What is a Budget Deficit? - Definition, Causes & History

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  • 0:02 Budget Deficit
  • 0:20 Causes
  • 2:43 History of the U.S. Deficit
  • 3:27 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Budget deficits are an important policy issue facing the United States. In this lesson, you'll learn about what a budget deficit is, its causes and its history in the United History. You'll also have a chance to take a short quiz.

Definition of Budget Deficit

A budget deficit occurs when an individual, business or government budgets more spending than there is revenue available to pay for the spending, over a specific period of time. Debt is the aggregate value of deficits accumulated over time. We will be focusing on government deficits in this lesson.

Causes of Budget Deficit

The causes of a budget deficit are both simple and complex. At its most rudimentary level of analysis, a budget deficit is caused when a government spends more than it collects in taxes. Reducing tax rates may also cause a deficit, if spending isn't reduced to account for the decrease in revenue. However, the world is more complex, and a bit more than a mere rudimentary analysis is required.

Periods of economic growth and economic decline can have a tremendous effect on the ability of a government to finance its spending. In fact, a budget deficit can occur even if a government doesn't increase its spending one cent or lower its tax rate one percent. Let's use a simple math problem to illustrate the point.

Imagine that a small country has a flat income tax rate of 20%, and the country's economy produced taxable income of $20 billion. Since the island paradise imposes a flat rate of 20% on taxable income, it was able to generate $4 billion in revenue for the year.

The island was hit with a hurricane and also got swept up in a global recession. Both events decimated the primary industry - tourism. These twin disasters caused the taxable income to fall from $20 billion to $14 billion. This reduction in taxable income results in the government collecting only $2.8 billion in revenue, which is a reduction of 1.2 billion or 30%. So, even if this tiny banana republic didn't increase it's spending one cent, or lower its tax rate, it will still suffer a budget deficit.

Deficits can increase even more during economic downturns, if the government attempts to stimulate economic growth with spending, as many economists recommend. This is what happened in the Great Depression with the New Deal. Of course, deficits explode in this type of situation, because a government is dramatically increasing its spending while revenues are dramatically declining.

Unplanned expenses can also cause a deficit. National disasters such as droughts, floods and hurricanes not only destroy assets, but also impede or stop economic activities that results in less taxable income from which to collect revenue. War is another example of a major unplanned event that is very costly. Even if a war is planned, it's often difficult to project an end date and the resources necessary to successfully execute it.

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