Question

As of March 2013, the U.S. deficit balance was $16 trillion. Why do think the U.S. government should be concerned? Should the government be equally concerned, if it were a surplus?

Your response should be at least 500 words in length.

Answer 1

Before discussing the scenario for USA, it is important to have knowledge about the government budget. It is an annual statement of government’s income and expenditure. The Government budget deficit is a situation in which the government’s expenditure is more than its income, or its revenue. It is shown as below:

Budget = Total Revenue – Total expenditure,

If the expenditure is more than its revenue, it is budget deficit,

If the expenditure is less than its revenue then it is a budget surplus, and

If the expenditure is equal to its revenue, then it is a balanced budget.

The revenue is earned by imposing taxes in the economy and non tax revenue can be earned by imposing fees, other charges, etc. Whereas, the expenditure part involves spending on people, on development projects, spending on social security, grants, etc.

Now coming to the case for USA, As of March 2013, the U.S. deficit balance was $16 trillion which is very high. A high budget deficit for any government is very risky as the process of financing can have serious consequences on the economy of that country. A high budget deficit means government is spending more and earning less. It means that government has to borrow in order to meet its finances. The government has three options available to finance its budget deficit:

(a) The government can issue the bonds to the public and pays a fixed rate of return every year to the holders of the bond. But we should note that, the interest payments in each year will create more and more public debt. Because, bonds issued in year 1 would be a burden for the upcoming years because the interest is to be paid on the bonds in subsequent years. Similarly, bonds issued in year 2 to finance the budget deficit, would be a burden on the following years. The cycle continues and can create huge public debt which becomes nearly impossible to pay back.

(b) The government can finance from the central bank: The central bank can purchase all the bonds from the government and prints the excess money. This is called seigniorage. It will create inflation in the economy.

(c) The government can borrow from international institutions, foreign countries etc. This would depreciate the domestic currency.

The high government deficit can hamper the growth rate of the country. The investor confidence decreases because of high public debt on government. The chances of default by government increases which affects its domestic stock market, investment level and consumer confidence. The recent example is of Greece.

In order to reduce budget deficit, the government has to reduce its unnecessary expenditure, mainly revenue expenditure and capital expenditure should be maintained because it should not hamper the development projects. The government on the other side, should increase its revenue by increasing the tax rate.

A budget surplus is a good condition for an economy which means the government is earning more and spending less in the economy. But it also implies that there are high tax rates and less spending by the government. But it is still a good condition than high budget deficit. A budget surplus indicates that government has excess income to spend more on other projects. This increases its GDP, investment level, boosts moral of investors, consumer confidence.