Fiscal Policy » The Government Budget and Government Spending

What is a government budget?

Your family may plan how much money comes in each month and how much goes out. A government does the same on a much bigger scale. It plans what money it expects to collect and what it plans to spend, usually for one year.

Key terms:

• Government budget: a plan of the government's expected revenue (mainly from taxes) and its planned spending, usually for one year.
• Government budget deficit: when government spending is greater than government revenue.
• Government budget surplus: when government revenue is greater than government spending.

If revenue and spending are exactly equal, the budget is balanced. There is no deficit and no surplus.

Calculating a deficit or surplus

The method is the same every time: compare revenue with spending.

• Spending bigger than revenue: deficit = spending - revenue.
• Revenue bigger than spending: surplus = revenue - spending.

A deficit means the government must find the extra money from somewhere, for example by borrowing. A surplus means it has money left over.

Where does the government spend?

Governments spend money in many areas. These are the main ones.

Why spend in each area, and what are the effects?

Each area has its own reasons and effects. The effects are not always good, because money spent in one area cannot be spent in another. That is opportunity cost.

• Education. Reason: a more educated workforce is more skilled, and education is a merit good that people may under-consume if left to the market. Effects: workers become more productive and can earn more, and the economy can grow. The benefit takes years to appear.
• Healthcare. Reason: healthy people can work and live longer, and many could not afford treatment without help. Effects: fewer days lost to illness and a healthier population. Healthcare spending can become very large as populations age.
• Defence. Reason: to protect the country and its people. Effects: a sense of security and jobs in the armed forces and in the firms that make equipment. The opportunity cost is that the money could have gone to schools or hospitals.
• Infrastructure. Reason: private firms may not build roads and railways that everyone can use, and good transport helps all businesses. Effects: lower transport costs, easier trade and more investment by firms. It also creates jobs while it is being built.
• Welfare. Reason: to give people a basic income if they are old, sick or unemployed, and to reduce poverty. Effects: more equal incomes and steady spending by households in hard times. Some argue that very generous welfare may weaken the incentive to look for work.
• Debt interest. Reason: the government has to pay it, because it borrowed in the past to cover deficits. Effects: this spending buys no new service. The more interest the government pays, the less is left for schools, hospitals and roads.

Governments differ in how much they spend in each area. Many countries debate whether more should go to one area or another. A good answer shows both sides.

Some spending is also provided directly by the government, which you met in the lesson Regulation and Direct Provision. Raising the money through taxes comes in the next lessons.

Exam-style question

The government of Sorvane plans its budget for next year. It expects revenue of $60 billion. It plans to spend $14 billion on education, $18 billion on healthcare, $6 billion on defence, $10 billion on infrastructure, $12 billion on welfare and $5 billion on debt interest.

(a) Define a government budget deficit. [2 marks]

(b) Calculate the size of Sorvane's budget deficit or surplus. [2 marks]

(c) Explain one reason for, and one effect of, government spending on healthcare. [4 marks]