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Deficits and Debt

Deficits and Debt

Have you or a loved one ever realized that you spent more than you earned in one month? We would all like to believe that some sort of magic happened and that we are getting by, even though we earn less than we spend. However, we hate to break it to you that you're running a deficit when this happens. When you spend more than you earn, that is a deficit. Now, for you to be able to spend more than you earn, the money must come from somewhere. When you borrow money to finance your deficit, you accumulate debt. This shows that deficits and debt, while they are not the same, tend to come together and must be reduced. So, if you want to learn more about deficits and debt reduction/surplus and the relationship, read on!

Deficits and Debt Differences

Deficits and debt go together, but they are not the same. So, what are the differences between deficits and debt? First, let's explain what deficits are. To simplify things, when the government spends more than the national revenue, a deficit is created. Let's look at a very simple example.

The government earns $10 trillion in revenue for a given year and budgets this $10 trillion for its activities in that year. However, a pandemic hit, and this was not accounted for in the budget for the year, so the government ended up spending $3 trillion over the budgeted amount.

In the above example, we can see that the government has spent $3 trillion more than it earned, and this represents the deficit. So, what is a deficit? It is the amount by which the government spends over its revenue.

A deficit is an amount by which the government spends over its revenue.

What about debt? This is simply what the government owes in order to finance its deficits. This is because you simply cannot spend money that does not exist, so the government has to get that money somehow. The government usually borrows money to finance deficits using treasury notes, bonds, and government trust funds, among other financial securities.

Debt is what the government owes as it borrows to finance its deficits.

So, from the explanations above, we can say that the difference between deficits and debt is that deficits are how much the government spends over its revenue, whereas debt is what the government owes as it borrows to finance the deficit.

A deficit is what the government spends, and debt is what the government owes.

What the government wants is a balanced budget where federal spending equals revenue.

A balanced budget is an annual budget where the government's spending matches its revenue.

Deficits and Debt Relationship

What is the relationship between deficits and debt? Simple - deficits increase debt. To explain this, we can take a hint from the difference between deficits and debt. Deficits are how much the government spends over its revenue, and debt is what the government owes as it borrows to overspend. Therefore, once a deficit emerges, the government borrows from somewhere to finance this deficit, and a debt emerges as a result. Take a look at Figures 1 and 2 below.

Reducing Deficits and Debt, USA Annual Federal Deficit graph, StudySmarterFig. 1 - USA Annual Federal Deficits. Source: US Treasury Data Lab1

From Figure 1 above, we can see that there were deficits from 2002 to 2021, with 2001 being the only year in the period the USA did not run a deficit.1

Reducing Deficits and Debt, USA Annual Federal Debt graph, StudySmarterFig. 2 - USA Annual Federal Debt. Source: US Treasury Data Lab2

Figure 2 shows that the USA has had an increase in federal debt each year from 2001 to 2021.2

Deficits and Debt Surplus

Let's talk about surpluses. Deficits are when the government spends more than its revenue, which then makes the government have to borrow. So, what is a surplus? A surplus is an amount by which the government's revenue exceeds its spending! If this happens, the federal debt will be reduced as the surplus pays off some of the debt.

A surplus is an amount by which the government's revenue exceeds its spending.

Using a simple example, let's show how a surplus can be made.

Let's assume that the government only acquires revenue from taxes and spends money on welfare and national defense. In year one, the government makes $2 trillion in revenue from taxes. However, there was an ongoing war that year, and the government spent $1.2 trillion on national defense while spending $1 trillion on welfare. This means that while the government made $2 trillion in revenue in year one, it spent $2.2 trillion. Now, in year two, the war is over, and the government makes the same revenue of $2 trillion from taxes while spending $1 trillion on welfare.

From the example above, we can see that in year one, the government ran a deficit since it made $2 trillion but spent $2.2 trillion. This means that the extra $0.2 trillion in year one was financed by debt. Now, in year two, the government made $2 trillion and spent $1 trillion, and this means there is a surplus of $1 trillion. As explained earlier, the surplus pays off a part of existing debt. Therefore, the surplus of $1 trillion pays off the existing debt of $0.2 trillion, leaving $0.8 trillion.

For a real-life example of a surplus, look at Figure 1. As shown in Figure 1, from 2001 to 2021, the USA only ran a surplus in 2001.1 All other years after 2001 saw deficits.

There is a surplus in 2001 since the point for 2001 is above 0, while all the remaining points are below 0.

Deficits and Debt Reduction

Clearly, deficits and debt are not things we want, and this means we must try to get rid of them. So, how can the government reduce deficits and debt? If you wanted a simple answer, that would be "by spending according to budget!" However, things don't always work out in reality, so what can the government do? Let's find out.

