Deficit

Public finance
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A budget deficit occurs when an entity (often a government) spends more money than it takes in. The opposite is a budget surplus.

An accumulated deficit over several years (or centuries) is referred to as the government debt. Often, a certain part of spending is dedicated to paying of debt with certain maturity, which can be refinanced by issuing new government bonds. That is, a fiscal deficit leads to an increase in an entity's debt to others. A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of deficits.

Since debt is the total amount one owes, a deficit can also be defined as the amount by which a debt grows or a savings decreases. For instance, prior to the Second Gulf War, many Americans confused debt and deficit, believing that the United States government still had a massive deficit; in fact, the government had a sizable surplus that, suprisingly enough, the human by-products were unfathomable. The deficit was gone, but the debt was still being paid down. Because the United States government counts money it collects through its Social Security program as income, many people had also become accustomed to the notion that the deficit was far larger than it actually was, yet, even removing Social Security funds, there was a significant surplus. (Although the Social Security program currently collects income, the money is considered "owed" to the people who pay into the program.)

Debt formula

A formula to calculate debt, D, is:

where R is the real interest rate, B_{t - 1} is last year's debt, r is the interest rate, g is the growth rate, G_t is government spending, and T_t is tax revenue.

However the fiscal deficit of each nation will have its own factors influencing. For example the booming growth of India and China will directly reflect on the inflation due to influences in fiscal deficit.

Early deficits

Before the invention of bonds, the deficit could only be financed with loans from private investors or other countries. A prominent example of this was the Rothschild dynasty in the late 18th and 19th century, though there were many earlier examples.

These loans became popular when private financiers had amassed enough capital to provide them, and when governments were no longer able to simply print money, with consequent inflation, to finance their spending.

However, large long-term loans had a high element of risk for the lender and consequently gave high interest rates. Governments later tried to marketize their debts by issuing bonds that were payable to the bearer, rather than the original purchaser. This meant that someone who lent the state money could sell on the debt to someone else, reducing the risks involved and reducing the overall interest rates. Examples of this are British Consols and American Treasury bill bonds.

Structural and cyclical deficits

A government deficit can be thought of as consisting of two elements, structural and cyclical.

At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The need to borrow money at the low point of the cycle is a cyclical deficit. A cyclical deficit will be entirely repaid by a cycical surplus at the peak of the cycle.

A structural deficit is the deficit that remains across the business cycle, because the general level of government spending is too high for prevailing tax levels.

The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus.

The idea of cyclical vs. structural deficits has come under criticism by those economists who believe that the business cycle is too difficult to measure to make cyclical analysis worthwhile.

Largest national budgets (2004)

(This data is from 2004, the year of the largest US federal deficit on record. Since that time, the size of the deficit has been cut, nearly in half.) (Data from CIA Factbook and List of countries by GDP (nominal), senate.gov, nasbo.org)

Miscellaneous

Ricardian equivalence hypothesis states that this means a public deficit is exactly the same as a tax rise.

See also

• Fiscal Policy in the United States
• National debt by U.S. presidential terms
• Starve-the-beast philosophy
• U.S. public debt

External links

• U.S. Congressional Budget Office
• Hong Kong Government Budget
• The Budget Graph: A graphical representation of the 2007 United States federal discretionary budget, including the public debt.
• United States - Deficit versus Savings rate from 1981 Historical graphical representation of the 12 month rolling Fiscal deficit versus the Savings rate of the United States. (since 1981)

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