What Is a Balanced Budget?
A balanced budget is a financial plan where total expected revenue equals total planned expenditure. This concept is primarily applied in public finance, particularly within government fiscal policy, aiming for financial stability and responsible management of public funds. When a government achieves a balanced budget, it means it is collecting enough in taxes and other income to cover its government spending without needing to borrow more money. The term can also refer to a budget that, in hindsight, showed revenues equaled or exceeded expenses over a given period.
History and Origin
The idea of a balanced budget has deep historical roots, particularly in government finance. For much of U.S. history prior to 1940, federal budgets were typically balanced, except during periods of major wars or economic recession. This adherence to a balanced budget norm was a significant feature of early American fiscal policy.6 The shift away from a strict annual balanced budget in the modern era, particularly since the Great Depression, reflects evolving economic theories and the increased role of government in stabilizing the economy.
Key Takeaways
- A balanced budget occurs when an entity's total revenues match its total expenditures.
- It is most commonly associated with government financial planning and fiscal policy.
- Achieving a balanced budget can reduce the accumulation of national debt.
- While often seen as a sign of fiscal responsibility, maintaining a strict balanced budget can limit a government's flexibility during economic downturns.
- Modern economic thought often emphasizes a cyclically balanced budget rather than an annually balanced one.
Formula and Calculation
For any entity, a balanced budget is achieved when:
In governmental terms, this typically means that total tax receipts and other governmental income are equal to total outlays for programs, services, and debt servicing. If total revenue exceeds total expenditure, it results in a budget surplus. Conversely, if expenditures exceed revenues, it leads to a budget deficit.
Interpreting the Balanced Budget
A balanced budget is often interpreted as a sign of financial health and prudent management, particularly for governments. It suggests that a government is living within its means and not accumulating additional debt to finance current operations. For instance, a government consistently running a balanced budget may have greater flexibility to respond to unforeseen crises or invest in long-term projects without overburdening future generations with debt. However, the interpretation can vary. Some economists argue that strict adherence to a balanced budget, especially during a severe economic contraction, can hinder recovery by preventing necessary counter-cyclical government spending.
Hypothetical Example
Consider the hypothetical country of Economia. For the upcoming fiscal year, Economia's Ministry of Finance projects total tax revenue and other income to be $100 billion. The government's planned expenditures for public services, infrastructure projects, defense, and social programs also total $100 billion. In this scenario, Economia has achieved a balanced budget because its total projected revenues precisely match its total planned expenditures. This allows Economia to fund all its operations without increasing its national debt for the year.
Practical Applications
Balanced budgets are a cornerstone of financial planning across various sectors. In government, the pursuit of a balanced budget is a key aspect of fiscal policy and sound public finance. Many countries and sub-national entities (like states or provinces) have legal or constitutional requirements to maintain balanced budgets. For example, the European Union's Stability and Growth Pact sets rules for member states to ensure sound public finances, aiming for a medium-term budgetary position of close to balance or in surplus.5 This pact, established to safeguard economic stability within the EU, includes limits on budget deficits and public debt relative to gross domestic product (GDP). The International Monetary Fund (IMF) also advises member countries on fiscal policy issues, often emphasizing fiscal sustainability, which can involve efforts to balance budgets and manage public debt.4
Limitations and Criticisms
While a balanced budget is often seen as a desirable goal, it faces several limitations and criticisms, particularly when applied rigidly to government finances. One significant critique, particularly from Keynesian economists, is that a strict annual balanced budget can exacerbate economic downturns. During a recession, tax revenue naturally falls while demand for social programs (like unemployment benefits) increases, leading to an automatic increase in the budget deficit. These "automatic stabilizers" cushion the economic blow.3 A requirement to balance the budget in such circumstances would force governments to cut spending or raise taxation, which could further depress demand and prolong the downturn, potentially leading to deeper and longer recessions and increased unemployment.2
Furthermore, critics argue that a balanced budget amendment could limit a government's flexibility to respond to emergencies or make necessary long-term investments in areas like infrastructure or education, which might require deficit spending in the short term but yield significant economic growth in the long run.1
Balanced Budget vs. Budget Deficit
The primary difference between a balanced budget and a budget deficit lies in the relationship between an entity's revenues and expenditures. A balanced budget occurs when total revenues are equal to total expenditures. This implies that no new debt is being accumulated to cover current operations for that period.
In contrast, a budget deficit arises when total expenditures exceed total revenues. When an entity, particularly a government, runs a deficit, it typically must borrow funds to cover the shortfall, leading to an increase in its national debt. The confusion often occurs because both terms relate to the balance of a budget. However, a balanced budget represents a state of equilibrium, or even a surplus, while a budget deficit represents a shortfall that requires financing.
FAQs
What happens if a government consistently runs a balanced budget?
If a government consistently runs a balanced budget, it avoids accumulating new national debt to cover current operations. This can lead to greater fiscal stability, potentially lower interest rates on existing debt, and increased flexibility to manage future economic fluctuations.
Is a balanced budget always desirable for a government?
Not always. While often seen as a sign of fiscal responsibility, many economists, particularly proponents of Keynesian economics, argue that strict adherence to an annually balanced budget can be counterproductive during economic downturns. In a recession, deficit spending can act as an automatic stabilizer, stimulating demand and aiding recovery. During times of prosperity, however, a balanced budget or a budget surplus is generally considered healthy to build reserves and pay down debt.
How does a balanced budget relate to the economic cycle?
A balanced budget, particularly a cyclically balanced budget, considers the broader economic cycle. This approach suggests that governments should aim to balance their budget over the course of an entire economic cycle, running deficits during economic slowdowns (when taxation revenues decline and government spending on social safety nets increases) and surpluses during periods of economic growth (when revenues are higher). This strategy allows fiscal policy to act as a stabilizing force without accumulating excessive long-term debt.
Can a balanced budget affect monetary policy?
While a balanced budget is primarily a fiscal policy tool, it can indirectly influence monetary policy. A sustained period of balanced budgets, by reducing government borrowing, might ease pressure on interest rates, potentially giving central banks more room to maneuver with their monetary tools. Conversely, large, persistent deficits could lead to higher interest rates, complicating the central bank's efforts to manage the economy.