Chapter 14, Problem 14.1LO

To determine

Causes of government budget deficits and meaning of public debt.

Concept:

Budget deficits: It occurs when the government’s expenditure exceeds its estimated revenue.

Public Debt: It is also called as government debt. It represents the total outstanding liability of a country’s federal government. It arises when the government borrows money to finance their expenditures (when tax revenues aren’t high enough).

Explanation of Solution

The federal government budget deficits occur because of the following reasons:

(a) High spending and low taxes: The government can face budget deficit if they are spending too much and/or keeping the taxes low. This would lead to a deficit on government budget. Sometimes the government spends more and levy lower taxes in order to gain popularity and votes.

(b) High level of tax avoidance or tax evasion: Most of the time people and businessmen takes advantage of tax loop holes and don’t pay the taxes. The governments in some countries are less effective. So, the tax collection drops and causes to a budget deficit.

(c) Demographic pressure: If the country has ageing population, then government spending will be more on the state pension and their health care facility. The tax rate will also be low. While, a fast growing population will also put more pressure on the government to fund essential public and merit goods.

(d) Fundamental macroeconomics shifts: In the time of recession, the government has to spend more and decrease the tax rate in order to boost aggregate demand. This also causes to a government budget deficit.