2. 13 The Budget: The Politics of Taxing and Spending
Dealing with the budget is one of the most intractable issues of American government, but also one of the most important. Here Wall Street traders watch as the stock market plunged after Standard and Poor's downgraded the U.S. credit rating in response to the inability of Congress and the president to agree on a plan to meet the government's financial obligations.
Mario Tama/Getty Images

3. 13
Learning Objectives
In this chapter we will learn where the federal government gets its money and how it decides how to spend it. We'll begin by looking at tax revenue and borrowing, and their implications for the national debt. Next will will consider spending and discover why the federal budget grows. Then we will analyze the complex budgetary process and assess the impact of politics on taxes and spending.
Describe the sources of funding for the federal government and assess the consequences of tax expenditures and borrowing.
13.1
Analyze federal expenditures and the growth of the budget.
13.2

4. 13
Learning Objectives
Outline the budgetary process and explain the role that politics plays.
13.3
Assess the impact of democratic politics on budgetary growth and of the budget on scope of government.
13.4

5. Federal Revenue and Borrowing
13.1
Federal Revenue and Borrowing
Justice Holmes famously said that taxes are the price we pay for civilization. He did not mind paying taxes for this reason. But most Americans today do not share his view. There is much grumbling that taxes are too high but there is even more complaint when it comes to cutting the programs that taxes fund. Americans, it seems, want something for nothing. We expect a lot from the federal government but we are not willing to pay for it.
The federal government collects several different types of taxes, including personal and corporate income taxes, social insurance taxes, and excise taxes. It also borrows a lot of money.
Personal and Corporate Income Tax
Social Insurance Taxes
Borrowing
Taxes and Public Policy

6. 13.1 FIGURE 13.1 The federal budget: An overview
Let's look at this diagram. The federal budget consists of revenues and expenditures. When expenditures exceed revenues, the budget runs a deficit. The accumulation of debt over time creates the national debt. Data are estimates for fiscal year 2015.
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government Printing Office, 2014), Tables 1.1 and 7.1.

7. Personal and Corporate Income Tax
13.1
Personal and Corporate
Income Tax
When Congress first attempted to levy a small income tax in 1894, the Supreme Court declared it unconstitutional.
In 1913, the Sixteenth Amendment was added to the Constitution, explicitly permitting Congress to establish an income tax. The Internal Revenue Service was created to collect and process tax payments.
Today, it receives over 140 million individual tax returns each year. The federal income tax is generally progressive, that is, higher incomes are taxed at a higher rate. Current tax rates range from %, much lower than in the past.
Sixteenth Amendment (1913)
IRS
140 million individual income tax returns
Income tax is progressive
% current tax rates

8. Personal and Corporate Income Tax
13.1
Personal and Corporate
Income Tax
Who pays income tax? In 2013, 43% of filers made so little money that they were not required to pay any taxes at all. The richest 1% provided 35% of all tax revenue, and the richest 10% provided 68%. The bottom 50% provided only 3% of all tax revenue that year. In 2015, corporate taxes yielded about 13 cents of every federal revenue dollar, compared with 46 cents from individual income taxes.
Some people have proposed getting rid of the progressive income tax and instituting a flat tax, where everyone, regardless of income, pays the same tax rate. What financial impact would a flat tax have?
Who pays taxes?
42% paid no taxes
1% paid 37%
10% paid 70%
Bottom 50% paid 2%
The flat tax

9. 13.1 FIGURE 13.2 Federal revenues
Individual income taxes make the largest contribution to federal revenues, but nearly a third of federal revenues comes from social insurance taxes. In bad economic times, tax revenues decrease as fewer people are working and paying taxes. Revenue from individual income taxes also decline after tax cuts, such as in In 2011–2012, there was a temporary decrease in social insurance taxes to help stimulate the economy. This is a stacked graph in which the difference between the lines indicates the revenues raised by each tax.
What type of tax makes up the largest portion of federal revenues?
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government
Printing Office, 2014), Table 2.1.

