How Does the US Federal Budget Work?

With all the talk about the budget, deficit, and debt lately, I’ve been trying to understand how the US federal budget works. It hasn’t been easy. I haven’t found any comprehensive and even-handed analysis of how the government spends and taxes, so I have tried to collect the information I found into one place and give it some context. I relied extensively but not exclusively on information from Wikipedia (which has a very good page on the budget) and used additional readings to double-check it. I use fiscal year (FY) 2010 numbers except where indicated. I include a list of sources at the end of this post if you want to do your own research or check my facts. Please let me know if you feel I’ve made a mistake, left something out, or failed to explain something. I will continue editing to improve this overview. This post will focus on how the budget does work and I am working on a companion post about how I think it should work. I’ve tried, for the most part, to keep my opinions out of this one.

The post is divided into three sections: Big Numbers, Spending, and Income.

Big Numbers

I hear these big numbers all the time, but rarely do I hear the context that makes them meaningful.

US Gross Domestic Product (GDP) in FY2010: $14,508 billion(1; 1.2)

The biggest of the big numbers to which we reference all else.

Total federal spending for FY2010: $3,456 billion(23.8% of GDP)(1; 1.3)

23.8% of GDP is relatively high compared to recent historical averages. The average across the previous twenty years has been 20.3%, including the high 2009 level of 25%(1; 1.3). As far as I’ve been able to tell, the recent rise is attributed to increased social spending during the recession and its aftermath, stimulus programs, rising healthcare costs, and paying for two ongoing wars.

Total federal tax receipts for FY2010: $2,162 billion(14.9% of GDP)(1; 1.3)

14.9% of GDP is relatively low compared to recent historical averages. The average across the previous twenty years has been 18.1%(1; 1.3). The drop is generally attributed to a weak economy (meaning less income to tax) and tax breaks passed in hopes of stimulating the economy.

Federal budget deficit for FY2010: $1,293 billion(8.9% of GDP)(1; 1.3)

8.9% of GDP is extremely high compared to recent historical averages. The average across the previous twenty years has been 2.26%, including the high 2009 level of 10%(1; 1.3). The recent rise is due to the combination of decreased revenues and increased spending.

Total federal debt for FY2010: $13,551 billion(93.4% of GDP)(10)

93.4% of GDP is very high compared to historical averages. However, there are two points to be made about how to interpret this number. The first is that it is made up of two different kinds of debt; one is debt held by the public, which amounts to $9,019 billion(62.1% of GDP), and the other is intragovernmental debt, which accounts for the remaining $4,532 billion(18). Debt held by the public is the treasury debt held by private citizens, companies, and other governments and must be paid back or face a catastrophic default. Intragovernmental debt is the money that the federal government has borrowed from its own Social Security and Medicare trust funds. It is money that it has promised to its citizens, though changing the benefits paid in the future would wipe out some of these obligations(20). The second point is that if we compare our debt held by the public in relation to GDP with other countries, we look pretty good. Our 62.1% level puts us behind 11 advanced economies, including Japan’s 183%, the UK’s 85.5%, Israel’s 74.4%, and France’s 67.4%.(20)

Spending

Spending can be divided into two categories; mandatory spending and discretionary spending. Mandatory spending means payments required by law rather than spending decided each year in the political appropriations process, as discretionary spending is.

Mandatory Spending, 61% of total spending($2,112 billion)(2): Entitlement programs are based on paying for current beneficiaries with current tax revenue rather than current beneficiaries with the taxes that those beneficiaries paid in the past. This is what creates the scary ‘unfunded obligations’ argument that many people make when pushing for entitlement reform. At this point both Social Security and Medicare have built up substantial surpluses, though as more people retire, healthcare costs continue to rise, and because government has borrowed from these surpluses to pay for current programs, in the next decade or two the funds will run out under the current arrangement.

