The government budget balance, also alternatively referred to as general government balance, public budget balance, or public fiscal balance, is the overall difference between government
revenues
In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business.
Commercial revenue may also be referred to as sales or as turnover. Some companies receive revenu ...
and
spending. A positive balance is called a ''government budget surplus'', and a negative balance is a ''government budget deficit''. A
government budget is a financial statement presenting the government's proposed revenues and spending for a
financial year
A fiscal year (or financial year, or sometimes budget year) is used in government accounting, which varies between countries, and for budget purposes. It is also used for financial reporting by businesses and other organizations. Laws in many ...
. A budget is prepared for each level of government (from national to local) and takes into account public
social security
Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...
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
Real gross domestic product (real GDP) is a macroeconomic measure of the value of economic output adjusted for price changes (i.e. inflation or deflation). This adjustment transforms the money-value measure, nominal GDP, into an index for quantit ...
, 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
A country's gross government debt (also called public debt, or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit oc ...
, 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
The balance of trade, commercial balance, or net exports (sometimes symbolized as NX), is the difference between the monetary value of a nation's exports and imports over a certain time period. Sometimes a distinction is made between a balance ...
, 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.
[Financial Times-Martin Wolf-The Balance Sheet Recession in the U.S. – July 2012](_blank)
/ref>
Financial journalist Martin Wolf
Martin Harry Wolf (born 16 August 1946 in London) is a British journalist of Austrian-Dutch descent who focuses on economics. He is the associate editor and chief economics commentator at the ''Financial Times''.
Early life
Wolf was born in ...
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."
Economist Paul Krugman
Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was ...
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."
The sectoral balances (also called sectoral financial balances) derive from the sectoral analysis
Sectoral analysis, also known as sectorial analysis, is a statistical analysis of the size, demographic, pricing, competitive, and other economic dimensions of a sector of the economy
An economy is an area of the production, distribution an ...
framework for macroeconomic analysis of national economies developed by British economist Wynne Godley
Wynne Godley (26 September 192613 May 2010) was an economist famous for his pessimism about the British economy and his criticism of the British government. In 2007, he and Marc Lavoie wrote a book about the " Stock-Flow Consistent" model, an a ...
.
GDP (Gross Domestic Product
Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is oft ...
) 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
Within the budgetary process, deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget ...
is a flow, measured per unit of time, while the government debt
A country's gross government debt (also called public debt, or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit oc ...
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:
:
where ''Y'' is GDP (production; equivalently, income), ''C'' is consumption
Consumption may refer to:
*Resource consumption
*Tuberculosis, an infectious disease, historically
* Consumption (ecology), receipt of energy by consuming other organisms
* Consumption (economics), the purchasing of newly produced goods for curren ...
spending, ''I'' is private investment spending In macroeconomics, investment "consists of the additions to the nation's capital stock of buildings, equipment, software, and inventories during a year" or, alternatively, investment spending — "spending on productive physical capital such as mach ...
, ''G'' is government spending on goods and services, ''X'' is exports and ''M'' is 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 payment
In macroeconomics and finance, a transfer payment (also called a government transfer or simply transfer) is a redistribution of income and wealth by means of the government making a payment, without goods or services being received in return. Th ...
s.
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
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox
*
*
*
*
*
* macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of ...
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
A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union,
and oversees their commercial banking system. In contrast to a commercial bank, a central b ...
, 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.["Deficit Spending 101 – Part 1 : Vertical Transactions"](_blank)
Bill Mitchell, 21 February 2009
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 deficit
The government budget balance, also alternatively referred to as general government balance, public budget balance, or public fiscal balance, is the overall difference between government revenues and spending. A positive balance is called a ''g ...
s 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
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
. 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.
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.[Michael Burda and Charles Wyplosz (1995), ''European Macroeconomics'', 2nd ed., Ch. 3.5.1, p. 56. Oxford University Press, .]
The ''primary deficit'' is defined as the difference between current government spending on goods and services and total current revenue from all types of tax
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or n ...
es net of transfer payment
In macroeconomics and finance, a transfer payment (also called a government transfer or simply transfer) is a redistribution of income and wealth by means of the government making a payment, without goods or services being received in return. Th ...
s. The ''total deficit'' (which is often called the fiscal deficit or just the 'deficit') is the primary deficit plus interest payments on the debt.
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 trend
*all the economic indicators that are the subject of economic forecasting
**see also: econometrics
*general trends in the economy, see: economic history
Economic history is the academic learning of economies or economic events of the past. R ...
s 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 benefit
Unemployment benefits, also called unemployment insurance, unemployment payment, unemployment compensation, or simply unemployment, are payments made by authorized bodies to unemployed people. In the United States, benefits are funded by a comp ...
s. 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
Norway, officially the Kingdom of Norway, is a Nordic country in Northern Europe, the mainland territory of which comprises the western and northernmost portion of the Scandinavian Peninsula. The remote Arctic island of Jan Mayen and the ...
