The Federal Budget

1

Who Decides?

• Law• President• Realities of political system• “Power of the Purse” with Congress

– Constitution does not specify HOW Congress does this

2

Appropriation Bills

• Specify how much money will go to different agencies and programs

• Legislation must be passed to give the federal government the legal authority to spend the money (authorization bills)

3

Mandatory Spending

• Government must (by law) pay out benefits to all eligible recipients– Example: Social Security

– Made up of mostly earned – benefit programs– Spending is determined by eligibility rules

4

Mandatory Spending

• Example:• Congress decides to create a program like the

Supplemental Nutrition Assistance program (SNAP) (know as food stamps)– Set a criteria for who is eligible– Amount of money is determined each year is

determined by how many people are eligible– Congress can change the eligibility rules

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• Mandatory spending makes up nearly 2/3s of total federal budget– Social Security is the largest

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Discretionary Spending

• Spending that goes through annual appropriations process each year

• Congress sets the level of spending on discretionary programs

• (Congress can choose to increase or decrease)

8

TAX BREAKS

• When the government gives a tax break it is choosing to give up tax revenue

• This is done to benefit society• Tax breaks are expected to cost the federal

government 1.24 trillion in 2015– Examples: low taxes on capital gains, home

mortgage interest

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The Federal Budget

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Budget DeficitsThe amount by which government spendingexceeds governmentrevenues in a single

year.

National DebtThe total amount of

money the federal government owes to pay for accumulated

deficits.

Contrast Deficit versus Debt (how related?)

Two Key Terms needed for understanding the Budget:

Over $9,500,000,000,000(Almost 70% of GDP)

Debt/Deficit

• Government debt is the total of all past government deficits. For example, if the government runs deficits of $1 billion a year for ten years, the addition to debt is $10 billion

• The federal debt is held by the public, as a percentage of GDP

14

Budgets, Deficit Spending, & National Debt• The Growing Federal Budget (Outlays):

– George Washington’s Budget=> $3-5M per year– Post Civil War costs=> $1B+ then down again– WWI=> back up to $1B– 1962=> $100B– 1987=> $1 Trillion ($1,000,000,000,000)– 2001=> $1.8 Trillion– 2003=> $2.212 Trillion– 2004=> $2.272 Trillion– 2005=> $2.338 Trillion– 2006=> $2.5 Trillion– 2007=> $2.77 Trillion– 2008=> $2.8885 Trillion

– 2009=> $3.1 Trillion (President Bush’s Budget submit- Feb 2008)15

The Rise and Fall of Deficit Spending • 19th Century=> Balanced Budget (w/few exceptions)

• Budget Deficits => Key contributing events:– 1930s => FDR’s New Deal programs– 1940s => WWII– 1960s => LBJ’s War on Poverty & Vietnam War– 1980s => Reagan Tax cuts & rise of Defense spending– 1990s => Clinton Tax increase & Economic growth

• (Brief period of budget surplus- late 1990s-early 2000)

– 2003-09 => Bush Tax cut, Econ downturn, 9/11, Iraq War, Katrina & other natural disasters, oil shock,

etc

– (Return to budget deficits for indefinite future) 16

The Ideal Budget?

17

Balanced Budget

A federal budget in which spending and revenues are equal.

Budget Surplus

A federal budget inwhich revenues exceed spending.

OR

How has Federal Government faired in meeting this “ideal” criteria?*

Receipts ($$$ in) = $pent (Outlays)

Budget Deficits & Surplus Over Time

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ed

$427B407B

projected

2005 2006 2007 2008 2009 2010 2011 2012

248B

410B

Projected 239B

Projected

Projected

415B

Projected

457B

Projected

377B

Consequences of a Large National Debt • Is debt always bad? (investment vs. consumption)

– Depends: Tuition for College versus Spring Break Vacation• When Government borrows $$$ => from whom?

– Pays Interest on $$=> US & Foreign investors, Fed. Pensions• The trade offs:

– Lost opportunities (discretionary spending)– Impact on interest rates? – Impact on private sector growth? – Impact on jobs? => – Impact on economic growth=> – Impact on the National Economy (GDP)?

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($$ too expensive) consumer spending?

