What Is A Budget Deficit?

If you’re ever unlucky enough to see the news, you’ve probably heard of a budget deficit. It’s boring economist talk and it  applies to governments and your personal finances. 

It’s typically a good indicator of things going on with the economy. And while that definitely sounds complicated, it affects how far your money goes. So, what are budget deficits? Let’s get into it.

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Budget Deficit Explained?

Simply put, a budget deficit is when you spend more money than you have coming in. 

An easy way to go into a budget deficit is by using  a traditional credit card… Spend too much on the card, but then your paycheck can’t cover it all—that’s a deficit. 

Another example would be if your bills are higher than normal this month, and your paycheck can’t cover it. 

It’s important to understand deficits because blowing your budget can be hard to recover from.

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What is a Government Budget Deficit?

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Just like you and me can go into deficits, so can governments. And if the government is in a deficit, as always, it can mean higher taxes, less funding for local services, and reduced government aid… cheers 🚬

A government budget deficit is when federal revenue is lower than expenditure. So income from taxes might not cover the extra military spending, social security, or tax cuts. 

And a government deficit can be felt closer to home too. Local and state governments can’t run a deficit, so they must ask for federal aid if they run out of cash. And if the federal government is struggling, it has less to hand out. Maybe that’s why your street is full of potholes 🚧

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What Are The Causes of Budget Deficits?

In very simple terms, a budget deficit happens when spending is higher than income. This can happen if income is lower than expected, if spending is higher than expected or a combination of the two.

Here are some of the factors that can have an impact on the government’s bottom line:

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Recession

In the relatively short time we’ve been alive, we’ve seen huge economic downturns. That’s when money things go to sh*t, and it’s also called a recession. 

Stock market and housing prices fall and unemployment increases as companies lay off employees. People spend less, affecting governments’ bottom lines. Shoutout 2008 ✌️

It’s hard to bring in taxes if people can’t work or buy things, and less revenue from tax means a greater chance of a budget deficit. When a recession hits, the Federal Reserve often decreases interest rates to encourage spending and borrowing. Unfortunately, it’s not that simple ⬇️

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Inflation

Wars, pandemics, ships stuck in the Suez Canal, and general issues interrupt the supply chain. That’s how you get things like medication, toilet paper, and even electricity ⚡

The US outsourcing manufacturing and relying on imports create huge issues in meeting demand. (It’s also resulted in five million US jobs lost.) 

As things become scarcer, their prices increase, leading to inflation. That causes a weaker dollar at home and overseas, reducing buying power for everyone in the US. 

In 2022, the US imported 8.33 million barrels of oil every day from 80 countries. (F the environment, I guess.) Thanks to inflation, the US government has to work with a weaker dollar across many currencies. 

Inflation doesn’t directly cause a budget deficit, but the overall economic impact of inflation often means the government often needs to borrow more money to help people out. If the cost of essentials goes up too much, people hit financial hardship and place more reliance on things like social security.

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COVID-19

It’s hard to forget the biggest world event of most of our lives. The US government spent a lot of money during the pandemic. $4.37 trillion went into funding grants, loans, paycheck protection, and various coronavirus relief funds.

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Defense spending

A 2021 Brown University Costs of War paper noted that the US government has spent $5.8 trillion in response to 9/11. And all that moolah has to come from somewhere. In 2023, defense spending was 13% of the government’s budget. 

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Social programs

The American Dream isn’t the reality for many, especially during a recession 🏈 That’s why the US government supports citizens with housing, food, childcare, education, and more.

21% of the US government’s budget goes on Social Security, amounting to $1.4 trillion. That pays for retirement benefits and helps people who can’t work due to disability. 

Another 8% of the budget goes on economic security programs. These aim to keep people safe and above the poverty line. Just a few of these include: 

• SNAP (previously called food stamps)
• Childcare assistance
• Housing assistance
• Programs to protect abused or neglected children 

Military veterans and retired government workers also form part of the budget. Their benefits amount to 8% of expenditure.

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Medical insurance

As we know, the whole US healthcare system is a bit of a racket 🤡 Thought the US government spent a lot on Social Security? Well, it spends even more on medical insurance. 

Medicare, Medicaid, Affordable Care Act (ACA), and the Children’s Health Insurance Program (CHIP) take up 24% of the government’s budget: $1.5 trillion. 

These programs ensure people on a low income, people with disabilities, and retirees can afford medical care. 

