In this lesson, you will learn about the federal budget. Is the United States spending too much, and if so, why hasn’t it cut down? You will explore how the U.S. government spends money and how it collects money. Specifically, this lesson covers:
A country spends, raises, and regulates money in accordance with its values. In all, the federal government’s budget for 2022 was $6.27 trillion. The budget’s key areas of expenditure provide insight into modern American values (Figure 1).
(Figure 1) The 2022 fiscal year budget by percent spent on each category. Net interest is the money the federal government pays on its debt. The general government category covers the costs the government pays to maintain itself and its operations. The federal government spends most of its money on social welfare programs. Source: Fiscal Data, Department of Treasury
But these values are only part of the budgeting story. Policymakers make considerable efforts to ensure that long-term priorities are protected from the heat of the election cycle and short-term changes in public opinion. One of the key ways they do this is by making some parts of the annual budget mandatory; that is, some spending cannot be changed from year to year.
1a. Mandatory Spending
The president and Congress have developed a federal budget with spending divided into two broad categories: mandatory and discretionary (see Figure 2). Of these, mandatory spending typically represents approximately two-thirds of the entire annual budget while discretionary spending represents approximately one-third.
The overwhelming portion of mandatory spending is earmarked for social welfare programs that provide retirement and unemployment benefits and healthcare to the elderly and the needy. The costs of programs tied to age are relatively easy to estimate and grow largely as a function of the aging of the population. Income and disability payments are a bit more difficult to estimate. They tend to go down during periods of economic recovery and rise when the economy begins to slow down.
Congress does not vote on mandatory funding each year. Rather, Congress sets the formulas for mandatory payouts.
EXAMPLE
Congress does not determine the amount of money spent on Social Security each year. As a mandatory program, the number of beneficiaries determines the amount of money annually spent on the program.
Because these policies are complex and because they are popular among voters, major reforms to entitlement formulas are difficult to enact. As a result, the size and growth of mandatory spending in future budgets are largely a function of previous legislation that set the formulas up in the first place. So long as supporters of particular programs can block changes to the formulas, funding will continue almost on autopilot.
think about it
How do the budget and mandatory spending reflect the political values of the American people? What goals do you think the federal government is trying to meet through its spending policy?
This decision to put some policy-making functions out of the reach of Congress also reflects economic philosophies about the best ways to grow, stimulate, and maintain the economy. Much of the mandatory spending reflects the Keynesian belief that social welfare programs that encourage consumer spending are key to maintaining a healthy economy and preventing recessions. The role of politics in drafting the annual budget is indeed large, but we should not underestimate the challenges elected officials face as a result of decisions made in the past.
1b. Discretionary Spending
Portions of the budget not devoted to mandatory spending are categorized as discretionary spending because Congress must pass legislation to authorize money to be spent each year. When Congress debates federal budget cuts, discretionary programs are the primary targets. About 50 percent of the approximately $1.2 trillion set aside for discretionary spending each year pays for most of the operations of government, including employee salaries and the maintenance of federal buildings. It also covers science and technology spending, foreign affairs initiatives, education spending, federally provided transportation costs, and many of the redistributive benefits most people in the United States have come to take for granted.
The other half of discretionary spending—and the second-largest component of the total budget—is devoted to the military. Defense spending is used to maintain the U.S. military presence at home and abroad, procure and develop new weapons, and cover the cost of any wars or other military engagements in which the United States is currently engaged.
In theory, the amount of revenue raised by the national government should be equal to these expenses, but with the exception of a brief period from 1998 to 2000, that has not been the case. The budget control efforts implemented in the early 2010s managed to cut the annual federal deficit—the amount by which expenditures are greater than revenues—by more than half by 2015 (Figure 2).
(Figure 2) The federal deficit is the difference between the federal government’s spending and its revenue. Source: Fiscal Data, Department of Treasury
However, the amount of money the U.S. government needs to borrow to pay its bills, as shown in Figure 1, is 8 percent of its entire annual budget—and may well increase as the United States borrows more each year and goes further into debt. Annual deficits grow the national debt—the amount of money the government owes its creditors—a number which has skyrocketed over the past several decades (Figure 3).
Balancing the budget has been a major goal of both the Republican and Democratic parties for the past several decades, although the parties tend to disagree on the best way to accomplish the task.
reflect
Have you heard of or discussed ideas for how to solve the debt crisis? How would they affect you?
