Abstract

A budget deficit is a situation whereby an individual or a state spends more than its income. This paper examines the factors that can cause a government to experience a budget deficit. It examines how the budget deficits will influence the economic growth in a country. It examines government trade policies, as well as how they can lead to a budget deficit in a country. There is also a discussion on the budget deficit and its effect on the economic growth in the United States.

Introduction

In an economic set up, there is often an exchange of goods and services. Regardless of the economic activity that an individual carries out, s/he will have both income and expenditure. However, a time reaches when one can spend more than he can receive as an income. The same scenario can be seen in state level, where the government could spend much more money that it can generate from revenues.

A budget deficit occurs when a government has spent more than its financial savings in a given year (Economy Watch, n.d. para.1). It particularly occurs when the government has failed to accurately plan for its expenses. A careful plan will take into consideration the net income that a government has, which can be used in the national budget. This is what can prevent high rates of budget deficit.

Why high budget deficits today will reduce the economic growth rate in the future

In order to understand the relationship that does occur between the budget deficit and the economic growth of a country, it is important to examine factors that are associated with each of them.

Factors that will determine the level of budget deficit recorded include revenues from taxes, the size of the government’s expenditure below which its operations can be paralyzed, and the availability of lending agencies. On the other hand, the factors that determine the economic growth rate are the investment that are made in a country by both public and private sector, the human capital that is available, as well as the government policies that have been put in place and their effectiveness.

The legislations that determine the openness of an economy for investment, as well as the other micro and macro-economic conditions prevailing in a country also affect economic growth. There is thus a relationship between the economic growth and budget deficit. How they are related is subject to arguments with a few suggesting a positive relationship.

However, budget deficit will have negative impact on the economic growth in that will affect the socio-economic conditions and the business environment in a given area. High government budget deficits will impose heavy taxes on the citizens thereby lowering their spirits of investment (Barro, 2008, p360). It will also call for the governments to cut their spending. As a result, the salaries and wages of government employees will be reduced leading to reduced incentives to work

Higher budget deficits will prompt the governments to increase their borrowing especially from the private sector. The central banks will be forced to sell gilts and bonds to the private sector, eventually leading to an accumulation of national debts. The effect is that the tax rates in the future will be raised to meet the required expenditures. This will slow the economic growth. Besides, continued government borrowing from the private sector may lead fading away of the private sector. This is referred to as ‘crowding-out effect’.

Cumulative budget deficit results into what we term as Government Debts (Economy Watch, n.d. para.2). This will lead to an increase in the interest rates since the government has to increase their rates as a strategy to win more investors. Borrowing money by the small-scale investors will greatly be reduced in reaction to the high interest rates thereby lowering economic growth rate.

There will also be a need to review the government fiscal and monetary policies every time a country records such high deficit level. This process will be detrimental to the steady economic growth.

Reasons for high budget deficits; how they matter

The possible reasons that can make a government spend more than it can produce include low rates of taxes and interest coupled with an increased expenditure. In deed, it does matter a lot to consider these factors. If a budget deficit results from low taxes rates, then it is due the greed that is shown by the “bequest-constrained individuals” who would wish that the rates were lowered without lowering the expenditures (Chen 2003, p2).

The effect is that such a debt will be carried forward to the future generation who will be forced to pay heavy taxes to settle the problems that were caused by their predecessors (Barro 2008, p361). It has also been observed that if an economic growth is expected to increase in the near future, then more of these selfish individuals emerge.

However, the chronologies of the deficits that have been experienced in different countries indicate that there is a difference between how the tax rates influence budget deficits in the developed and the developing countries. In the developing countries, it was observed that it was difficult to incorporate the spirit of democracy and the number of greedy individuals was seen to increase after an economic recession (Chen, 2003, p14).

Other factors like the wage rates and the number of those who are employed are also important in dealing with the budget deficit. If the current population has a low rate of income in terms of the wages, then it will attempt to bring forward future resources to the present state forcing the future generations to experience tax burden (Chen 2003, p16).

Besides, if it is increased expenditure that has led to the budget deficit, then it is important to consider why such an increase should occur when the net income is either decreasing or has remained steady.

An increase in government expenditure should be after increased total revenue has been recorded. Political instability can also be a reason that leads to financial deficit in a country, of course due to the effects it will have in developing government policies on trade. The trend that was witnessed in the United States in the 1950s to 1980s followed the wars that were experienced in the period (Executive Office if the president of United States of America, 2009, p12). Thus, these factors are important to be considered.

The role of fiscal and monetary policies in determining the level of budget deficit

The fiscal and the monetary policies that are imposed by a particular government will influence the economic growth of the country. The rates of tax levied on both the imported and exported commodities and the income tax levied on the employees will determine the total revenue that the government will have.

Very low rates of taxes may lead to low revenue collection forcing the government to spend more than it can generate. This will lead to the budget deficit. On the other hand, very heavy taxes on the imported and exported products may demoralize both foreign and domestic investors in a country leading to a poor business environment in the country (Chen 2003, p20).

