A2 Economics Revision - From Budget surplus to deficit

Here is a suggested answer to this question: “Explain why a government budget might move from surplus to deficit” (15 marks)

Explanation questions do not require any evaluation - just do what it says on the tin!

Define a budget surplus (where govt spending is less than tax revenues) and a deficit - when the government must borrow to cover a shortfall between spending and tax in a given year

Support your answer with evidence - for example the UK budget deficit for 2009-10 was £163 billion, or 12 per cent of national income.
Many other EU countries have budget deficits, indeed no EU country ran a surplus in 2009. Greece, Spain, Portugal and Ireland have all been in the news for running up huge fiscal deficits

Explain why the fiscal position of a government may move from surplus to deficit

(1) The effects of a recession - a decline in national output leads to lower incomes, profits and employment - this leads to weaker tax revenues from consumers and businesses. A downturn also causes a rise in welfare payments and the government may also have to increase spending on subsidies. The deficit will rise if the government allows the automatic stabilisers in the economy to have their effect. (i.e. the government’s own budget will change in a counter cyclical way, as real GDP declines, government borrowing increases).

(2) The budget deficit may appear if the government deliberately chooses to run a deficit as part of a fiscal stimulus programme, i.e. a Keynesian stimulus to demand either through lower taxes (e.g. the cut in VAT) or discretionary increases in current and capital spending (e.g. bringing forward spending on transport infrastructure or investment in new schools and hospitals). The Uk government along with many other countries have chosen to use fiscal policy and a budget deficit as part of an active demand management policy to reduce the risks of an extended recession and price deflation.

(3) The budget may move from surplus to deficit if there is a economic shock affecting either government spending or taxes. E.g. the need to bail out the banks in the aftermath of the financial crisis. Or a rise in inflation caused by higher food and oil prices which leads to higher spending in providing public and merit goods

Most of the causes of a budget moving from surplus to deficit are likely to be cyclical in nature. But some of the causes will be structural e.g. changes in the age-structure or size of the population, a decision by the government to introduce a long-term reduction in taxes.