Government budget deficits

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.

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.

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.