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Chapter 16- The Federal Budget

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1 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.

2 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 Policy: Expenditures, Taxes, Laws, Regs, non-decisions And the method used to set fiscal policy priorities?

3 The Federal Budget Two Key Terms:
Contrast Deficit versus Debt (how related?) Budget Deficits The amount by which government spending exceeds government revenues in a single year. National Debt The total amount of money the federal government owes to pay for accumulated deficits.

4 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 1997=> $1 Trillion 2001=> $1.8 Trillion 2003=> $2.212 Trillion 2004=> $2.272 Trillion (20.2% of GDP/GDP= Trillion) 2005=> $2.338 Trillion (19.8% GDP – OMB estimate 4/2005) => 19.8% of GDP (OMB estimate 4/2005)

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) 2003 => 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 Budget Surplus Balanced Budget A federal budget in
which revenues exceed spending. Balanced Budget A federal budget in which spending and revenues are equal. OR

7 Budget Deficits & Surplus Over Time
2004 2005 projected $427B 4

8 Growth in National Debt

9 OMB Budget Totals- Summary (04/05)

10 Consequences of a Large National Debt
Is debt always bad? (investment vs. consumption) Tuition for College versus Spring Break Vacation When Government barrows $$$ => from whom? Interest payments => US & Foreign investors, Fed. Pensions The trade offs: Lost opportunities (discretionary spending) Impact on interest rates? Impact on private sector growth? ($$ too expensive) Impact on jobs? => consumer spending? Impact on economic growth=> Impact on the National Economy (GDP)?

11 Government Revenue Where Does Government Revenue Come From?
Government Revenue in Historical Perspective: Changes over time => Figure 16-3 & slide Social Security Act of 1935 (FICA) FICA contributions increased over time=> (greater deduction from your paychecks) Result: FICA contributed more & more to Federal revenues Examine change in Government revenue sources

12 Government Revenue Sources- 1900

13 Government Revenue Sources- 1960

14 Government Revenue Sources- 2000

15 Government Revenue Sources- 2005
What tax source has increased the most in a relatively short time?

16 Income versus Payroll Taxes
Contrast the different types of taxes: Progressive tax (what is it & why is it progressive?) Regressive tax (what is it & make makes it regressive?) 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. How does US Tax burden compare with other Industrial Nations?

17 Comparing Tax Burdens

18 Where Does Government Spending Go?
The Changing Nature of Government Spending: Changes over time Shift from Cold War Defense spending to Human Resources Federal Spending by Type

19 Changing Federal Spending 1940-2005
What has triggered this increase in Federal spending on individuals?

20 The Growth of Entitlement Programs
Entitlement programs – who qualifies? Social Security => Pay as you go system => Federal Pyramid scheme? (trend & impact?) 1950: (15 to 1)=> 1990: (5 to 1)=> Post Baby Boom retirement: (3:1) COLA & the CPI (Box 16-1 & slide)=> impact? Proposed adjustments? (increase taxes, cut benefits, up eligibility?) Making hard choices=> The 3rd Rail & who votes? Other Entitlement Programs Medicare (40M elders)=> $221Billion & growing Medicaid (35M poor) & Food Stamps (17M poor) Federal retirement & VA disability benefits Entitlement programs are “non-discretionary” (?)*

21 Congressional Spending
Two major categories of Federal Spending: Non-discretionary Spending Federal spending on programs such as Social Security that cannot be controlled through the regular budget process. (For 2005: $1.481 Trillion) Discretionary Spending Federal spending on programs that can be controlled through the regular budget process. (For 2005: $857 Billion of a $2.338 Trillion Budget) Contrast the two spending categories within the Federal Budget

22 Entitlement Expenditures Discretionary vs. Non-discretionary
_______________________ $1.481 Trillion $857 Billion* 7% *How has Discretionary spending decreased over time?

23 Decreasing Discretionary Spending
How can we increase Discretionary spending?

24 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 Controlling Pork barrel politics Easier said than done=> conflicting objectives: Incumbent objective: improve reelection chances: One man’s pork is another’s vital program Vehicle for “pork” => bill riders (Senator Stevens & Alaska’s “Bridge to Nowhere”)*

25 Problems in the Budget Process
Legislation that appropriates Federal money for local projects of questionable value that may ingratiate a legislator with his or her constituents. Pork Barrel Spending Government subsidies or tax breaks of questionable value to private corporations. Corporate Welfare

26 Who is Responsible 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 & Budget riders* *Usually attached to last minute Omnibus “must pass” Bills 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)*

27 Top Tax Breaks for 2005 $400+ Billion in lost annual revenue

28 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): The President submits a budget to Congress Congress must then approve the budget Lets examine in more detail

29 Budgetary Reform in the 1970s
Nixon’s impoundments & growing deficits 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 & slide)*

30 The Budget Cycle Wrong!

31 The 2 Year Budget Process (Theory)
FY 2005 Budget FY 2006 Budget FY 2007 Budget Role of Continuing Resolutions (Reality)

32 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

33 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

34 Budget Deal of 1997 Let’s make a deal: (Clinton & the GOP Congress)
Aim: balance budget by 2002 & Contract w/America Reality: Presidents have a vote too (veto) Forced compromise=> major cuts in Federal programs Surplus first appears in 1998 (1st since 1969) Combined effects of all of above? (Table 16-1) Is the author right about the cause of surpluses?

35 Surpluses Until the Bubble Burst
Deficit spending has returned – why? Combination of several factors: 2000=> Tech Bubble burst => $$$ recession Stock Market freefalls (NASDQ down 60%) Corporations cut spending & Job losses grow 9/11/2001 => another major shock to economy (people sell more stocks, stop flying=> airlines fail) Cost of Katrina & other natural disastors Recent Oil shock Impact of War on Terrorism & War in Iraq?*

36 Impact of War on Terrorism
War on Terror (Afghanistan & elsewhere) => Significant increase in defense $pending Bush Budget (initially: where to spend surplus) Tax cut (now substantially reduced by Congress) Increased spending on Defense & Homeland Defense War with (now in) Iraq=> cost estimates (In the Hundred(s) of Billions range) Cost of 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??

37 More Budget Reforms? (Non-Starters)
Line-Item Veto (OBE) => unconstitutional Court ruling: act violated separation of powers Balanced Budget Amendment (unlikely to pass) Impractical & too hard to implement in near term OMB projects deficits into 2008 & beyond 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) Any tax reform must by revenue neutral

38 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? Budget cycle (“The POM) => No fiscal discipline Political Realities (The dirty little secret): Political priorities determine budget fiscal priorities Politicians respond to conflicting Public demands Whatever is most likely to get them reelected

39 Next Assignment Review of Test II results Chapter 17a: Domestic Policy
Learning Objectives 1-5

40 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.

41 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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