What is the Budget Deficit?

By Levi Anthony - Posted 4/10/2011

What is the budget deficit?
Late Friday night the U.S. Government averted a shut down. Part of the disagreement between the Democrats and Republicans was over the budget deficit and how much spending should be cut. The federal government is currently running a huge budget deficit. If you spend $1200 a month when your income is $1000, then you are running a monthly deficit of $200. Similarly, when the government spends more than the income it takes in, then it runs a budget deficit. On the other hand, if the government takes in more money than it spends, the difference is called a surplus.

The budget deficit for the current 2011 fiscal year will be around $1.4 trillion. Here is a chart showing the deficit for the years 1970-2010.

As you can see, for most of these years the country has been running substantial deficits. The deficit on this chart is measured as a percentage of GDP. This is a better way of looking at it rather than the raw amounts. GDP means Gross Domestic Product. Economists use this to measure the value of the total goods and services produced by a country in one year. Hence, the deficit for 2010 was about 10% of GDP.

What created these deficits?

The deficit results from a number of factors which include:

1. The collapse of the economy at the end of 2008 and the slow recovery mean that the government is collecting less money.

2. Increase spending by the government in various areas from providing more money for the unemployed to funding wars in Iraq and Afghanistan.

3. Giving tax cuts, mainly to the wealthy. Both the Bush and Obama administrations gave substantial tax cuts to the rich. Tax cuts mean less money going to the government.

To put the deficit in perspective, here is another useful chart which shows that the United States is not alone in running huge budget deficits. Because of the recession that started in 2008, most of the rich countries have huge deficits as well.

 

How should we close the deficit?
1. Borrow to fill the gap. The problem with this is that borrowing will increase the national debt which is already gigantic and growing. And the debt has to be repaid. The government usually borrows this money from individuals, private businesses and foreign governments.

Sometimes, the government borrows from itself. How is this possible, you ask? Well, the government borrows from all that money you and I pay into Medicare and Social Security. This money is invested in trust funds and when they run surpluses the government borrows the extra.

2. Cut spending - the government can cut back on some of the programs it provides. Problem here is that vital public services might be eliminated or drastically reduce. Besides, many economists argue we should not cut the deficit in a time of recession as this will drain money away from the economy at a time when it needs it.

3. Raise taxes - the government can raise taxes to get the additional income it needs to close the deficit. What’s the problem with this approach? – No one likes to pay more taxes.

Because each of these options have serious consequences, a government should not rely exclusively on only one approach to close a budget deficit; the best approach is a combination of the three. So you have some borrowing, some spending cuts, and some tax increases.

Republicans and conservatives say the main cause of the deficit is that the government is spending too much money. Hence, the solution is simple – cut spending.

Democrats agree that some spending cuts are needed but also many of them want to increase taxes on the rich as well. They believe that the Republican plan to close the deficit through spending cuts alone will fall too heavily on the middle class and working people. The wealthy should contribute to closing the deficit by paying more taxes.
At the same time, Republicans and some Democrats are dead set against raising taxes on corporations and the wealthy. They believe this is counter-productive and will only hurt the economy.

 




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