Budget Surplus and Budget Deficit: Videos & Practice Problems

The government's budget consists of tax revenues (inflows) and expenditures, including government purchases and transfers like welfare payments (outflows). A budget surplus occurs when tax revenues exceed outflows, while a budget deficit arises when outflows surpass revenues. During recessions, increased government spending often leads to larger deficits. The cyclically adjusted budget deficit smooths these fluctuations by estimating what the deficit would be at potential GDP, accounting for automatic stabilizers that adjust taxes and spending based on the business cycle.

Budget Deficit and Surplus; Cyclically Adjusted

Now, let's discuss the government's budget and discuss a budget surplus and a budget deficit. So the government's budget involves the inflows. Well, the government gets its money from taxes, right? So the taxes are the tax revenue and then it's going to spend money on its purchases, government purchases, and they're also going to have transfers. So when I say transfers, this is generally like welfare payments, or any sort of transfer of money that they're doing. It's not actual spending. Maybe unemployment payments that they're making. Any sort of transfer that they're making without actually getting something in return, right? No. They're not really receiving anything when they give welfare out to poor people. They're basically doing their job as the government, to do these transfers. However, purchases are more like when they build a highway system or something like that. That's government purchases.

So here's our general equation for our budget. We're going to have the government savings which is the budget surplus or deficit. The government savings is equal to the tax revenue which is the inflows, right? Just like we said, this is the inflows to the government minus the outflows, right? Which are the purchases and the transfers that they give to other people, okay? So if those inflows are greater than the outflows, if there's more money coming in from taxes than money going out, well, we have a budget surplus. There's a surplus and the government will be saving money. They'll have some savings of their own. So, this budget surplus is when the inflows from tax revenues exceed the outflows from purchases and transfers, right? That's a surplus. They have money left in the bank at the end of the day.

However, something much more common in the US is the idea of a budget deficit. And this is when the inflows from tax revenues are less than, the outflows from purchases and transfers. So there's more money being spent than money coming in from taxes, okay? So we have here a graph of the budget deficit here in the US. So when you think of the USA, think budget deficit, okay? That's generally the position we've been in for quite a while here like you can see on the graph. So here's our 0% of GDP. So any point above this 0 is a time when we were in a budget deficit. And notice, this starts all the way back in 1964 all the way through 2013 here on this graph. And we're pretty much always above that zero line, right? We're pretty much always in a budget deficit, except for a short period there in the 1990s.

Okay? So these purple spots on the graph are recessions. I want to point something out about these recessions here on the graph, okay? What does it look like the trend happens during these recessions? During each of these recessions, there's an increase happening. Right? There's an increase in government spending or excuse me, in the budget deficit during these recessions. And that's because of the government spending like I just said. So during recessions, government spending increases, right? Because the government is trying to counteract this lull in the economy. There's a decrease in just consumption and GDP. So the government spends money to try and get the economy going again. So these increases in government spending, you can imagine are going to lead to larger budget deficits, right? Because they're going to increase their spending, increase their purchases, and that's gonna increase the budget deficit. So that's the trend that we kinda see happening here during these recessions is that the government is trying to counteract the recession by increasing their spending in each of these cases.

