The causes, effects and solution to the budget deficit

Causes

A budget deficit is a common occurrence in modern times as most governments could not sustain the corresponding level of revenues needed to support the budgetary requirements. The budgetary requirements are brought about and dictated by the rising needs and expectations of the country and people and government’s ultimate responsibility of meeting and servicing them.

A budget deficit increases likewise on account of the natural cycle of business. The business cycle comes full circle from the stages of "trough", to "expansion", to "peak" and to its "downturn" before it rotates again on the same wheel. Trough is the bottompoint before the start of the economic upturn, expansion is the continued rise in economic activities that culminates at the peak before economic events slackens into the period of downturn.

During good economic times, that is at the stage of the business cycle from expansion to peak, government revenues is at its highest as the private business sector is able to pay more taxes from good business brought about by a favorable economic environment. It is axiomatic, though, that in such good times, government has the tendency to correspondingly appropriate more expenses in its budget and even at times increasing its budgetary appropriations at a level more than the increase in its revenues. Thus, a budgetary deficit still occurs. Upon the other hand, during a lull and decline in economic activities, that is during the phase of the business cycle from the downturn up to before the start of the trough, it is natural that the level of tax collection likewise plummets. During these times, government is unable to immediately adjust its budgetary expenses vis-à-vis the revenues and, therefore, a budget deficit becomes inevitable.

In the particular case of the Philippines, which relies on foreign borrowings to fund its infrastructure and utilities development projects, it is obvious that when the peso is devalued vis-à-vis the international currency (the dollar), our contracted foreign debt even further worsens the budgetary deficit as the servicing of our foreign debt obligation is included in our yearly budgetary appropriations. In short, with the devaluation of the peso against the dollar, the servicing of our foreign debt balloons which exacerbates and worsens the budget deficit.

Effects

A budget deficit in government is similar, in accounting consequence, to that of a private business company where the income that flows-in must be sufficient to meet the budgeted expense projected. Yet, unlike private business entities which when affected by downturns in the business cycle can immediately respond by cutting expenses even a mid-year of its operation, government is unable to instantaneously do so during such downturns.

The immediate effect of a budget deficit is the negative perception of the general public, both local and international, on the ability of government to manage its fiscal affairs which seriously impairs its financial and credit rating including its ability to borrow more money to service the country’s foreign debt. Government is unable then to forthwith address the deficit and, as in the Philippines, starts blaming everybody else but itself for its budgetary woes.

Still, during times of a budget deficit, the Philippines most particularly makes a knee-jerk reaction by trying to desperately narrow the gap between revenues and expenses through two measures that, far from helping alleviate the situation, actually exacerbates the already contracting and sluggish economy.

In attempting to balance the budget, government tries to increase its revenues by imposing additional taxes upon the citizens and private businesses and, at the same time, tries to lessen expenses by cutting-down on expenditures. This twin cosmetic measures, while seemingly logical at first blush, are actually self-defeating and counter-productive as they result to further economic miseries for the country and people.

In the case of government measures to cut-down on all expenses leaving only what it deems are the most necessary government budgetary expenditures, its unintended effect and consequence is the further contraction and constriction of the economy as then both the government and the private business companies would now together refuse and be reluctant to do the investing thereby grinding economic activities to a slow-down, if not a standstill and halt. The symbiotic relationship between government and business is abruptly disrupted with this natural reaction of government to forthwith attempt to balance the budget. Indeed, government’s tendency to cut-down expenses in times of sluggishness in the business cycle is contrary to the successful Keynesian theory and formula that it is precisely in periods of economic downturns, when private business are reluctant to invest, that the government must do the investing and spending through new money raised from long-term bonds secured against future taxes in order to rev-up the economy from its slumber.

Yet a worse measure adopted by government in periods of budgetary deficits is its attempt to bridge the budgetary gap by increasing its revenues through the imposition and collection of more taxes from private businesses and the people. This is a horrendous, if not cruel, imposition upon the taxpayers who are being singled out by government to bear the burden of increasing the coffers of government to remedy a deficit situation that was not caused by the taxpayers, but by governmental policies, directions and oversights themselves. It becomes no less a tragedy as government, which is suppose to serve the people, instead overburdens the taxpayer with more taxes as they are made to undergo a harrowing experience upon their pockets for government’s inefficiency in managing the fiscal, monetary and economic affairs of the nation.

The Solution

To recapitulate, a recession or a contraction of the economy as reflected in a budget deficit is neither solved by the capping of governmental expenses nor by the imposition of more taxes upon the taxpayers to raise more revenues. The result, in both instances, is only a prolonging of the economic stagnation since there are no catalysts to rev-up the economy as both government and the private sector are holding-back on investments – in government’s case because it is deliberately cutting-back on expenses, and in the private sector’s instance because it has been additionally burdened with more taxes.

Rather than these defeatist measures, government should instead, during periods of fiscal deficits and when the economy is in a sluggish mood, embark on an expansionary monetary program designed to rev-up, propel and shore-up economic activities and thereby extricate the economy from its current economic contraction. This expansionist monetary policy consists in government’s increasing the level of money supply in circulation to a point that will enable it to expand economic activities through investments in income generating ventures, programs and projects.

This can be accomplished with government borrowing against future taxes by selling long-term bonds and securities to the central bank which shall, in turn, issue the corresponding new local money. The new local money thus created will be used to finance development projects such as the construction and establishment of infrastructure and utilities all over the country thereby catalyzing growth and expansion and creating a more favorable business and economic climate for private businesses to thrive in. Faced with such government assistance and more business opportunities at hand, the private sector can thus itself expand and grow, make more profits, employ more people and pay more taxes to the government. The economy, erstwhile on a downturn, could then be buoyed into expansion, thanks to government’s direct and active intervention through investments and expenses from borrowed money secured against future taxes. In short, government’s monetary expansion leads to economic expansion.

Concluding, it is no doomsday scenario for government to find itself in a financial deficit. In fact, the people and country’s over-increasing needs dictate an actuality where government expenses will, for the meantime, exceed its revenues. As the mightiest country on earth, the USA, was never bothered by such a situation, so should we not, except that we should approach the budget deficit properly by adopting and pursuing an expansionary monetary attitude and policy.

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