G-16: The Federal Budget

President’s Budget (Fiscal Year 2009)

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Chapter 16- The Federal Budget • (1). Examine the Federal Budget, deficit spending, and the national debt.• (2). Discuss the historic impact of deficits & budget surplus on the national debt.• (3). Outline how the government obtains revenue from an historical perspective.• (4). Contrast various Federal taxes levied, including: progressive & regressive taxes.• (5). Examine how government spends its revenue and the changing nature of spending.• (6). Discuss the growth of entitlement programs and various attempts to limit them.• (7). Explain why "pork barrel" spending persists regardless of the vocal criticism.• (8). Explain why Budget Deficits persist, and discuss the role of Congress, the President,

and the Public in contributing to this problem.• (9). Examine how our Budgetary Process has evolved and discuss key reform efforts.• (10). Explain how the Federal Budget Cycle works and the significance of appropriations. • (11). Discuss the brief period of budget surpluses and reason for the return of deficits.• (12). Evaluate the Budget Process and explain the dominant role of politics affecting it.

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Policymaking system => the Big Picture • Politicians, campaign promises, and political reality:

– Talk is cheap=> Money appropriated sets Gov. policy priorities– i.e. Government priorities determined by what is actually funded

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Policy: Expenditures, Taxes, Laws, Regs, non-decisions

And the method used to set fiscal policy priorities?

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)

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)5

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) 6

The Ideal Budget?

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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

Key Terms Review:

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?________________

The amount by which government spendingexceeds governmentrevenues in a single

year.

?_________________

The total amount of money the federal

government owes to pay for accumulated

deficits.

Contrast Deficit versus Debt

Two Key Terms needed for understanding the Budget:

Growth in National Debt (in $$ Billions)

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DEBT

$9.5 Trillion Your share: $31,000

Accumulation of Deficits/year =

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

– Depends: Tuition for College versus Spring Break Vacation• When Government barrows $$$ => 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*

• Examine change in Government revenue sources

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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

15What 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 (Priorities for 2007)

19What has triggered this increase in Federal spending on individuals?

The Growth of Entitlement Programs • Entitlement programs

– Who qualifies?• Social Security =>

– Pay as you go system? – Generational Pyramid scheme– Trend & impact?

• 1950: (15 workers to 1 retiree) • 1990: (3.5 to 1) • Post Baby Boom retires: (3:1)

• COLA & the CPI (Box 16-1) – Impact?

• Proposed adjustments? – Increase taxes– Cut benefits– Tighten eligibility

• Making hard choices=>– The 3rd Rail & who votes?

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Other Entitlement Programs

• Medicare (40M elders)=> – $221Billion & growing

• Medicaid (35M poor) – Food Stamps (17M poor)

• Federal retirement & VA disability benefits

• All Entitlement programs are “non-discretionary” *

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Congressional Spending

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?_____________ Spending

Federal spending on programs such as Social Security that cannot be controlled through the regular budget process. (For 2005: $1.481 Trillion)

?_____________ Spending

Federal spending on programs that can be controlled through the regular budget process. (For 2005: $857 Billion of a $2.338 Trillion Budget)

Two major categories of Federal Spending:

Contrast the two spending categories within the Federal Budget

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” 26

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

31Role 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 32

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)

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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

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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

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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

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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 37

Chapter 16 KEY TERMS • Balanced budget: A budget in which spending and revenues are equal.• Budget and Accounting Act of 1921: An act of Congress that created the Bureau of the

Budget and allowed the president to review and coordinate the spending proposals of federal agencies and departments.

• Budget deficit: The amount by which government spending exceeds government revenues in a single year.

• Budget surplus: The amount by which government revenues exceed government spending in a single year.

• Congressional Budget and Impoundment Control Act of 1974: An act of Congress that created the new budget process and the Congressional Budget Office and curtailed the president’s power to impound funds.

• Congressional Budget Office (CBO): A nonpartisan congressional agency in charge of assisting Congress in reviewing and coordinating budget requests to Congress.

• Continuing resolutions: Temporary laws Congress passes to keep the government running when Congress misses the deadline for passing the budget.

• Corporate welfare: Government subsidies or tax breaks of questionable value to private corporations.

• Cost-of-living adjustment (COLA): An increase in Social Security or other benefits designed to keep pace with inflation.

• Discretionary spending: Federal spending on programs that can be controlled through the regular budget process.

• Entitlement programs: Programs, created by legislation, that require the government to pay a benefit directly to any individual who meets the eligibility requirements the law establishes. 38

Chapter 16 KEY TERMS (2)• Flat tax: Any income tax system in which taxable income is taxed at the same percentage

rate, regardless of the taxpayer’s income.• Line-item veto: The ability of the executive to delete or veto some provisions of a bill to

become law.• National debt: The total amount of money the federal government owes to pay for

accumulated deficits.• Non-discretionary spending: Federal spending on programs such as Social Security that

cannot be controlled through the regular budget process.• Office of Management and Budget (OMB): The agency in charge of assisting the

president in reviewing and coordinating budget requests to Congress from federal agencies and departments. Formerly the Bureau of the Budget.

