Understanding Fiscal Deficit: Definition, Formula, and Effects

The fiscal deficit is a frequently discussed topic in economic discussions and policy debates. It represents the shortfall in the government’s revenue compared to its expenditures. A fiscal deficit helps in ascertaining a country’s economic growth and stability. If you are a taxpayer, a policymaker, or someone simply interested in economics, understanding the fiscal deficit and how it works is critical. This article provides a clear understanding of fiscal deficit meaning, its causes, and its implications. 

What Is Fiscal Deficit?

Fiscal deficit refers to the shortfall in the budget and the amount of borrowing the government may need. Factors that cause an increase in the deficit include government spending, economic downturns, or a shortfall in revenue collection.  

The government usually finances the deficits via borrowings, by issuing bonds and Treasury bills in the capital market.  

How Is the Fiscal Deficit Calculated?

 A fiscal deficit is the difference between the government’s revenue and expenditure. When the expenditure exceeds the revenue earned, it results in a deficit. The opposite situation, where revenue exceeds expenditure, is called surplus.

The mathematical formula to determine deficits is:

Fiscal Deficit = Total Expenditure – Total Revenue Generated   

Here is an elaborate formula for fiscal deficit calculation:

Fiscal Deficit = (Revenue Expenditure – Revenue Receipts) + Capital Expenditure – (Recoveries of loans + other Receipts)

Let’s understand the fiscal deficit formula with a simplified example.

Suppose the government’s expenses for a period were Rs. 600 crore, while its revenues were Rs. 400 crore. 

Fiscal deficit = (Revenue expenditure + Capital expenditure) – (Revenue receipts + Capital receipts excluding borrowings)

Or, Fiscal deficit = Rs. (600 – 400) crore = Rs. 200 crore

Gross fiscal deficit: The gross fiscal deficit is excess expenditure, including net loan recovery, over-revenue receipts (including grants), and non-debt capital receipts.

Net fiscal deficit: It is Gross Fiscal Deficit (GFD) minus the net lending of the central government. 

It is important to understand that a budget deficit doesn’t automatically imply that the country’s economy is in bad shape. Budget deficits can increase when the government invests heavily in asset generation for long-term growth, like highway construction, building airports, or industries that will generate revenue in the future. Hence, while addressing the issue of the fiscal deficit, both revenue and spending portions should be carefully examined.   

What Causes Fiscal Deficit?

The following are the reasons for a rise in the fiscal deficit.

• Rise in government spending – if the revenue earnings don’t rise at an equal pace, the deficit will increase.
• A decline in tax receipts or revenue from other sources can increase the gap between expenditures and income.
• The government’s revenue collection may decline during an economic downturn. The earnings can fall during a recession while its expenditures can rise.
• During war or natural disasters, the government may increase its spending to boost the economy.
• If a significant portion of the budget goes towards social welfare or subsidies it will increase the deficit volume.
• If the government’s debt rises, it may need to pay a hefty amount in interest, which can increase expenditure. 

What Are the Components of the Fiscal Deficit Calculation?

There are two major parts to calculating the fiscal deficit: 

Income components: It represents the earnings from direct and indirect sources, including all tax revenues and income generated from non-taxable variables. 

The government’s earnings from taxes include income tax, corporation tax, customs duties, excise duties, and Goods and Service Tax (GST).

The non-tax income components include external grants, interest receipts, dividends, receipts from Union Territories (UTs), and profits earned by the government. 

Expenditure component: The expenditure side involves expenses towards salaries, pensions, and also expenses incurred for assets, infrastructure, and healthcare development.

What Is Ideal Fiscal Deficit According to FRBM Act?

FRBM stands for Fiscal Responsibility and Budget Management. It was introduced in 2003 to ensure fiscal discipline. The latest fiscal deficit target set by the FRBM Act for 31st March, 2021, was 3%, and the Central Government’s borrowing was to be capped at 40% of GDP by 2024-25.   

How Is the Fiscal Deficit Balanced Out?

The most common way for the government to close the gap between its expenses and income is to borrow from the market by issuing bonds to investors. Government bonds, or G-secs are considered an extremely secure and risk-free form of investing. 

Fiscal Deficit and Keynesian Economics

To understand why the fiscal deficit is so critical, you must look into the economic theory proposed by John M. Keynes. Keynesian economists believe in countercyclical fiscal policies to regulate and stabilise the economy. It proposes that the government adopt expansionary fiscal policies in the form of undertaking labour-intensive infrastructure projects, increasing government spending, and reducing taxes, to stimulate the economy during downturns. Similarly, they advocate increasing the tax limits to control inflation when there is significant demand-side growth. 

The Keynesian theory argues that during recessions, fiscal deficits can be beneficial as they inject money into the economy, create jobs, and revive consumer spending. In a recession-like situation, the laissez-faire approach may fail to restore the balance in the economy; the government must provide the impetus it needs. 

For understanding, the laissez-faire approach is an alternative economic philosophy that promotes free-market capitalism and opposes government intervention.

Impact of Fiscal Deficit on Macroeconomics

How the government spends and invests money impacts the country’s macroeconomic indicators. When the deficit increases and the government resorts to borrowing, it affects the money supply and the interest rate. 

When government borrowing increases, the interest rate in the market increases. Higher interest rates increase the cost of lending for corporations. It results in lower profit and a lower stock price.    

Final Words

Understanding the fiscal deficit is critical to comprehending the government’s financial activities and their effects on overall economic health. It reflects the imbalance between expenditure and revenue, impacting the economy and policy decisions. While it has many positive sides, a considerable deficit in the budget can be a matter of concern. Managing fiscal deficits prudently is essential for ensuring long-term fiscal stability and sustainable economic growth.

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