In simple words, a budget deficit means expenses exceed revenues. In relation to a country, a budget deficit occurs when the government of that country spends more money than it receives in revenue over a year.
In this article, we will discuss what are the types of budget deficit, their causes and how to manage it.
What are the types of budget deficit?
Budget deficits can be classified into different types based on their causes.
Here are the two main types of budget deficit:
Revenue Deficit
A revenue deficit occurs when a government’s revenue is insufficient to meet its operational expenditures. Here is the mathematical formula to calculate revenue deficit:
Revenue deficit = Total revenue expenditure – Total revenue receipts
If the above calculation results are positive, revenue deficit exists.
Revenue expenditure means expenses that do not result in creation of physical assets.
Revenue receipt means income from taxes, fees and other regular sources except borrowing.
Fiscal Deficit
Fiscal deficit occurs when the government’s total expenditure exceeds its total revenue except for the borrowing part. Here is the mathematical formula to calculate fiscal deficit:
Fiscal deficit = Total expenditure – Total receipts excluding borrowings.
If the calculation results in a positive, the government has a fiscal deficit.
Total expenditure includes all government spending such as salaries, infrastructure projects, social welfare programs and interest payments on existing debt.
Total receipts include all the income generated by the government such as taxes, fees, dividends, and non-tax revenues.
Please note the difference between fiscal and revenue deficit. In the fiscal deficit we consider all expenditures and revenues. Whereas, in case of revenue deficit, we only consider revenue receipts and revenue expenditure, excluding capital expenditure and capital revenue.
Other than revenue deficit and fiscal deficit we also have following type of budget deficits
Primary Deficit: It occurs when a government’s total expenditures, excluding interest payments on existing debt, exceed its total revenues. In other words, the fiscal deficit when it is reduced by the payment of interest.
Primary Deficit = Total Expenditures (excluding interest) – Total Revenues.
Effective Revenue Deficit: The revenue deficit when it gets reduced by the non-payment of grants which is required for the creation of the capital assets.
Effective Revenue Deficit = Revenue Expenditure – Revenue Receipts – Grants for Capital Expenditure.
What are the causes of the budget deficit?
When the government increases spending on infrastructure projects, social programs, military expenditure and in other projects in excess of their revenue, it creates a budget deficit.
Decrease in revenue can also lead to a budget deficit. Revenue of a country can be decreased due to lower income tax revenue collection and tax cuts.
Any unexpected expenditure, such as a natural disaster or health crisis can increase government spending substantially with lower revenue collection. This may increase the budget deficit.
Large amounts of existing debt can lead to substantial interest payments, which consumes a significant portion of the country’s budget and contributes to the budget deficit.
How does the government manage budget deficits?
To cover the budget deficit, the government wants funds.
Government can borrow money by issuing bonds, disinvestment of assets and reducing government spending on non-essential programs.
Increased debt also increases the borrowing cost of the government. Interest payment will consume a significant portion of the budget by reducing government’s expenses in other programs.
Government may also increase tax rates to increase revenue.
Here are the various strategy the government may adopts to manage budget deficit:
- Reduce spending
- Raise tax rates and collections
- Issuing government bonds to raise funds
- By adjusting interest rates and encouraging policy to promote economic growth. A stronger economy typically increases tax revenues.
In economic downturns, governments use budget deficit as a tool to stimulate the economy by spending more and giving tax cuts. However, a large budget deficit is a concern for the government.