Reducing Deficits and Debt: Legislation

As part of efforts to keep the federal deficit under control, congress pushed for a mandatory balanced budget.

A balanced budget means that the government's spending equals its revenue.

This was done by passing legislation referred to as the Balanced Budget and Emergency Deficit Control Act of 1985. However, this attempt failed because the government could simply carry the debt forward and not account for it in a specific fiscal year. Additionally, the economic decline in 1990 made it difficult to cut the budget to meet the balanced budget requirement.

Another effort was the Budget Enforcement Act, which sought to balance the budget by reducing other aspects of the budget to finance new expenditures. Later efforts included the Balanced Budget Agreement, which placed limits on discretionary spending by congress. It is important to note that these legislative approaches failed and were all ultimately removed.

Reducing Deficits and Debt: Revenue Increase

This approach was implemented as the Omnibus Budget Reconciliation Act of 1993. With the aim of reducing the federal deficit by $500 billion within the next five years, the government implemented a series of tax increases and reductions in government spending. This means that the government made more revenue by collecting higher taxes while spending less. This yielded positive results as four years of surpluses were recorded.

Reducing Deficits and Debt: Spending Reduction

This approach focuses on reducing spending by the government. The aim is simply to reduce spending such that it matches the budget or that the revenue is equal to or more than the spending. This approach can work; however, it is not easy to implement since unexpected economic changes result in unexpected spending. For instance, terrorist attacks and wars in 2001 resulted in unexpected spending on disaster relief and national security. In addition to this, some spending, such as healthcare and income supplements, just cannot be reduced easily.

Deficits and Debt Summary

In summary, deficits are the amount by which the government's spending exceeds its revenue, whereas debt is the amount owed by the government as it borrows to finance the deficit. Rather than deficits, the government wants either a balanced budget or a surplus.

A balanced budget refers to an annual budget where the expenditure equals revenue. Surpluses also refer to the amount by which the government's revenue exceeds its spending. The government can try to reduce deficits and debt through legislation, revenue increases, or spending decreases.

You should look at our explanation of The Effect of Government Spending or Federal Government Expenditures to learn more about government spending.

Deficits and Debt - Key takeaways

  • A deficit is an amount by which the government spends over its revenue.
  • Debt is what the government owes as it borrows to finance its deficits.
  • A balanced budget is an annual budget where the government's spending matches its revenue.
  • A surplus is an amount by which the government's revenue exceeds its spending.
  • The government can try to reduce deficits and debt through legislation, revenue increases, or spending decreases.

References

  1. US Treasury Data Lab, Federal Deficit Trends Over Time, 2022. https://datalab.usaspending.gov/americas-finance-guide/deficit/trends/
  2. US Treasury Data Lab, Federal Debt Trends Over Time, 2022. https://datalab.usaspending.gov/americas-finance-guide/debt/trends/

Frequently Asked Questions about Deficits and Debt

The government exceeds its revenue to create a deficit. Hence, it has to borrow to finance the deficit, creating debt as a result.

The government can try to reduce deficits and debt through legislation, revenue increases, or spending decreases.

With deficit and debt, the government's spending exceeds its revenue, whereas a surplus means that the government's revenue has exceeded its spending.

Deficits increase debt, whereas surpluses decrease debt.

As the government creates a deficit by spending over its revenue, it borrows to finance this spending, which results in public debt.

Final Deficits and Debt Quiz

Question

What is a deficit?

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Answer

A deficit is the amount by which the government spends over its revenue.

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Question

What is debt?

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Answer

Debt is what the government owes as it borrows to finance its deficits. 

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Question

What is the difference between deficit and debt?

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Answer

The difference between deficits and debt is that deficits are how much the government spends over its revenue, whereas debt is what the government owes as it borrows to finance the deficit.

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Question

What is a balanced budget?

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Answer

A balanced budget is an annual budget where the government's spending matches its revenue.

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Question

What is a government budget surplus?

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Answer

A surplus is the amount by which the government's revenue exceeds its spending.

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Question

The revenue exceeds the spending in a deficit.

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Answer

False

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Question

Deficit creates debt.

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Answer

True

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Question

Surpluses increase debt.

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Answer

False

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Question

Deficits add to revenue.

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Answer

False

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Question

A budget is balanced as long as the spending is not more than the revenue.

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Answer

False

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Question

There is a surplus as long as the spending is not less than the revenue.

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Answer

False

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Question

Legislation is one of the ways the government tries to reduce deficits and debt.

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Answer

True

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Question

Revenue can be increased by increasing taxes.

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Answer

True

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Question

Unexpected spending does not affect spending decreases.

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Answer

False

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Question

US Government's spending has been equal to its revenue from 2001 to 2021.

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Answer

False

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