, Russia
Russia (, , ), or the Russian Federation, is a transcontinental country spanning Eastern Europe and Northern Asia. It is the largest country in the world, with its internationally recognised territory covering , and encompassing one-eig ...
, and members of the Organization of Petroleum Exporting Countries
The Organization of the Petroleum Exporting Countries (OPEC, ) is a cartel of countries. Founded on 14 September 1960 in Baghdad by the first five members (Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela), it has, since 1965, been headquart ...
(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, ''structural'' and ''cyclical''. At the lowest point in the business cycle
Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examin ...
, there is a high level of unemployment
Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work during the refere ...
. This means that tax revenues are low and expenditure (e.g., on social security
Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...
) 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
Within the budgetary process, deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget ...
''. By definition, the cyclical deficit will be entirely repaid by a cyclical surplus at the peak of the cycle.
The '' structural deficit'' is the deficit that remains across the business cycle, 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.
The ''fiscal gap
The fiscal gap is a measure of a government's total indebtedness proposed by economists Laurence Kotlikoff and Alan Auerbach, who define it as the difference between the present value of all of government's projected financial obligations, includi ...
'', a measure proposed by economists Alan Auerbach
Alan J. Auerbach (born in 1951) is an American economist. He is currently the director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley. He received his undergraduate degree in economics and ...
and Laurence Kotlikoff
Laurence Jacob Kotlikoff (born January 30, 1951) is a Professor of Economics at Boston University, a William Warren Fairfield Professor at Boston University, a Fellow of the American Academy of Arts and Sciences, a Research Associate of the Natio ...
, 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.
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:
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
Rothschild () is a name derived from the German ''zum rothen Schild'' (with the old spelling "th"), meaning "with the red sign", in reference to the houses where these family members lived or had lived. At the time, houses were designated by sign ...
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
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are as ...
, with consequent inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
, to finance their spending.
Large long-term loans are risky for the lender, and therefore commanded high interest rates. To reduce their borrowing costs, governments began to issue 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
Consols (originally short for consolidated annuities, but subsequently taken to mean consolidated stock) were government debt issues in the form of perpetual bonds, redeemable at the option of the government. They were issued by the Bank of Englan ...
and American Treasury bill
United States Treasury securities, also called Treasuries or Treasurys, are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation. Since 2012, U.S. gov ...
bonds.
Deficit spending
According to most economists, during recessions, the government can stimulate the economy by intentionally running a deficit.
As Professor William Vickrey
William Spencer Vickrey (21 June 1914 – 11 October 1996) was a Canadian-American professor of economics and Nobel Laureate. Vickrey was awarded the 1996 Nobel Memorial Prize in Economic Sciences with James Mirrlees for their research into the e ...
, awarded with the 1996 Nobel Memorial Prize in Economic Sciences put it :
Ricardian equivalence
The Ricardian equivalence
The Ricardian equivalence proposition (also known as the Ricardo–de Viti–Barro equivalence theorem) is an economic hypothesis holding that consumers are forward-looking and so internalize the government's budget constraint when making their co ...
hypothesis, named after the English political economist and Member of Parliament David Ricardo
David Ricardo (18 April 1772 – 11 September 1823) was a British political economist. He was one of the most influential of the classical economists along with Thomas Malthus, Adam Smith and James Mill. Ricardo was also a politician, and a ...
, 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
In economics, crowding out is a phenomenon that occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market, either on the supply or demand side of the market.
One type freque ...
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.
Determinants of government budget balance
Dependent variables
Dependent variables include budgetary variables, meaning deficits and debt
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
s, and nominal or cyclically adjusted data.
''The debt ratio'', either gross (without effect of the inflation) or net, is used as a wider measure of government actions rather than measure of government deficit. Nevertheless, government generally set their yearly budget aims in flow terms (deficits) rather than in stock terms (debts). This is partly because stock markets variables are harder to target as circumstances outside direct government control (e.g. economic growth, exchange rate changes and asset price changes) affect stock variables more than flow variables.
Concerning the ''nominal'' or ''cyclically adjusted data'', the latter is preferable measure of the policy-related part of the budget and reduces the mutual partiality that may originate from the interaction between economic growth and budgets. However, there are serious warnings in estimating cyclically adjusted balances, especially defining trend/potential output.
Independent variables
Concerning factors clarifying variances in budgetary results, there are budgetary, macroeconomic, political, and dummy variables.
