Budget Surplus Definition
Effects, Advantages, Disadvantages
WRITTEN BY PAUL BOYCE | Updated 1 April 2022
What is a Budget Surplus
A budget surplus is where government brings in more money than it spends. In other words, it receives more in taxes than it spends on defence, welfare, or education. This is also known as a positive budget balance.
A budget surplus is the opposite of a budget deficit which is where the government spends more than it brings in. This contrasts with a budget surplus, which is where the government brings in more than it spends.
- A budget surplus occurs when government brings in more from taxation than it spends.
- Budget surpluses are not always beneficial as they can create deflation and economic growth.
- Budget surpluses are not necessarily bad or good, but prolonged periods of surpluses or deficits can cause significant problems.
In today’s age, few nations achieve a budget surplus. Instead, most opt for expansionary policy alongside a budget deficit. That involves significant levels of government spending to stimulate the economy, but not receiving enough in taxation to cover those costs. For instance, according to OECD data, most European countries have a budget deficit. They all spend more on government programs than they receive through taxes.
The main exceptions being Germany, Switzerland, Norway, and Sweden, all of which achieve a budget surplus. On the face of it, it can seem like a budget surplus is a good thing. Spending as much as you take in is only logical economics. However, it can come with its own problems.
Effects of Budget Surplus
- Impacts Growth
- Declining Government Debt
- Lower Interest Rates
- Lower Quality Public Services
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.
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 Budget Surplus
Receiving more than you spend is simple economics, yet many countries choose instead to spend their way out of recessions and to drive new economic growth. This often provides a short-term stimulus, but at the cost of long-term growth. Instead, a budget surplus can be advantageous for a number of reasons such as:
1. Fights Inflation
On occasion, the economy can ‘heat up’; causing high levels of inflation. During periods of high economic growth, we may see strong price increases. Although inflationary pressures can also occur during periods of economic decline.
Essentially, inflation is caused by a growth in the money supply. With that said, a budget surplus will take money out of the economy, thereby reducing the money supply, and creating a deflationary environment.
2. Fiscal Flexibility
Having a budget surplus allows governments the room to maneuver. Having a surplus in one year is not going to give much flexibility, but one over a period of time will.
What a consistent surplus would do, is reduce the overall debt burden. It is only under these circumstances by which governments have greater flexibility.
For instance, it is far easier to increase spending from a low level of debt. If a nation such as Greece wanted to borrow more, it would find it incredibly difficult.
So flexibility allows governments to increase spending or reduce taxation in order to try and stimulate the wider economy. Something it would be unable to do under a high level of debt and large budget deficit. `
3. Low Interest
When a nation has a large budget surplus, it means that it doesn’t need to borrow so much money. It can pay off its existing debt, thereby reducing its overall burden. As a result, the risk of the nation defaulting on its debt also reduces, which encourages more investors to purchase government debt – as it is a safe investment. Interest rates decline as there is more demand for government debt than there is from the government to supply this debt – so investors are willing to take a lower rate.
4. Reduces Government Debt
When a government has a budget surplus, it can do many things with the excess cash that it accumulates. Usually, this will be used to reduce existing debt that accumulated during periods of a budget deficit. This helps the nation reduce its debt burden and increase its global standing as a reliable debtor. So when the nation needs cash in the future, it can easily obtain capital as investors trust in its ability to pay it back.
Disadvantages of Budget Surplus
A budget surplus might seem like sensible economics, but doesn’t come without its disadvantages to the wider economy:
1. Lower levels of Investment
A budget surplus means that the government is taking more from the economy that it is putting in. In other words, it is starving the economy of money. By taking more tax than needed from businesses and consumers, we see less in the way of consumer spending and business investment.
Businesses have less money than they would otherwise. At the same time, so to do consumers, which can directly influence businesses investment decisions.
Even though it may not impact investment directly, it can reduce potential investment. So, what investment would have been if taxation was reduced.
2. Deflationary Effect
When government operates a budget surplus, it is removing money from circulation in the wider economy. With less money circulating, it can create a deflationary effect.
Less money in the economy means that the money that is in circulation has to represent the number of goods and services produced. As there is less money available, it means that there is less to represent the goods in the economy.
3. Economic Decline
Government spending is a component of GDP. So when it is taxing more than it’s spending, it is effectively taking money away from the wider economy. If this isn’t being spent, it is just sitting there doing nothing – when instead it could be used by private firms to invest in new and productive capital equipment.
General FAQs on Budget Surplus
A budget surplus occurs when governments bring in more through taxation than it spends.
A budget surplus is bad for the economy because it takes money away from private hands and the wider economy. It is not used by government, nor by private corporations. Therefore, it causes at least a temporary restriction on economic activity.
A budget deficit is where the government is spending more money than it is bringing in through taxes. By contrast, a budget surplus is where the government is taxing more than it spends – therefore bringing in more money.