If you pay attention to politics, work for a company, or are around accountants often, you’ve probably heard of a budget deficit. While the way people talk about budget deficits make them sound confusing and difficult, the concept is actually pretty simple: it’s when expenses exceed income.
There’s a little more to it than that, and it helps to understand budget deficits more in context. In this post, we’ll explain what you need to know about budget deficits, so the next time it comes up, you can better understand the situation — whether that’s talking politics or figuring out your family budget.
Read on for a full explainer, or just click on a link below to answer your specific question.
Let’s start with a simple question.
What is a Budget Deficit?
A budget deficit occurs when spending exceeds income — when the total amount of money that you’re spending is greater than the total amount of money that you’re bringing in. This can occur at small and large scales. For instance, your home budget might be running at a deficit if your total monthly expenses are more than your monthly household income.
Budget deficits happen in companies when the costs of operation are greater than revenue. The same basic principle applies: the company is running at a deficit because the total amount that they’re earning is less than what they owe. Just like at the individual level, this can result in debt.
Lastly, it can also happen at the state level — like the California 2009 budget crisis — and at the national level. And when it does happen on that scale, it’s something that is often the subject of political debate. It’s a little more complicated when considering the national deficit, but the basic principle is the same: government revenue is less than government spending. Right now, the federal government of the US is running a deficit — it’s spending more than it is taking in. As of late 2020, the federal deficit was $3.3 trillion. This is caused by a few factors.
Budget Deficit Causes
In the case of an individual or company, the causes of a deficit can be pretty clear: you’re spending more than you’re making. When it comes to the government, things can be a little more complicated.
The exact causes of a government budget deficit can be hard to track down, but in general, they are caused by low taxes and high spending. That’s because the government’s main source of revenue is taxation, so having low tax income means that the government’s total income is low.
National budget deficits can be caused by a number of factors:
- Tax cuts that decrease revenue, such as those intended to boost large companies’ ability to hire employees
- Low GDP (gross domestic product — the money being made in the country) resulting in low overall revenue, and so low tax revenue
- Poorly-designed tax structures that under-tax high-earners and over-tax low-earners
- High spending on many programs, like Medicare and Social Security
- High military spending
- High spending on subsidies to various industries
Just because something is one of the causes of the deficit does not mean it should be eliminated entirely. For instance, Medicare and Social Security are necessary for the country to function. But given that spending is also high in other areas, and that tax rates are lower than is necessary to fully cover expenses, government spending results in a deficit.
What is the Impact of Government Deficit on the Economy?
Talk of the deficit can sound pretty abstract, but it has a number of effects that the average person might want to worry about. For instance, if the deficit were high enough, the government might seek to cut funding to important programs, such as Medicare or Social Security. The impact of the government budget on the economy can be severe if they cut programs like these that millions of people rely on.
On the other hand, many investors and large corporations worry about the deficit because they fear it will urge the government to raise taxes on them. Ultimately, however, Brookings finds that the deficit is, for now, not something the average American needs to worry about.
- Budget deficits can have an effect on the value of government bonds. Read more about federal deficits and national bonds on our blog.
That’s because it continues to be a debate among economists whether there is a level of debt that will hurt a nation’s economy. As of right now, the deficit seems not to be damaging the US economy. However, because economists are uncertain, no one knows if that will change.
How Governments Reduce a Budget Deficit
One thing is certain: the government is often interested in a lower fiscal deficit when it grows too high. And right now, it’s about as high as it’s ever been. That’s led many different political groups to suggest their own methods of reducing the federal deficit. Here are some commonly-floated federal budget deficit solutions:
- Increase taxes. Some groups want to increase federal revenue to offset the deficit. This could largely be achieved by increasing taxes, particularly on the wealthy, who, in spite of the deficit — and pandemic-induced recession — are still doing very well. Tax increases have downsides for politicians, however, as they are often unpopular, and proposing them can sometimes be a political disaster.
- Increase growth. The government can also increase tax revenue by stimulating growth in the economy. When the economy is growing, people are making more money. And when there’s more money being made, there’s more money eligible for taxation, increasing the total tax revenue the government can collect. Increasing growth is tricky. Some believe cutting taxes increases growth, but there’s no evidence that that works. Others believe direct stimulus can help, but this can also put the government into more debt.
- Cut spending. Cutting spending can come in a number of different forms. Some groups advocate for cutting spending on social programs like Social Security, Medicaid, and aid for state-based programs. Some advocate cutting the military budget, which is much higher than any other developed nation. Ultimately, this becomes a hotly contested political matter.
As the deficit continues to grow, you’re likely to hear more and more arguments about what the best way to cut it might be. Ultimately, something will have to be done, even if in the short term it seems not to be damaging the economy or ordinary Americans’ finances.
How You Can Guard Against a Budget Deficit
As we mentioned before, budget deficits aren’t just about the government — private individuals can experience deficits as well. Because of factors like loans and credit cards, some people might be running a deficit and not even know.
Luckily, there are steps you can take to lower your fiscal deficit.
- Know your monthly income. It’s important to keep tabs on the amount of money you’re bringing in each month. This is especially important if you work multiple jobs, work inconsistent hourly shifts, perform contract or freelance labor, or receive grants. Knowing the approximate or average amount you bring in each month is key.
- Know your monthly expenses. Just as it’s important to know how much money you’re bringing in each month, you should also know how much money is going out. Monthly expenses, for most people, can be inconsistent. Your car doesn’t need a $300 repair every month (hopefully). So, it’s good to do your best to figure out the average amount you spend each month, then use that when assessing your finances.
- Plan your spending to match your income. The last piece of the puzzle: once you know your money-out and money-in, you can plan expenses around the amount of money you’re bringing in. That way, you can ensure that you’re not draining your savings, living paycheck to paycheck, or running up a massive credit card debt to cover your costs of living.
While all of this may sound complicated, especially those whose income and expenses can vary monthly, there’s actually a simple way to keep track: Mint. The Mint app monitors your money out and money in. All you have to do is connect your bank accounts and credit cards, and the app takes care of the rest. It also allows you to build your own budget and plan spending ahead of time, that way you can prevent falling into debt.
Here’s what to keep in mind as you think about budget deficits:
- Budget deficits occur when expenses are greater than revenue.
- They can occur at the individual, company, or governmental level.
- The national deficit is often politically important. As of late 2020, it stood at $3.3 trillion.
- However, economists are unsure whether a high deficit is bad for the economy, at least for now.
- There are two ways they can combat the deficit: increasing revenue through higher taxes and/or more economic activity, or cutting expenses by cutting back on government-run programs.
- At the individual level, you can prevent a budget deficit by carefully monitoring your income and expenses, budgeting, and ensuring that your expenses are less than your total income.
Budget deficits sound scary, and knowing how to reduce a budget deficit can be confusing — but they don’t have to be. With the right policies — whether personal or national — they can be managed.