10. Social Insurance Taxes
13.1
Social Insurance Taxes
Social Security and Medicare taxes are withheld from your paycheck and matched by your employer. Today they account for about one third of federal revenue.
Social Security
Medicare
Both matched by employers
Provide 1/3 of federal revenue

11. Borrowing 13.1 Tax revenue does not cover expenditures Bonds
Tax revenue does not cover federal expenditures so the government borrows money. The Treasury Department sells bonds, agreeing to pay interest to the bondholders.
The federal government borrows money from itself, such as by taking money from Social Security funds to pay military pensions or farm subsidies. This borrowing creates intragovernmental debt.
Tax revenue does not cover expenditures
Bonds
Sold by Treasury Department
Borrowing from itself
Intra governmental debt

12. Borrowing 13.1 National debt is about $17.5 trillion
The national debt stands at $17.5 trillion and is growing every minute. In fact, 6% of federal spending is interest on this debt. Congress imposes a debt ceiling, which is a limit on how much money the government can borrow. When the president asks Congress to raise the debt ceiling, they can make it conditional on concessions in various policy areas. Thus, the debt ceiling is a powerful bargaining chip for Congress.
If your income decreases, you have to cut your expenses. For the federal government, when tax revenue decreases it is usually because of an economic downturn. But then more people are in need of government services, such as unemployment benefits and food stamps, that form the social safety net. The government may also spend money to stimulate the economy or bail out important industries. Thus, the government usually has to spend more money when its revenue declines.
National debt is about $17.5 trillion
6% of federal spending are interest payments
Debt ceiling
Spending increases when revenue declines

13. 13.1 FIGURE 13.3 Total national debt
The national debt climbed steadily throughout the 1980s, leveled off in the 1990s, and has risen sharply since 2001 and especially after the financial crisis of 2008.
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government
Printing Office, 2014), Table 7.1.

14. Taxes and Public Policy
13.1
Taxes and Public Policy
Tax expenditures represent tax revenue that is lost due to exemptions. For example, taxpayers can deduct charitable contributions and mortgage interest payments from their taxable income, and businesses can deduct expenses for new equipment and facilities. Tax exemptions benefit the wealthy and businesses more than the majority of Americans. Can you see why?
Tax cuts are always popular with voters – who doesn't want to retain more of their paycheck or get a fatter tax return check? Tax reductions score political points with voters but they raise the deficit because it is much harder to cut expenses. Tax cuts also disproportionately benefit the wealthy because they generally only affect income taxes, not excise taxes.
Tax expenditures
Charitable contributions
Mortgage interest
Business equipment
Benefit the wealthy and businesses
Tax reduction
Popular with voters
Benefits the wealthy

15. 13.1
TABLE Tax expenditures: The money government does not collect
Tax expenditures are essentially money that government could collect but does not because they are exempted from taxation. The Office of Management and Budget estimated that the total tax expenditures in 2015 would be more than $1.1 trillion—an amount equal to more than one-third of the total federal receipts. Individuals receive most of the tax expenditures, and corporations get the rest. Here are some of the largest tax expenditures and their cost to the treasury.
SOURCE: Budget of the United States Government, Fiscal Year 2015: Analytical Perspectives (Washington, DC: U.S.
Government Printing Office, 2012), Table Data are estimates for fiscal year 2015.

16. 13.1
13.1 What percentage of federal spending is simply interest payments on the national debt?
Before we continue, I want to test your understanding of the national debt and the interest the government pays on it with this brief question. 6% 3%
11%
None 16

17. 13.1
13.1 What percentage of federal spending is simply interest payments on the national debt?
Six percent of annual federal spending goes to servicing the national debt. These interest payments are not optional, and this money is unavailable for education or health care or other federal endeavors. 6% 3%
11%
None 17

18. Federal Expenditures 13.2 Big Governments, Big Budgets
Federal expenditures have grown rapidly since the 1930s, both in terms of actual dollars and in the variety of categories of spending. Why does the government spend so much? Why do federal expenditures keep rising? Where does the money go? We will explore these questions in this section.
Big Governments, Big Budgets
The Rise of the National Security State
The Rise of the Social Service State
Incrementalism
The "Uncontrollable" Expenditures

19. 13.2 FIGURE 13.4 Federal expenditures
The biggest category of federal expenditures is payments to individuals, composing more than 60 percent of the budget. National defense accounts for about one-fifth of the budget. This is a stacked graph in which the difference between the lines indicates the amount spent on each category. The economic crisis of 2008–2009 led to a dramatic increase in the budget.
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government
Printing Office, 2015), Table 6.1.

