44 Federal Budget and Spending

The Federal Budget

The federal budget is the annual statement of the expenditures and tax revenues of the government of the United States. The President proposes a budget to Congress in February. The Congress passes budget acts by September and the President either signs them or vetoes them.

Budget balance = Tax revenues — Outlays

If tax revenues exceed outlays, the government has a budget surplus.

If outlays exceed tax revenues, the government has a budget deficit.

In recent years, the federal government has run a budget deficit. For the 2014 fiscal year, the projected U.S. budget balance is $3,000 billion − $3,627 billion = −$627 billion, that is, a budget deficit of $627 billion. In 2009, the U.S. government experienced its largest budget deficit ever, as the federal government spent $1.4 trillion more than it collected in taxes. This deficit was about 10% of the size of the U.S. GDP in 2009, making it by far the largest budget deficit relative to GDP since World War II.

Personal income taxes ($1,358 billion) and Social Security taxes ($1,031 billion) are the two largest sources of tax revenues. Transfer payments ($2,253 billion) — Social Security benefits, Medicare and Medicaid benefits, unemployment benefits, and other cash benefits paid to individuals and firms — and expenditure on goods and services ($1,152 billion) are the two largest components of government outlays.

Baby boomers will result in a massive increase in the Social Security and Medicare benefits that need to be paid. The government’s Social Security and Medicare obligations are a debt (estimated at $91 trillion) that must be considered when developing a path towards fiscal sustainability. The options for addressing the Social Security and Medicare time-bomb include raising income taxes, raising Social Security taxes, cutting Social Security benefits, and cutting other federal government spending. While all of these options entail major sacrifices, a combination of these measures will lessen the severity of the sacrifices. (21)

Federal Spending

Each year, the government borrows funds from U.S. citizens and foreigners to cover its budget deficits. It does this by selling securities (Treasury bonds, notes, and bills) — in essence borrowing from the public and promising to repay with interest in the future. From 1961 to 1997, the U.S. government has run budget deficits, and thus borrowed funds, in almost every year. It had budget surpluses from 1998 to 2001, and then returned to deficits.

The interest payments on past federal government borrowing were typically 1–2% of GDP in the 1960s and 1970s but then climbed above 3% of GDP in the 1980s and stayed there until the late 1990s. The government was able to repay some of its past borrowing by running surpluses from 1998 to 2001 and, with help from low interest rates, the interest payments on past federal government borrowing had fallen back to 1.4% of GDP by 2012.

National debt is the amount of outstanding government debt that has arisen from past budget deficits. The difference between the deficit and the debt lies in the time frame. The government deficit (or surplus) refers to what happens with the federal government budget each year. The government debt is accumulated over time; it is the sum of all past deficits and surpluses.

If you borrow $10,000 per year for each of the four years of college, you might say that your annual deficit was $10,000, but your accumulated debt over the four years is $40,000.

These four categories — national defense, Social Security, healthcare, and interest payments — account for roughly 71% of all federal spending, as Figure 6.5 shows. The remaining 29% wedge of the pie chart covers all other categories of federal government spending: international affairs; science and technology; natural resources and the environment; transportation; housing; education; income support for the poor; community and regional development; law enforcement and the judicial system; and the administrative costs of running the government. (22)

About 73% of government spending goes to four major areas: national defense, Social Security, healthcare, and interest payments on past borrowing. This leaves about 29% of federal spending for all other functions of the U.S. government.
Figure 6-115: Federal Spending, 2014 by Openstax is licensed under CC-BY-4.0

The Path from Deficits to Surpluses to Deficits

Why did the budget deficits suddenly turn to surpluses from 1998 to 2001? And why did the surpluses return to deficits in 2002? Why did the deficit become so large after 2007? Figure 6.6 suggests some answers.

When government spending exceeds taxes, the gap is the budget deficit. When taxes exceed spending, the gap is a budget surplus. The recessionary period starting in late 2007 saw higher spending and lower taxes, combining to create a large deficit in 2009.
Figure 6-6: Total Government Spending and Taxes as a Share of GDP, 1990–2014 by Openstax is licensed under CC-BY-4.0

Government spending as a share of GDP declined steadily through the 1990s. The biggest single reason was that defense spending declined from 5.2% of GDP in 1990 to 3.0% in 2000, but interest payments by the federal government also fell by about 1.0% of GDP. However, federal tax collections increased substantially in the later 1990s, jumping from 18.1% of GDP in 1994 to 20.8% in 2000. Powerful economic growth in the late 1990s fueled the boom in taxes. Personal income taxes rise as income goes up; payroll taxes rise as jobs and payrolls go up; corporate income taxes rise as profits go up. At the same time, government spending on transfer payments such as unemployment benefits, foods stamps, and welfare declined with more people working.

This sharp increase in tax revenues and decrease in expenditures on transfer payments was largely unexpected even by experienced budget analysts, and so budget surpluses came as a surprise. But in the early 2000s, many of these factors started running in reverse. Tax revenues sagged, due largely to the recession that started in March 2001, which reduced revenues. A series of tax cuts was enacted by Congress and signed into law by President George W. Bush, starting in 2001. In addition, government spending swelled due to increases in defense, healthcare, education, Social Security, and support programs for those who were hurt by the recession and the slow growth that followed. Deficits returned. When the severe recession hit in late 2007, spending climbed and tax collections fell to historically unusual levels, resulting in enormous deficits. (22)


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