Government budget balance

A government budget is a financial statement presenting the government's proposed revenues and spending for
a financial year. The government budget balance, also alternatively referred to as general government
balance,[1] public budget balance, or public fiscal balance, is the overall difference between government
revenues and spending. A positive balance is called a government budget surplus, and a negative balance is
a government budget deficit. A budget is prepared for each level of government (from national to local) and takes
into account public social security obligations.

The government budget balance can be broken down into the primary balance and interest payments on
accumulated government debt; the two together give the budget balance. Furthermore, the budget balance can be
broken down into the structural balance (also known as cyclically-adjusted balance) and the cyclical component: the
structural budget balance attempts to adjust for the impact of cyclical changes in real GDP, in order to indicate the
longer-run budgetary situation.

The government budget surplus or deficit is a flow variable, since it is an amount per unit of time (typically, per year).
Thus it is distinct from government debt, which is a stock variable since it is measured at a specific point in time. The
cumulative flow of deficits equals the stock of debt.

Sectoral balances
The government fiscal balance is one of three major sectoral balances in the national economy, the others being the
foreign sector and the private sector. The sum of the surpluses or deficits across these three sectors must be zero
by definition. For example, if there is a foreign financial surplus (or capital surplus) because capital is imported (net)
to fund the trade deficit, and there is also a private sector financial surplus due to household saving exceeding
business investment, then by definition, there must exist a government budget deficit so all three net to zero. The
government sector includes federal, state and local governments. For example, the U.S. government budget deficit in
2011 was approximately 10% GDP (8.6% GDP of which was federal), offsetting a capital surplus of 4% GDP and a
private sector surplus of 6% GDP.[2]
Financial journalist Martin Wolf argued that sudden shifts in the private sector from deficit to surplus forced the
government balance into deficit, and cited as example the U.S.: "The financial balance of the private sector shifted
towards surplus by the almost unbelievable cumulative total of 11.2 per cent of gross domestic product between the
third quarter of 2007 and the second quarter of 2009, which was when the financial deficit of US government
(federal and state) reached its peak...No fiscal policy changes explain the collapse into massive fiscal deficit between
2007 and 2009, because there was none of any importance. The collapse is explained by the massive shift of the
private sector from financial deficit into surplus or, in other words, from boom to bust."[2]

Economist Paul Krugman explained in December 2011 the causes of the sizable shift from private deficit to surplus:
"This huge move into surplus reflects the end of the housing bubble, a sharp rise in household saving, and a slump in
business investment due to lack of customers."[3]

The sectoral balances (also called sectoral financial balances) derive from the sectoral analysis framework for
macroeconomic analysis of national economies developed by British economist Wynne Godley.[4]

GDP (Gross Domestic Product) is the value of all goods and services produced
within a country during one year. GDP measures flows rather
than stocks(example: the public deficit is a flow, measured per unit of time, while
the government debt is a stock, an accumulation). GDP can be expressed
equivalently in terms of production or the types of newly produced goods
purchased, as per the National Accounting relationship between aggregate
spending and income:
Sectoral financial balances in U.S.
economy 1990–2012. By definition,
the three balances must net to zero.
where Y is GDP (production; equivalently, Since 2009, the U.S. capital surplus
income), C is consumption spending, Iis private investment and private sector surplus have
spending, G is government spending on goods and services, X is exports and M is driven a government budget deficit.
imports (so X – M is net exports).

Another perspective on the national income accounting is to note that households can allocate total income (Y) to the
following uses:

where S is total saving and T is total taxation net of transfer payments.

Combining the two perspectives gives

Hence

This implies the accounting identity for the three sectoral balances – private domestic, government budget and
external:

The sectoral balances equation says that total private saving (S) minus private investment (I) has to equal the public
deficit (spending, G, minus net taxes, T) plus net exports (exports (X) minus imports (M)), where net exports is the
net spending of non-residents on this country's production. Thus total private saving equals private investment plus
the public deficit plus net exports.

