Governments have both earning and spending as their responsibilities. Therefore, they earn revenues and spend money on public projects, such as infrastructure, education, and public health.
There are two possible results of this −
The government may either have a surplus or
A deficit in the budget.
Surplus refers to the extra revenue left while deficit refers to the loss of the government in terms of fiscal balance.
The fiscal budget of a government is calculated by the revenues earned by the government by comparing it with the expenditure. When the expenditure is more than revenues earned, a fiscal deficit occurs.
The fiscal deficit is the amount that is the gap between revenues earned and expenditures made. Obviously, expenditures must be more than revenues earned for a fiscal deficit to occur.
The fiscal deficit may be expressed in general absolute figures or as a percentage of the GDP of the nation. That is, fiscal deficit may be shown as the total money spent by the government in excess of its income or via a percentage of the total Gross Domestic Product of the nation.
In any case, the income taxes and other revenues are considered in calculating the income while the capital borrowed to make up the loss is omitted.
The government usually revises the fiscal deficit in a new budget.
For example, finance minister Nirmala Sitharaman revised the fiscal deficit target for 2019-20 to 3.3 percent of GDP. It is 10 basis points lower than the target for the 2018-19 period.
It must be noted that a fiscal deficit is the more common result of government budgets than a budget surplus. The reason for this is that the government invests more funds in public projects than its total income of it. As larger portions of the budget go for financing the projects, the government always tends to spend more than the earnings. Hence, the fiscal deficit is more common than budget surpluses.
The gross fiscal deficit (GFD) is the extra amount of total expenditure. This includes loans net of recovery over non-debt capital receipts and revenue receipts (including external grants).
The net fiscal deficit (NFD) is the gross fiscal deficit after deducting the net lending of the Central government.
Usually, a fiscal deficit occurs either due to a major hike in capital expenditure or a revenue deficit. Capital expenditure is the fund that is used to create long-term assets such as buildings, factories, and other developments.
A deficit is usually financed by raising money by issuing different instruments like treasury bills and bonds in capital markets or borrowing from either the central bank of the country.
Since to have a fiscal deficit, a government has to spend more than its income, a fiscal deficit means that the government is spending beyond its means.
Since the formula for calculating fiscal deficit is very easy, there is no theoretical complexity in calculating the fiscal deficit.
The formula is -
$$\mathrm{Fiscal\:Deficit\:= \:Total \:Revenues - Total\:expenditures}$$
Total revenues include the sum of revenue receipts, recovery of loans, and all other forms of receipts by the government. An interesting take from the above formula is that the result of the formula must be negative the amount of which is the fiscal deficit in real terms. It is so because the expenditure in the case of fiscal deficit is more than the earned revenues by the government.
As mentioned earlier, a fiscal deficit is a more common occurrence than a surplus. Most countries have fiscal deficits in their budgets than surpluses. The reasons for big deficits may include large infrastructure projects that have the potential to provide big returns in the future.
The fiscal deficit can also be expressed as a percentage of GDP. The formula, in this case, would be −
$$\mathrm{Fiscal\:Deficit\:=\:\frac{Total \:Expenditure \:-\:Total\:Revenue}{GDP} \times 100}$$
The fiscal deficit calculations have two components — Income and Expenditure.
The income component of fiscal deficit calculation includes all forms of collections by the government. These are further divided into tax-based and non-taxable income.
The revenue generated from taxes levied by the Centre fall under the tax-based income. The income that is generated from the non-tax variable fall under the non-taxed bracket. The taxable income consists of the amount generated from income tax, corporation tax, excise duties, Customs duties, and GST, among others. Meanwhile, the non-taxable income comes from interest receipts, dividends external grants, and profits of public sector companies. This bracket also includes the receipts from Union Territories, among others.
The government allocates funds for several works in its Budget. These expenditures include payments for pensions, salaries, emoluments, the creation of assets, funds for infrastructure, health, development, and many other sectors that form the expenditure component.
Fiscal deficits are important to check because they show the government's intention to charge up the economy by spending more than its income. Moreover, it also shows the government’s expenditure on necessary projects that will offer better returns to the public in the form of assets in the future.
Although the governments show fiscal deficit in the budgets, they tend to recover the loss by selling bonds and bills in the capital markets. This short-run policy shows that the government is able to meet the gap between surplus and deficit by resorting to necessary policies.
Governments usually try to invest as much as possible for the welfare of the nation and economy. Therefore, the expenditure is often more than the income. In such cases, having a deficit is common among most nations of the world. It is a trend in almost all developed and developing nations to have budgets that have a deficit.
Fiscal deficit figures, however, do not show the borrowings of the government and so, one trying to find out the real economic condition of the country must look for additional information apart from the fiscal deficit budget to ideally understand the condition of the economy.
However, fiscal deficits are an important tool of macroeconomics as they serve critical information about budgets.
It is not easy to balance long-term fiscal deficits because they are more or fewer investments in non-refundable assets. However, in the short run government issues bonds to get the funds that equal the fiscal deficit amount.
These bonds are sold to the banks that buy these bonds because they are extremely safe investments. These banks then distribute the loans to their customers at higher rates. The government also expands its policies and schemes during deficit situations without having to cut spending or raise funds.
Q1. Between fiscal deficit and surplus which is more common?
Ans. Fiscal deficit is more common than fiscal surpluses.
Q2. What are the two components of fiscal deficit?
Ans. The two components of fiscal deficit are income and expenditure of the government.
Q3. How is the fiscal deficit balanced in the short run by governments?
Ans. In the short run, the government issues bonds to get the funds that equal the fiscal deficit amount. These bonds are sold to the banks that buy these bonds because they are extremely safe investments. These banks then distribute the loans to their customers at higher rates. The government also expands its policies and schemes during deficit situations without having to cut spending or raise funds.
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