Background on Budget & Economy
Major components of FY2013 budget
(Pres. Obama's latest budget)
|Spending in FY2013's $3.8 trillion budget
||Federal revenue sources|
$820 billion (22%) Social Security payments
$811 billion (21%) Medicare/Medicaid/SCHIP payments
$246 billion ( 6%) interest on the National Debt
$583 billion (15%) other ‘mandatory’ payments (including TARP)
$700 billion (18%) national defense
$565 billion (15%) other ‘discretionary spending’
$ 97 billion ( 3%) Overseas Contingency Operations (war supplementals)
$1,294 billion (34%) individual income taxes
$990 billion (26%) social insurance (FICA/Medicare)
$365 billion (10%) corporate income taxes
$234 billion ( 6%) other taxes & duties
$901 billion (24%) budget deficit
The federal budget is not difficult to understand.
Politicians intentionally muddy the water and thereby make the federal budget difficult to understand, to gain political advantage for one political goal or another. We will explain the basics here -- everything else is politics.
- Spending and revenue: The budget has two important halves:
spending (where the money goes) and revenue (where the money comes from).
The two sides have to equal each other, in order to account for all the money.
Where the money goes
- National Debt: The annual budget deficits don't get paid off each year -- they just accumulate year after year, into the National Debt, which is currently over $15 trillion. We pay interest in that debt -- amounting to $246 billion in FY2013.
- Entitlements: The largest budget spending items, totalling $1.6 trillion in 2012, are Social Security, Medicare, and Medicaid -- the so-called ‘entitlement programs.’ The policy options for these programs are discussed in the Social Security section.
- Non-discretionary spending: The federal budget separates ‘mandatory payments’ from ‘discretionary spending.’ Entitlements and interest (plus another $583 billion in smaller programs) are deemed ‘non-discretionary’ while everything else is deemed ‘discretionary.’ Those terms are political double-talk -- Congress has the discretion to make political decisions on funding ‘mandatory’ programs just like every other political decision. But because so many people rely on these funds, it is politically difficult to alter them in the short-term, so most discussion applies to the very long-term (with small changes in current policy that have large effect years later).
- National Defense spending: Funding the Pentagon is by far the largest discretionary item in the budget. The policy options for defense programs are discussed in the Homeland Security section.
- Supplemental spending: Congress and the Bush Administration routinely pretended that the wars in Iraq and Afghanistan posed unexpected expenses. Therefore they were not funded in the regular budget, but instead by a special ‘Supplemental Spending Bill’ which is voted on separately, outside of the budget, each year.
Pres. Obama in 2010 changed to using an on-budget ‘Overseas Contingency Operations’ instead of off-budget war supplemental bills.
- Discretionary spending: All other non-defense expenditures total up to 14% of the budget. This budget section is where most Congressional debate focuses, even though the other budget sections are far larger. Republicans endlessly lambast NEA spending ($0.1 billion for the National Endowment for the Arts in 2008) and Democrats equally lambast spending on the Special Prosecutor (about $0.06 billion to produce the report that led to Bill Clinton's impeachment).
- If Republicans want to reduce the size of government, or if Democrats want fiscal responsibility, they should focus on the Big Four listed above: defense spending; Social Security; Medicare/Medicaid; and the budget deficit. Everything else is political -- they have a very minor impact on the budget totals. On the other hand, we should keep in mind the enormous scale of the budget: as one analyst said, ‘A billion here, a billion there, and pretty soon you’re talking real money.’
- Politicians often call for "freezing all but the non-defense non-entitlement budget" -- a typical politicians' attempt to muddy the water -- defense and entitlements account for the majority of the budget.
- Furthermore, Congress has full control over "mandatory" spending (it's only mandated from the previous year; Congress can change it at any time).
- Voters should listen for other (very common!) attempts at muddying the water, by looking at what are the actual underlying amounts being discussed.
