Budget Surplus and Budget Deficit: Videos & Practice Problems

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.

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.

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.

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.

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.