One frequently offered solution is to simply cut spending. This has proven to be much easier said than done. If Congress were to try to balance the budget only through discretionary spending, it would need to cut about one-third of spending on programs like defense, higher education, agriculture, police enforcement, transportation, and general government operations. Given the number and popularity of many of these programs, it is difficult to imagine this would be possible. To use spending cuts alone as a way to control the deficit, Congress will almost certainly be required to cut or control the costs of mandatory spending programs like Social Security and Medicare—a radically unpopular step.
terms to know
Mandatory Spending
Required federal government spending primarily for social welfare programs that Congress does not need to approve each year.
Discretionary Spending
Government spending that Congress must authorize each year.
Federal Deficit
The amount by which federal expenditures are greater than revenues.
National Debt
The total amount the U.S. government owes.
2. Tax Policy
All governments must raise revenue in order to operate. The most common way is by applying some sort of tax on residents in exchange for the benefits the government provides (Figure 4). As necessary as taxes are, however, they are not without potential downfalls. First, the more money the government collects to cover its costs, the fewer residents are left with to spend and invest. Second, attempts to raise revenues through taxation may alter the behavior of residents in ways that are counterproductive to the state and the broader economy. Excessively taxing necessary and desirable behaviors like consumption (with a sales tax) or investment (with a capital gains tax) will discourage citizens from engaging in them, potentially slowing economic growth. The goal of tax policy, then, is to determine the most effective way of meeting the nation’s revenue obligations without harming other public policy goals.
(Figure 4) A U.S. marine fills out an income tax form. Income taxes in the United States are progressive taxes.
Taxation policies can be distributive, meaning they collect money from many to the benefit of fewer individuals.
EXAMPLE
School districts collect taxes from all households in their jurisdiction to pay for education for children in kindergarten through 12th grade.
Taxation policies can also be redistributive. Progressive taxes increase as the taxpayer’s income increases. Federal income tax is progressive. The more you earn, the higher the percentage of your income you have to pay to the federal government.
EXAMPLE
You pay 10% of what you earn for the first $10,275 that you earn. If you earn more than that, then you pay 12% on income over $10,275, but under $41,775. For the income that you earn over $41,775, you pay 22%. However, if you earn over $89,075, you will pay 24% of that income. You then pay 32% of incomes over $170,050, 35% for incomes over $215,950, and 37% for incomes greater than $539,900.
So, if you earn about $10,000 you pay about one-tenth of your income on federal tax. However, if you earn $600,000, you are paying closer to one-third of your income on federal taxes.
By contrast, regressive taxes charge the same percentage to all individuals regardless of their income level.
EXAMPLE
Sales taxes are regressive. Everyone pays a fixed percentage of the cost of the goods they buy. If the government charges a 7 percent sales tax, then everyone, regardless of how much money they earn, will pay $7 for $100 of groceries.
With regressive taxes, individuals with lower incomes pay a greater percentage of their income for the goods or services that they buy.
IN CONTEXT
Consider the use of excise taxes on specific goods or services as a source of revenue. Sometimes called “sin taxes” because they tend to be applied to goods like alcohol, tobacco, and gasoline, excise taxes have a regressive quality, since the amount of the good purchased by the consumer, and thus the tax paid does not increase at the same rate as income (Figure 5). A person who makes $100,000 per year spends only 1 percent of this income on $1,000 of gasoline per year. A person who makes $20,000 spends 5 percent of their income on $1,000 of gas per year. That makes buying gas much more affordable for the person earning a higher income.
(Figure 5) A gas station shows fuel prices over $3.00 a gallon; shortly after, Hurricane Katrina disrupted gas production in the Gulf of Mexico in 2005. Taxes on gasoline that are based on the quantity purchased are regressive excise taxes.
The federal government relies heavily on income tax, a progressive tax. Income tax accounts for a little under half of all tax revenue that the government receives. However, payroll taxes are regressive. These are a flat percent of your total income that you pay for Social Security and Medicare. The total amount the government collects on these taxes may vary from year to year (as taxpayers’ income varies), but they can account for a little over one-third of the total federal tax revenue.
terms to know
Progressive Tax
A tax that increases the tax rate as the wealth or income of the taxpayer increases.
Regressive Tax
A tax applied that remains at the same rate regardless of the income of the taxpayer.
Excise Tax
A tax applied to specific goods or services as a source of revenue.
summary
In this lesson, you learned how U.S. spending policy divides the budget into mandatory spending and discretionary spending. You discovered that members of Congress only get to approve discretionary spending annually, and this only accounts for one-third of the total budget. You also examined both progressive and regressive taxation policy and how the federal government relies on both.
