Budget Deficit: Components and Types

“What we do want to see is reforms that are going to have a permanent effect on the budget deficit.”

 - Ed Parker

 

Whether we talk about any company, individual or Government deficit is a very critical situation. It only adds to debt and reduces the profits or surpluses. For any nation there are two main types of deficits namely- Trade Deficit and  Budget Deficit.

 

Trade Deficit occurs when the imports are more than the exports. A simple example is- If a country imports goods worth $2 million and exports goods worth $1million then it has a trade deficit of $1million.

 

Budget Deficit on the other hand occurs when the government spends more than it collects as revenues in a given year. In this blog we will learn more about the concept and types of Budget Deficit.

 

Also Read | Debt Funds

 

Concept of Budget Deficit

 

Let us take an example to understand what Budget Deficit is. Suppose the government makes $15 million from taxes and different sources as revenues in a year and its expenses are worth $16 million in that year. Then we can conclude that it has a budget deficit of $1 million in the same year.

 

So, Budget Deficit occurs when the expenditure exceeds the revenues. If we combine the deficits of previous years then we get the National Debt of a country. In short, the Budget Deficit states the monetary or financial health of a country.

 

The government can take multiple steps to correct this situation. It can cut all excess expenditures, improve current revenue generating options to get more or it can employ both these options together.

 

Just like Budget Deficit we have Budget Surplus. It is the exact opposite of Deficit and it shows how sound the financial health of a country is. In the 20th century only some countries had a budget deficit. But due to world wars many countries got into severe deficit issues due to excess borrowings, expenditure on weapons and later on expense on growth.

 

Budget Deficit if severe can lead to inflation. Inflation means an increase in prices which means the purchasing power of people will diminish. If we talk about the United States then the budget deficit can lead to injection of more money by the Federal Reserve to curb inflation.

 

If a country is trapped into a Budget Deficit every year then all its monetary policies will also be inflationary. What are the options to reduce Budget Deficit?

 

• Promote growth through Fiscal Policies. (Increasing taxes and reducing government spending)

 

• Print more currency to settle debts.

 

The second option can be a little risky as it can lead to devaluation of currency ultimately leading to hyper-inflation.

 

Components of Budget Deficit

 

There are two components in Budget Deficit namely - 

 

• Revenue

 

Government gets revenues through tax collections. Taxes on consumption, income tax, corporate taxes etc. For individuals and companies the source of revenue is the sale of goods.

 

• Expenses

 

Government has to incur expenses on various things like public healthcare, education, infrastructure, defense, subsidies and improving the growth of a country. For individuals and companies expenses are incurred on factors or production- land, labor, capital, entrepreneurship as well as on production.

 

Implications of Budget Deficit

 

We cannot always call the Budget Deficit a negative indicator of the economy. There are certain positive implications of Budget Deficit as well. For example:

 

• It leads to an increase in Aggregate Demand which in turn boosts economic growth. Reason being reduction in taxes.

 

• If an economy faces recession the government can use the deficit as a tool to combat it. It may start optimal utilization of the available resources and government spending.

 

• In order to use expansionary Fiscal policy, the budget deficit can be useful to finance it.

 

Also Read | Types of Budgets for Businesses

 

Types of Budget Deficit

 

Budget Deficit is used by companies, individuals and mostly by the Government. There are three types of Budget Deficit given below.

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Types of Budget Deficit

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1. Fiscal Deficit

 

In Fiscal Deficit total expenditures are more than the total receipts but it excludes the borrowings. In simple words, the amount of Fiscal Deficit is what the government needs to borrow to cover up the expenses.

 

Fiscal Deficit= Total Expenditure- Total Receipts(excluding borrowings)

 

The impact of Fiscal Deficit is that unnecessary expenses are incurred by the government. Problem of Deficit Financing also arises because of printing more currency. Overall growth of a country is also impacted due to increase in borrowings.

 

What can you do to reduce Fiscal Deficit?

 

• Reduction of expenditure.

 

• Reduction in subsidies and bonuses.

 

• Increase taxes.

 

• Divesting in PSU

 

2. Revenue Deficit

 

It occurs when the revenue expenditure exceeds the revenue receipts. In simple words, a shortfall in the receipts due to excess revenue expenditure is called Revenue Deficit.It indicates that the revenues earned by the government are not sufficient to cover up and perform the government functions.

 

Revenue Deficit = Total Revenue Expenditure- Total Revenue Receipts

 

The impact of Revenue Deficit is that it causes reduction in the assets because to overcome the shortfall, the government has to sell the assets. It also causes inflation. More borrowings would mean more debt and more debt means burden.

 

How can you reduce Revenue Deficit?

 

• By controlling excess expenditure.

 

• Increasing the current taxes and applying new taxes.

 

3. Primary Deficit

 

The concept of Primary Deficit is somewhat different from the above two. It means the fiscal deficit of the year that comes after reducing the interest payments from all the pending borrowings.

 

In simple words, Primary Deficit defines the expenses of the government that will be covered by the borrowings when no interest payments are done. If the Primary Deficit is zero then it means that a country needs additional credit to settle the interest payments.

 

Primary Deficit = Fiscal Deficit - Interest Payments

 

How to reduce Primary Deficit? Whatever steps that are taken to reduce Fiscal Deficit will reduce Primary Deficit as well.

 

Also Read | Expansionary Fiscal Policy

 

Budget Deficit has some serious implications on the overall economic condition of a country.