External environment - Government policy

Theory 4 - Surplus or deficit - do we care?

We often hear about the government running a budget surplus or deficit, but what does this mean? Well governments tend to generally spend more than they collect in tax revenue. Like anyone else spending more than they have, they have to borrow the difference. This situation is described as the government running a budget deficit.

The opposite situation is, of course, possible where the government spends less that they collect in tax, though it is quite rare given the pressure governments tend to be under to provide constantly improving public services. In this case, the situation would be described as a budget surplus.

The amount that the government need to borrow is called the Public Sector Net Cash Requirement (PSNCR). This amount will depend on a lot of factors, some of them political, but a key determinant will be the level of economic growth. If economic growth is healthy then tax revenue from income tax will be rising, people's spending will be increasing and so taxes like VAT will be yielding good levels of revenue and companies will tend to be more profitable, meaning that corporation tax receipts will also be healthy. All this, combined with lower spending on unemployment and other benefits will mean a healthy situation for the government. However, once growth starts to fall, then all these effects will start to be reversed and governments will find their spending on benefits and so on increasing, while their tax receipts are falling. This will tend to increase the PSNCR significantly.