- Here is an analysis of partisan muddying of the water, in our review of Tom Coburn's book "The Debt Bomb":
Coburn's most partisan offense is what we call "The Big Lie" of Republican budget analysis: citing only entitlements as sources of the nation's debt, while ignoring defense spending. On charts on pp. 16-7, and in analyses elsewhere in the book, Coburn cites only four categories of "Sources of Long-Term Debt": Interest costs, Medicare and Medicaid, Social Security, and Other Spending. Coburn's thesis is that "Other Spending," the biggest category at the time the book was written, will shrink in the future, while entitlements and interest grow. The Big Lie is that in the FY2013 budget, defense spending is MOST of "Other Spending," comprising $797 billion compared to $565 billion of all other discretionary spending. That compares to $820 billion for Medicare/Medicaid and $811 billion for Social Security. If one counts the defense-related departments -- $60 billion for the Department of Veterans Affairs and $55 billion for the Department of Homeland Security (also counted by Coburn in "Other Spending") -- defense spending is larger than either major entitlement program.
This Big Lie is a fixture of Republican budget analysis -- pretending that defense spending can't be meaningfully cut. But Democrats are just as guilty -- pretending that entitlements can't be meaningfully cut, for example by calling them "entitlements." Coburn suggests the solution for entitlements is to privatize Social Security (p. 208) and to raise the retirement age for Medicare (p. 199). Those indeed get at the heart of the spending issues for entitlements -- but on defense, Coburn avoids getting at the heart of the issue. All of Coburn's suggestions for defense spending cuts are to trim around the edges, like reducing waste in contracting (p. 260ff), rather than actually reducing, for example, military overseas operations (he voted three times during the period this book was written to keep US troops in Iraq, see VoteMatch question 17, with no offsetting cuts to pay for it).
Where the money comes from
- Individual income taxes: The biggest component of federal revenue is the income tax -- and this is what politicians mostly talk about when discussing policy. The $1.3 trillion in personal income taxes does not include state income taxes, sales tax, or any other local tax. Tax policy is detailed in our Tax Reform section.
- Social insurance (FICA): This comes up in the 2012 debates as ‘raising the cap.’ In theory, each person's individual FICA funds their own retirement, so the tax is "capped" at income of $106,800 in 2012, up from $92,500 in 2008. Income above $106,800 has no FICA tax. In practice, the sum of FICA payments all go into the Social Security Trust Fund, so some politicians say the individual link is meaningless, and therefore FICA is a regressive tax (the wealthy pay less). Raising the cap, or removing it entirely, would raise revenue substantially. Details are discussed in the Social Security section.
- Corporate income taxes: US corporate income taxes are the second-highest in the world, tax-cutter politicians constantly remind us. The sum is still only 1/6th of what individuals pay. Details of all corporate tax policy are discussed in the Corporations section.
- Other taxes & duties: While only 6% of federal revenue comes from everything other than those three sources, this smallest section once again includes a lot of the political debate. The "Death Tax" (inheritance tax) is included here; and Mitt Romney was damaged by claiming that raising user fees in this category should not count as tax increases.
- Budget deficit: Unlike normal budgets, the federal government can print its own money.
The deficit amounted to $901 billion in 2012.
The form of printing money to cover the deficit varies from year to year; the recent favorite is federal bonds that are sold to foreign governments and other wealthy entities.
That leads to political accusations that, for example, the Chinese government is funding our deficit.
- The “fiscal cliff” refers to the set of policy changes set to take place on Jan. 1, 2013, unless Congress changes the laws before then (or shortly therafter, retroactively).
The set of policies includes the expiration of the Bush tax cuts; the implementation of the "sequester"; and the raising of the national debt borrowing limit.
Alarmists claim that allowing the current policy set will send the US back into recession, hence the alarmist metaphor of "going over the cliff".