In macroeconomics, the Modern Money Theory describes any transactions between the government sector and the
non-government sector as a vertical transaction. The government sector includes the treasury and the central bank,
whereas the non-government sector includes private individuals and firms (including the private banking system)
and the external sector – that is, foreign buyers and sellers.[5]
In any given time period, the government's budget can be either in deficit or in surplus. A deficit occurs when the
government spends more than it taxes; and a surplus occurs when a government taxes more than it spends. Sectoral
balances analysis shows that as a matter of accounting, government budget deficits add net financial assets to the
private sector. This is because a budget deficit means that a government has deposited, over the course of some time
range, more money and bonds into private holdings than it has removed in taxes. A budget surplus means the
opposite: in total, the government has removed more money and bonds from private holdings via taxes than it has
put back in via spending.

Therefore, budget deficits, by definition, are equivalent to adding net financial assets to the private sector, whereas
budget surpluses remove financial assets from the private sector.

This is represented by the identity:

where NX is net exports. This implies that private net saving is only possible if the government runs budget deficits;
alternately, the private sector is forced to dissave when the government runs a budget surplus.

According to the sectoral balances framework, budget surpluses offset net saving; in a time of high effective demand,
this may lead to a private sector reliance on credit to finance consumption patterns. Hence, continual budget deficits
are necessary for a growing economy that wants to avoid deflation. Therefore, budget surpluses are required only
when the economy has excessive aggregate demand, and is in danger of inflation. If the government issues its own
currency, MMT tells us that the level of taxation relative to government spending (the government's budget deficit or
surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the
government's activities per se.

Primary balance
"Primary balance" is defined by the Organisation for Economic Co-operation and Development (OECD) as
government net borrowing or net lending, excluding interest payments on consolidated government liabilities.[6]

Primary deficit, total deficit, and debt

The meaning of "deficit" differs from that of "debt", which is an accumulation of yearly deficits. Deficits occur when a
government's expenditures exceed the revenue that it levies. The deficit can be measured with or without including
the interest payments on the debt as expenditures.[7]

The primary deficit is defined as the difference between current government spending on goods and services and
total current revenue from all types of taxes net of transfer payments. The total deficit (which is often called the fiscal
deficit or just the 'deficit') is the primary deficit plus interest payments on the debt.[7]

Therefore, if refers to an arbitrary year, is government spending and is tax revenue for the respective year,
then

If is last year's debt (the debt accumulated up to and including last year), and is the interest rate attached to
the debt, then the total deficit for year t is

where the first term on the right side is interest payments on the outstanding debt.

Finally, this year's debt can be calculated from last year's debt and this year's total deficit, using the government
budget constraint:
That is, the debt after this year's government operations equals what it was a year earlier plus this year's total deficit,
because the current deficit has to be financed by borrowing via the issuance of new bonds.

Economic trends can influence the growth or shrinkage of fiscal deficits in several ways. Increased levels of economic
activity generally lead to higher tax revenues, while government expenditures often increase during economic
downturns because of higher outlays for social insurance programs such as unemployment benefits. Changes in tax
rates, tax enforcement policies, levels of social benefits, and other government policy decisions can also have major
effects on public debt. For some countries, such as Norway, Russia, and members of the Organization of Petroleum
Exporting Countries (OPEC), oil and gas receipts play a major role in public finances.

Inflation reduces the real value of accumulated debt. If investors anticipate future inflation, however, they will
demand higher interest rates on government debt, making public borrowing more expensive.total borrowing=fiscal
deficit of that year

Structural deficits, cyclical deficits, and the fiscal gap

A government deficit can be thought of as consisting of two
elements, structuraland cyclical. At the lowest point in the business cycle, there
is a high level of unemployment. This means that tax revenues are low and
expenditure (e.g., on social security) high. Conversely, at the peak of the cycle,
unemployment is low, increasing tax revenue and decreasing social security
spending. The additional borrowing required at the low point of the cycle is
the cyclical deficit. By definition, the cyclical deficit will be entirely repaid by a
cyclical surplus at the peak of the cycle. French government borrowing
(budget deficits) as a percentage of
The structural deficit is the deficit that remains across the business cycle, GNP, 1960–2009.
because the general level of government spending exceeds prevailing tax levels.
The observed total budget deficit is equal to the sum of the structural deficit with
the cyclical deficit or surplus.

