What is a Deficit?

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Definition:

A deficit is a negative difference between the amount of an item or resource, such as money, that you need to accomplish a task, and the amount that you have.

🤔 Understanding a deficit

A deficit is the difference between the quantity of a resource, such as money, that you have and what you need to accomplish a task. Specifically, a deficit occurs when you have less of the resource than you need to achieve the task. If you have more than you need, you have a surplus. Deficits can refer to many things, such as a budget deficit (when you have less money than you plan to spend) or a trade deficit (when you import more goods than you export).

Example

One example of a deficit is the U.S. government’s budget deficit. In 2020, the government expected to spend more money than it brought in, which means that it expects to have a budget deficit. As of March 6th, 2020, the Congressional Budget Office projected that the government would receive $3.6 trillion in revenue and spend $4.7 trillion. This results in an expected budget deficit of $1.1 trillion for 2020.

Takeaway

A budget deficit is like not having enough milk for your cereal…

You go grocery shopping to buy cereal and milk. You eat cereal and milk for breakfast over the week and realize that you didn’t buy enough milk to go with the amount of cereal you purchased. You have a deficit of milk. To make up for the shortfall, you have to borrow milk from a neighbor, buy more milk, or eat cereal without milk. Similarly, a person experiencing a deficit, whether it be a budget deficit or a deficit of some other resource, needs to borrow that resource, acquire more, or find a way to do without.

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What is a deficit?

A deficit occurs when you have less of something than you need.

The term deficit is commonly used when discussing budgets, especially government budgets. Often, a government creates a budget that involves spending more money than it expects to receive from taxes and other sources of income. The difference between the amount the government plans to spend and the amount it expects to make is its deficit.

Businesses can also have budget deficits, meaning they spend more than they earn. That means the company won’t produce a profit. This is common among startups that need to invest a lot of money in getting their business off the ground.

Deficits only occur when a person or business has less of something than it needs. If the group has more than it needs, it has a surplus instead. When an organization, like a government, has a deficit in its budget, it needs to find a way to make up that deficit. If the organization has some money saved, it can spend out of its savings to make up for the shortfall. If its savings aren’t sufficient to cover the deficit, it needs to borrow money.

Borrowing money usually involves paying interest and fees, which adds costs to the organization’s budget over time. Borrowing money to finance deficit spending can cause a government or business to fall into a cycle of debt unless it cuts other costs or can increase its revenue.

What are some examples of a deficit?

One well-known example of a deficit in the United States is the trade deficit. The United States tends to import far more than it exports. In 2019, the U.S. imported $254.3 billion worth of goods and services but exported only $207.1 billion, leading to a trade deficit of $47.2 billion Like the federal government, individual states can have a budget deficit.

For example, Massachusetts expects to have a shortfall of as much as $900 million for the 2021 fiscal year.

The University of Connecticut is running a deficit for its sports program. In 2019, its sports produced $38.6 million in revenue but cost $42.3 million to run, giving it a deficit of $3.7 million.

What are the types of deficits?

There are a few different types of deficits that an organization or government can experience.

Budget deficit

A budget deficit happens when a person or group, such as a company or a government, expects to spend more money than it receives in revenue. This includes all sources of income, such as taxes, tariffs, customs, or the selling of goods and services, as well as all forms of expenses, including wages, paying for services, and paying previous debts.

When a company or a government makes more than it plans to spend, it has a budget surplus instead of a deficit.

Trade deficit

A trade deficit occurs when a country buys more things from abroad than it exports. For example, the United States had a trade deficit of $616.8 billion in 2019, meaning it imported goods worth $616.8 billion more than it exported.

Primary deficit

The primary deficit is a measure of an organization’s budget deficit without accounting for the cost of interest payments. For example, if a government plans to receive $800 billion and spend $900 billion, of which, $50 billion goes toward interest payment, its primary deficit is $50 billion. Its total budget deficit is $100 billion.

The primary deficit looks only at spending on services and goods. If a government runs a large primary deficit, there is a significant imbalance in its income and expenditures. If there is no primary deficit, meaning that the budget deficit is only created by interest costs, then the government could operate without a shortfall if it managed to pay off its existing debts.

What causes a deficit?

A deficit occurs when a government or organization wants to spend more money than it makes. There can be a lot of reasons for deficit spending.

For a government, one reason to run a deficit is providing stimulus during a weak economy. The United States ran a budget surplus as recently as 2007. As the 2008 financial crisis began, revenues dropped, and government spending rose with efforts to help the economy get out of recession. This led to a federal budget deficit.

Another reason to run a deficit is low interest rates. When it is cheap to borrow money, some organizations think it makes sense to borrow, in hopes of earning returns higher than the interest rate they’ll pay. This is common among businesses, especially small startups. These businesses borrow money or use their founders and investors’ savings to fund activities in hopes that the company will grow and turn a profit in the future.

What is the difference between deficit and debt?

A deficit occurs when a company or government budgets more spending than its revenues can support. It plans to spend more than it makes.

When an organization runs a deficit, it needs to find some way to cover its additional costs. One option is using money it has saved in the past. Another is to borrow money from a lender. For example, the government can issue bonds when it needs to borrow.

A debt is an obligation that a person, government, or business owes to another. If someone borrows money to cover a deficit, they go into debt. Businesses can be in debt without having a deficit. So long as their revenue covers their expenses, including debt payments, they can have a budget surplus while being in debt.

How does deficit spending work?

When a government or business wants to spend money, the money has to come from somewhere. Typically, the company takes the money it makes and uses it to cover its expenses. If the business doesn’t make enough money to pay its bill, it has to find another way to cover its costs.

There are two main ways to finance deficit spending.

One is to take money out of savings. A person, business, or government can open a savings account when it has a budget surplus and set aside its extra money. When it has a deficit, it can tap its savings to cover the additional costs.

The second option is borrowing money. The organization needs to find a willing lender and agree to repay the money that it borrows. For a government, this means issuing debt, such as bonds. Borrowing is typically the less desirable option because borrowing money has a cost, in the form of interest.

How does a government deficit affect the economy?

The impact of government deficits on the economy is widely debated. Some economists argue that deficit spending is desirable, while others feel that it damages the economy.

People who favor government deficits argue that deficit spending is an essential tool for propping up weak economies and helping the country avoid or recover from a recession. Deficit spending also lets the government invest in projects that benefit future generations and can increase tax revenue, such as highway or rail systems.

Those who argue against deficits say that the government needs to pay the money back eventually. That means that the government will have to increase revenues, possibly by raising taxes or cutting its spending, such as social programs, in the future.

What are the risks of running a deficit?

One of the primary risks of running a deficit is that a government having a shortfall and increasing its debt during good times leaves it less equipped to handle an economic downturn. If the government already spends more than it makes and borrows money to fund its spending, it will have to increase its borrowing further to stave off recession. That can lead to higher interest rates and force it to commit more of its future revenue to debt payments.

Governments that run a deficit need to borrow money to do so, which can also lead to the crowding-out problem. When a government borrows money, it increases the cost of borrowing for private individuals and businesses, which can reduce private spending in the economy.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

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© 2022 Robinhood. All rights reserved.