Define the term budget deficit (as it applies to the federal government) and describe the difference between a cyclical deficit and a structural deficit. Provide a hypothetical numerical example to help support your answer

Answer 1

A federal budget deficit occurs when government expenditures exceed tax revenues. A cyclical deficit is the part of the budget deficit that results from a downturn in economic activity. Any remaining deficit is termed a structural deficit and is the part of the deficit that would exist if the economy were operating at full employment. For example, assume that government expenditures are currently $500 billion and tax revenues are currently $450 billion, resulting in a $50 billion budget deficit. Assume further that the government estimates that if the economy were operating at full employment government expenditures would only be $475 billion and tax revenues would be $460 billion. From this information we can conclude that the deficit at full employment would be $15 billion (the structural deficit). Based on the previous calculation of the budget deficit at $50 billion, we can conclude that the cyclical deficit is $35 billion.