Some economists have criticized the distinction between cyclical and structural deficits, contending that the business
cycle is too difficult to measure to make cyclical analysis worthwhile.[8]

The fiscal gap, a measure proposed by economists Alan Auerbach and Laurence Kotlikoff, measures the difference
between government spending and revenues over the very long term, typically as a percentage of gross domestic
product. The fiscal gap can be interpreted as the percentage increase in revenues or reduction of expenditures
necessary to balance spending and revenues in the long run. For example, a fiscal gap of 5% could be eliminated by
an immediate and permanent 5% increase in taxes or cut in spending or some combination of both.[9]

It includes not only the structural deficit at a given point in time, but also the difference between promised future
government commitments, such as health and retirement spending, and planned future tax revenues. Since the
elderly population is growing much faster than the young population in many developed countries, many economists
argue that these countries have important fiscal gaps, beyond what can be seen from their deficits alone.

National government budgets

Data are for 2010:[10]

 National Government Budgets for 2010 (in billions of US$)
Budget
Nation GDP Revenue Expenditure Expenditure/GDP Balance/Revenue Balance/GDP[11]
Balance[11]
US
14,526 2,162 3,456 -1,293 23.8% 14.88% -8.9%
(federal)
US
14,526 900 850 +32 7.6% +5.6% +0.4%
(state)
Japan 4,600 1,400 1,748 +195 38.0% -24.9% +3.6%
Germany 2,700 1,200 1,300 +199 48.2% -8.3% +6.1%
United
2,100 835 897 -75 42.7% -7.4% -3.3%
Kingdom
France 2,000 1,005 1,080 -44 54.0% -7.5% -1.7%
Italy 1,600 768 820 -72 51.3% -6.8% -3.5%
China 1,600 318 349 -31 21.8% -9.7% +5.1%
Spain 1,000 384 386 -64 38.6% -0.5% -4.6%
Canada 900 150 144 -49 16.0% +4.0% -3.1%
South
600 150 155 +29 25.8% -3.3% +2.9%
Korea

Early deficits
Before the invention of bonds, the deficit could only be financed with loans from
private investors or other countries. A prominent example of this was
the Rothschild dynasty in the late 18th and 19th century, though there were many
earlier examples (e.g. the Peruzzi family).

These loans became popular when private financiers had amassed enough capital
to provide them, and when governments were no longer able to simply
print money, with consequent inflation, to finance their spending.

Large long-term loans are risky for the lender, and therefore commanded high United States deficit or surplus
interest rates. To reduce their borrowing costs, governments began to issue percentage 1901 to 2006.
bonds that were payable to the bearer (rather than the original purchaser) so that
the lenders could sell on some or all of the debt to someone else. This innovation
reduced the risk for the lenders, and so the government could offer a lower interest rate. Examples of bearer bonds
are British Consols and American Treasury bill bonds.

Deficit spending
According to most economists, during recessions, the government can stimulate the economy by intentionally
running a deficit. As Professor William Vickrey, awarded with the 1996 Nobel Memorial Prize in Economic Sciences
put it :

Deficits are considered to represent sinful profligate spending at the expense of future generations who
will be left with a smaller endowment of invested capital.

This fallacy seems to stem from a false analogy to borrowing by individuals. Current reality is almost the
exact opposite. Deficits add to the net disposable income of individuals, to the extent that government
disbursements that constitute income to recipients exceed that abstracted from disposable income in
taxes, fees, and other charges. This added purchasing power, when spent, provides markets for private
production, inducing producers to invest in additional plant capacity, which will form part of the real
heritage left to the future. This is in addition to whatever public investment takes place in infrastructure,
education, research, and the like. Larger deficits, sufficient to recycle savings out of a growing gross
 domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an
economic sin but an economic necessity. Deficits in excess of a gap growing as a result of the maximum
feasible growth in real output might indeed cause problems, but we are nowhere near that level.

