What is government deficit and why does it matter?

Government deficit is a key indicator that attracts a lot of policy interest. It reflects when the fiscal balance – also referred to as net lending (+) minus net borrowing (-) – is negative. The fiscal balance represents the difference between the revenue and expenditure of general government for a specific reference period, and is calculated following the rules of the System of National Accounts, specifically the 2008 SNA for non-European countries and the European System of Accounts (ESA 2010) for European countries.

This article outlines how government total revenue and expenditure are calculated and how the fiscal balance is derived, and it explains why analysts have a particular interest in cases where governments run a deficit. Furthermore, it sheds light on how government expenditure is allocated across the different functions of government according to the COFOG classification, offering users deeper insights into the specific purpose of the various government expenses. This classification is currently being revised, to better align the breakdowns to the main policy domains of today.

The fiscal balance covers all entities within the government sector, including central, local, and state governments, as well as social security institutions. It excludes public corporations – entities controlled by government but classified in the corporate sector because they produce market output – which taken together with general government make up the broader public sector. A positive balance indicates that the government has earned more than it has spent, allowing it to reduce the government debt or to invest. A negative balance (i.e., government deficit) makes the government a net borrower, requiring additional funds to finance its activities. It is often expressed as a percentage of GDP, providing a useful measure of fiscal sustainability.

While deficits may allow countries to maintain living conditions during economic shocks (such as financial crises and the COVID-19 pandemic, etc.), recurrent deficits imply an accumulation of debt that may constrain governments capacity to respond to future shocks. Furthermore, it may lead to growing pressures on public finances and discourage consumption and investment decisions. For all these reasons, government deficit is highly scrutinised by financial analysts, policy makers, monetary authorities, and investors, among others, in order to assess the economic impact of deficits and to monitor the sustainability of government finances. Figure 1 presents the fiscal balance across OECD countries for 2023 and 2024 where available. In 2023, the average general government fiscal balance across OECD countries was 4.6% of GDP, indicating a widespread government deficit. In 2023, only six OECD countries recorded a fiscal surplus, whereas 31 member countries ran fiscal deficits, highlighting the overall trend of most governments spending more than they receive.

In addition to net lending/net borrowing, analysts often examine net saving, as the former may be heavily influenced by government investments – such as in infrastructure, R&D, green energy, or digital transformation. These investments, along with investment grants used to acquire fixed assets for specific projects (e.g. large-scale construction projects), differ from current expenditures because they create long-term value and support economic growth. For this reason, many analysts focus more on the balance between current revenues and current expenses, applying the principle that current revenues should fully cover current expenditures, allowing that investments can be financed by borrowing.

Government revenue mainly consists of “compulsory levies”, i.e., taxes and social contributions. However, it also includes other sources such as from sales of goods and services (typically provided by government entities at below market prices), property income and various other public revenues.

Government expenditure mainly includes intermediate consumption (i.e., purchases of goods and services used as input for government output), employee compensation (including employer social contributions), social benefits, subsidies and other transfers to households, interest charges, and gross fixed capital formation (investments).

The complete equations for total government revenue and expenditure are as follows:

When spending, governments need to strike a balance between achieving their policy goals and maintaining fiscal discipline. Expenditures on essential public services – such as healthcare, pensions, education, and infrastructure – can stimulate economic activity, but must be balanced against the state’s capacity to generate revenue, primarily through taxation. Strong economic growth typically supports fiscal health by boosting tax revenues, while periods of sluggish growth or decline tend to widen deficits. In addition, high levels of existing public debt can amplify deficits, as a growing share of public funds is required to service interest payments. Political decisions – such as expanding social programs, introducing tax cuts, or implementing austerity measures – also play a significant role in shaping the fiscal balance and are important elements to consider in any analysis of government deficits.

Expressing the deficit as a percentage of (nominal) GDP allows economists and policymakers to assess how significant the deficit is relative to the size of a country’s economy and enables international comparisons (see Understanding national accounts Box 9.3). This ratio provides insight into the long-term sustainability of public finances and the government’s ability to manage its budget without accumulating excessive debt. When the deficit grows faster than GDP, it can lead to rising public debt and financial instability.

Figure 2 presents the breakdown of total revenue and expenditure for France, Norway, and Japan. It reflects different fiscal strategies and priorities of the countries, shaped by their unique economic and political contexts.

It illustrates that the majority of France’s government expenditure consist of social benefits and social transfers in kind – services provided directly to households by government, such as health care and education. These constitute 25.6% of GDP, reflecting the country’s strong social safety net and welfare programs. On the revenue side, France relies heavily on taxes (28.1% of GDP) and social contributions (16.5% of GDP), underscoring the central role of compulsory levies in financing public services.

