Debt vs. Deficit: What’s the Difference?

Debt vs. Deficit: An Overview

Debt and deficit are two of the most common terms in all of macro-finance. They’re also the most politically relevant, inspiring legislation and executive decisions that affect many people. Although people often use these words interchangeably, they are inherently different and the magnitude of each doesn’t necessarily have anything to do with the other. But it does have plenty to do with people’s personal situations, the health of corporations, and the underlying economy. Debt is any money that is owed to someone else while the term deficit refers to a situation where expenses exceed revenues or liabilities exceed assets. Put simply, debt is the accumulation of years of deficit and the occasional surplus.

Debt

The term debt basically means money that you owe money someone else. As such, it is negative by definition, which means it can never be positive. Entities borrow money from others to finance large purchases, make investments, and choose to grow when they don’t have enough capital themselves. Doing so puts them into and increases their debt. Despite the negative connotation, it doesn’t necessarily indicate a weak economy or situation.

Individuals incur debt when they borrow from banks, lenders, and other individuals to finance large purchases, such as cars and homes. Types of consumer debt include credit cards, loans, and mortgages. Without these types of debt, people wouldn’t be able to afford basic necessities like housing.

Companies and countries incur debt by borrowing from investors when they issue bonds. These are obligations that need to be paid back to bondholders by some date. That date, which is called the maturity date, is usually fixed. Government debt, for instance, depends on whether the money is in the form of:

• Treasury bills (less than a year)
• Treasury notes (1 to 10 years)
• Treasury bonds (beyond)
• One of the many other securities the federal government issues

The U.S. government’s ability to pay its debts becomes a vicious or virtuous circle. The national debt was more than $31.1 trillion in October 2022, which was a record. The government’s full faith and credit is so strong that it makes these T-bills and other obligations attractive enough to entice investors, which then encourages subsequent issues of debt. This becomes problematic when the Treasury lends money to private investors and to the Federal Reserve, paying the right pocket with what it has in the left pocket, to say nothing of foreign governments.

Deficit

A deficit is simply the negative version of a surplus. To calculate a deficit, subtract any expenditures from total revenue or total liabilities from total liabilities. Anyone can run a deficit, whether that’s an individual, household, corporation, or government. Of course, with a private company, a deficit is normally called a loss (a surplus is called a profit).

Running a deficit can increase the level of debt an entity has, which is why people believe that deficits can be unsustainable over time. For instance, a consumer runs a deficit if they owe $150 but only have $100 to cover all their expenses. They can continue running in a deficit if their assets don’t increase but their liabilities do or if they keep spending more money than they make.

Corporations and governments can increase their deficits by spending more. As such, running a deficit continues to eat away at any surplus balance they have. Deficits come with a negative connotation but they aren’t necessarily a bad thing. For instance, governments try to boost economic growth when they increase their spending and, therefore, increase their deficit.

There are a number of different types of deficits. The main ones include:

• Budget Deficits: These occur when expenses exceed revenue. Budget deficits are generally used to describe the health and well-being of a country. Governments normally run a budget deficit when the amount they spend (on social programs and other obligations) exceeds the amount of tax revenue they collect. The projected deficit for the U.S. was about $3 trillion in 2021.
• Trade Deficits: These deficits occur when a country’s exports are less than its imports. Trade deficits are also called negative balances of trade.
• Revenue Deficits: These happen when the projected net income is more than realized net income.

Key Differences

We’ve highlighted some of the obvious differences between debt and deficit. But now let’s take a look at some of the key factors that set these two apart.

Repayment

Deficits don’t rely on principal and interest payments as there is no external party to whom the entity owes any money. But that isn’t the case with debt.

Debt involves the need to repay interest. For instance, when you take out a loan to purchase a car, the lender charges interest on top of the principal balance. This is known as the cost of borrowing. You pay this additional charge until the loan is paid off in full.

Similarly, corporations and governments pay investors interest at regular intervals when they purchase bonds. Once the maturity date hits, the debt issuer pays the principal balance back to the investor.

Sources

Another key difference is the source of the debt and deficit. With debt, you end up owing someone else money that you borrow from them. This may be a bank, another financial institution, another country, or another individual. So a debtor has to go to a lender to borrow money.

Deficits, on the other hand, don’t involve a third party. That’s because you end up spending more of your own money. As such, households, companies, and governments run deficits on their own.

Consistency

The amount of debt can change over time because you can either add to it or pay it down. Interest also factors into the amount of money an entity owes to someone else. This principle doesn’t apply to deficits, which can remain the same if governments take careful steps with the amount of money they spend on an annual basis.

Special Considerations

In this section, we look at the difference between the national debt and the budget deficit, which have to do with accounting and cash flows. When governments borrow, they issue bonds and effectively go into debt. Bondholders purchase these coupons and become the lenders or creditors. The money raised through bond sales can be used for purposes such as spending on infrastructure, military readiness, and welfare benefits.

A government deficit occurs when more money is spent (often by borrowing) than what comes in as income. In the case of a national budget deficit, this means that government expenditures exceed inflows from taxes and other revenues, such as fines, duties, and fees.

These two items are often related to one another in the economy. If a government spends more than it receives, it may be forced to raise additional money via borrowing in order to cover all of its obligations (including interest payments on prior debts). One alternative is to raise taxes to generate more income instead of borrowing; however, tax hikes are almost universally admonished by most voters, and so can be politically harmful.

If budget deficits widen and debt balloons, it can cause economic instability and ultimately lead to a recession and the devaluation of the currency as people lose confidence in the government’s ability to handle its finances and continue repaying ongoing obligations.