentina's Debt Crisis
Argentina has defaulted on its debt for its high levels of borrowing. In 2001, the interest payments on their loans began to skyrocket — Argentina was no longer paying off its debt. Other countries lost trust in Argentina's financial institutions after this incident, which only hurt them more. A banking crisis and recession followed shortly after.
Learn more about the causes and consequences of government borrowing in our article - National Debt
The Government Budget - Key Takeaways
- The Government Budget is a document written by government officials that estimates their spending and revenues for the fiscal year.
- Fiscal policy can affect government spending and revenue.
- There are three possible states of the government budget:
- a budget deficit is spending exceeding revenues
- a budget surplus is revenues exceeding spending
- a balanced budget is spending and revenues being equal
- The budget balance equation is:
- The impacts of prolonged deficits are: crowding out and defaulting on debt.
References
- DataLabs, Federal Deficit Trends Over Time, 2001-2021, https://datalab.usaspending.gov/americas-finance-guide/deficit/trends/
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