Like France, Norway relies on taxes and social contributions as key sources of revenue—though social contributions play a somewhat smaller role. Norway’s fiscal profile is distinguished, however, by its substantial property income, representing 17.7% of GDP. This revenue largely stems from distributed income generated by state-owned corporations engaged in petroleum activities. On the expenditure side, Norway records relatively large investments, with gross capital formation representing 5.4% of GDP, indicating a focus on long-term investments. Overall, a positive balance is recorded, with revenues exceeding expenditures. Norway is one of the few OECD countries in this situation, holding the largest net lending position in 2024 at 13.1% of GDP (see also Figure 1).

Japan’s government revenue structure is based primarily on taxes, which account for 20.5% of GDP – lower than in France and Norway – and social contributions, which represent 13.4% of GDP, a level comparable to the other two countries. The expenditure side shows a more modest profile overall, with the largest portion allocated to social benefits and social transfers in kind (20.9% of GDP), likely reflecting Japan’s aging population and the need for pension and healthcare support. However, spending on compensation of employees (5.1% of GDP) and investments (i.e., gross capital formation) (4.0% of GDP) is significantly lower than in France and Norway, suggesting a smaller size and role of the government in the economy.

The Classification of the Functions of Government (COFOG) is an internationally agreed standard used to categorise government expenditures based on their purpose. It enables analysis of how government spending is distributed across different levels of government – central, state, local, and social security funds – and across key areas, such as health, education, defence, environmental protection, etc. – thus providing a measure of the relative weight of the various public service provisions. COFOG also facilitates the examination of government expenditure trends over time and supports international comparisons.

COFOG consists of ten Divisions: General public services (01), Defence (02), Public order and safety (03), Economic affairs (04), Environmental protection (05), Housing and community amenities (06), Health (07), Recreation and culture (08), Education (09), and Social protection (10). Each division is further broken down into groups and classes, providing a detailed framework for expenditure analysis.

The COFOG classification distinguishes between individual and collective consumption expenditure. The former concerns expenses that benefit specific groups of households, such associal services, health and education. The latter includes expenses that benefit the community at large, such as defence, public order and safety, infrastructure and network services.

The OECD collects and publishes COFOG data on Division and Group level of detail. These data are available in the dataset: Annual government expenditure by function (COFOG). Furthermore, the publication National Accounts at a Glance (NAAG) Chapter 6A presents government expenditure by function at the Division level as a percentage of GDP:  NAAG Chapter 6A: Government expenditure by function.

Figure 3 presents an interactive chart on government expenditure by function for G7 countries (except Canada) for the year 2023. Users can view the data expressed either as percentage of GDP or as percentage of total government expenditure. The chart is organised at the COFOG Division level but can be expanded to the COFOG Group level by clicking on the relevant category (where available).

In most of the countries presented, social protection constitutes the largest category of government spending as percentage of the GDP in 2023 and within this category, old-age benefits (i.e., pensions) represent the largest share. This is followed by health expenditures, particularly those related to hospital services, expenditures relating to economic affairs, and general public services, the ranking depending on the country. Among G7 countries, the highest government spending on defence in 2023 was recorded in the United States (3.0% of GDP), followed by the United Kingdom (2.2% of GDP), and France (1.8% of GDP).

When analysing these results, it is important to consider that the scope of the government sector may vary slightly across countries. In some countries, health and education are publicly funded and considered part of the government sector, while in others these services may fall outside government spending. For instance, there is a notable difference in the classification of hospital expenditures between France and Germany. In France, hospital spending accounted for 41.8% of total health expenditures in 2023, compared to 36.5% in Germany. This discrepancy is partly due to the classification of many German hospitals as public corporations (i.e. outside of the general government). In contrast, similar institutions in France are included within general government.

These classification differences can affect the categorisation of public expenditure, particularly in areas such as compensation of employees, and should be taken into account when making international comparisons.

The COFOG classification is currently being revised to better reflect evolving data needs and policy priorities (see here for more information). Proposed updates include (i) incorporating new policy areas related to environmental protection, research and development, digitalisation, and education; (ii) improving the classification of multi-purpose spending, for example, infrastructure projects that contribute to both economic development and environmental protection; (iii) enhancing granularity to allow more detailed analysis; and (iv) aligning with updated frameworks, such as the Classification of Individual Consumption by Purpose (COICOP).

The revised COFOG classification is expected to be completed by 2027.