From a macroeconomic perspective, the key functions of government are as follows:
- It purchases goods and services.
- It collects revenues through personal and corporate taxes and other fees.
- It gives transfers to households.
The amount that the government collects in taxes does not need to equal the amount that it pays out for government purchases and transfers. If the government spends more than it gathers in taxes, then it must borrow from the financial markets to make up the shortfall.
Figure 3.14 The Complete Circular Flow shows two flows into the government sector and one flow out. Since the flows in and out of the government sector must balance, we know that
government purchases = tax revenues − transfers + government borrowing.
Government borrowing is commonly referred to as the budget deficit. It is also possible that the government takes in more than it spends, in which case the government is saving rather than borrowing, so there is a budget surplus rather than a deficit. 1
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