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Interest

Much like you have to pay interest on your debts, the US government can’t wiggle out of that, either. 10% of its budget pays for debt interest, around $663 billion. That credit card interest doesn’t feel quite as bad now 🙃 

It turns out that it’s pretty pricey to run a country—$6.3 trillion, to be precise. 

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Taxes

Not bringing enough cash in is a huge issue. The government has to cover its $6.3 trillion spending somehow. With only $4.8 trillion from revenue, the government has to borrow the rest, digging that deficit hole even more. 

So, what’s the answer? Increasing tax is one way. When governments don’t tax high earners enough, they miss out on a big chunk of revenue 💡

Overtaxing lower earners means they have less to spend, impacting the wider and local economy. It could also push them below the poverty line, meaning more social security payments.

The US is considered a low-tax country. The highest US tax bracket in 2024 is 37% for earnings over $609,350 for a single taxpayer.

Compare that to Norway, one of the top countries on the Human Development Index (HDI), which looks at quality of life. Norway’s average tax rate is 35.7% on a  $60,000 salary. US tax rates are wild. (And the US is 21st out of 191 on the HDI.)

The US government could rake in an extra $26 trillion over 10 years. It just needs to match the average tax rate of other Organization for Economic Cooperation and Development (OECD) countries (like Norway).

It’s not just personal tax, though. Governments also want to encourage businesses to set up in their countries. So they offer competitive corporation tax rates. They can lose vast amounts of revenue if they don’t charge businesses enough. 

And let’s not forget the billionaire-shaped elephant in the room. Some companies are set up to avoid tax, but that’s a story for another day. 

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Personal budget deficit

On a personal level, you can end up in a deficit if your job cuts your hours or living costs a bit more one month. If your landlord increases your rent and your car decides it’s a great time to stop working, it’s easy to end up in the red.

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Effects of Budget Deficits

A government might try to break out of a deficit by decreasing spending and increasing taxes. But there’s a fine balance. 

If it cuts spending too much, services can fall into a black hole. People can end up in poverty if they rely on government aid. Infrastructure may start failing, costing more in the long run. 

Raising taxes too much can impact the economy. After all, who’s gonna be spending money on ✨ fun stuff ✨ if they don’t have any spare? And if corporations have to pay more tax, they’ll be less willing to take on more employees. 

As deficits are expensive to run, interest mounts up, adding even more to the deficit. If interest rates climb, so does the government debt interest.

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Managing Budget Deficits

A great way to deal with a budget deficit is to bring more money in. Whether that’s the US government increasing taxes or you taking on a side hustle, deficits aren’t unbeatable. 

The other option is to decrease spending, but that’s often not realistic on a federal or personal level.

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Do Budget Deficits Cause Inflation?

Whether budget deficits cause inflation is a hot topic for economists, but there’s no consensus. Some studies say yes, while others say no 🥨

If governments “print money” to cover the deficit, this can reduce the dollar's spending power and cause inflation. Simply put: More money for growth is good. Too much money can be a problem. (Capitalism is wild.)

But whether deficits cause inflation or not, it’s still something we have to deal with in personal finance. 

Inflation means you spend more, so you can’t save as much. It can also impact your budget. 

If you have $300 a month for groceries and prices fly up, you can’t buy as much as you used to, and you have to spend more to get the same. This cuts into your paycheck and your savings power 🚩

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How Does Budget Deficit Affect Interest Rates?

Running a deficit doesn't necessarily increase interest rates. 

The US government acts separately from the Federal Reserve (the Fed), which controls interest rates. The Fed’s goal is to keep the economy stable.  

If inflation gets out of hand, the Fed may increase interest rates. That means borrowing will cost more, you’ll get more interest when you save, and prices should decrease as inflation reduces. Should. 

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Cleo’s Final Thoughts

As with everything ever, deficits are pretty complex. The US government hasn’t had a deficit-free year since 2001, and we’ve seen plenty of economic changes since. 

The COVID-19 pandemic, the 2008 crash, and 9/11 aftereffects have all greatly contributed to the deficit and wider financial outlook.

While the US government’s deficit is waaay outta hand, yours doesn’t need to be 💙

If you’ve been struggling with a deficit, it can feel impossible to climb out and cut down debt, let alone start saving. With Cleo, you can learn how to save and benefit from her AI budget planner, helping you move in the right direction.