The economic activities through which the government generates their revenues will not be supported thereby leading to low government income. There will little money circulation in the country. The interest rates that are imposed by a country’s central bank will determine the rate of investment. If too low rates are imposed, the government through the central bank may not be able to raise the revenue that it requires.

Conversely, if the interest rates are exceptionally high, then very few investors will be encouraged to borrow from the commercial banks since the high interest rates in the central bank will b translated to these banks. Poor investment means low government revenue and since there is an optimal level of government expenditure, it may be forced to borrow from other sources. Budget deficit level will then be forced to shoot.

How the budget deficits affect the long-term economic growth and the debt that US has to contend with

The budget deficit in the US has had varying trends in the past three or so decades. It was recorded at a low rate of 1 to 2 percent in the 60s and 70s. The figure increased in the 80s and was lower in the beginning of the 1990s (Barro, 2008, p435). The current situation is yet different from what was seen in the recent past.

The budget deficit in the United States rose rapidly from the figure that was recorded last year. This was caused by an increased spending following the position of the New Years holiday. The budget deficit in the month of January 2011 was recorded at $49.8 billion compared to $42.6 billion that was recorded a year before (Guidice 2011, para.2).

There was an increased rate of government expenditure as compared to the gain in the total revenue that was received from the taxes and other sources leading to the increase witnessed in such budget shortfall.

The debt that a country has to contend with is affected by the kind of budget deficit that it has. There is a mathematical relationship between the debt that a government can have and the budget deficit that it can experience. The formula for the debt is given as:

D= RBt_1 + Gt(r-g) – Tt

Where R= real rate of interest

Bt-1 = debt of the previous year

r= rate of interest

g= growth rate

Gt=government expenditures, and Tt= tax revenue (Economy Watch, n.d. Para. 5).

The expression Gt(r-g) –Tt defines the budget deficit in a given year. An increase in it will translate to a proportional increase in the debt depending on the debts that were recorded previously.

Besides, it has been foreseen that the deficit is set to increase this year and hit a historical figure beyond the $1.4 trillion that was recorded in 2009 (Guidice, 2011, Para. 3). In fact, it is projected to be $1.5 trillion at the end of the year. Quite a number of factors are seen to be the cause of this continued increase in budget deficit.

One important factor is the cutting down of taxes levied on the employed group. There has been a move to give emergency benefits to the jobless people as a move to narrow down the gap between the living standards of the employed and the jobless people in the US (Guidice, 2011, Para. 3).

The other factor is the agreement that was reached by the current president and the republicans who took control of the house business last year and have been in the forefront advocating for spending cuts. Unfortunately, all this moves tend to increase the government expenditure while reducing the revenue that is generated. They will definitely lower the economic growth in the States. The country will definitely be faced with higher debts to accommodate.

Conclusion

A high budget deficit in a country does have an influence on the growth of an economy, and as such, it needs to be fully addressed. It will affect the investment that the country can make as well as the foreign investment that can be attracted into the country.

The kinds of policies that are adopted in an economy are the immediate determinants of the level of foreign and domestic investment that can be applied in an area. It is thus evident that the factors that lead to a country’s budget deficit are actually material in determining the ways of overcoming the financial deficit.

References

Barro, R. (2008). Macroeconomics: a modern approach. OH: Cengage Learning. Retrieved February 16, 2011 from http://books.google.co.ke/books?id=g_y0eJLbDA4C&pg=PA432&dq=budget+deficit+in+the+United+States&hl=en&ei=2CxdTfCnCcer4Ab3mbyPCw&sa=X&oi=book_result&ct=book-preview-link&resnum=4&ved=0CD8QuwUwAw#v=onepage&q=budget%20deficit%20and%20economy&f=true.

Chen, D. (2003). Intertemporal Excess Burden, Bequest Motives, and the Budget Deficit Washington, D.C: World Bank publications. Retrieved February 16, 2011 from http://books.google.co.ke/books?id=qa0YzptRBZcC&pg=PA6&dq=budget+deficit&hl=en&ei=quxcTeKvItSD5AbbyqS5Cw&sa=X&oi=book_result&ct=book-preview-link&resnum=6&ved=0CEAQuwUwBQ#v=onepage&q&f=false

Economy watch. (N.d). Budget Deficit. Retrieved February 16, 2011 from http://www.economywatch.com/budget/important-concepts/deficit.html

Executive Office if the president of United States of America. (2009). Budget of the United States Government: Fiscal year 2009. Washington: U.S. Government Printing Office. Retrieved February 16, 2011 from http://www.gpoaccess.gov/usbudget/fy09/pdf/hist.pdf.

Guidice, V. (2011). Budget Deficit in U.S. Rose to $49.8 Billion. Retrieved February 16, 2011 from http://www.businessweek.com/news/2011-02-10/budget-deficit-in-u-s-rose-to-49-8-billion.html.