• Pork barrel: Legislation that appropriates government money for local projects of questionable value that may ingratiate a legislator with his or her constituents.

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

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

• Revenue neutral: The quality of any tax reform plan that will neither increase nor decrease government revenues.

• Social Security Act of 1935: The act of Congress that created the Social Security tax (Federal Insurance Contribution Act—FICA) and Social Security programs.

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Next Assignment (Fall)

• Chapter 17a: Domestic Policy – Learning Objectives 1-5– Economic Theories: Fiscal Policy vs. Monetary Policy

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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

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Government Revenue Sources- 2000

50%

3%

32%

5%10%

Income TaxesExcise TaxesPayroll TaxesEstate, CustomsCorporate Taxes

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Next Week’s Assignment (Spring)

• Tuesday: Chapter 16b – The Federal Budget– Learning Objectives 7-12– The Budget Process

• Thursday: Chapter 17a – Domestic Policy– Learning Objectives 1-5– Economic Theories– Fiscal Policy vs. Monetary Policy

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Chapter 16b- The Federal Budget• (7). Explain why "pork barrel" spending persists regardless

of the vocal criticism.• (8). Explain why Budget Deficits persist, and discuss the

role of Congress, the President, and the Public in contributing to this problem.

• (9). Examine how our Budgetary Process has evolved and discuss key reform efforts.

• (10). Explain how the Federal Budget Cycle works and the significance of appropriations.

• (11). Discuss the brief period of budget surpluses and reason for the return of deficits.

• (12). Evaluate the Budget Process and explain the dominant role of politics affecting it.

46

Review: Budget Deficits & Surplus Over Time

47

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

Impact of War on Terrorism• War on Terror (Afghanistan & elsewhere) =>

– Significant increase in defense $pending

• Bush Budget (initially: where to spend surplus)– Tax cuts resulted in reduced Federal revenues – Increased spending on Defense & Homeland Defense

• War in Iraq=> cost estimates escalate with time– In the Hundred(s) of Billions range (Budget Supplements)

– Cost of the Peace to be determined!– Uncertainty of final outcome => credible exit strategy– Key factor: patience & political will of American people

• Impact on Wall Street & link to economic growth?48

More Budget Reforms? (Non-Starters) • Line-Item Veto => ruled unconstitutional

– Court ruling: act violated separation of powers– Recently raised again by President Bush (proposed

Amendment?)

• Balanced Budget Amendment (unlikely to pass)– Impractical & too hard to implement in near term (Deficits!)– OMB projects deficits into 2008 & beyond (as % of GDP)

• Flat tax (pros & cons?) => also OBE – why?– Loss of momentum & Bush’s Budget tax cuts =>– Never had President’s support

• Recent (2005) Tax Reform Proposals – (Lack of Congressional & Presidential support)– Finally: any tax reform must by revenue neutral (?) 49

Next Week’s Assignment (Spring)

• Tuesday: Chapter 16b – The Federal Budget– Learning Objectives 7-12– The Budget Process

• Thursday: Chapter 17a – Domestic Policy– Learning Objectives 1-5– Economic Theories– Fiscal Policy vs. Monetary Policy

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Presidents’ Budget FY 2008 -Projections

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Budgetary Reform in the 1970s • Nixon’s impoundments & growing deficits

– Congressional reaction?– Congressional Budget & Impoundment Act of 1974– Congressional Budget Office (CBO) vs. OMB

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

• Bottom Line:– Changing the rules fails to overcome basic disagreement

• The Budget Cycle (Figure 16-9 in text & next slide)*52

Budgetary Reform in the 1980s • Gramm-Rudman Reform attempts at fiscal discipline

– Goal: Reduce deficits (result?)– Disagreement of budget priorities trump reforms

• Key influence: Divided Government – Lack of consensus & political will– President Reagan (GOP)=> Tax cuts & strong Defense– Congress (Democrats)=> preserve domestic programs

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

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Deficits to Surpluses & Back Again • Serious attempt to reduce deficit spending (Table 16-1)

• 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)– Deficits begin to gradually fall very slowly

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Budget Deal of 1997 • Let’s make a deal: (Clinton & the GOP Congress)

– GOP Aim: balanced budget by 2002 • Adhere to GOP promises made in Contract with America

• Reality: Presidents have a vote too (veto)– Forced compromise=> major cuts in Federal programs– Surplus first appears in 1998 (first since 1969)

• Combined effects of all of above? (Table 16-1)– Growth of Deficits abated

• Is the author right about the cause of surpluses?– Role of economic growth?

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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 grow– 9/11/2001 => another major shock to economy – (People sell more stocks, stop flying=> airlines fail)

• Then- additional economic problems emerge:– Cost of Katrina & other natural disasters– Growing energy costs (oil & natural gas)– Rise in DOD spending & cost of War (& Peace) in Iraq?– Finally: Tax cuts not offset by cuts in Federal spending56

Is the Budget Process Irrational?• Role of past Budgets=> tinkering at the margins

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

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

fiscal discipline• Political Realities (The dirty little secret):

– Political priorities determine budget fiscal priorities – Politicians respond to conflicting Public demands– & Will do whatever is most likely to get them reelected

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