What lies behind the fiscal deficit?

Tough interest struggles are hidden behind a fiscal deficit. The concealment is propelled as many of the interests at stake cannot be openly defended, privileges or advantages for a few and scorn or prejudice for population majorities. An opaque veil makes it harder to recognize how decisions are made regarding the composition of public spending, the State income structure, and the way to finance the fiscal deficit. The impact is hidden and the opportunity cost of each of these critical decisions is whisked away. In captured democracies that is one of the ways in which the imposition of flagrant inequities is accomplished.

It is worth explaining that a fiscal deficit is not an isolated fact, apart from the rest of facts that characterizes an economic system. On the contrary, the existence of fiscal deficits is closely linked with the diversity of factors that generate, reproduce, increase or reduce them. These factors transcend the sphere of what is merely economic; it has its roots in a complex web of interests and needs that struggle among them to prevail and impose.

A fiscal deficit exists when public expenditure outweighs public revenue. We refer to a primary fiscal deficit when the costs of interest payments and amortization of incurred debts are not included. If those financial payments are included, then we talk about a total fiscal deficit or plainly fiscal deficit.

Different types of deficits

A critical question that is seldom explicit is that there are different types of deficits, not just in terms of its magnitude (larger or smaller) but also for its nature (composition of public expenditure, public revenue, and way of financing them). What we must know is that every type of fiscal deficit generates different social and economic impacts that can reinforce the sustainability of the course of a society or can add to the effects of the prevailing concentration and inequality process that produces recurrent situations of instability and crisis.

Fiscal deficits run from moderate to large. Its size is associated with its level of functionality or dysfunction: the larger the fiscal deficit, the larger the dysfunction that permeates over the rest of the economic system. There are those who proclaim that it is imperative to always aim at having fiscal surplus but others state that such is not necessarily something positive for developing countries. A moderate fiscal deficit can boost the economy by adding an additional margin to consumption or investment through a public expenditure that surpasses what is collected as public revenue.

That public expenditure differential, larger than revenues, is covered by indebtedness or monetary issue which, if prudently managed, would not generate much disorder or distortion but rather an invigorating impulse for the economy. On the contrary, if fiscal deficit were to grow disproportionally and become permanent, the level of dysfunction would be greater and greater as the sources of funding (greater tax burden, larger monetary issue, or a serious increase in costs and availability of additional indebtedness) have destructive effects over economic activity, price stability, financial sustainability and affect decisional sovereignty.

So far we have said that a large and permanent fiscal deficit is unsustainable while smaller deficits could be beneficial if they were appropriately managed. What we have not dwelt on yet are how the different types of deficits are generated and what is the social and economic impact of each of them, including opportunity costs[1]. This leads us to the composition of public expenditure, public revenue, and the options that are available for financing a fiscal deficit.

That is, it is absolutely insufficient to only consider the magnitude of the deficit as behind that total (that aggregated variable, as we economists use to say) is hidden what is really important to analyze and solve: the varied interests and needs struggles between different actors that form each society. These struggles are solved in accordance with the power that each group holds. The most powerful have the ability to impose their interests over the rest, which does not mean that their interests are the only ones considered but rather that they are those that obtain more preeminence. Budgetary decisions are not taken based on one-person-one-vote rather on the ability of each actor to influence them.

In this way, the composition of public spending, the State’s revenue, and how fiscal deficit is financed impiously express the correlation of forces that prevails in the country and sub-national jurisdictions (provinces and municipalities). And even though they try to hide it, this process leaves favored and disadvantaged. The power to impose unequally distributes resources and responsibilities; establishes and reproduces privileges and lags.

Composition of public spending

Every expenditure item of public spending can be used to solve scarcity situations or to materialize latent potentialities that require the State’s assistance. Public resources can be allocated in many diverse sectors, such as road infrastructure, communications, irrigation and river basin management, social services like education, health, retirement and pension benefits, allocations to vulnerable sectors, citizenship security, environmental sanitation, public central administration, the judiciary and the legislative branch, armed forces, payment of amortizations and interests of public debt. There are not few sectors that struggle for resources which are always limited, so it is needed to establish priorities between and among sectors.

