What Is a Budget Deficit?

A budget deficit occurs when expenses exceed revenue and can indicate the

financial health of a country. The term is commonly used to refer to government
spending rather than businesses or individuals.Budget deficits affect
the national debt, the sum of annual budget deficits, and the cumulative total a
country owes to creditors.A budgetary deficit is referred to as the situation in
which the spending is more than the income. Although it is mostly used for
governments, this can also be broadly applied to individuals and businesses.In
other words, a budgetary deficit is said to have taken place when the individual,
government, or business budgets have more spending than the income that they
can generate as revenue.Budgetary deficit is the difference between all receipts
and expBudget Deficit – Components

1. Revenues

For national governments, a majority of revenue comes from income taxes,

corporate taxes, consumption taxes, and social insurance taxes. For non-
governmental organizations and companies, revenues come from the sale
of goods and services.

2. Expenses

For governments, expenses include government spending on healthcare,

infrastructure, defense, subsidies, pensions, and other items that contribute to
the health of the overall economy. For non-governmental organizations and
companies, expenses include the amount that is spent on daily operations and
factors of production, including rent and wages.

Budget Deficit – Implications

Contrary to what it may sound like, a budget deficit is not always a negative
indicator of economic health. Some of the implications of a budget deficit are
described below:

1. Increase aggregate demand

A budget deficit implies a reduction in taxes and an increase in government

spending, which results in an increase in the aggregate demand of the country
and subsequent economic growth, ceteris paribus.
2. Boost the economy during a recession

During a recession, the economy tends to experience a decrease in investment

spending from the private sector, along with lower aggregate consumption and
demand. A government may choose to borrow and run a deficit to combat the
situation by taking measures to spend effectively.

3. Increase government spending

Government spending serves many purposes, including investments in

infrastructure, healthcare, human capital, unemployment benefits, pension
programs, and so on. A nation’s government may choose to spend more than its
revenues allow by running a deficit.

4. Fiscal policy

A budget deficit may be used to finance an expansionary fiscal policy, which

involves lowering income and corporate taxes (therefore reducing revenue for the
government) and increasing government spending on infrastructure and
investments to attract foreign capital and boost economic growth.

5. Higher taxes in the future

A current budget deficit that runs persistently often implies that the government
will need to increase taxes in the future to pay off the accumulated debt since
taxes are one of the primary sources of revenue for the government.

6. Higher interest rates and bond yields

In order to borrow large amounts, governments often offer higher interest rates to
investors and international banks that lend them money. Increased government
borrowing results in higher interest rates and bond yields since investors and
banks require compensation for the risk through interest payments.

Budget Deficit – Theories

1. Ricardian Equivalence Theory

The Ricardian Equivalence Theory argues that using budget deficit or borrowing
to stimulate the economy exerts no effect. It relies on many assumptions,
including one that states that the government will increase taxes to pay off the
current deficit.

According to the theory, households take it into account while making investment
and saving decisions and choose to save more to compensate for the future
increase in taxes. Therefore, consumption in the economy decreases, and the
increase in government spending financed by a deficit does not impact the
economy.

2. Crowding Out Theory

The Crowding Out Theory states that an increase in government spending and
borrowing leads to a decrease in investments from the private sector. It is
because governments borrow by selling bonds to the private sector and by
borrowing from foreign sources, such as other countries and international banks.

However, it often results in higher interest rates, as well as higher spending on

bonds by the private sector – which leads to lower funds for private sector
investments and a higher cost of borrowing (due to higher interest rates).

Therefore, the increase in government spending is often met with a relatively

smaller decrease in private sector investments, which offsets the overall effect of
the expansionary move.

enses in both revenue and capital account of the government.

types of Budget Deficits

There are three types of budget deficit. They are explained follows:

1. Fiscal deficit
2. Revenue deficit
3. Primary deficit

Fiscal Deficit
Fiscal deficit is defined as the excess of total expenditures over the total receipts,
excluding the borrowings in a year. In other words, this can be defined as the
amount that the government needs to borrow in order to meet all expenses.
The more the fiscal deficit, the more will be the amount borrowed. Fiscal deficit
helps in understanding the shortfall that the government faces while paying for
the expenditures in the absence of lack of funds.
The formula for calculating fiscal deficit is as follows:
Fiscal deficit = Total expenditures – Total receipts excluding borrowings

Impact of Fiscal Deficit

The following impacts of fiscal deficit should be kept in mind.

1. Unnecessary expenditure: A high fiscal deficit leads to unnecessary

expenditure done by the government that leads to potential inflationary
pressure on the economy.
 2. Printing more currency by RBI for meeting the deficit, also known as deficit
financing, leads to the availability of more money in the market, leading to
inflation.
3. Borrowing more will hinder the future growth of the economy, as most of
the revenue will be utilised towards meeting debt payments.

Remedial Measures for Fiscal Deficit

Fiscal deficit can be reduced by the following ways:

1. Reduced public expenditure

2. Reduction in bonus, leave encashments, and subsidies
3. Increase tax to generate revenue
4. Disinvestment of public sector units

Revenue Deficit
Revenue expenditure is defined as the excess of total revenue expenditure over
the total revenue receipts. In other words, the shortfall of revenue receipts as
compared to that of the revenue expenditure is known as revenue deficit.
Revenue deficit signals to the economists that the revenue earned by the
government is insufficient to meet the requirements of the expenditures required
for the essential government functions.
The formula for revenue deficit can be expressed as follows:
Revenue deficit = Total revenue expenditure – Total revenue receipts

Impact of Revenue Deficit

Revenue deficit has the following impacts on the economy.

1. Reduction in assets: For meeting the shortfall in the form of revenue

deficit, the government has to sell some assets.
2. It leads to the conditions of inflation in the economy.
3. A large amount of borrowing leads to a greater debt burden on the
economy.

Remedial Measures for Revenue Deficit

The following remedial measures can be taken by the government in reducing the
revenue deficit.

1. By reducing unnecessary spending

2. By raising the rate of taxes and applying new taxes wherever possible

Primary Deficit
Primary deficit is said to be the fiscal deficit of the current year subtracted by the
interest payments that are pending on previous borrowings. In other words, the
primary deficit is the requirement of borrowing without the interest payment.
Primary deficit, therefore, shows the expenses that government borrowings are
going to fulfil while not paying for the income interest payment.
A zero deficit shows that there is a requirement for availing credit or borrowing
for clearing the interest payments pending.
The formula for the primary deficit is expressed as follows:
Primary deficit = Fiscal deficit – Interest payments
Measures to reduce the primary deficit can be similar to the steps taken to reduce
the fiscal deficit as the primary deficit is any borrowings that are above the
existing deficit or borrowings.
This concludes the topic of budget deficit, which is one of the metrics of
measuring the economic growth of a nation along with GDP. To read more of
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