- The “sequester” refers to automatic budget cuts mandated after the debt-ceiling crisis of 2011. The “Super committee" failed to come up with a budget replacement plan in late 2011, so the sequestration rules take effect in 2013. Those rules specify across-the-board spending cuts of $1.2 trillion in the period 2013 to 2021. The cuts apply to Medicare and DoD roughly equally; i.e., social spending and defense spending are both cut for political balance.
- The “debt ceiling”: The 2013 budget includes a deficit of $901 billion (more spending than revenue). The annual budget deficits don’t get paid off each year—they just accumulate year after year, into the National Debt, which is currently over $15 trillion. We pay interest on that debt—amounting to $246 billion in 2012. Congress determines the “debt ceiling,” which is the total amount that the federal government can be in debt. The actual debt must remain lower than the “debt ceiling” or the government may not borrow more money; currently the ceiling is set at $16.4 trillion.
- “Dodd-Frank” refers to Sen. Chris Dodd (D, CT) and Rep. Barney Frank (D, MA), the co-authors of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. The legislation was intended to reform the rules of the financial and insurance industry to avoid another "meltdown" like the one in mid-2008 which initiated the Great Recession.
- “Earmarks” refers to itemized spending in legislation, i.e., funding targeted toward a particular project in a particular place. The controversy comes about because often the particular place includes the home district of the legislator writing or sponsoring the bill (which is known derisively as "Pork-Barrel Spending"). Earmarks are currently legal and are generally considered ethical; earmark reform focuses on publicizing their existence and perhaps on a future Line Item Veto to remove some.
- “Fannie & Freddie” refer to the Federal National Mortgage Association (FNMA, Fannie Mae) and Federal Home Loan Mortgage Corporation (FHLMC, Freddie Mac). Fannie and Freddie were "GSEs"--government-sponsored enterprises--half-private, half-federal, until 2008, when they were placed under full federal control. Their role is to assist banks with creating individual mortgages.
- “PAYGO” refers to a "pay-as-you-go" policy, where all expenditures in a bill are explicitly paid for, instead of requiring borrowing. The Budget Enforcement Act of 1990 required all new spending bills to include how the spending would be balanced by revenue enhancements (taxes or fees) or other spending cuts. The PAYGO statute expired in 2002, but some congressional bills still describe offsets for new spending.
- “Simpson-Bowles” refers to the National Commission on Fiscal Responsibility and Reform, and its conclusions released in 2010. It is named after its two chairs, Sen. Alan Simpson (R, WY) and Erskine Bowles (D, NC). The Commission proposed reducing the national debt by a combination of increased revenue (raising taxes, including a 15-cent gas tax); reductions in discretionary spending; Medicare cost controls; raising the Social Security retirement age; and a reduction in entitlements.
- “QE3” refers to “Quantitative Easing” of the money supply by the Federal Reserve, the third round of which took place in Sept. 2012. The QE3 program entails purchasing $40 billion monthly in mortgage-backed securities. QE1 and QE2, earlier in the Great Recession, injected $2.3 trillion into the economy, also via the securities market. Critics call the programs “printing money” which is inherently inflationary.
Major components of FY2009 budget
(Pres. Bush's last budget)
|Spending in FY2008's $2.9 trillion budget
||Federal revenue sources|
$610 billion (21%) Social Security payments
$602 billion (21%) Medicare/Medicaid/SCHIP payments
$244 billion ( 8%) interest on the National Debt
$302 billion (10%) other ‘mandatory’ payments
$550 billion (19%) national defense
$392 billion (14%) other ‘discretionary spending’
$192 billion ( 7%) War on Terror ‘supplemental spending’
$1,220 billion (42%) individual income taxes
$910 billion (31%) social insurance (FICA/Medicare)
$345 billion (12%) corporate income taxes
$171 billion ( 6%) other taxes & duties
$246 billion (9%) budget deficit
Major components of FY2000 budget
(Pres. Clinton's last budget)
|Spending in FY2000's $1.8 trillion budget
||Federal revenue sources|
$405 billion (23%) Social Security payments
$328 billion (18%) Medicare/Medicaid payments
$215 billion (12%) interest on the National Debt
$226 billion (13%) other ‘mandatory’ payments
$262 billion (15%) national defense
$330 billion (19%) other ‘discretionary spending’.
