Pursuing Budget Balance

One indicator of sensible fiscal practices is maintaining balance between spending and revenues. However, occasional deficits may be necessary. They may even be practical to counteract economic downturns or spur growth. Annual deficits are caused when spending exceeds revenue in a given year. They can accumulate into ongoing debt. This is the grand total of all past annual deficits and surpluses. During periods of low interest rates, government may be able to handle high debt with relative ease. But when interest rates are higher, the cost of debt increases.

The federal government often runs an annual budget deficit. Since 2001, it has run a deficit each year. The deficit hit record levels in the wake of the COVID-19 pandemic. While it has since decreased, the deficit remains high by historical measures.

Unsustainable deficits and debt can cause stress to economic systems over time. Eventually, they may undermine investor confidence in government bonds. Interest rates may increase, investments and productivity may decline, and economic growth may be undermined. Deficits and debts may force the government to cut spending and limit policymakers’ ability to react to economic crises.

Federal policymakers face challenges in attempting to balance the budget. They need to adopt fiscal policies that cut the deficit to sustainable levels without jeopardizing economic growth or essential social programs. Periods of solid economic growth are the most opportune moments to keep the national debt under control.

Balancing budgets has its own set of unique challenges at the state and local levels. State budget dynamics are different from those of the federal government due in part to states’ balanced budget requirements. Generally, this requirement applies only to states’ operating budgets. State investments in capital projects, such as roads, bridges, and school construction, are not subject to the requirements. Instead, they can be financed through bonds or other borrowing measures.  

Some states use rainy day funds to help them maintain budget balance. These are special funds built up during good economic times used to cushion the blow of unexpected economic adversity. These funds often help sustain spending on needed public programs during recessions. In contrast, states with balanced budget requirements but no rainy day funds must reduce spending during recessions. Unlike the federal government, states cannot finance budget deficits by issuing debt. This removes even more money from the economy and compounds the effects of the recession.

During economic downturns, some states need new revenue sources to keep their budgets balanced. Policymakers often resort to temporary or one-time revenue sources for the additional funds. However, this type of funding is unstable and cannot sustain vital programs over the long term.