     –Social Security, 20% of total spending($706 billion)(1; 3.2): What is usually referred to as Social Security is Old Age, Survivor, and Disability Insurance(OASDI) and is a social insurance program. 53 million people received benefits in 2009(2). There is a large current surplus because historically we have payed far more into the fund than we’ve paid out, but future deficits are on the horizon, starting in 2037. Social security is not means-tested, meaning that all people who payed into the system receive payments from the government, based on the average of the highest 35 years of covered earnings (earnings from which the FICA tax was taken)(3).

     –Medicare/Medicaid, 22% of total spending($793 billion)(2): In 2009 medicare covered an estimated 45 million persons (38 million aged and 7 million disabled)(2). Medicare is a federal single-payer health insurance plan for the elderly, while Medicaid is a state-run and state/federal funded health insurance program for persons with low income and assets. Medicaid is means-tested while Medicare is not (anyone above a certain age is entitled to medicare coverage)(4)(5).

     –Other Mandatory spending, 12% of total spending($416 billion)(2): This category includes the Supplemental Nutritional Assistance Program, or SNAP (previously known as food stamps), unemployment insurance, and the Child Health Insurance Program(15). The number of Americans receiving SNAP benefits reached an all-time high of 45 million in May 2011(6).

      Interest payments on publicly-held debt 6% of total spending($197 billion)(2): This number is lower than it would be at the moment due to the fact that we have historically low interest rates on our Treasury debt. This amount also does not include the non-cash interest expense of $118.5 billion, which the government owes to itself for borrowing from the Social Security, and Medicare, and other trust funds(The intragovernmental debt mentioned in Big Numbers)(2)(11).

Discretionary Spending, 39% of total spending($1,326 billion)(2): This category of spending basically includes ‘everything else,’ from defense spending to education to foreign aid. This is what the appropriations committees determine each year after a budget is requested by the president.

     –Defense, 19% of total spending($666.7 billion)(1; 3.2): This amount only includes what is spent through the Department of Defense(DoD) and does not include all defense-related spending. Non-DoD defense-related spending includes Veteran’s Affairs, Homeland Security, and Military aide(these are counted in the next category). One table on the Wikipedia page on defense spending shows that if you aggregate all defense-related expenses it approaches or exceeds one-third of all federal spending(7).

Military Personnel: $155.7 billion
Operations and Maintenance: $276 billion
Procurement: $133.6 billion
Research, Development, Test, and Evaluation: $77 billion
Military Construction: $21.2 billion
Family Housing: $3.2 billion
Other: $90 million

     –Non-defense discretionary spending, 19% of total spending($660 B)(2): The breakdown figures in this category may not be exact. I have not found a comprehensive set of numbers for non-defense discretionary spending, so most of the numbers I am using are from the Office of Management and Budget that relate to agency spending(1; 4.1). The reason that they may not be entirely accurate is that I’m not sure what spending has already been accounted for in previous categories, for example I haven’t included Health and Human Services here because their numbers clearly reflect Medicare and Medicaid spending. I have chosen some of the largest categories that I don’t think include already-counted spending.

Veteran’s Affairs: $108.2 billion
Transportation: $77 billion
Education: $64.1 billion(16) (This includes federal Pell grants)
Elementary, Secondary, and Special education: $37.4 billion(16)
Foreign Aid (Military and Non-military): $45.2 billion
-State Department: $23.8 billion (most goes to foreign economic aid)
-Foreign military aid(22): $14 billion (2009 number, 2010 was likely less)
-Peace Corps budget: $0.4 billion(12)
—-Average Nicaragua PCV living allowance: $0.0000025 billion ($2,500)(21)
Homeland Security: $44.4 billion
Energy: $30.8 billion (includes $19 billion in nuclear energy, defense-related(1; 3.2))
Agriculture: $21 billion(1; 3.2)
NASA: $18 billion
Environmental Protection: $11 billion

Income

Pretty much just tax revenue plus one random $76 billion footnote.

