Budget deficit and economic growth

Abstract

Budget deficit in general terms refers to the difference between the government spending and its revenues, commonly acquired from tax proceeds (Bauno & Blinder, 2009). However the government also has the tax burden from budget deficit to contend with besides the monetary and fiscal burden of the recurrent and development expenditure. So, a more profound definition of the total budget deficit is the difference between a government total spending including its payment on taxes, and the total revenues collected from taxes. Since the United States government is not a pure capitalistic economy, but rather a mixed economy, the government revenues should also include government income from state levied services such as telecommunication, transport, national insurance policy and natural resources exploitations.

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Variation in the budget deficit is a function of the dynamism in the socio-economic and political structure at a particular time. In addition there is the government policy intervention to counter the course of budget deficit towards undesired and unanticipated trends. Government total spending in a financial year in terms of social responsibilities such as security, health care and education is finitely fixed at the size of its populations. However, the economic activity which earn a government revenues through taxes , is infinitely varied by the market forces, and this is what creates the budget deficit. The government fiscal policies intervention only results in mitigation or aggravation of the deficit.

Budget deficit is expressed as a cyclical, structural or a fiscal gap. Cyclical deficit is variable between the various, levels of business, whereas structural deficit is fixed at a finite amount of government spending. Fiscal gap measure of budget deficit was devised to overcome the complexity incurred in measuring deficit at the presumptuous business cycle levels. Its measured as a percentage of the GDP ( Gross Domestic Product) to illustrates the interventions required to amend the deficit.

The purpose of this paper is to put emphasis on government fiscal and monetary policies as a causative of budget deficit. In addition, the paper also discusses the implication of various policies which instigates budget deficit in the growth of an economy. As the government tries to contend with its domestic and external socio-political challenges, economic theory is used as a means to resolve these challenges and not as an end to these challenges. The paper tries to outline the issue of budget deficit in an economy with special focus on the United States financial sector.

Budget deficit and economic growth

Various economic fields of thoughts have differing ideologies on the effect of budget deficit on economic growth. This includes the direct correlation of budget deficit and economic growth by Keynesian economists with Neoclassical economists. This is done by conversely illustrating the downward trend of economic growth with increase in budget deficit. Strikingly, there do exists the Ricardian economic theorists who state that , the economic growth is completely immune to budget deficit implications.

Keynesian economic theory correlation of budget deficit and economic growth is based on the effect of the multiplier function in his economic model. Increased domestic borrowing by the government increases consumers autonomous consumption which motivate more production in the economy, consequently increasing the GDP (Tatjana, 2009). The budget deficit acts multiplicatively across the economy to accelerate economic growth to induction of more production from increased autonomous consumption.

Neoclassical economic theory is based on the economic analysis on the economic trend in terms of output, employment opportunity and income levels using hypothesis formulated by various economists with constant functions of utility, demand and supply (Roth, 1998). Discrete micro-economic models derived from these economic functions are used to formulate various theories that explain production, consumption, employment, budget deficit and economic growth in the face of various market conditions. In particular, the combinative analysis of both the production and consumption as indicated by neoclassical theory illustrates an inverse relationship between economic growth and budget deficit. Ricardian economist theory is only applicable in other economics resolutions with no insight into the relation between economic growth and budget deficit. There is thus no motivation of its illustrations in this context but it is applicable in other economic analysis.

Government fiscal and monetary policy

Government fiscal policies are not an attempt to arbitrate the economic contention of the various economic theorists. A particular government has many issues to contend with rather than the obvious intrigues of economic consideration. The government fiscal and monetary policies reflects less the government’s effort to resolve the economic structure that characterize the budget deficit. Instead there tends to be more of the socio-political environment either domestically and externally that tends to impinge the state at one particular time. A government only follows a particular course of an economic theory for socio-political resolution, rather than the efficiency of the theory in reducing budget deficit or fostering economic growth. This is put into action while consideration major factors that stimulate economic growth such as strategic decisions and long term goals.

Fiscal and monetary policies formulated from such a perspective will not address the issue of a budget deficit. Consequently, if the Keynesian economic theory is realized, the economic growth will take the course of the neglected budget deficit. However, the relative growth of the economy over a specified stretch of time has been s significant variable. This variation in the economic growth is more of the political contention in the United States history rather than a reflection of its domestic structure.

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The United States economy has completely been defiant to Neoclassical economic theory. The economic growth has persistently been positive with the budget deficit progressively increasing in each financial year. However, as mentioned earlier, economic growth figures are only perceptive of the social welfare of the general public. Furthermore, it is the general public who are responsible for bringing in the much needed revenue.

Economic policy in the United States has been more swayed by political as compared to economic motivations. At any given time, the White House Administration, has had a global political challenge to contend with, besides its domestic economic responsibility. A good example is the financing of the Gulf war in early 90’s or the current situation in Iraq. The government has been forced to spend quite a significant amount of money aimed at financing these wars. In addition, its responses to these political challenges have acted to aggravate more economic budget deficits. This only serves to create more problems instead of offering solutions. Consequently, the United States budget deficit is the highest among the developed countries, with estimates hitting a record high of 20% in 2003-2004 financial year (Roth, 1998). The above fiscal and monetary trends are a reflection of the various political challenges in the United States history.

Taxation

Budget deficit is measured in monetary figures or as a percentage of the deficit to the GDP. Taxation forms the bulk of government revenues used to fund budgetary expenses. The obvious solution of a government to fund its budget deficit is to increase taxes on consumer goods. Additionally the government might be forced to make private enterprises and individual business to remit more revenue in order to cater for this deficit. Domestic borrowing is another popular approach mostly used by developing countries. According to the Neoclassical economic theory, the forces of demand and supply in the face of increased price of consumer goods arising from taxes will work to slow the economic growth. This is made more if the purchasing power of the end consumers is affected. Conversely, in Keynesian theory, taxation is viewed as an impetus of economic growth depending on the government policy of soliciting domestic or foreign borrowing.

Defense spending

An increased government spending on defense strategy, is directly correlated with an increase in budget deficit. In my own simplistic argument, a government has to choose between being a military, or an economic superpower. The United State government has been forced to dig deep into its financial resources in order to finance its defense mechanisms. In most cases this is an issue which has cost the average American tax paper a lot of money.

Conclusion

The correlation between budget deficit and economic growth has been a source of contention by various economists. This is mainly because budget deficit has serious implication on the general welfare of citizens of a particular nation. This brings a lot of challenges to budget planners of a particular government. The bottom line remains that, a budget deficit no matter its figure, is bound to have detrimental effects to the growth of the economy. It’s for this reasons that registrations should enacted in order to check government spending. In the United States this legislation could only be enacted by the congress. This will serve to address the problem while taking into consideration its impact on all stakeholders.