The Effects of a Budget Deficit
When people discuss budget deficits, they are usually, but not always, talking about government deficits. Most other organizations do not have the ability to run deficits for very long. The effects of a budget deficit depend on the severity of the deficit and how it is handled. Long-term deficits lead to increasing debt, which leads to larger interest payments. As the size of interest payments grows, they take up a larger portion of the budget, which can increase the deficit problem. Eventually debt needs to be dealt with, and there are a limited number of ways to deal with debt.
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Good Debt
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There is one positive way to deal with the debt created by deficits. Sometimes there are valid reasons to take on debt. It can be a way to stave off short-term hardship and it can also be invested. If a company takes on debt but uses the money to expand or improve its business, it could be good in the long run. If the business improves its income for the long term it can make debt a profitable proposition. The same basic principle can be applied to government. If the government spends debt in ways that improve government revenue for the long term it can be good for government and society.
Cut Spending
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Cutting spending is one obvious way to deal with deficits and debt. Governments and businesses must take care when cutting spending, though. Usually deficits occur because needs are greater than income allows. Cutting spending on essential services or on operations that generate revenue runs a risk of decreasing revenue beyond the amount saved by the cuts. In other words, $1 million in cuts can result in $2 million in lost revenue. This can mean a need for more cuts or new deficits.
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Increase Taxes
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Increased taxes are never a popular option, but they, too, are another way to deal with deficits and debt. Governments must exercise caution when instituting tax increases. In addition to being unpopular, taxing businesses more than they can afford can result in higher unemployment and a greater demand for government services. Increasing personal taxes can also lead to an increased demand for government services. So, if tax increases aren't done carefully, it can result in increased spending and lower revenues.
Printing Money
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Governments, and only governments, have the option of printing money to cover debts. This option, while it sounds like the easiest, can have some of the worst consequences. Generally the more money there is in circulation the less valuable that money becomes. A decrease in the value of currency can cause rapid inflation. Inflation can lead to many of the problems outlined under the spending cut and tax increase options. Inflation means that everyone, government included, must pay more for certain items. Additionally, inflation can hurt business and individuals, causing higher unemployment and greater demand for government services. Lowering the value of currency can increase the interest rate, increasing cost of borrowing money, which can increase the cost of government debt. So, by printing money, the government may find itself in a position where it must pay more in debt interest, and have higher expenses and lower income.
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References
- Economics Help: Economic Effects of a Budget Deficit
- Tutor2u: Macroeconomics/International Economy
- NCPA; The Likely Effect of the Federal Budget Deficit; William B. Conerly; July 2010
- New York Times; Now Isn't the Time to Cut the Deficit; Christina D. Romer, October 2010
- CBS MoneyWatch; The Relationship Between Budget Deficits, Fed Independence, and Inflation; Mark Thoma; December 2009
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