Budget Deficits and the National Debt

To understand fiscal health, we must distinguish between a flow and a stock. A budget deficit is a flow: it occurs in a single year when government spending ($G$) exceeds tax revenue ($T$). Mathematically, if $G > T$, the result is a deficit. Conversely, a budget surplus occurs if $T > G$. The national debt is a stock: it is the total accumulation of all past annual deficits minus any surpluses. Think of the deficit as the water flowing from a faucet into a bathtub (the debt). Even a small flow will eventually fill the tub if it never drains.

When the government runs a deficit, it must borrow money by selling Treasury bonds. This increases the demand for 'loanable funds' in financial markets. According to the laws of supply and demand, an increase in demand for loans drives up the interest rate ($r$). As $r$ increases, it becomes more expensive for private businesses to borrow money for new factories or technology. This phenomenon is called the crowding out effect. Essentially, government borrowing 'crowds out' private investment ($I$), which can slow down long-term economic growth.

Some economists advocate for a Balanced Budget Amendment (BBA), which would legally require $G = T$ every year. Proponents argue this ensures fiscal responsibility and protects future generations from interest burdens. However, critics argue a BBA would be pro-cyclical. During a recession, tax revenues ($T$) naturally fall. To keep the budget balanced, the government would be forced to cut spending or raise taxes—exactly the opposite of the expansionary fiscal policy needed to fix a recession. This could turn a mild downturn into a deep depression.