Budget Surplus and Budget Deficit

Should the government use its fiscal policy to influence demand in the economy then it

needs to choose either expenditure changes or tax changes, as its policy instruments,

or a combination of both. The government could:

Increase demand by directly spending more itself, for example, future investment

and spending on the health service or employing more people. If the government was to

influence demand by spending more, this would have to be financed either through

increasing taxes or borrowing. However, by increasing taxes, organisations, households

and individuals would have less to spend.

Increase demand indirectly by reducing taxation - Tax cuts are often followed by

cuts in government spending. Therefore, total demand will not be stimulated within the

economy. Again, tax cuts could also be funded by an increase in government

borrowing. Should the government decide to lower tax then organisations, households

and individuals would have more money after tax thus have the ability to spend more.

When the government is running a budget deficit it means that total public expenditure

exceeds revenue. As a result, the government has to borrow through the issue of

government debt.  

If the government sector is taking in more revenue than it is spending, there is a budget

surplus allowing the government to repay some of the accumulated debt, of perhaps

cut the burden of tax or raise government expenditure.