How Budget Deficit Works

A budget deficit occurs when an operation that usually functions at a profit operates at a loss. Most budget deficits arise due to unforeseen circumstances, such as a shift in policy, economy, or unexpected events. While applicable to companies and individuals, this term mainly describes government spending. When a government operates at a budget deficit, a common solution to recouping the loss is to tax its citizens.

Example of Budget Deficit

An example of a budget deficit would be if a nation had a yearly spending budget of 3.5 trillion. This government manages its spending well and typically operates at a profit, bringing in ample funds from taxation, exports, and services. However, this country faced a hurricane and sustained quite a bit of damage.

Because of the hurricane, the federal government needed to step in to help fund recovery efforts on a local level. The federal government funneled money into not only restoring damaged infrastructure but also improving it. The country spent much more than forecast in the annual budget to restore damaged electrical systems, water treatment facilities, roadways, and bridges.

As a direct result of the overspending, this government rose taxes on its citizens by 3%. Additionally, the country elected to cut spending in other places, such as its military. The decision to rebuild broken infrastructure and improve on it meant that these new systems operated at a much lower cost. In fact, because of their investment in solar energy, this country produced an overabundance of energy and sold it to neighboring countries.

Overall, by the following year, this government was able to balance its spending. But for a while, this government was spending more money than they were bringing in, creating a budget deficit.

Significance of Budget Deficit

The budget deficit is a significant term because it allows for the understanding of finance. It is especially true in the instances where this term describes government spending. Using words like deficit and surplus allows a nation's citizens to have a more comprehensive understanding of their country. When taxes increase, people understand that the government's spending is exceeding the amount of money the government is bringing in. However, the correlation of a deficit to unemployment becomes an actual driving factor in how its citizens vote. Spending is not the only issue, as many governments run a deficit intentionally. When the government at large spends, it creates spending in the economy as a whole, often bolstering the economy within the nation's borders.

However, deficits must be paid, and governments do this with taxation. There are instances where taxation is not enough to prevent the deficit from rolling into debt. Once a deficit becomes a long-term problem, interest accumulates, increasing the original amount. It is not only unsustainable for a federal government but companies and individuals. If a deficit continues long term, a person or company may fall into bankruptcy.