Question

Explain how to manage/overcome budget deficit of a country. Give explaination for each method.

Answer 1

A budget deficit occurs when government spending is more than revenue. This results in accumulation of public sector debt which can disastrous for economic growth.

Methods to control or overcome budget deficit are:

Reduce Government Spending

The government can evaluate different departments and can cut wasteful spending. This will prove very helpful for reducing budget deficit. Government has to decide what type of spending it has to cut. For example if government cut spending on pensions then it will make people work longer and will increase productive Capacity of nation. But if spending on public Investment is reduced then it will adversely affect aggregate demand and aggregate supply and will imbalance the Equilibrium. Do, it will be more feasible for government to adopt cut in pension spending as economic growth will be impacted less But at the same time the inequality in society will increase.

Tax Increase

Higher taxes help the government to collect more revenue and help in reducing the budget deficit. But in this case timing and economic conditions prevalent is very important. Suppose the economy is going through recession and government increase taxes than this will result in decline in aggregate demand and spending, thus further lowering the rate of economic growth. But on the other hand high taxes during time of high growth will have less impact on economic growth.

France increased taxes on the rich to over 70% . This had a mixed response.Some have complained this is too high and creates disincentives to work in France. If high marginal tax rates do reduce incentives to work, the tax revenue raised may be less than planned.

So, we can say that type of tax increased also affects Economic Growth.

Economic growth

One of the best ways to reduce the budget deficit as a % of GDP is to promote economic growth. If economy us growing and prospering then without raising tax rates government can collect sufficient revenue and reduce deficit. If Economic Growth is good then people and Corporate will have good income. People will pay more VAT ( Value Added Tax), Business organization's will pay more corporate tax and workers will pay more income tax. This is the most effective way to reduce deficit as it does not involve raising tax rates or cutting expenditure.

Bailout

Countries under special circumstances can get bailout from international institutions like IMF. Bailouts provide the countries with temporary funds and they can deal with temporary liquidity crunch.However, in the case of severely indebted countries, a bailout may be insufficient to deal with the underlying level of debt. Also, bailout conditions can be highly controversial.

To conclude to reduce the fiscal deficit government has to adopt combination of policies after weighing all the pros and cons. But Economic Growth seems to be the most effective and least painful method to overcome budget deficit.