Balanced Budget

Balanced Budget

What is a Balanced Budget?

A balanced budget is a situation in financial planning or the budgeting process where total expected revenues are equal to total planned spending. This term is most frequently applied to public sector (government) budgeting. A budget can also be considered balanced in hindsight after a full year’s worth of revenues and expenses have been incurred and recorded.

A balanced budget (particularly that of a government) is a budget in which revenues are equal to expenditures. Thus, neither a budget deficit nor a budget surplus exists (the accounts “balance”). More generally, it is a budget that has no budget deficit, but could possibly have a budget surplus. A cyclically balanced budget is a budget that is not necessarily balanced year-to-year, but is balanced over the economic cycle, running a surplus in boom years and running a deficit in lean years, with these offsetting over time.

Balanced budgets and the associated topic of budget deficits are a contentious point within academic economics and within politics. Many economists argue that moving from a budget deficit to a balanced budget decreases interest rates, increases investment, shrinks trade deficits and helps the economy grow faster in the longer term.

What Does Balanced Budget Mean?

The term is mostly used when referencing governmental spending and programs. You can think of this like a governmental plan to break even. Once all revenues have been collected and expenditures have been paid, the government has zero revenues left over. It does not have a surplus with extra cash in the bank. Likewise, it doesn’t have a deficit where it owes extra money at the end of the year. Revenues equal expenditures.

Balanced budgets are typically evaluated on an ongoing basis. They are evaluated before they pass to see if the estimates are accurate, during the period to track the progress, and after business cycle to see if they were successful.

It can be critical for a government entity to achieve a balanced budget, for two reasons. First, it may not be able to sell enough debt securities to fund the shortfall, or at least not at a reasonable interest rate. Second, future taxpayers are saddled with the burden of paying for the shortfall, perhaps through increased taxes. However, a budget deficit by the federal government can be useful in a period of declining economic activity, since the excess spending can bolster economic activity. Conversely, the best opportunity to enact a budget surplus is during a period of strong economic growth, when the government is in the best position to pay down debt, thereby preparing for deficit spending during the next recession.

Components of a Balanced Budget

Revenues

For corporations and non-governmental organizations, revenues come from the sale of goods and/or services. For governments, the majority of revenues come from income taxes, corporate taxes, social insurance taxes, and consumption taxes.

Expenses

For corporations and non-governmental organizations, expenses include the amount that is spent on daily operations and factors of production, including rent and wages. For governments, expenses include spending on infrastructure, defense, healthcare, pension, subsidies, and other factors that contribute to the health of the overall economy.

Advantages and Disadvantages of a Balanced Budget

Proponents of a balanced budget argue that excessive budget deficits saddle future generations with untenable debt. Just as any household or business must balance its spending against available income over time or risk bankruptcy, a government should strive to maintain some balance between tax revenues and expenditures. Most economists agree that an excessive public sector debt burden can pose a major systemic risk to an economy. Eventually, taxes must be raised or the money supply artificially increased—thus devaluing the currency—to service this debt. This can result in a crippling tax bill once taxes are eventually raised, excessively high interest rates that crimp business and consumer access to credit, or rampant inflation that may disrupt the entire economy.

On the other hand, running consistent budget surpluses tends to not be politically popular. While it may be beneficial for governments to sock away surpluses for so-called “rainy day funds” in case of a downturn in tax revenue, the government is generally not expected to operate as a for-profit business. The existence of surplus government funds tends to lead to demands for either lower taxes or, more often, increased spending since money accumulating the public accounts makes an attractive target for special interest spending. Running a generally balanced budget may help governments to avoid the perils or either deficits or surpluses.

However, some economists feel budget deficits and surpluses serve a valuable purpose, via fiscal policy, enough so that risking the dire effects of excessive debt may be worth the risk, at least in the short run. Keynesian economists insist that deficit spending represents a key tactic in the government’s arsenal to fight recessions. During economic contraction, they argue, demand falls, which leads to gross domestic product (GDP) declines. Deficit spending, Keynesians say, can be used to make up for deficient private demand or to stimulate private sector spending by injecting money into key sectors of the economy. During good economic times, they argue (though perhaps less forcefully), governments should run budget surpluses to restrain private sector demand driven by excessive optimism. For Keynesians, a balanced budget in effect represents an abdication of the government’s duty to use fiscal policy to steer the economy one way or another.

Federal and State Balanced Budgets

A number of amendments have been proposed to the United States Constitution requiring that the federal government budget be balanced as a matter of law. None of the amendments have passed. However, the vast majority of the states in the U.S. have passed legislation requiring some form of balanced state budget. In fact, as many as 49 states have balanced budget requirements, according to the National Conference of State Legislatures, though a handful of those states’ status as balanced budget states are disputed. Vermont is the only state that clearly has no balanced budget legislation.

The United States government has only achieved a budget surplus four times since 1970. It happened during consecutive years from 1998 until 2001.

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