Okay? And that's basically what we're dealing with here in fiscal policy. So the size of the budget deficit, as we can see, is dependent on the business cycle, right? When we're in a recession, we're going to increase our Government spending. When we're expanding, the Government doesn't need to spend so much. So what they do to try and keep this graph from being so volatile, it kind of staggers a lot, they use the cyclically adjusted budget deficit or surplus. So what they do to kind of tame the graph just a little bit is they're going to assume that the government budget deficit or they wanna see what the deficit or surplus would be if the government if the economy was at its potential GDP. So if we were already at our long run potential at any point in time, remember during a recession, we're below our long run potential. During an expansion, during an inflationary period, right? We could be beyond our potential in a situation of overemployment, and just rising prices and being somewhere beyond our potential and it needs to be tamed back down. So what they do is they use this cyclically adjusted budget deficit or surplus. They want to take out the effect of those temporary spending changes that are going on. So remember that this automatic stabilizer, we've talked about this before. This is when spending and taxes change automatically through the business cycle. So remember that there's going to be some, some things that are being affected based on our point in the business cycle. Well, we want to tame this so that it looks more constant. So in a recession, remember that income is decreasing, leading to lower taxes. And during an expansion, income is increasing leading to higher taxes. That's the idea of the automatic stabilizer. There's no change in the fiscal policy. There's nothing being done specifically. However, the level of taxes is going up or down. Now, when you look at a cyclically adjusted budget deficit on the graph, it doesn't look too much different than the other one, than the actual budget deficit. So the purple line here is the budget deficit, the actual. And then, you can see the orange line is a little bit tamer, right? It's always kind of closer to the inside, than the actual budget deficit. And that's because they're adjusting it based on these factors of where we are in the business cycle. They're taking out those changes in taxes that are occurring, based on where we are in the business cycle. They want a more clear picture of what's actually happening. Now, I want to make a point that it's one thing to know what a cyclically adjusted budget deficit or surplus. In this class, it's not going to go so deep. It's more about just maybe knowing the definition of what this is and more likely understanding just what a budget deficit or budget surplus is. I added this in because it's just something that a lot of textbooks like to talk about and just throw it in there. And I just wanted to have it here for you just in case you needed to know it. Just double check how deep you're really going to go with this. For the most part, you just need to know what a budget deficit or budget surplus is. Cool? Alright guys, nothing too crazy here. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the difference between a budget surplus and a budget deficit?

A budget surplus occurs when a government's tax revenues exceed its expenditures, including government purchases and transfers. This means the government has extra money left over after covering all its expenses. In contrast, a budget deficit happens when the government's expenditures surpass its tax revenues, leading to a shortfall that needs to be financed through borrowing. Essentially, a surplus indicates financial health and savings, while a deficit suggests the government is spending more than it earns, often requiring loans to cover the gap.

How does a recession impact the budget deficit?

During a recession, economic activity slows down, leading to decreased income and consumption. To counteract this, the government often increases its spending to stimulate the economy. This increased spending, combined with lower tax revenues due to reduced incomes, typically results in a larger budget deficit. The government may invest in infrastructure projects, provide unemployment benefits, and other welfare programs to support the economy, all of which contribute to higher expenditures and thus a larger deficit.

What is a cyclically adjusted budget deficit?

A cyclically adjusted budget deficit is an estimate of what the budget deficit or surplus would be if the economy were operating at its potential GDP, without the temporary effects of the business cycle. This adjustment accounts for automatic stabilizers, such as changes in tax revenues and welfare spending that occur naturally during economic fluctuations. By smoothing out these cyclical effects, the cyclically adjusted budget deficit provides a clearer picture of the government's fiscal position, independent of short-term economic conditions.

Why is the U.S. often in a budget deficit?

The U.S. is often in a budget deficit due to a combination of high government spending and insufficient tax revenues. Major expenditures include defense, social security, healthcare, and welfare programs. Additionally, during economic downturns, the government increases spending to stimulate the economy, further widening the deficit. Structural issues, such as tax cuts and increased entitlement spending, also contribute to persistent deficits. As a result, the U.S. frequently spends more than it earns, leading to ongoing budget deficits.

What role do automatic stabilizers play in the budget deficit?

Automatic stabilizers are mechanisms that adjust government spending and tax revenues in response to economic conditions without the need for new legislation. During a recession, tax revenues decrease due to lower incomes, and government spending on welfare programs like unemployment benefits increases. Conversely, during economic expansions, tax revenues rise, and welfare spending decreases. These automatic adjustments help stabilize the economy but also influence the budget deficit, making it larger during downturns and smaller during upturns.