Cyclical vs. Structural Deficits: Definitions & Examples

Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

A deficit occurs when the government spends more than it takes in. Deficits can be divided into two main components, cyclical and structural. We will explore both and explain why one of them can be very difficult to reduce.

Deficit Problem

The prime minister of the hypothetical country of Nad is confused. He is wondering why the budget deficit is not coming down. Deficits arise when the government spends more than it takes in. When it takes in more than it spends, it's a surplus. He promised the people he would fix this deficit problem. The legislature has done what he recommended, they have passed responsible bills that reduce spending and still the deficits go up. He is perplexed and calls in a few of his economic advisers to provide some explanation.

Cyclical Deficits

Mr. Cyd is the first expert to enter the room. He begins by explaining to the prime minister that the deficit is kind of a summary number. Deficits are best understood by breaking the number down into its component pieces. He tells the prime minister that he is an expert in one of those pieces called the cyclical deficit. The cyclical deficit is caused by the ups and downs of the business cycle. You see when the business cycle is in an expansion phase and the economy is doing well, two things happen:

  • Government receipts increase because more people are working and paying taxes. An expanding economy also mean corporate and business profits are getting bigger, so they are paying more taxes on their profits too.
  • Government expenditures drop because fewer people are collecting unemployment checks and relying on social programs to make ends meet.

So when the economy is doing well and people have jobs, this cyclical part of the deficit disappears. But when the economy is doing poorly like it has been in our country, the opposite happens. Tax receipts fall as workers get laid off and business profits go down. Expenditures go up since people who used to be working and paying taxes are collecting unemployment checks instead! That creates a bigger cyclical deficit and that is what has been happening in the country of Nad.

So the prime minister concluded that this piece of the deficit will fix itself when the economy improves. But Mr.Cyd isn't finished yet. He explains that even if Nad were at full employment and turns the cyclical deficit into surplus, it wouldn't completely fix the deficit problem. The full employment deficit is the deficit that is still there even at full employment. He told the prime minister he was no expert on that part, and suggested the prime minister find someone else to explain it.

Structural Deficits

Ms. Strud entered the room next. She is an expert on structural deficits, that is the piece that remains even if Nad were to be at full employment. How could we still have a deficit with all of that tax revenue coming in the prime minister wondered. Ms. Strud explained that understanding structural deficits isn't hard, but fixing them is very difficult. That involves getting the legislators to make hard and difficult choices. Hmm wondered the prime minister, every time he has given them hard choices to make they go home on recess!

Ms. Strud started to explain where Nads structural deficits come from. They come from automatic spending for ongoing government programs. They are underlying and persistent. She tells him about three major government programs that are responsible for most of Nads structural deficit. They are:

  • Nad Security which provides income for senior citizens.
  • Nadicare which provides health insurance coverage for the seniors. and
  • Nadicade which provides health insurance for low income citizens.

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