Budgetary variables
''Debt-to-GDP ratio'' is used to characterise the long-run sustainability of government fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
. Countries with very high debt-to-GDP ratio are considered to be more financially vulnerable during recessions, and due to it, their creditors demand higher interest rates on new loans or long-term loans with variable interest to cover the potential loses. This measure often even worsens country's budget balance and increase the risk of country ending in insolvency or, in some cases, in bankruptcy.
''Lagged budget balance'' means that past fiscal policy decisions done by government can influence the condition of public finance
Public finance is the study of the role of the government in the economy. It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achiev ...
s in the following years (e.g. huge government spending during COVID-19 pandemic
The COVID-19 pandemic, also known as the coronavirus pandemic, is an ongoing global pandemic of coronavirus disease 2019 (COVID-19) caused by severe acute respiratory syndrome coronavirus 2 (SARS-CoV-2). The novel virus was first identi ...
in most developed countries).
Macroeconomic variables
''Unemployment rate/output growth/output gap'' are variables measuring the responsibility of government practising fiscal policy to macroeconomic terms. They help government to understand the current economic situation and choose the correct policy to sustain economic prosperity.
''Long-term and short-term interest rate'' both worsen the budget balance because they increase the amount states must pay on interests, therefore their budget expenditures. In addition, increase of interest rate is an important mean of monetary policy to regulate the inflation, which clears the value of debt.
''Inflation'' is generally considered to affect the budget balance, but its effect is not a priori clear. During inflation, government is often forced to compensate its effect to ordinary people, which means more expenditures. On the other hand, if country is highly indebted, soaring inflation allows country pay less real value of debt, or, in case of a deal with a creditor, pay it faster.
''Asset prices'' may influence government budget both directly and indirectly and its influence on budget balance is dubious, similar to inflation. Budget may be directly affected via budgetary items, for instance by higher revenues from capital gains tax or wealth tax, or indirectly via second-round effects of asset prices, e.g. lower revenues from consumer tax because of lower amount of money, which can inhabitants spend on goods and services.
''Welfare level'' has quite straightforward effect on budget balance, if it is supposed that low welfare
Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...
states have higher budget deficits due to need to finance catching-up expenditures. However, Greece
Greece,, or , romanized: ', officially the Hellenic Republic, is a country in Southeast Europe. It is situated on the southern tip of the Balkans, and is located at the crossroads of Europe, Asia, and Africa. Greece shares land borders ...
and Japan are considered as developed countries, but their debt is one of the highest in the world and any significant increase of interest rate
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, ...
s would lead to huge financial problems, therefore this assumption is quite problematic.
Political variables
The economic institutions, among them those, which apply fiscal policy, are directly influenced by ''de jure'' (under the law) political power. Form of the state budget can be influenced by political instability (higher frequency of elections), political orientation of those possessing political power or by the way of doing budgetary process (degree of cooperation between authorities), which is examined in a field called political economy
Political economy is the study of how economic systems (e.g. markets and national economies) and political systems (e.g. law, institutions, government) are linked. Widely studied phenomena within the discipline are systems such as labour ...
.
''Election year'' has significant effect on budget balance, because before and after the elections, there is a tendency called political business cycle, referring to the fact that politicians tend to spend more money before and after the elections to please the voters. Due to it, there is a negative correlation between political stability and budget balance meaning the less political stability, the less balanced budget.
''Government composition index'' refers to the political ideology of the government. It is generally supposed that left-wing parties
Left-wing politics describes the range of political ideologies that support and seek to achieve social equality and egalitarianism, often in opposition to social hierarchy. Left-wing politics typically involve a concern for those in soci ...
are more-expenditure and deficit-prone than the right-wing parties
Right-wing politics describes the range of political ideologies that view certain social orders and hierarchies as inevitable, natural, normal, or desirable, typically supporting this position on the basis of natural law, economics, authorit ...
. On the other hand, left-wing parties tend to set more “socially just” progressive tax rates, which in most cases increase tax revenues, therefore budget deficit is not that much higher than during the government of right-wing parties.
''Type of government'' means if the government is single party or a coalition. A single party government does not have to deal with ideology disagreements like the coalition type of government. It is considered to be more active in enforcing new laws or measures and has more balanced budgets.
''Fiscal governance'' is variable, that measures if the major budgetary powers have been allocated to the Minister of Finance (“delegation”), if the role of the Minister of Finance is to enforce pre-existing deal between other ministers (“commitment”), if spending decisions are made without discussion with other ministers (“fiefdom”) or if it is a combination of delegation and commitment (typology based on ).
