Government Deficits and National Debt

Key Terms: Debt, Deficit, and Surplus

  • Debt: The total amount a government owes due to past borrowing.
  • Deficit: When government spending exceeds its revenue in a given year.
  • Surplus: When government revenue is greater than its spending in a given year.

Understanding the Budget

  • Budget: A plan showing expected government revenue and spending needed to effectively and efficiently function.
  • Government Budget Balance: The difference between tax revenue and government spending.
  • Government receipts, revenue, and income are mostly earned through taxes.
  • Government expenses or outlays are government spending and transfers.

Understanding the Budget Balance

The state of the government budget balance can be in 3 states:

  • Balanced Budget: Revenue = Spending
    • Revenue=SpendingRevenue = Spending
  • Budget Surplus: Revenue > Spending
    • Revenue > Spending
  • Budget Deficit: Spending > Revenue (non-desirable)
    • Spending > Revenue

Fiscal Policy & Budget Balance

  • Fiscal policy is the way a government decides to spend money and collect taxes to help manage the economy.
  • Governments may adjust spending and taxation to influence the economy:
    • Expansionary Fiscal Policy – Increases spending or cuts taxes → tends to lead to deficits.
    • Contractionary Policy – Cuts spending or raises taxes → could lead to surpluses.
  • Continuous deficit spending is what creates the national debt over time.

Expansionary Fiscal Policy Explained

  • The purpose is to boost economic growth by increasing AD to recover from economic slowdowns or recessions.
    • To do so the government could:
      • Decreases taxes or increase government spending.
      • Both actions will lead to an increase in AD, but at the same time, they decrease government revenue and increase its spending which might lead to budget deficits.

Contractionary Fiscal Policy Explained

  • The purpose is to slow down the economy when it’s growing too fast and causing problems such as high inflation.
    • To do so the government could:
      • Increase taxes or decrease government spending.
      • Both actions will lead to a decrease in AD.
      • This will prevent the economy from growing so fast and very high prices.
      • At the same time, these actions would increase the government’s tax revenue and decrease its spending which might lead to budget surpluses.