Deficits are more common than you think. Nine out of top 10 global economies run a fiscal deficit.
Everyone manages budgets in life. It could be a household budget or a personal budget. Even the wealthy have budgets. It's just that their budgets are larger than those of the common folk. We know intuitively that our expenditure should be less than our income—or at least equal to it. Otherwise, we can’t survive for long. If we want to spend more, we need to earn more. If our income drops, we should spend less. Ignore this balance and it will lead to your ruin.
A budget allows us to understand our income and expenditure—and the gap between them. If your income is more than your expenditure, you are running a budget surplus. Agreed, we call it savings, but governments call it surplus. If your expenditure exceeds income, what you have is a deficit. To get by, you may take a loan from friends. Since governments don’t have friends, they borrow from banks or from people via bonds. So far, it’s simple.
If you don’t spend anything at all, you will end up with a surplus. But, that’s a choice none of us can make. There are essential expenditures like rent, food and transportation. Similarly, governments have essential expenditures like paying salaries, maintaining roads and running schools (revenue expenditures). Governments try to meet these expenditures with income generated from taxes and other public services (revenue income).
Besides essential expenses, governments also invest in infrastructure, research and other programs. Such investments create assets that generate more income in the future. This is called capital spending. To meet capital spending needs, a government may take loans from central banks. These loans are called capital receipts. They may sell companies or land or telecom spectrum. Income from such sales is also grouped under capital receipts.
A government budget is a forecast of all income and expenditure for the coming fiscal year.
With the help of simple math, you can understand your government’s fiscal position. Add revenue income and capital receipts (exclude borrowing) to get total income. For total spending, add up revenue and capital expenditure. Now, subtract the total income from total spending. If total spending and total income match, the budget is in balance. If the income is higher than spending, the government is running a surplus. More often, expenditures are likely to overshoot income resulting in a fiscal deficit.
A government running a fiscal deficit will need to borrow to meet its expenses. This sounds like a bad thing. The reality is that even strong economies run deficits. The United States, the United Kingdom, Canada and India all run deficits. It is only when deficits get out of hand that it becomes a serious problem. A government with a high deficit finds it hard to raise loans. When it does, it generally borrows at a higher interest rate.
Note: Germany is alone among advanced economies in running a surplus
Deficits also tend to widen every year for several reasons. Increased borrowing adds to the interest burden. Expenditures could rise, income may fall. One thing feeds into another. Soon the government may find itself unable to meet its commitments. A government in deficit is also unlikely to make the right investments that create wealth in the future. So, keeping deficits under control is a no-brainer, except when government spending is required to prop up economic growth.
If you want to understand your government’s fiscal performance, look at its deficit. If it’s growing, look at where the expenditure is going. If it’s shrinking, see if any public services are being cut or if taxes are being raised. A deficit and how it is being managed will tell you a lot about your government and its priorities.