Economics of a Budget (Fiscal) Surplus

Budget surpluses are rare for the UK. The last one happened nearly twenty years ago.

What might cause a budget surplus?

• Strong tax revenues e.g. from high employment, rising incomes or taxes of profits / rents from natural resource exports.
• Typically a government’s fiscal position improves when the economy is experiencing a period of strong economic growth.
• Direct and indirect tax revenues grow (including the effects of fiscal drag) whilst welfare spending drops (as unemployment declines).
• But a fiscal surplus might also be the result of a long period of fiscal austerity involving higher tax rates and deep cuts in state spending.

Advantages of a budget surplus

• A surplus allows a government to repay some of their existing national debt
• This might lead to a fall in bond yields which makes future government borrowing less expensive
• A budget surplus gives a government scope for meeting a future crisis e.g. a fiscal stimulus during a downturn or in response to an external shock
• Government might use a budget surplus to cut taxes to stimulate the supply-side of the economy
• Surplus revenues might be used to fund an increase in public sector infrastructure spending

Potential drawbacks of a budget surplus

• If taxes > government spending, this is a net leakage from the circular flow of income which can have a deflationary effect on real GDP
• Fiscal austerity to achieve a budget surplus can have damaging effects on the quality of public services and might increase inequality
• There is nothing inherently wrong in running a budget deficit – especially during a downturn or to increase infrastructure investment
• There is an argument for countries such as Germany to make bigger use of a fiscal stimulus to help other nations inside the Euro Zone