''Number of political parties'' refers to effective number of them in parliament, as a high number means requirement for large coalitions, increasing the probability of higher budget deficits. Limited number on the other land may lead to autocracy and loss of welfare influencing the budget balance, because democracy is key determinant of economic institutions, and therefore high economic welfare.
''Overall political index'' measures quality of political institutions in a country, which are key determinant of quality economic institution, stating the higher the quality, the lower are expected deficits.
Dummy variables
Dummy variables are variables used mainly in Econometrics and Statistics to categorize data can only take one of two values (mostly 0 or 1). Here, it refers to events unique only for some parts of the world.
''Run-up to EMU'' refers to the consolidation measures about the fiscal policy in European countries to qualify to the European monetary union
The economic and monetary union (EMU) of the European Union is a group of policies aimed at converging the economies of member states of the European Union at three stages.
There are three stages of the EMU, each of which consists of prog ...
(EMU), which were supposed to control government overspending. However, these criteria concerning maximum debt-to-GDP ratio and budget deficit are not evident to have some changing effect on budgets and debts of member states.
''Country-specific and year dummies'' relate to unusual economic events, which have significant effect on state budget balance, country-specific dummies for example to the German unification in 1990 and year dummies to macroeconomic shocks not fully reflected in the variables, like oil shocks in 1970s or 11th September terrorist attacks
11 (eleven) is the natural number following 10 and preceding 12. It is the first repdigit. In English, it is the smallest positive integer whose name has three syllables.
Name
"Eleven" derives from the Old English ', which is first attested i ...
.
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.
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 education. (Alesina, Favor & Giavazzi, 2018).
Cancellation of part of the debt: bankruptcy
During the Greek government-debt crisis
Greece faced a sovereign debt crisis in the aftermath of the financial crisis of 2007–2008. Widely known in the country as The Crisis ( Greek: Η Κρίση), it reached the populace as a series of sudden reforms and austerity measures that ...
, the cancellation of part of the debt in 2011, which is called a "haircut
A hairstyle, hairdo, haircut or coiffure refers to the styling of hair, usually on the human scalp. Sometimes, this could also mean an editing of facial or body hair. The fashioning of hair can be considered an aspect of personal grooming ...
", has certainly alleviated the situation of Greek finances, but has put many banks in difficulty. Thus, Cypriot banks lost 5% of their assets in the haircut, which caused a banking crisis in this country.
Inflation
As the interest rates on government debt securities are generally fixed, rising prices reduce the relative weight of interest payments for a government that sees its revenues artificially inflated by inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
. Nevertheless, the threat of inflation leads creditors to demand higher and higher rates. Inflation thus becomes a decoy that gives governments time but is then paid for in the form of permanently penalizing rates. In the American model, however, inflation remains an option that is often sought. In the European model, the declared choice is price stability in order to ensure the durability of the euro.
See also
* Budget crisis
A budget crisis is an informal name for a situation in which the legislative and the executive in a presidential system deadlock and are unable to pass a budget. In presidential systems, the legislature has the power to pass a budget, but the e ...
* Current account (balance of payments)
In economics, a country's current account records the value of exports and imports of both goods and services and international transfers of capital. It is one of the two components of its balance of payments, the other being the capital accou ...
* Fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
* Generational accounting
Generational accounting is a method of measuring the fiscal burdens facing current and future generations. Generational accounting considers how much each adult generation, on a per person basis, is likely to pay in future taxes net of transfer p ...
* Government budget
* Public finance
Public finance is the study of the role of the government in the economy. It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achiev ...
* Sectoral balances
;U.S.-specific
* Deficit hawk
* Fiscal policy of the United States
Fiscal policy is any changes the government makes to the national budget to influence a nation's economy. "An essential purpose of this Financial Report is to help American citizens understand the current fiscal policy and the importance and magn ...
* National debt of the United States
The national debt of the United States is the total national debt owed by the federal government of the United States to Treasury security holders. The national debt at any point in time is the face value of the then-outstanding Treasury ...
* National debt by U.S. presidential terms
The history of the United States public debt started with federal government debt incurred during the American Revolutionary War by the first U.S treasurer, Michael Hillegas, after the country's formation in 1776. The United States has c ...
* Starve the beast
* Taxation in the United States
The United States of America has separate federal, state, and local governments with taxes imposed at each of these levels. Taxes are levied on income, payroll, property, sales, capital gains, dividends, imports, estates and gifts, as well as ...
* United States federal budget
The United States budget comprises the spending and revenues of the U.S. federal government. The budget is the financial representation of the priorities of the government, reflecting historical debates and competing economic philosophies. Th ...
References
External links
{{Authority control
Government spending
Tax