Even the analogy itself is faulty. If General Motors, AT&T, and individual households had been required to
balance their budgets in the manner being applied to the Federal government, there would be no
corporate bonds, no mortgages, no bank loans, and many fewer automobiles, telephones, and houses.[12]

Ricardian equivalence

The Ricardian equivalence hypothesis, named after the English political economist and Member of Parliament David
Ricardo, states that because households anticipate that current public deficit will be paid through future taxes, those
households will accumulate savings now to offset those future taxes. If households acted in this way, a government
would not be able to use tax cuts to stimulate the economy. The Ricardian equivalence result requires several
assumptions. These include households acting as if they were infinite-lived dynasties as well as assumptions of no
uncertainty and no liquidity constraints.

Also, for Ricardian equivalence to apply, the deficit spending would have to be permanent. In contrast, a one-time
stimulus through deficit spending would suggest a lesser tax burden annually than the one-time deficit expenditure.
Thus temporary deficit spending is still expansionary. Empirical evidence on Ricardian equivalence effects has been
mixed.

Crowding-out hypothesis

The crowding-out hypothesis is the conjecture that when a government experiences a deficit, the choice to borrow to
offset that deficit draws on the pool of resources available for investment, and private investment gets crowded out.
This crowding-out effect is induced by changes in the interest rate. When the government wishes to borrow, its
demand for credit increases and the interest rate, or price of credit, increases. This increase in the interest rate makes
private investment more expensive as well and less of it is used.[13]

Potential policy solutions for unintended deficits

Increase taxes or reduce government spending

If a reduction in a structural deficit is desired, either revenue must increase, spending must decrease, or both. Taxes
may be increased for everyone/every entity across the board or lawmakers may decide to assign that tax burden to
specific groups of people (higher-income individuals, businesses, etc.) Lawmakers may also decide to cut government
spending.

Like with taxes, they could decide to cut the budgets of every government agency/entity by the same percentage or
they may decide to give a greater budget cut to specific agencies. Many, if not all, of these decisions made by
lawmakers are based on political ideology, popularity with their electorate, or popularity with their donors.

Changes in tax code

Similar to increasing taxes, changes can be made to the tax code that increases tax revenue. Closing tax loopholes and
allowing fewer deductions are different from the act of increasing taxes but essentially have the same effect.

Reduce debt service liability

Every year, the government must pay debt service payments on their overall public debt. These payments include
principal and interest payments. Occasionally, the government has the opportunity to refinance some of their public
debt to afford them lower debt service payments. Doing this would allow the government to cut expenditures without
cutting government spending.[14]

A balanced budget is a practice that sees a government enforcing that payments,

procurement of resources will only be done inline with realised revenues, such
that a flat or a zero balance is maintained. Surplus purchases are funded through
increases in tax.

Balanced budget

According to Alesina, Favor & Giavazzi (2018), “we recognized that shifts in fiscal
policy typically come in the form of multiyear plans adopted by governments
with the aim of reducing the debt-to-GDP ratio over a period of time-typically
three to four years. After reconstructing such plans, we divided them into two
categories: expenditure-based plans, consisting mostly of spending cuts, and tax-
based plans, consisting mostly of tax hikes.” They suggest that paying down the
national debt in twenty years is possible through a simplified income tax policy
while requiring government officials to enact and follow a balanced budget with
additional education on government spending and budgets at all levels of public The government surplus/deficit of
education. (Alesina, Favor & Giavazzi, 2018).[ struggling European countries
according to European sovereign
debt
crisis: Italy, Cyprus, Portugal, Spain, G
Kingdom and Ireland against
the Eurozone and the United
States (2000–2013).