Tax Income ($2,163 billion)(1; 2.1): The tax income received by the federal government can be thought of as a two-part calculation. The statutory tax rate times gross income, minus the tax credits, deductions, and exemptions, referred to as ‘tax expenditures’(8). Tax expenditures and loopholes explain the fact that the US has the highest statutory corporate tax rates in developed countries, but one of the lowest rates of corporate tax income(24). This is because corporations keep much of their profits out of the country or use tax exemptions in creative ways(19). One of the current proposals talked about by both major parties is to ‘simplify’ the tax code and lower tax rates by eliminating these tax expenditures for both individual and corporate income.

     –Individual income, 42% of tax income($899 billion)(1; 2.1): The US individual tax code has six different marginal rates and four brackets(individual, married filing jointly, married filing separately, and head of household). The marginal tax rate system means that each dollar is taxed only in the rate category in which is is earned. If a person made $10,000 in taxable income(meaning after credits, deductions and exemptions) in FY 2010 and files as an individual, then they would have paid 10% tax on the first $8,375 and 15% on the remainder. The marginal tax rate for an individual filer in FY 2010 looked like this(23):

  • 10% $0 – $8,375
  • 15% $8,376 – $34,000
  • 25% $34,001 – $82,400
  • 28% $82,401 – $171,850
  • 33% $171,851 – $373,650
  • 35% $373,651+

     –Social Security and Medicare taxes, 40% of tax income($865 billion)(1; 2.1): Social security and Medicare are paid for by FICA payroll taxes that total a combined 15.3% on the first $106,800 of income(though for FY2010 the tax was 13.3%)(3)(4). The tax is paid half by the employee and half by the employer(except in FY2010, when the employee got a slight tax break)(8).

     –Corporate income, 9% of tax income($191 billion)(1; 2.1): Companies with income above $50,000/yr pay about 35% tax on income minus exemptions, deductions, and credits(9). Though the statutory marginal tax rate is 35%, the effective marginal tax rate is more like 17.2% for the reasons discussed above(17).

     –Excise, 3% of tax income($67 billion)(1; 2.1): Examples of products or services subject to an excise tax include: alcohol, tobacco, gasoline and diesel fuel, coal, firearms, telephone service, and air transportation.(13)

     –Other, 6% of tax income($141 billion)(1; 2.1): Unemployment Insurance tax ($45 billion on employers taken from the first $1000, on average, of wages paid)(12), Estate and gift taxes ($19 billion in taxes taken from the value of assets upon their passing from one person to another by means other than sale)(8), customs duties($25 billion), and various fees (for use of national parks, for instance)(8).

Other Income: I stumbled upon this extra item and am not sure where to count it, but I don’t find it counted in tax revenue, so I’ll just mention it separately.

     –Deposits of earnings from the Federal Reserve ($76 billion): The Federal Reserve is required by law to return all profits from their transactions after paying a statutory 6% dividend to member banks for their capital investment(14).

Hope this is helpful! Thanks for reading, and don’t forget to comment below.

Sources

  1. OMB historical tables (table indicated in citation: 1.2, 1.3, 2.1, 3.2, and 4.1)
  2. US Federal Budget Wikipedia page
  3. Social Security Wikipedia page
  4. Medicare Wikipedia page
  5. Medicaid Wikipedia page
  6. SNAP Wikipedia page
  7. Military Budget of the United States Wikipedia page
  8. Taxation in the United States Wikipedia page
  9. Corporate tax in the United States Wikipedia page
  10. United States Public Debt Wikipedia page
  11. Peace Corps website
  12. Federal Unemployment Tax Act Wikipedia page
  13. Excise Tax in the United States Wikipedia page
  14. Federal Reserve System Wikipedia page
  15. State Children’s Health Insurance Program Wikipedia page
  16. Department of Education summary of discretionary funds
  17. AEI Report Card on Effective Corporate Tax Rates
  18. President’s budget proposal for FY2012, table S-1 Budget Totals
  19. 5 Ways GE Plays the Tax Game
  20. Economists say U.S. debt may not be as high as you think”
  21. This is my estimate for fun. Please do not quote me as an authority. 🙂
  22. USAID Foreign Assistance Fast Facts: 2009
  23. Income Tax in the United States Wikipedia page
  24. High Corporate Tax Rate Is Misleading
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