Government Revenue• Where Does Government Revenue Come From?• Government Revenue in Historical Perspective:

– Changes over time*– Social Security Act of 1935 (FICA)*

• The *Federal Insurance Contributions Act (FICA) tax is a United States payroll (or employment) tax[1] imposed by the federal government on both employees and employers to fund Social Security and Medicare

• FICA contributions have increased over time=>– (increased deductions from your paychecks)• Result: FICA contributed more & more to Federal

revenues*20

Government Revenue Sources- 1900

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55%

45% Custom DutiesExcise Taxes

Government Revenue Sources- 1960

44%

13%

16%

4%

23%

Income TaxesExcise TaxesPayroll TaxesEstate, CustomsCorporate

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Government Revenue Sources- 2005

23What tax source has increased the most in a relatively short time?

Payroll Taxes versus Income Taxes

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?_____________ Tax

A tax system in which those with high incomes pay a higher percentage of their income in taxes than those with low incomes.

?_____________ Tax

A tax system in which those with high incomes pay a lower percentage of their income in taxes than those with low incomes.

Contrast the different types of taxes: Progressive tax (what is it & why is it progressive?) Regressive tax (what is it & make makes it regressive?)

How does US Tax burden compare with other Industrial Nations?

Comparing Tax Burdens

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Where Does Government Spending Go?• The Changing Nature of Government Spending:

– Changes over time– Shift from Cold War Defense spending to Human Resources

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Federal Spending by Type

Federal Spending

27What has triggered this increase in Federal spending on individuals?

Entitlement ExpendituresDiscretionary vs. Non-discretionary

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9%

_______________________

*How has Discretionary spending changed over time?

$857 Billion*

$1.481 Trillion

19%

Decreasing Discretionary Spending

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How can we increase Discretionary spending?

Limiting Entitlement Programs

• Areas requiring special attention:– Long term budget problems (the Baby Boomers)

• Social Security concerns & escalating Health Care costs– Difficulty restraining growth of entitlement programs– Need for more revenue (Taxes vs. Economic growth)

• Cutting costs: Political will vs. political costs– Political Costs of cutting Entitlement Programs is normally

greater than the political benefits & will necessary to do it

• Another problem in the Budget Process is:– Controlling Pork barrel (“ear marks”) politics *

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Problem in the Budget Process

• Controlling Pork barrel* politics: – Easier said than done=> conflicting objectives:– One man’s pork is another’s vital program – Incumbent objective: improve reelection chances:

• Vehicle for “pork” => bill riders & “ear marks” – Example?• Senator Ted Stevens & Alaska’s “Bridge to nowhere” 31

Pork BarrelSpending

Legislation that appropriates Federal money for local

projects of questionable value that may ingratiate a legislator

with his or her constituents.

Corporate Welfare • Another example involves Government subsidies

or tax breaks for businesses– AKA: Corporate Welfare

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Corporate Welfare

Government subsidies or tax breaks of

questionable value to private corporations.

Responsibility for Budget Deficits• Congress and the President

– Role in perpetuating budget deficits=> – Decisions on programs, spending levels, & taxes

• Congressional appropriations & Presidential veto• Pork Barrel politics. Earmarks, & Budget riders*• *Usually attached to last minute Omnibus “must pass” Bills

– Classic example: April 2007 Defense Supplemental

• The American Public– Congress responds to the wishes of the voters– Balancing the budget vs. preserving key programs

• Top tax breaks favored by public (Figure 16-8)*

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Top Tax Breaks

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$400+ Billion in lost annual revenue

The Budgetary Process - Historic overview • Budgetary Process from George Washington to Nixon:

– Key Change: Budget & Accounting Act of 1921 => • Power of President’s control over Executive Branch enhanced• The President submits consolidated Budget to Congress from then on…

– Office of Management & Budget (OMB) – Nixon reforms in 1970• Little change in Budget process until 1974:

– (The President proposes and Congress disposes):

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The President submits a budget

to Congress

Congress must then approve

the budget- (or not)

Lets examine in more detail

The (2 Year) Budget Process

36Role of Continuing Resolutions (Reality)

FY 2009 Budget FY 2010 BudgetFY 2008 Budget

New Fiscal Year

Theory vs. reality!

