Budget Analysis and Deficit Financing

1. INTRODUCTION
"A national debt, if it is not excessive, will be to us a national blessing."
-Alexander Hamilton

What Causes a Budget Deficit?

Both levels of taxation and spending affect a government's budget deficit. Common scenarios
that create deficits by reducing revenue and increasing spending include:

• Tax structure that under taxes high-wage earners but overtaxes low-wage earners.

• Increased spending on programs like Social Security, Medicare, or military spending.

• Increased government subsidies to targeted industries.

• Tax cuts that decrease revenue but provide corporations with funds to increase employment.

• Low GDP, or gross domestic product, results in lower tax revenue.

Budget deficits may occur as a way to respond to certain unanticipated events and policies, such
as the increase in defense spending after the September 11 terror attacks.

Effects of a Budget Deficit

Budget deficits affect individuals, businesses, and the overall economy. As the government takes
steps to improve the deficit, spending for programs such as Medicare or Social Security may be
curtailed. Improvements to infrastructure may also be affected.

To increase revenue, tax hikes may occur for high-income earners or large corporations which
may affect their ability to invest in new business ventures or hire new employees.

A looming concern of a budget deficit is inflation, which is the continuous increase of price
levels. In the United States, a budget deficit can cause the Federal Reserve to release more
money into the economy, which feeds inflation and continued budget deficits can lead to
inflationary monetary policies, year after year.

Strategies to Reduce Budget Deficits

Countries counter budget deficits by promoting economic growth through fiscal policies, such
as reducing government spending and increasing taxes. Determining the best strategies regarding
which spending to cut or whose taxes to raise are often widely debated.

To pay for government programs while operating under a deficit, the federal government
borrows money by selling U.S. Treasury bonds, bills, and other securities. This strategy carries
the risk of devaluing the nation’s currency, which can lead to hyperinflation.

Reduced regulations and lower corporate income taxes improve business confidence, stimulate
further employment, and promote economic growth leading to higher taxable profits and an
increase in income tax revenue.