20. Big Governments, Big Budgets
13.2
Big Governments, Big Budgets
Big government needs big money
1/3 of GDP is govt. spending
Why has government grown?
Public demand
Changes in economy
Changes in social conditions
Economic downturns
Urbanization
Pollution
The bigger the government, the bigger the expenses. Today, federal government expenditures represent one quarter of GDP.
Why has government grown so big? The simple answer is that it has grown in response to public demand. Changes in the economy after the Industrial Revolution, and changes in social conditions after urbanization and industrialization, have increased demand for government services. Economic downturns also increase this demand, as do negative economic externalities like pollution.

21. The Rise of the National Security State
13.2
The Rise of the National Security State
Defense spending increased during the first and second world wars. The Cold War that began after the end of World War II kept military expenses from declining after the end of the war. In fact, they grew substantially. During the 50s and 60s, the Department of Defense received over half of the federal budget. This era also saw the growth of the military-industrial complex, which has done its best to keep military spending high.
But despite the power of the military-industrial complex, defense spending did decline after the end of the Cold War. It increased after 9/11, but it receives about 1/5 of the federal budget today.
Much of the defense budget pays for employees and pensions, the purchase of military hardware, and cost overruns.
Permanent military establishment
Cold War
Military-industrial complex
DoD spending half of federal budget during Cold War
Decreased until 9/11
1/5 of federal budget today
Military expenses
7 million pensions
Procurement
Cost overruns

22. 13.2 FIGURE 13.5 Trends in national defense spending
Defense expenditures increased rapidly during the Reagan administration and declined with the end of the Cold War. They increased again after the September 11th, 2001, terrorist attacks and the invasion of Iraq in 2003, decreasing as the wars in Iraq and Afghanistan wound down.
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government
Printing Office, 2014), Table 6.1.

23. Stealth bomber 13.2 Philip Wallick
The U.S. Air Force unveiled its new stealth bomber in The plane's unusual shape allows it to fly undetected by enemy radar, but such technology costs money—over $2 billion per plane. These huge expenditures contributed to substantial increases in the defense budget in the 1980s.
Philip Wallick

24. The Rise of the Social Service State
13.2
The Rise of the Social Service State
The biggest slice of today's budget pie goes to income security programs, the so-called social safety net. Social Security was created by FDR in 1935 to reduce poverty among the elderly. In the 1950s, disability insurance was added to the program. In 1965, as part of President Johnson's Great Society programs, a health insurance program for the elderly, called Medicare, was launched. Coverage for prescription drugs was added to this program in 2003.
Where does the money for Social Security and Medicare come from? It is deducted from your paycheck. The money collected from today's workers pays current retirees. When today's workers become old enough to collect, the workers of that era will be paying their benefits. In this manner Social Security forms an intergenerational contract. It works perfectly in theory. The only problem is that as birth rates decline and the elderly live longer, the ratio of workers to beneficiaries is changing. In 1940, there were about 40 workers for each retiree; today there are 3. Medicare faces a similar problem. What can be done to solve it?
Income security expenditures
Social Security
Medicare
Intergenerational contract
More beneficiaries than workers

25. Social Security and Medicare
13.2
Social Security and Medicare
Much of the federal budget goes to providing Social Security and Medicare for the elderly. These programs have been very successful in reducing poverty among the elderly but are the biggest contributors to rising deficits.
Lisa DeJong/AP Images

26. 13.2 FIGURE 13.6 Trends in social service spending
Social service spending, principally on health, education, and income security, has increased substantially since the 1960s and now makes up about two-thirds of the budget. With more people reaching retirement age in the last few years, spending on Social Security and Medicare has increased especially rapidly.
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government
Printing Office, 2014), Table 3.1.

27. 13.2
Incrementalism
The term incrementalism simply means that the best predictor of this year's budget is last year's budget. There is little flexibility for the president and Congress in the budget process. Each year, agencies expect to get a little more money than they did the previous year–an incremental increase.
There are exceptions, of course. When the government shifts priorities it may drastically cut the budget of an agency. NASA's budget grew rapidly when the space program was launched then plummeted when it was discontinued. But the general trend is slow but steady growth each year.
Best predictor of this year's budget is last year's
Incremental increase for each agency
Exceptions

28. "Uncontrollable" Expenditures
13.2
"Uncontrollable" Expenditures
Each year, the president proposes the budget and Congress approves it – or not. The budget is too large to review in its entirety each year, but it would seem that cuts could be made if they were desired. So why then do we say the budget is uncontrollable?
We say the budget is uncontrollable is because about two thirds of it is automatic; it is not a fixed or lump sum that Congress can adjust downward if it chooses.
Interest on the debt, for example, must be paid. Congress has no discretion to allocate less money to interest payments next year.
Why is the budget uncontrollable?
2/3 of budget automatic
Interest

