ECONcepts Vol. 3: Government Budget
By the Education & Research Core | August 2015

What is the Government Budget for?

The government budget is a periodic statement or list of expected government revenue and planned expenditure initiatives. The budget is usually divided by sector (social services, capital building, debt servicing etc.) and further, into different projects and undertakings.

The budget serves the economic function of prioritizing where national output will go, segmenting itself between private and public investment and consumption. Implicitly, it incentivizes the increase or reduction of output in such sectors.
What are Surplus and Deficit?

In the time period of a budget’s enactment, when the revenue and expenditures are equal, the budget is then referred to as a balanced one. However, this instance is rather rare; often there is either an excess of funds or a lack of them.

Budget surplus occurs when the revenue the government receives exceed government expenditure for that time period. On the other hand, a budget deficit occurs when expenditure exceeds government revenue. It is of note that a budget surplus or deficit does not flat out come together with economic performance; it may very well be an effect of what ranges from better tax collection and spending cuts to overoptimistic revenue expectation and overspending.
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Negative effects of debt and overspending
Economic Effects of Surplus and Debt

In the event of a budget surplus, the government has an array of options: it can, for example, save the revenue for the future, use it to settle debts, fund new initiatives and reprogram such funds to current endeavors (some actions noted may have political and transparency contentions).

In the event of a deficit, the government then borrows funds in order to cover for its spending; this is otherwise known as government debt or the accumulated government borrowings. This is further divided into internal debt, which is what a state owes to its residents, and external debt, when assets are owed to foreign bodies.

Debt has an adverse effect to the economy that changes depending on the time period. In the short run (or actual employment is less than full employment) a deficit usually denotes higher than usual government spending or discretionary tax cuts. These measures lead to people having more money to spend and the creation of new goods and capital which increase economic activity and employment, as well as possibly higher inflation.

The practice of constant debt and overspending, however, does not last for long. The conventional measure to get rid of government debt is to levy higher taxes on the citizens; this will create a distortion of incentives. On Year 1, for example, a lower tax rate may encourage you to spend more since your purchasing power is increased. Come Year 2 however, when government levies higher taxes to pay its debt, you are incentivized to spend less. This decrease will lead into a decrease in economic activity that puts the debt situation in an even more delicate position. Furthermore, extra revenue that is gained would be used to pay any existing debt instead of capital accumulation and services, further hampering the development of a nation.
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The cause and effects of the Greek Financial Crisis
Application of Theory: The Greek Economic Crisis

The dangers of sustained government and debt and overspending is highlighted in the crisis that Greece is currently undergoing. Greece as a nation has been riddled with problems like weak tax collection, political favoring and unsustainable social services. This led to incredulous deficit spending, that was masked by the government for continued lent credit from investors.

This led to a halt a few years ago when Greece deficit spending was discovered to have been much greater than reported, approaching a debt was almost twice its GDP. This led to a halt in credit and investments, leaving Greece unable to settle its debt.

This led to the International Monetary Fund, the European Central Bank and the European Commission to give them two bailouts amounting to 240 billion euros to help Greece, in exchange for austerity measures that included increased taxes and spending cuts.

This came in too late though, for Greece could not use the money for economic, using it instead to pay off external debts. This left the government with barely any funds to spur an economic comeback, which accompanied by the severe austerity measures, has plunged the country into a great economic and humanitarian crisis.

References:
“Economics” by Samuelson and Nordhaus. 19th ed.
“Greece’s Debt Crisis Explained” The New York Times.
ECONcepts Series

Vol. 1: John Nash & Game Theory

Vol. 2: Economics of Taxation

Vol. 3: Government Budget

Vol. 4: Unemployment