Budgetary Reform Attempts (1970-2000) • Both Congress & the President have attempted to make the

Budget process more rationale & disciplined thru reforms– Nixon impounded $$$ to slow spending & deficit growth– Democratic Congressional reaction:

• Congressional Budget & Impoundment Act of 1974• Establishment of Congressional Budget Office (CBO) vs. OMB

• Divided government (Different Parties hold Executive & Congress)

– Conflicting budget priorities (President vs. Congress)– Result: Continuing resolutions

• Bottom Line:– Changing the rules has failed to overcome basic disagreements

between a GOP President and a Democratic held Congress 37

Budgetary Reform in the 1980s • Congress passed the Gramm-Rudman Reform in an attempt

to bring fiscal discipline to the Budget process:– Goal: Reduce deficits (result?)– Growing deficits continued– Partisan disagreement over budget priorities trumped reforms

• Key influence (again): Divided Government – Lack of consensus & political will– President Reagan (GOP) pushed for Tax cuts & strong Defense– Congress (Democrats) desired to protect domestic programs ($$)

• Result: increased defense spending & tax cuts=> (but)– Not offset by cuts in domestic programs=> result?– Historic level deficits ensued – (And it’s not that much different from what we are seeing now)

38

Deficits to Surpluses & Back Again • 3 Serious attempts to reduce deficit spending made in 1990s

• Budget Enforcement Act (BEA) of 1990– Set limits on spending growth & imposed sanctions– Three separate categories “walled off” from changes

• Defense, domestic policy, & international affairs• Increases must be offset by program cuts within own “walls”• (No robbing Defense to pay for domestic program increases)

• Clinton Budget for 1993 – Some program cuts & higher taxes raised- result:*– Deficits begin to gradually fall very slowly for first time

39

Budget Deal of 1997

• Let’s make a deal: (Clinton & the GOP Congress)– GOP Aim: balanced budget by 2002

• GOP promise made in Contract with America• Reality: Presidents have a vote too (veto)

– Forced compromise=> major cuts in Federal programs– Surplus first appeared in 1998 (first since 1969)

• Combined effects of all of above (Table 16-1)– Growth of Deficits began to decline & then disappeared

40

Surpluses Until the Bubble Burst• By 2002: Deficit Spending had returned – why?• Combination of several factors:

– 2000=> Technology Bubble burst=> $$$ recession– Stock Market freefalls (NASDQ down by 60%)– Corporations cut spending & Job losses grew– 9/11/2001 => another major shock to economy – People sold more stocks, stop flying=> airlines failed

• Then- additional economic problems emerged:– Cost of Katrina & other natural disasters– Growing energy costs (oil & natural gas)– Rise in DOD spending & growing cost of Iraq War ($500B)– Finally: Tax cuts not offset by cuts in Federal spending

41

Is the Budget Process Irrational?• Role of past Budgets amount to tinkering at the margins

– Incremental Budgeting=> autopilot budgeting– Zero based budgeting=> too hard & disruptive

• Mechanical systems of reform as a substitute?– Conclusion: The Budget cycle was not a

substitute for fiscal discipline– Political Realities dictate political behavior

• The dirty little secret in Washington is:– Political priorities determine budget fiscal priorities – (& Divided Government results in conflicting priorities)– Politicians respond to conflicting Public (or voter) demands

• & will do whatever is most likely to get them reelected 42

Back-up Slides

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Problem: Based on assumptions that GDP will grow 3.3%, & Federal revenues will steadily increase as a result.

Any Problem with the Administration’s Projections?

Actual GDP growth: 2.2% in 2007& 1.5% projected for 2008 (IMF)

Deficit as a % of GDP

Social Security & Medicare Trends

45

Government Revenue Sources- 2000

50%

3%

32%

5%10%

Income TaxesExcise TaxesPayroll TaxesEstate, CustomsCorporate Taxes

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Review: Budget Deficits & Surplus Over Time

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ed

$427B382B

projected

2005 2006 2007 2008 2009 2010 2011 2012

How does Congress contribute to Budget Deficits? What’s the problem?

248B

379B

Projected 239B

Projected

Projected

415B

Projected

457B

Projected

377B