Problem

Government budget deficits

Other Names:
National public sector deficits
Unsustainable national fiscal policies
Unbalanced national budgets
Government deficit spending
Imprudent national budgets
Government overspending
Imbalance of government revenue mobilization and expenditure allocation
National current account deficit
Nature:
The excess of government spending over revenues generated from taxes, import duties and the like. It is sometimes divided into "above the line" (recurrent spending including interest on debt) and "below the line" (capital projects, investment, debt principal repayment). The former is analogous to the "profit and loss" account of an enterprise, whereas the latter is analogous to its "investment sources and uses", with the combined account being equivalent to the "cash flow" account. A country's current account deficit is therefore the gap between its domestic savings and investment. A budget deficit is a form of dis-saving. Large budget deficits generate inflationary pressures.
Background:
An excessive one year deficit in governmental accounts or a pattern of continuing deficits over a number of years creates public or national debt. The remedy of reducing expenditures is rarely effective, some elements being inviolable in some countries, as, for example, social welfare spending, civil service payrolls, or defence and foreign aid budgets. The government may also be constrained not to raise taxes, so that financing of the deficits must be done through the creation of fiat money or by borrowing on the non-governmental money markets. Deficits indicate excessive governmental spending. Governmental borrowings to finance them reduce the financial resources available for private investment. Governmental increases in taxation reduce the incentives to invest. If there are no disincentives, deficit borrowings will cause interest rates to go up as there will be a demand for capital exceeding supply. Unsustainable fiscal deficits provoke capital flight because domestic savers anticipate a coming crisis that is likely to involve a major devaluation and new taxes on income and consumption.
Incidence:
Deficits can be more easily absorbed by countries with high rates of domestic private savings and well-developed capital markets. Thus a relatively high deficit need not cause problems in an efficient high-saving economy, whereas in a low-saving, highly distorted one, even a small deficit might be destabilizing.
Claim:
Fiscal deficits are a principal cause of the international debt crisis, both directly, because they mean greater public borrowing, and indirectly, because they encourage the private sector to send its capital to elsewhere.
Counter Claim:
Deficits in themselves do not automatically imply macroeconomic problems. If the use of public resources is sufficiently productive, future income can be generated to cover the servicing costs of any debts incurred. If expenditures rise owing to temporary factors, such as wars or natural disasters, then deficits may be justified as a way to spread the cost over several years.

Some countries have adopted laws that require the national budget to be balanced. Electoral promises to balance the budget may also be made. The economic rationale for this is questionable. A budget designed to achieve targets consistent with an appropriate response to inflation, public debt, and private sector growth does not necessarily require a balanced budget, even if this can be achieved in practice. Balanced budget laws are relatively easy to circumvent in practice by excluding certain items, such as state-controlled enterprises. Preoccupation with balanced budgets can also complicate fiscal planning. They also provide the finance ministry with a ready-made excuse for resisting calls for public spending.

Reduced By:
Capital gains tax
Problem Type:
D: Detailed problems
Date of last update
02.12.2017 – 02:56 CET
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