Budget Surplus

What is a Budget Surplus?

When a governmental entity has revenues from taxes, fees, and other impositions which exceed its budgeted outlays, it is said to have a budget surplus. When a business under-spends its budget but all else remains the same, i.e., sales are at projected levels, it is said to have “improved profits” rather than experienced a surplus. Both the phrases “budget surplus” and “budget deficit” are usually applied to public entities.

Surpluses are almost always the consequence of two interacting forces: on the one hand efforts to contain costs or spending have been successful; and, on the other hand, revenues (over which government rarely has any genuine control except by raising or cutting taxes) have exceeded expectations.

A budget surplus occurs when tax revenue is greater than government spending. With a budget surplus, the government can use the surplus revenue to pay off public sector debt.

Budget surpluses are quite rare in modern economies because of the temptation for politicians to spend more money and cut taxes.

What Does Budget Surplus Mean?

Either way, this is a very important metric for all businesses because it shows the company is running efficiently and it has money left over after paying its expenses, which it can be used to invest, grow, or pay their shareholders. However, a budget surplus can only occur as the result of either increasing revenues, or lowering of expenses. If companies continually have a budget surplus, or profit, this signals to investors that the company is strong, and will further increase investment and growth in the company.

When is It Appropriate to Have a Budget Surplus?

A budget surplus is appropriate when the economy is in the growth phase of the economic cycle. In a recession, demand is depressed, and it is expected to have a budget deficit. Trying to attain a budget surplus in a recession will involve higher taxes and lower spending – but these policies could make the recession worse. Therefore, it is better to wait until the economy recovers, and automatic fiscal stabilisers improve (higher growth automatically leads to higher income tax revenues).

Effects of Budget Surplus

1. Impacts Growth

If the government is bringing in more money than it’s spending, the question arises – where is the surplus going? Well, it might be spent to reduce existing debt, or, more likely – future government spending. Either way, it is money taken away from the private sector and the wider economy.

If the government reduces its debt, it also reduces the money supply, which can create deflationary pressures and have a detrimental impact on consumer behavior. As government income comes from taxes, it is taking money away from consumers who would otherwise be able to spend that in the wider economy. At the same time, taxes affect businesses – which means lower levels of consumption and lower levels of investment. Both of which are two factors of economic growth.

2. Declining Government Debt

If governments decide to use the surplus, they may wish to reduce its debt burden. For instance, nations such as Greece, Italy, and Portugal have amassed unsustainable levels of debt. Greece has had to rely on IMF and EU bailouts just to keep on top of it. So using the surplus to reduce the debt and wider economic pressure may be necessary.

In Keynesian economic theory, it is widely acknowledged that governments should run a budget surplus during economic growth. It suggests that a surplus should be used so that governments can stimulate growth again in bad times. In other words, save in the good times and spend in the bad times.

3. Lower Interest Rates

When governments post a surplus, it means debt levels can be reduced. In turn, it makes lending to government less risky. If government has lower levels of debt, it is less likely to default.

As government bonds or gilts become rarer on the market, they command a higher price, but a lower yield.

4. Deflation

Going from a budget deficit to a budget surplus may cause deflation. This is because it would provide a negative pull on aggregate demand. We can look at this from two angles.

First of all, if the budget surplus is a result of reduced government spending, there is less money being spent in the wider economy. So overall demand may decline if this is the sole cause – thereby creating deflationary pressure.

Second of all, if the surplus comes from higher taxes, it means businesses and consumers have fewer funds to spend and invest. In relation to the wider economy, this means reduced demand for goods and services. Again, this puts deflationary pressure on prices as demand declines.

5. Lower Quality Public Services

If the budget surplus arises from a decline in government spending; it means there are fewer funds for publicly provided goods. For instance, if government spends less, it must choose where to cut spending from.

This may be welfare, defence, education, policing, or healthcare, among others. What happens as a result is that such services suffer. For instance, cuts in the education budget may mean fewer resources for schools. Alternatively, or in addition, it may mean pay caps on public workers.

Advantages of a Budget Surplus

A budget surplus gives an economy more flexibility during times of economic difficulties. Governments can use the extra cash to stimulate the economy in times of recession rather than depend on debt. Again, having a budget surplus enables a country to clear off its debts and therefore save on interest payments.

Likewise, a government with a primary budget surplus has an option to default on a loan as it reorganizes its finances temporarily. With a budget deficit, governments are tied to the debt since they cannot operate without it.

Another advantage of running on a budget surplus is that it paints a good picture of a country, therefore attracting investment. Governments with a history of operating on budget surpluses are more likely to secure loans with better terms than those always operating on budget deficits.

Disadvantages of a Budget Surplus

A budget surplus resulting from an unnecessary increase in taxes can do more harm to an economy than good.

When taxes are high, people’s spending power declines and, as a result, the demand and supply for goods decline. This can lead to a recession since employment creation and wages rise to depend very much on demand and supply.

Governments must, therefore, review their tax policies regularly to determine if the surpluses are a result of a cash-starved private sector. Budget surplus should result in tax cuts where the private sector purchasing power is deemed to be low.