29. "Uncontrollable" Expenditures
13.2
"Uncontrollable" Expenditures
It is the same with entitlements, which make up the bulk of the federal budget. Everyone over 65 is entitled to Medicare. Social Security and veterans' benefits must also be paid to everyone who is eligible.
The only way Congress could change entitlement allocations would be to pass laws altering the programs.
For example, Congress could raise the age of Medicare eligibility from 65 to 70. But such changes are not popular with voters, and Congressmen want to keep their jobs.
2/3 of budget automatic
Interest
Entitlements

30. 13.2 Why does the federal government have so little discretion over its own budget?
Now that you know where 2/3 of the budget is going, you should be able to answer this question.
Federal law forbids Congress from tampering with president's budget
The president is obliged by the Constitution to sign whatever budget bill Congress sends him
Entitlements create uncontrollable obligations
All of the above 30

31. 13.2 Why does the federal government have so little discretion over its own budget?
Entitlement payments are determined by eligibility rules, not lump sum budget allocations.
Federal law forbids Congress from tampering with president's budget
The president is obliged by the Constitution to sign whatever budget bill Congress sends him
Entitlements create uncontrollable obligations
All of the above 31

32. The Budgetary Process 13.3 Budgetary Politics The President's Budget
The budgetary process begins and ends with the president, but the role that Congress plays in the middle is critical. Some of the fiercest political battles in Washington are waged over the annual federal budget.
Budgetary Politics
The President's Budget
Congress and the Budget

33. Budgetary Politics 13.3 Stakes and strategies Players
Budgets determine who gets what, when, and how. Everyone has a stake in the budget. Each political actor adopts a strategy in the budget game. Agencies, for example, emphasize how their programs benefit a senator's state or representative's district. Agencies always pad their budget requests, assuming they won't get all the money they ask for.
The main actors in the budgetary process include interest groups, agencies, OMB, the president, Congressional committees and subcommittees on budget, taxation, authorization, and appropriation, the CBO, the GAO, and Congress as a whole.
The budget process happens every year, and the part of each political actor is carefully scripted.
Stakes and strategies
"Who gets what, when, and how"
Actors adopt strategies
Players
Large cast
Roles carefully scripted

34. Government shutdown 13.3 Doug Mills/AP Images
Because budgetary policy is so important, decision makers may be reluctant to compromise. In 1995–1996, the inability of the president and Congress to reach agreement led to the shutdown of much of the federal government.
Doug Mills/AP Images

35. 13.3 FIGURE 13.7 The players in the budgetary process
This graph shows the main players in the federal budget process. Why is Congress at the center?

36. The President's Budget 13.3 Presidents used to play limited role
Prior to the passage of the Budget and Accounting Act in 1921, the president did not prepare and submit a budget to Congress. Agencies made their requests directly to Congress and the president had a very limited role in the budgetary process.
Now, the president's Office of Management and Budget prepares the annual budget and submits it to the president for approval. Once approved, it goes to Congress.
The budget is due to Congress the first Monday in February but preparations begin a year in advance as OMB begins soliciting budget requests from agencies. Guidelines, policies, priorities, and targets all have to be established. Agency heads usually threaten to go directly to the president if their priorities are not met by OMB. The jockeying and negotiations can continue until the last minute, with the budget being rushed to the printers hours before it is due on Capitol Hill.
Presidents used to play limited role
Budget and Accounting Act
Prepares budget with help of OMB
Budget schedule
Due first Monday in February
Process begins a year in advance

37. Congress and the Budget
13.3
Congress and the Budget
As you know already, the Constitution gives Congress the power to authorize federal appropriations.
Expenditures must be linked to expected revenues. Yes, we know the government spends more than it takes in, but there is some consideration of revenue. Each April Congress must pass a budget resolution which binds Congress to a total expenditure level. Part of this process is reconciliation, that is, changes to laws and authorizations that will enable Congress to stick to its budget ceiling. The second part of this process is the passage of authorization bills that establish or change government programs.
Later, Congress must pass appropriations bills to fund programs established by authorization bills. Congress cannot appropriate more money than is authorized, but it can give the program less money, or none at all.
More often than not recently, Congress has been unable to resolve its political dickering and reach agreement on appropriations bills. To keep the government functioning, Congress has to pass continuing resolutions, which are laws that allow agencies to spend at last year's levels.
Power of the purse
Budget resolution
Reconciliation
Authorization bills
Appropriations bills
Continuing resolutions

38. 13.3 FIGURE 13.8 The budget process
Why do we say that the biggest predictor of this year's budget is last year's budget?