$900 billion (48%) individual income taxes
$637 billion (34%) social insurance (FICA)
$189 billion (10%) corporate income taxes
$157 billion (8%) other taxes & duties
Budget Deficit versus National Debt
A budget deficit means that the amount the government receives in taxes in one fiscal year is less than the amount that the government has spent. Generally, the government ‘borrows’ money from people by issuing bonds to cover the deficit.
The accumulated borrowing is the ‘National Debt’ that the government must repay in the future. The current federal debt stands at over $13 trillion, which is the equivalent of roughly $40,000 per person.
The federal government pays over $200 billion in annual interest on the national debt.
Social Security Trust Fund
- Much debate focuses on how the budget deficit is calculated and how the Social Security Trust Fund is accounted for.
- The Trust Fund is ‘off-budget,’ which means it is not counted in the reporting of the budget.
- However, the government reports the budget surplus or deficit from a ‘Unified Budget’ which does include the Trust Fund. Hence the growth of the Fund offsets the shortfall in the budget.
- In 1998, the budget surplus was reported as $40 billion on the unified budget. Discounting the Trust Fund, the budget would have been in deficit by $50 billion.
- By 2008, the budget deficit has returned in full force -- to $246 billion, and after 2008, increased substantially more for stimulus spending to deal with the Great Recession.
The Federal Reserve
Ben Bernanke is the chairman of the Federal Reserve Board, which is known as ‘The Fed.’
(Alan Greenspan was the previous chairman)
The Federal Reserve chairman is appointed to a 4-year term by the President but then cannot be removed, to allow The Fed independence in monetary policy.
Bernanke’s primary responsibility is to set the interest rates that the government pays on its bonds. Those rates in turn determine bank interest rates, mortgage lending rates, and other interest rates.
When the Federal Reserve Bank feels that there is to much inflationary pressure, they are likely to raise interest rates to slow the economy down.
Hence, Bernanke raises interest rates (‘tightens money’) when he sees the economy as ‘overheating,’ and lowers interest rates (‘loosens money’) when he sees deflation threatening.
The longest economic expansion in US history ended in October 2001.
During 2001, Alan Greenspan lowered interest an unprecedented 10 times in one year, to provide ‘monetary stimulus’ to the lagging economy. President Bush pushed for ‘fiscal stimulus’ by sending out $300 tax rebate checks to millions of taxpayers.
In 2007-2008, to attempt to counter the mortgage crisis leading to a recession, Ben Bernanke tried the same strategy, lowering interest rates repeatedly.
The Subprime mortgage crisis began with a sharp rise in home foreclosures in the United States during the fall of 2006 and became a global financial crisis during 2007 and 2008.
The crisis began with the bursting of the housing bubble in the U.S. and high default rates on "subprime", adjustable rate, and other mortgage loans made to higher-risk borrowers with lower income or lesser credit history than "prime" borrowers.
- The mortgage crisis may lead to a recession because of the large number of people affected, and because the construction sector is a large factor in the economy. Hence politicians are all proposing "stimulus packages" to stave off a recession.
Those proposals -- and reactions to Pres. Bush's version of a one-time tax rebate and later economic stimulus measures -- make up the majority of presidential candidates' comments in this topic area.
- ‘Economic Stimulus Act’: In Feb. 2008, Pres. Bush pushed legislation intended to avoid a full financial crisis, by mailing tax rebate checks of several hundred dollars to every taxpayer.
The checks arrived at a time when fuel prices reached an all-time high, breaking $4 per gallon of gasoline in the summer of 2008.
Discussion of additional economic stimulus (and whether the initial stimulus succeeded) was lost in the more urgent financial crises later in 2008.
