What Is the Federal Budget?
How Does It Work?
The federal budget is the government's estimate of revenue and spending for each fiscal year. Like a family budget, the federal budget itemizes the expenditure of public funds for the upcoming fiscal year. The federal government's fiscal year begins each October first.
Some budget expenses are mandatory spending such as money earmarked for Medicare. Other spending is discretionary and will get approved or disapproved through the passage of appropriation bills.
Where the Money Comes From
The revenue for most governments—including the United States—comes from tax revenues. These taxes include those on family incomes, business profits, and imports, such as customs duties and tariffs. It also includes sin taxes on activities the government wants to discourage, such as cigarette smoking and alcohol use. The government imposes use taxes on activities, such as gasoline, to pay for related activities, like building roads and bridges.
Pigouvian taxes impose costs on those who impose damages to society. An example would be a tax on manufacturers that pollute rivers. The U.S. does not impose many of these types of taxes, preferring to use regulations known as command and control rules.
Countries also derive revenues from state-owned businesses, such as oil companies. The revenue from these companies supplies revenue directly to these governments. The state-owned U.S. entities include—most notably—the U.S. Postal Service, the Federal Home Loan Banks, the Farm Credit Banks, and the Corporation for Public Broadcasting.
Federal spending is wide, varied, and huge. The 2020 U.S. federal budget is $4.746 trillion—for one fiscal year. Efforts have been made to curtail spending, but an election here and a war there, and before you know it, the budget has grown again.
Almost all governments spend on public safety and defense, transportation, and trade. Most also provide some social welfare payments, whether for unemployment compensation, retirement, and health care. The amount spent reflects the values and priorities of society.
National Priorities Project (NPP) a non-partisan, nonprofit research organization finds that in 2015—their most recent year with analysed data—just over 64% of the federal budget is on mandatory spending items, a little over 6% goes to paying interest on the federal debt, and the remaining 29% is discretionary spending.
The largest line item in the mandatory spending arena is Social Security, unemployment, and government labor taking up just over 48% of that category. The second-largest arena titan is Medicare and health spending at just over 38%. The rest of mandatory funds goe to food and agriculture, veterans benefits, transportation and other activities that benefit the public good.
Many would assume that military spending—for tanks, submarines, manpower, and might—would be a part of the mandatory pie. However, this spending falls into the discretionary category and makes up 53.7% of the total amount of funds. Discretionary government expenses account for around 6% and as does education which receives a smidge over 6%.
These numbers may be from 2015, but they can give you a general idea of where the government spends.
Deficit and Debt
When the government spends more than it takes in, it's known as deficit spending. It creates a budget deficit. A reduction of revenue with tax cuts also creates deficits. Each year's deficit is added to the sovereign debt—what a government borrows in the form of Treasury bonds, bills, and notes. Both deficit and sovereign debt are tools of expansionary fiscal policy. They expand the economy by pumping more money into it.
The money is borrowed from the future through the sale of Treasurys. If done right, an expansionary policy will boost the economy enough to easily pay off the debt when it comes due. If done poorly, it will saddle future generations with an unsustainable debt load. As mentioned earlier, in 2015 6% of the federal budget went to servicing this borrowing in the form of interest payments.
You can find out if a country has a sustainable debt load by looking at its debt-to-GDP (gross domestic product) ratio. It measures each year's total economic output. A healthy debt-to-GDP ratio should be 77% or less, according to the World Bank. According to the Federal Reserve of St. Louis Economic Data (FRED) the second quarter of 2019 U.S. debt as a percent of GDP is 103.21%.
Federal Budget Surplus
Spending that's lower than revenue creates a budget surplus. Tax increases can also create a surplus. Both are used in contractionary fiscal policy to slow economic growth. That removes money from the current economy in return for paying off future debt.
A budget surplus heads off a dangerous bubble when the economy is in the boom phase of the business cycle. It's also needed when the debt-to-GDP ratio is greater than 100%. Another term for the contractionary policy is austerity measures.
According to the FRED, since 1901, the largest U.S. surplus was in 2000.
U.S. Federal Budget
The U.S. federal budget is the amount of spending and revenue for the next fiscal year of the U.S. government. It runs from October 1 through September 30.
The U.S. federal budget has two categories of spending that are unusual. The mandatory budget pays for benefits established by prior Acts of Congress. These include Social Security, Medicare, Medicaid, and other such benefits. This budget estimates the costs to administer the benefits. It cannot be changed without another Act of Congress.
The authorization law requires that the U.S. Congress appropriated funds for current mandatory spending to keep mandated programs, such as Social Security, running.
The interest on the national debt must also be paid, although it's not part of the mandatory budget. If the interest is not paid, then the United States has defaulted on its debt.
The other category is discretionary spending. Most of this goes toward the military budget, the second-largest budget after Social Security. The rest funds management of all other government agencies. These include Health and Human Services, the Justice Department, and the U.S. Treasury. Congress determines current discretionary spending for each fiscal year.
The federal government has run a deficit since 2002. The president and Congress are engaging in expansionary policy. The large current U.S. budget deficit is a result of five major factors:
- Rising mandatory spending on Social Security, Medicare, and the like
- Increased military spending that was kicked off by President Bush’s War on Terror
- The 2001 recession and the 2008 financial crisis slowed growth and cut tax revenue
- The 2009 Economic Stimulus Act that ended the Great Recession
- Three tax cuts by presidents Bush, Obama, and Trump cut revenue
You can argue over which president contributed the most to the deficit. The truth is that they all did. The current U.S. federal budget breakdown explains how the combination of budget components and the national deficit impacts the U.S. economy.
Congress Determines the Federal Budget
The Constitution gives Congress power over the federal budget. Article 1, Section 9, states, "No money shall be drawn from the Treasury, but in Consequences of Appropriations made by Law."
The president's role is to submit a budget proposal to Congress. He asks all federal agencies to submit their budget requests to him. The Office of Management and Budget compiles these requests. The president submits this budget to Congress. Congress usually follows this budget as a guideline to create its own budget resolution. That is used to create the appropriations bill. These bills allocate funds for different categories of government agencies.
The budget process lasts 18 months. Here's the schedule for the FY 2020 budget, the third one to be submitted by President Trump.
- Early fall: Federal agencies submit budget requests to OMB.
- November: OMB sends its comments back to the agencies.
- December: Agencies submit the final budget request to OMB.
- January: OMB submits the budget to president.
- February: President submits the budget to Congress. Trump did so in March.
- April 15: Congress prepares its Budget Resolution.
- June 10: Congress creates Appropriation Bills.
- June 30: House approves all bills and submits them to the President.
- September 30: All bills must be signed into law.
This budgetary process was set into law by the 1974 Budget Control Act. But Congress doesn't always follow the schedule. When that happens, then Congress submits a continuing resolution to keep the government running until a budget is approved. When that doesn't happen, the government shuts down.