What is a Budget Deficit?

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Definition:

A budget deficit is when a person’s, company’s, or country’s expected income is less than their expected expenses during the budgeting period.

🤔 Understanding budget deficit

A budget deficit is when a person, company, or government spends or plans to spend more in a period than it receives or will receive in revenue. Budgets are an essential part of forecasting for anyone that interacts with money. People often build household budgets. Companies and even governments also need budgets to plan their spending. Budgets usually include information about the budgeter’s expected income, the money they expect to spend, and how they plan to spend it. If they plan to spend more money than they make, the difference between income and expenses is the budget deficit for that budget period. They either have to take on debt or spend money from savings to cover the shortfall. The term budget deficit is most commonly used in reference to government finances.

Example

One example of a budget deficit is the United States government’s budget for 2019. In 2019, the government expected to collect $3.5 trillion in revenue. It budgeted $4.4 trillion in spending. In this budget, the expenditure is higher than the income, so there is a budget deficit. $4.4 trillion minus $3.5 trillion is $900 billion, so the total budget deficit expected was equal to roughly $900 billion.

Takeaway

A budget deficit is like not bringing enough food on a camping trip…

Your body needs a certain amount of food to sustain itself. If you go for a long hike and camp in the woods, but run out of food, your body will likely enter a calorie deficit. Your body may burn fat, which is like going into debt or dipping into your savings.

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What is a budget deficit?

A budget deficit is a difference between a person’s, company’s, or government’s expected revenue and expenses for a period, where the expenses outweigh the revenue. In other words, budget deficits mean that the organization expects to bring in less money than it plans to spend during a set period, like a fiscal year.

When businesses build their budgets, they typically put together a list of things they expect to spend money on and how much money they expect to spend. They also list sources of income and how much they expect to make. If they plan to make less than they spend, they need to find another way to pay for the expenses, such as spending money out of savings or borrowing money from a lender.

Budget deficits are prevalent among governments because they tend to spend more money than they bring in with taxes.

Why does the government overspend?

There are a lot of reasons why governments overspend.

The most basic is that the government has more things that it wants to spend money on than it can afford to pay for through tax revenues. Governments spend billions or trillions of dollars each year, and it can be difficult for them to figure out what tax rate they need to charge to bring in enough revenue to cover expenses. In other cases, the government is unwilling to raise the tax rate sufficiently or may want to implement tax cuts to earn goodwill from citizens.

Another reason that governments spend more than they make is that some can easily borrow or print money. One of the significant risks of having a budget deficit is coming up with funds to cover the gap. Because some governments can print money to cover shortfalls, they can postpone or some stronger countries can avoid paying back deficits — though, printing too much money can ultimately lead to inflation.

Another explanation for overspending is that there is a hefty incentive for legislators to promote laws that involve spending on their constituents. The legislator’s constituents will benefit from the increased spending, while the cost of the expenditure may be spread across the entire country. This leads to individual legislators sometimes promoting spending in their district even if they generally prefer reduced government spending.

What are the risks of budget deficits?

One of the primary risks of a budget deficit is that the organization with the deficit will be unable to pay its budgeted expenses. If a person expects to make $40,000 in a year and spend $50,000 in the same year, there are two ways to handle this. One is to find somewhere to borrow $10,000. The other is to spend $10,000 out of their savings.

Neither of these options is sustainable for the average person if they continue to run a budget deficit. Eventually, they will build up a large enough debt balance that they won’t be able to find willing lenders, or they will run out of savings to finance their shortfall.

For some governments, this is less of a risk because they may have a strong credit rating that makes it easy for them to borrow vast sums of money at a relatively low/stable rate. Even if they struggle to find lenders, governments can often print currency to meet their expenses. However, when the government runs a budget deficit, there is a risk of long-term damage to the nation’s economy and potential runaway inflation.

What are the effects of a government deficit?

One effect of a federal budget deficit is a decrease in national savings and increased borrowing. Often, the government will turn to foreign nations to borrow money. This can give those countries influence over the government’s policies. Decreased saving can also lead to higher interest rates, which can weaken an economy. Consumers have more incentive to save money when rates are high, reducing consumer spending, which can shrink the economy.

When governments borrow money, they also need to pay it back over time. A budget deficit in one year means that the government’s expenses will likely be higher the next year thanks to interest costs. To reduce its costs in the next year, the government would need to cut expenses by more than the interest that its new loans charge.

If a country runs a budget deficit for a sustained period, it will wind up with a large amount of debt, saddling it with significant interest obligations. That can make it even harder for it to balance its budget while maintaining critical services for its citizens.

Long-term budget deficits can also lead to changes in consumer expectations and behavior. If the budget gap grows too large, investors might be unwilling to buy government bonds, increasing borrowing costs further. Foreign countries might worry about the government printing more money to meet its obligations, reducing the value of its currency. All of these can have a significant impact on the economy.

What are some strategies to reduce budget deficits?

There are two ways to reduce a budget deficit: Spend less money or make more money. On a national scale, there are a few ways to go about both of these goals.

Reducing spending usually means cutting spending on government programs. One example of this is the budget that Republican President Donald Trump announced in February 2020, which includes a $4.8 trillion reduction in spending on things like Medicare, Medicaid, and Social Security. The downside of cutting spending on government programs is that some citizens like and rely on the programs and will be unhappy with the government’s changes or could be harmed by the reduced spending.

The other option, increasing government income, is sometimes a bit more flexible. There are two ways a government can bring in more money.

One is to increase tax rates. Assuming the citizens of a country make roughly the same amount, increasing the tax rate from one year to another will give the government more money to work with. The downside is that few people like paying higher tax rates and increased taxes can negatively impact the economy.

The other way to increase tax revenues is to increase the country’s productivity. If a country experiences economic growth, it stands to reason that the country’s residents and businesses will make more money. Even if they pay the same tax rate, higher levels of income mean they’ll pay more taxes.

Finally, the government could have the Treasury print more money. The downside of this is that it could lead to inflation — or, in extreme cases, hyperinflation.

How is the budget deficit calculated?

To calculate a budget deficit, start by adding all of a person’s, business’s, or government’s expected revenue for a period. For example, if you plan to make $50,000 from your job, $5,000 from investments, and $10,000 for a side gig, you can add those numbers to find that your expected annual revenue is $65,000.

Then, add all of your expected expenses for the year together. You might plan to spend $10,000 on taxes, $20,000 on rent, $5,000 on a vacation, $15,000 on a car, and $30,000 on other miscellaneous expenses. Adding these numbers together gives you expected expenses of $80,000.

Finally, subtract your expected expenses from your expected revenue to find your budget deficit or surplus. In this example, $65,000 – $80,000 = -$15,000. That means that you have a budget deficit of $15,000 for the year.

What is the budget deficit by year?

The US tends to run a budget deficit, though the size of the deficit changes from year to year, adding to the national debt. The federal deficit from each of the past 10 years are:

  • 2010: $1.371 trillion
  • 2011: $1.366 trillion
  • 2012: $1.148 trillion
  • 2013: $719 billion
  • 2014: $514.1 billion
  • 2015: $465.8 billion
  • 2016: $620.2 billion
  • 2017: $714.9 billion
  • 2018: $785.3 billion
  • 2019: $992.1 billion
  • 2020: $1 trillion (projected)
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