Thus, the prevailing correlation of forces (mediated by the colonization of minds done by the economic power with the complicity of certain strata of politics, media, the judiciary and the educational system) will prioritize sectors that benefit the already favored ones vis-à-vis those that assist larger population masses.  Based on that, they capture expenditure items of public spending for their own benefit. There are hundreds or thousands of cases through which this sordid establishment of priorities is materialized. A couple of example will suffice to illustrate this point.

Frequently, large corporations are able to finance activities linked to their interests with resources from the national budget, being those roads, port facilities, certain types of science and technology, among many others. These investments discharge them from indirect costs, thus increasing their returns. Of course there are other alternative uses for those resources such as education, health, environmental sanitation, popular housing, micro enterprise funding, and other types of science and technology applications, more related with medium and popular sectors. It is not that we should fund only some sectors and nothing for the rest; what is at stake here is the proportion of resources that is directed to majority sectors vis-à-vis those already privileged or with larger ability to stand on their own.

Let us see another example of priorities within one sector. Let suppose a situation in which the country has an acceptable backbone network of routes but with a poor web of secondary roads that obstruct the mobilization of persons and products. Who decides which secondary roads to build? Roads that serve powerful economic groups and relatively more advanced territories or, alternatively, small rural producers, artisan workshops in lagged towns or communities that could be enhanced if they were to be integrated into the national road system? Would secondary roads that endanger the environment and benefit real-estate speculators be financed?

Many decisions are annually taken when defining the composition of public spending and a large part of them are not transparent with the purpose of concealing openly indefensible interests. Some of them carry on allocations from previous years as powerful sectors have become entrenched to preserve them or, maybe, for inertia without considering other options with better socioeconomic and environmental impact.

Composition of public revenues

The other part of a fiscal deficit is the composition of public revenues. Among them we can find taxes, duties, and levies that the State has the prerogative to impose, profits from public enterprises, plus public indebtedness contracted to finance public works in social and productive infrastructure. Once again, there are favored and displaced sectors.

In our countries, the tax system tends to be blatantly regressive: those who receive less income and have less wealth pay proportionally more than affluent sectors. This is such for various motives, among which two stand out. On the one side, taxes that prevail are those easier to impose and collect, those that levy consumption in a uniform way without differentiating among consumers. These taxes affect much more popular and middle income sectors than those affluent because the first one destine a larger part of their budget to consumption. On the other hand, regressive bias of our tax system greatly increases when high-income-and-wealth sectors evade their fiscal responsibility, either by using legal loopholes or by directly conducting criminal activities punished by law. For that they can count on the complicity of financial entities, fiscal havens, and their teams of lawyers and accountants specialized in circumventing tax laws.

In some occasions, painful setbacks happen when countries that were able to move further towards a more equitable tax system by imposing additional tributes to affluent sectors, see how those advances are reverted by neoliberal governments that take control of the State.

It is clear that the fiscal deficit does not depend solely on the level and composition of public spending but also on the level and composition of the revenues that the State is able to collect. When imposing to lower a fiscal deficit through mainly or only adjusting public spending  without considering how to enhance the progressiveness of the tax system and the type of contracted indebtedness, is an ill-intentioned economic policy as it conceals the huge inequalities that stand on the side of the tax burden.

Fiscal deficit financing

What happens, then, when a fiscal deficit occurs? Unless a country declares the cease of payments, it will have to finance it, i.e., finding a way to close the gap between public revenues and expenditures. The way of doing it tends to be a combination of monetary issue to pay local creditors and new indebtedness in foreign currency to refinance debts with foreign creditors (individuals, countries, or international organizations). A few times an emergency additional tax is established for affluent sectors to pay so that the country can avoid contracting new debt or making a larger currency issue.

Each modality to finance a fiscal deficit produces a diverse order OF consequences and impacts, both over the economic system (an excessive monetary issue adds pressures to structural inflationary tensions, while postponing payments to local creditors tend to depress economic activity) as well as over the country’s decisional sovereignty (large indebtedness entails larger financial costs and conditionality imposed by creditors, and any cease of payments restricts the access to new indebtedness).