39. 13.3 FIGURE 13.9 Fluctuating deficits
Annual federal deficits mushroomed during the Reagan administration (1981–1988), despite the president's oft-repeated commitment to a balanced budget. The deficit disappeared during the Clinton administration, and the nation began running a surplus in fiscal year By 2002, however, the United States was back in the red. Annual deficits grew even larger beginning in 2009 as the government dealt with the financial crisis that hit the United States in 2008, but they fell sharply as the economy recovered.
Source: Budget of the United States Government, Fiscal Year 2015: Historical Tables (Washington, DC: U.S. Government
Printing Office, 2014), Table 1.1.

40. 13.3 What type of bill must follow an authorization bill?
Now that we know the steps to a budget resolution, you should be able to tell me the answer to this question.
Continuing resolution
Reconciliation bill
Appropriations bill
None of the above 40

41. 13.3 What type of bill must follow an authorization bill?
After Congress authorizes a new program, such as a program to build highways, it must appropriate the money for the program in a separate bill.
Continuing resolution
Reconciliation bill
Appropriations bill
None of the above 41

42. Understanding Budgeting
13.4
Understanding Budgeting
The budgeting process is central to modern government. This was not always the case but as government has gotten bigger, it spends most of its time debating how to spend money.
Democracy and Budgeting
The Budget and the Scope of Government

43. Democracy and Budgeting
13.4
Democracy and Budgeting
Growth in government tied to democracy
Do elites oppose big government?
Bailouts
Contracts and subsidies
Interest groups want their piece, too
Americans tax and spend less
Americans want lower taxes but more pork
Deficits result
Although Americans complain about the size and scope of government, both are closely tied to democracy. Each citizen, rich or poor, has one vote. Since the poor outnumber the rich, and the old outnumber the young (in terms of voting), public policy skews in favor of social welfare programs that help the poor and the elderly, like Social Security, Medicaid, and Medicare.
Do elites oppose big government? No, they simply favor different types of programs. Corporations want bailouts, government contracts, and subsidies.
Interest groups want government to help them, too. Zoologists, for example, want aid from the National Science Foundation.
Despite the demands from voters that have caused government to grow, the American government taxes and spends far less than the governments of other wealthy democracies.
One of the most common criticisms of the federal government is that it cannot balance its budget. But consider how members of Congress are rewarded by voters: If they cut taxes, they are re-elected. If they cut programs and benefits to their constituents, they are defeated. If they bring pork barrel projects home to their states and districts, they get re-elected. The inevitable result of these incentives is deficits.

44. Arches National Park 13.4 Mike Theiss/National Geographic/Getty Images
Americans are of two minds about the budget. They prefer low taxes, but they also desire public services, like the preservation of scenic areas such as Arches National Park. As long as voters have contradictory demands for public policy, their elected representatives are unlikely to easily resolve basic decisions about taxing and spending.
Mike Theiss/National Geographic/Getty Images

45. The Budget and the Scope of Government
13.4
The Budget and the Scope of Government
In many ways, the budget represents the scope of government. The bigger the budget, the bigger the government, and vice versa. When people see a need, such as reducing poverty among the elderly or defending the nation's borders or preventing poor children from starting the school day without breakfast, the government finds a way to pay for it.
But the politics of budgeting are also the politics of scarcity because there is never enough money to meet all the demands for government activity and funding. Tough choices have to be made each year in the budget process.
The budget is the scope of government
When country has need, government pays
Politics of scarcity
Never enough funds

46. 13.4 What feature of American government tends to promote its growth?
As we have just covered, growth in government is tied to one of these choices. Which is it?
Republicanism
Federalism
Democracy
All of the above 46

47. 13.4 What feature of American government tends to promote its growth?
Democracy tends to lead to expansion of the government because it enables citizens to make demands on it and reward or punish officials as these needs are met or not met.
Republicanism
Federalism
Democracy
All of the above 47

48. 13
Discussion Questions
Why is the federal budget process so highly politicized?
Who are the main stakeholders in budget decision-making?
Why does the federal budget tend to increase each year?