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Economics Explained: Budget Deficit

You may have heard the words 'Budget Deficit' on the news. You may have seen headlines such as ‘Coronavirus has seen the government borrow £48.5bn in April and a further £55.2bn in May’. And the question on everyones lips is ‘Okay, that’s cool but how does it affect me?!’


These figures that are now totting up to a cool £103.7bn, basically mean that the UK's debt is now worth more than its economy (fun times).







So what’s Budget Deficit got to do with it?


The main way the Government pay back the money they have borrowed is by taxing the citizens more and/or spending less. Why do they do this? Because they are in a deficit.


A Budget Deficit is when government spending is greater than tax revenues.


There are a number of reasons why the government can enter a Budget Deficit, one of these being external events such as a global pandemic which practically bring the country economy to a halt. Others are...


Economic Cycles


A rising budget deficit also falls under the life cycle an economy goes through. If a country is experiencing a recession or a sustained period of slow growth, it is very likely you will see revenue decrease from direct and indirect taxes, but as the government have a social duty to the citizens, you will often see more money being paid out in welfare & unemployment benefits. This is called the cyclical effect and we are not saying its an act of god, but if the right levers are pressed at the right time and a country enters recession, a Budget Deficit is coming along to the party too.


During a recession, a government will most likely operate a Expansionary fiscal policy i.e. higher spending and lower taxes.


During a economic downturn, it is important to remember:

Tax revenues will be lower as

1. Fewer people are working, therefore, income tax will be less

2. Consumer spending is lower, therefore, VAT receipts are lower

3. Firms make less profit, therefore a fall in corporation tax.


Government spending will increase:

1. More will be spent on unemployment and welfare benefits


Economic Policy


A Government can choose to expand its fiscal policy to boost aggregate demand, output and employment (read more about what this means here). For example, this might be the Government buying a railway company back from a private company and employing 50,000 more people as public servants (workers in the public sector) in order to run the railway. This happened in 2018 when the Government bought Virgin Trains East Coast contract after they were running awfully when left up to the private sector. This often boosts an area of the economy which has suffered from lack of demand and income (or in the case of Virgin Trains East Coast, late running trains)


Tax

As a driver of a budget deficit, taxes can largely impact how much debt the Government needs to pay in comparison to what it is receiving. If a country has a track record of tax avoidance and tax evasion (this is illegal btw) - it means the government can't get as much money as income and this can be a big problem.


Demographic pressures


The population and who makes it can also affect the fiscal position too, for example, if the population is above a certain age, we will see a massive outpour when it comes to Government spending on pensions and pressure for the government to spend in areas such as healthcare.


Political landscape


Government spending levels can alter severely due to the party in power. Everyone knows the Conservative Governments tend to cut back on spending yet Labour governments are open to spending more.


In some countries, public spending is inflated by an agenda of the Government, for example, if the Government wants to promote a certain agenda this will be boosted by spending in this area. A downside of this is that countries whose governments depend on taxes or spending from certain areas, it may see the budget be severely influenced by movements in this sector. For example, the Saudi Arabian Government usually runs a large budget surplus - however thanks to the Oil price dip in 2010, this budget surplus went away.


Interest


Similarly to us, Interest payments are the devil. These often drive the speed of repayment, as well as intensity of debt. Higher bond yields will mean the interest payments are higher and thus an increase the budget deficit.

Okay, but how do they reduce a Budget Deficit?


Just like we want to reduce our personal debt, Governments want to reduce how much debt their country is in. The two ways to do this are by; increasing tax revenue or decreasing spending. As individuals, we can either increase our income, or decrease our expenses, so kind of similar!

We know the government can’t cut out their Starbucks coffee spend (although we do wonder what their order would be...) Cutting government spending is often the go to to resolve a budget deficit. But it’s a fine line. It’s important to remember government spending provides a life line for a lot of people (benefits and welfare) and also provides people with jobs and disposable income to spend (after all, the largest employer in the U.K. is Government based). If the government cuts spending too much, economic growth will slow down - this is bad as it leads to lower tax revenues and an even larger budget deficit (the circle of life)


Or there is the option of increasing revenue by raising taxes but realistically, who wants to pay more taxes? If taxes are too excessive, they will slow growth. Politically, to be known to raise taxes will often end a politician's career. Again, it's a fine line.


Fempire Finance

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