- ‘Housing and Economic Recovery Act’: In late July 2008, Congress enacted legislation intended to avoid a full financial crisis, by injecting $300 billion into the mortgage market to restructure subprime mortgage loans.
As a result, on Sept. 7, Fannie Mae and Freddie Mac, the quasi-governmental mortgage entities, were placed under federal control.
- ‘Fannie and Freddie’:
Fannie Mae and Freddie Mac are "GSEs" -- government-sponsored enterprises -- semi-public corporations designed to assist banks with creating individual mortgages.
The names are acronyms for Federal National Mortgage Association (FNMA, Fannie Mae)
and Federal Home Loan Mortgage Corporation (FHLMC, Freddie Mac).
"Semi-public" means half-private, half-federal, until 2008, when they were placed under full federal control. Their role is to assist banks with creating individual mortgages.
- ‘Emergency Economic Stabilization Act’: In Oct. 2008, Congress enacted a $700 billion package intended
to alleviate severely contracted liquidity in the global credit market (which means banks would not lend each other funds, and hence no credit would be available to consumers for mortgages or credit cards);
and to address insolvency threats to investment banks (which means, big banks would go broke, potentially causing a run on other banks as consumers lost confidence).
- This legislation is commonly referred to as the "financial bailout" in political discussions, even though the funding is structured as investments that may yield positive returns (which means, the net cost to taxpayers could conceivably be much lower than $700 billion, over several years).
- The essence of the financial bailout is that the Secretary of the Treasury is empowered to purchase "troubled assets" in the banking and insurance industry. with the intent of stabilizing and then re-selling those assets when the crisis is past.
- The final legislation went through several major revisions in Congress, including two well-publicized NO votes in the US House, followed by public speeches from Pres. Bush that changes would follow. Sen. McCain suspended his presidential campaign to deal with one version of the bailout vote.
- The popular $700 billion figure is also inaccurate; the final legislation totalled $850 billion, adding $150 billion in unrelated projects to garner positive votes from holdout members of Congress.
- The taxpayer cost of the bailout, if it totals a net cost of $700 billion, would be $4,635 per working American (based on an estimate of 151 million in the work force).
- Rhetoric abounds on both sides of the financial bailout: proponents insist it was necessary to avoid a full-blown Depression; opponents insist it is a federal takeover of the banking industry destined to cause hyperinflation.
- ‘Dodd-Frank’: refers to Sen. Chris Dodd (D, CT) and Rep. Barney Frank (D, MA), the co-authors of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. The legislation was intended to reform the rules of the financial and insurance industry to avoid another "meltdown" like the one in mid-2008 which initiated the Great Recession.
- ‘Earmarks’: refers to itemized spending in legislation, i.e., funding targeted toward a particular project in a particular place. The controversy comes about because often the particular place includes the home district of the legislator writing or sponsoring the bill (which is known derisively as "Pork-Barrel Spending"). Earmarks are currently legal and are generally considered ethical; earmark reform focuses on publicizing their existence and perhaps on a future Line Item Veto to remove some.
- ‘PAYGO’: refers to a "pay-as-you-go" policy, where all expenditures in a bill are explicitly paid for, instead of requiring borrowing. The Budget Enforcement Act of 1990 required all new spending bills to include how the spending would be balanced by revenue enhancements (taxes or fees) or other spending cuts. The PAYGO statute expired in 2002, but some congressional bills still describe offsets for new spending.
- ‘Simpson-Bowles’: refers to the National Commission on Fiscal Responsibility and Reform, and its conclusions released in 2010. It is named after its two chairs, Sen. Alan Simpson (R, WY) and Erskine Bowles (D, NC). The Commission proposed reducing the national debt by a combination of increased revenue (raising taxes, including a 15-cent gas tax); reductions in discretionary spending; Medicare cost controls; raising the Social Security retirement age; and a reduction in entitlements.