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Budget Deficit

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Balanced budget debate

The budget deficit is often in the media spotlight. The budget deficit is defined as the difference between what the government spends and what the government collects. Government spending takes the form of salaries, defense spending, aid programs, and other cash outflows. Government collection predominately take the form of taxes. When the government spends more than it collects, a budget deficit exists. When the government collects more than it spends, a budget surplus exists.

There are three basic sides to the balanced budget debate. The traditionalists argue for a reduction of the budget deficit on the grounds that it harms the economy. Another group holds the Ricardian view of government debt in believing that there is no real harm done to the economy by the national debt. A third group exists on the fringe with the opinion that the budget deficit is not an adequate measure of fiscal policy.

Traditionalists argue that a reduction in the budget deficit will significantly help the economy in the long run. This theory is based on the following logic. When the government runs a budget deficit, it is spending more than it is taking in. In this way, national savings decreases. When national savings decreases, investment--the primary store of national savings--also decreases. Lower investment leads to lower long-term economic growth. Similarly, lower investment is accompanied by higher domestic interest rates, which decreases net exports. Based on this logic, a budget deficit is a drain on the long-term economy.

But the Ricardian view of the budget deficit takes a much less negative position on this issue. Supporters of this view believe that a budget deficit represents trading taxes in the future for taxes today. That is, if the government spends more than it taxes today, then it must tax more than it spends tomorrow. Given that the public intrinsically understands this, a questionable premise, then the public will spend and save accordingly. Since the public is adjusting its spending and savings schedules to account for the necessary future increases in taxes, the budget deficit should have little long-term effect on economic growth.

The third position, a bit on the fringe, claims that the budget deficit is not a reasonable measure of fiscal policy. While these economists do believe that the government can affect spending, savings, and investment, they also believe that the budget deficit is simply an incomplete measure of these variables. Based on this position, the budget deficit should not be a focal issue in the economic policy debate.

Which of these views is most reasonable? There is likely a bit of truth in all of them. The best view of the budget deficit comes from understanding the major positions on the issue and creating some sort of compromise between the traditional, Ricardian, and fringe viewpoints.