These are short term solutions; that is, once the fiscal gap occurs we need to find out how to close it. However, to avoid the reproduction and perpetuation of large fiscal deficits, we should opt for much different types of solutions.

Options to avoid large fiscal deficits

First thing we should point out is that there is no one way of solving a fiscal deficit. There are those who proclaim they hold the only alleged truth in this field and try to impose it. There is no such thing as a unique economic truth without any other possible options. In reality, there exist a variety of options according to the circumstances and phases of development that condition each situation. For the purpose of this brief article and with the appropriate apologies, we will reduce our analysis to two main approaches.

Neoliberal solutions

Neoliberalism is one policy approach. It proposes to reduce a fiscal deficit by adjusting public spending, particularly those expenditure items that do not affect the interests of the sectors that support the neoliberal course. This criterion is also projected at the level of the distribution of the tax burden. They state that by sacrificing that type of public expenditures and protecting revenues of affluent sectors, the conditions of stability and growth will be generated. They do not see that what is being sacrificed are the basic needs that make up for the general wellbeing and, together with that, a good part of the productive web formed by small and medium enterprises is destroyed.

There would be less or worse health, education, sanitation, science and technology, retirement and pension benefits, subsidies to vulnerable sectors, jobs and salaries in the public administration. Furthermore, as these policies are complemented by drastic increases in public utilities rates (gas, water, electricity, municipal taxes, among others) that only large corporations can transfer to prices, plus a non-gradual opening of imports, all will end up asphyxiating small and medium size enterprises. On top of that, there is also a policy of high interest rates to cool down the economy which, not by chance, serves as mechanism for transferring revenues to the financial sector, the most benefited sector by the neoliberal policies. The result of this combination of factors is well known: large unemployment, loss of purchasing power of salaries, shrinking of the internal market and tax collection, permanent need to keep on deepening the adjustment process, all of which ends up in the acceleration of the concentration process of wealth and its flip side of larger inequalities.

In summary, this neoliberal approach faces fiscal deficits loading the burden of its solution on the shoulders of middle-income and popular sectors whose wellbeing drops dramatically due to the adjustment in public expenditure items that finance their rights and the regressive tax structure that erodes their revenues. In the meantime, affluent sectors preserve their privileges which, in a context of weakness of the rest of the actors, enables the exponential grow of their assets and wealth.

Transforming solutions

Other, much different, options for addressing a fiscal deficit focus on measures that protect rights and needs of middle-income and popular sectors. These measures are part of the collective effort to transform and not restore the circumstances that generated the problems; among many of them, the following:

  • Faced with a fiscal deficit, do not affect public expenditure items that finance the rights of middle-income and popular sectors, but rather those that benefit affluent sectors that can stand on their own.
  • Enhance with no exception the effectiveness of public expenditure items by establishing efficient modalities of implementation.
  • Transform the tax system to distribute the tax burden, to make it clearly progressive in its normative and implementation.
  • Increase tax collection by dismounting mechanisms used to evade tax and illegally flight capitals.
  • Control of currency issue as part of the political economy that promotes production and organic growth of the economy.
  • Prevent monopolistic or oligopolistic price makers abusing others.
  • Practice a prudent and selective indebtedness orientated towards financing investments in the real economy that secure an organic growth.
  • Transform the productive matrix to avoid external bottlenecks, thus, reducing the pressures for more indebtedness and, at the same time, help locally maximizing the multiplying effects of new investments with positive impacts in tax collection.
  • We should also introduce equality in value chains to strengthen participating small and medium-size enterprises, much more intensive in job creation and less prone to capital flight than larger ones.

It would be a mistake to close these brief lines without explicitly recognizing other factors that go beyond economics and that are absolutely critical to tackle neoliberal solutions to fiscal deficit. Transforming solutions need middle-income and popular sectors’ organizations capable of decisively influencing public policies and the allocation of the State’s resources, backbone of the effort to free democracies captured by powerful minorities. In the same way, it is absolutely determining to address cultural hegemony that prevails in our countries through a permanent action of unveiling of what is concealed by supporting genuine voices and not just echoes of the hegemonic ones. Organization and unveiling concealments, foundations of full democracies.


[1] . The opportunity cost reflects what could have been done if we would have applied the available resources in a different way.



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