What is Budget Surplus: Its Effects, Advantages and Impact with Examples
When the revenue of a government, business, or individual exceeds its expenses in a given period, it is known as a budget surplus. If a government has a budget surplus, it means that the economy is doing good and managing its income and expenses well. The government can use budget surplus as a means to clear debt, saving for future expenses or invest in infrastructure or other programmes.
Let’s dig deeper to learn more about the importance and uses of budget surplus, its calculation, benefits and limitations. Read on!
What is the Importance of Budget Surplus?
Budget surplus can help a Government clear debts and prepare for emergencies like recession. This way, the government can save on interests that they must pay to other countries, international organisations and banks.
In other words, balancing the budget will allow them to control their policies during hard times.
Components of a Balanced Budget
A balanced budget comprises revenues and expenses.
1. Revenues
NGOs, businesses and corporations earn revenues from the purchase and sale of goods and services. Government on the other hand, earns it from taxes or interests on debts that they offer to other nations.
2. Expenses
Businesses spend on working capital for business operations, including raw material costs, production costs, rent and salaries. Government expenditures include costs of infrastructure development, maintenance, defense, pensions, etc.
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How to Calculate a Budget Surplus?
Budget Surplus is the difference between the total income and total expenditure. A negative figure will indicate a budget deficit, whereas a positive figure will mean a budget surplus. Let’s understand this with an example.
The government of India reported a budget surplus in July 2022, which includes a revenue account surplus of Rs.42,509 crore and a fiscal account surplus of Rs.11,040 crore. This is the first time after March 2020 that the government has reported a fiscal account surplus. The primary reason behind this surplus is a steep rise in income from taxes and significant cuts in revenue spending.
Uses of Budget Surplus
The use of a budget surplus varies based on the entity that has the surplus. Here is how governments, businesses, and individuals use their budget surpluses:
1. Governments
There are multiple ways in which governments use their budget surpluses. Here are some of them:
- Tax reduction
- Funding existing development projects or starting new ones
- Funding research and other national initiatives
- Clearing debts
- Increasing defense spending
- Improving the infrastructure
- Saving for deficit situations
2. Businesses
Here are some ways in which businesses use their budget surpluses
- Business expansion
- Acquisitions
- Loan repayments
- Dividends to shareholders
- Buying back company stocks
- Allocating more towards initiatives related to corporate social responsibility
- Research and training
3. Individuals
Individuals generally use their budget surplus to clear their loans to save for future contingencies or any personal expenses.
Effects of Budget Surplus
Some of the notable effects of a budget surplus are below:
1. Affects Economic Growth
If the government’s income is more than its expenditure, it is natural to wonder where the surplus will be used. The government may use it to either pay off its existing loans, fund infrastructure or employ it for any of the above causes.
Debt reduction may also lead to a decrease in the money supply, which may create deflationary pressures or negatively affect consumer behavior.
2. Decreases Government Loans
Most governments use their surplus to repay their loans. For instance, many countries globally are under enormous debt. For example, Greece sought help from IMF and EU bailouts to stay afloat. Using the surplus to pay off loans can help to ease the economic pressure.
3. Reduces Interest Rates
A surplus situation declared by the government sends a message that debt levels can go down. Thus, the risk involved in lending to the government will be low. This will reduce the gilts or government bonds in circulation, leading to a decline in interest rates.
4. Taxes
If the surplus results from high taxes, it may leave consumers and companies with lesser funds for investments and expenditures, thereby decreasing the demand for goods and services. This will further increase deflationary pressure.
5. Cost Cuts on Critical Public Services
If the reason behind the budget surplus is a decrease in government expenditure, it may mean the amount of funds available for public services is low. Thus, the government will have to decide where to cut spending. These cuts may be from defense, healthcare, education, or other important sectors.
Advantages and Disadvantages of a Budget Surplus
Advantages of Budget Surplus:
1. Fiscal Flexibility
A budget surplus offers governments the space and capability to do what is important for the nation. While the flexibility may not be significant if the surplus is short-lived, it will make a difference if there is a surplus over a sizable period. If the surplus continues across consecutive periods, the debt burden on the government will decrease, increasing flexibility.
This generally implies that the government will now be able to spend more or decrease the taxes in their bid to stimulate the economy. This is impossible to achieve when the debt and budget deficit are high.
2. Combating Inflation
Inflation can cause ripples in the economy. This can happen both during times of economic slowdown or high economic growth. The primary reason for inflation is an increase in the supply of funds. Thus, when a budget surplus takes money out of the economy, it combats inflation.
3. Low-interest Rates
A country’s need to borrow money goes down with a large budget surplus. It can also clear its existing loans and decrease the debt burden. This will reduce the country’s risk of defaulting on its loans; thus, investors will regard the government debt as a low-risk investment. Due to the high demand for government debt, interest rates go down.
4. Decrease in Government Debt
A budget surplus is most commonly used to repay the loan accumulated during the deficit phase. Thus, the debt burden will decrease, and the country’s global reputation will improve. This will help the government to obtain loans in the future with ease.
Drawbacks of Budget Surplus:
1. Deflationary Effect
A government budget surplus reduces the money in circulation and thus has the potential to create a deflationary effect.
2. Lower Investment Levels
A budget surplus means that the amount of money withdrawn from the economy exceeds the amount invested. As consumers and businesses pay more taxes, they are left with less to spend or invest. It may not directly affect investments, but potential investments can go down.
3. Economic Slump
Since high taxes (than expenditures) remove money from the wider economy, it may reduce the money available for private firms to invest in business and equipment. This can be detrimental to economic growth.
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Difference Between Budget Surplus and Budget Deficit
A budget surplus occurs when the government earns more than it spends. On the contrary, a budget deficit occurs when the expenditure is more than the income.
The reasons behind a deficit could be increased government spending or lower tax collection, whereas those behind a surplus may be reduced spending or higher tax collection.
Final Word
If a government is able to channelise the budget surplus properly, it can save the nation from a recession. However, it can also have certain disadvantages, and thus caution is necessary to ensure that the surplus is used for the nation’s benefit.
FAQs
Ans: There are three types of government budgets – balanced budgets, deficit budgets, and surplus budgets.
Ans: A balanced budget is a financial planning situation in which the prospective revenues are equal to the planned expenses.
Ans: Whether or not a budget surplus is good depends on how the government spends it. If spent wisely, it can help the government to get rid of its debts. However, if the surplus is due to poor public services or exorbitant taxes, it can cause an economic slowdown.
Ans: The budget surplus formula is below:
Budget surplus= Total income- total expenditure
Ans: When the government uses a budget surplus to clear its debts, it reduces the money circulating in the economy. This leaves consumers and businesses with less money; thus, there isn’t enough for spending or investment. This reduces demand and causes deflation.
