Fiscal Deficit

Fiscal Deficit Meaning

Fiscal deficit refers to a situation where the government’s expenditure exceeds its revenues that it would generate. In simple terms, Fiscal Deficit is nothing but the difference between total revenue and total expenditure of the government. It serves as an indication of the total borrowings that a government might require.

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For eg:
Source: Fiscal Deficit (wallstreetmojo.com)

We note from the above graph that the fiscal deficit of US for 2019 is likely to exceed $1 trillion.

Fiscal Deficit Formula

Fiscal Deficit Formula = Total Expenditure – Total Receipts

(Excluding Borrowings)

Suppose if one were to get a negative amount out of the equation, then we would consider it to be a budget surplusA Budget Surplus A budget surplus occurs when the government's earnings through tax revenues is more than its spending in the current quarter or year. A government surplus is a positive sign in an economy because it demonstrates the government's earning power.read more, where the revenue of the government would exceed its expenditure

Example of Fiscal Deficit

Given below is a list of the UK government expenditure and receipts for the year 2010-11.

Calculate the total income.

Fiscal Deficit = (Total Expenditure -Total Receipts)

(697-548 billion pounds) = 149

Hence the fiscal deficit stands to 149 billion pounds.

Here we can notice how the expenditure of the government has exceeded its receipts and has thereby lead the economy into fiscal deficit.

Advantages

Increased Economic Growth: When a government resorts to borrowing to tackle fiscal deficit it is believed that it shall be channeled to productive purposes like that of infrastructural projects. This, in turn, would lead to the employment of more labor workforce and since more money now flows into the economy there will be the acceleration of economic growth
Private Sector Stimulation: A higher deficit may go on to bring about a positive fiscal multiplier that can go on to stimulate private sector investment. Certain spending by the government will lead to an increased fiscal multiplier, which is nothing but the ratio of a country’s additional income to the initial boost in spending that had initially lead to the extra income
Prudent Control: Whenever there is a deficit, a government may think twice before committing or making any sort of unnecessary investments. Higher interest rates may force them to think of various plans to pay back the debt as soon as possible. Thus a government will exercise efficient and prudent control over its spending when it is in the burden of debt
Supports Keynesian View and helps During the Recession: The Keynesian economicsKeynesian Economics Keynesian Economics is a theory that relates the total spending with inflation and output in an economy. It suggests that increasing government expenditure and reducing taxes will result in increased market demand and pull up the economy out of depression.read more considers fiscal deficit to have a positive impact as fiscal deficit which is tackled by the government by resorting to borrowing is used to channel the same towards productive purposes which may generate further jobs and thus help the economy come out of a recession

Disadvantages

Inflation: The government may sometimes go on to print currency to tackle the problem of fiscal deficit. This supply of extra currency in the economy may lead to inflation and may also devalue the currencyDevalue The Currency Currency devaluation is deliberately done in order to adjust the established exchange rates by the government and it is mostly done in the cases of fixed currencies. This mechanism is used by economies with a semi-fixed or fixed exchange rate, and it should not be confused with depreciation.read more
Debt Trap: The government will go on to tackle the fiscal deficit by resorting to borrowing, both from internal and external resources. The governments will have to repay the borrowings along with interest. This may go to eat on its revenues and then lead to a revenue deficit. By continuously borrowing, the government may go on to increase the revenue deficitRevenue Deficit The term "revenue deficit" refers to a situation in which a company's actual net income for a quarter or fiscal year is less than the net income projected at the start of the period. This could be the result of a change in business that has had a negative impact on the company and is responsible for the lag in actual net income.read more, which in turn will lead to fiscal deficit, leading to a vicious debt trap for the government of the country
Rising Costs: One possible manner of facing the deficit is to increase the taxes. Prices would go on rising at a significant level thereby leading to inflation. Standard of living may soon go on to drop down because of increasing costs
Crowds Out Private Sector Investment: The government when resorting to borrowing through the issue of high-interest bonds may divert funds from the investing public that will now flow into the government sector thereby reducing investments in the private sector. Thus private sector investments may be crowded out
Risk of Default: The overheated economy occurring due to excessive borrowing may cause the risk of failure on the part of the government due to excessive borrowing.

Limitations

Owing to additional borrowing to cover up the existing debt, it may lead the economy into a further debt trap and this becomes one of the greatest limitations of fiscal deficit

Conclusion

Though the fiscal deficit as supported by Keynesian theory helps in bringing the economy out of recession by using and channeling the funds borrowed, for productive infrastructural projects can help the economy slide out of recession by creating jobs for the people of the economy, it does certainly lag in some aspects. The additional borrowing that the governments usually resort as the means to take on fiscal deficit, may pile up as a certain humongous mountain of debt that may go to be eventually difficult to pay off. The government may be under the verge of default. These rising costs may further splurge inflation and other costs in the economy and go on to lower the standard of living of its citizens.

Just like how a knife when used properly in the hands of a surgeon may go on to give life; or take one, when in the hands of a thief, fiscal deficit too would be a blessing in disguise if the government exercises prudence in utilizing the borrowing in an efficient manner such that it would boost the economy and ensure it doesn’t fall into a debt spiral.

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Fiscal Deficit