Government Budgets and Fiscal Policy

Federal Government Spending and Outlays: 2020 and 2023 Analysis

Overview of Federal Spending in 2020

In the fiscal year of 2020, federal spending was characterized by significant outlays to address the pandemic and maintain social safety nets. Total outlays reached $31.2\%$ of GDP, totaling approximately $6.6$ trillion dollars.

• Mandatory Spending: Represented $21.8\%$ of GDP ($4.6$ trillion). This includes outlays for federal civilian and military retirement, some veterans' benefits, the earned income and child tax credits, the Supplemental Nutrition Assistance Program (SNAP), and other mandatory programs, minus income from offsetting receipts.     * Social Security: $5.2\%$ of GDP ($1.1$ trillion).     * Medicare: $3.7\%$ of GDP ($769$ billion). This consists of benefit payments minus income from premiums and other offsetting receipts.     * Medicaid: $2.2\%$ of GDP ($458$ billion).     * Paycheck Protection Program (PPP): $2.5\%$ of GDP ($526$ billion).     * Unemployment Compensation: $2.3\%$ of GDP ($473$ billion).     * Recovery Rebates: $1.3\%$ of GDP ($275$ billion).     * Other Mandatory: $4.7\%$ of GDP ($988$ billion).

• Discretionary Spending: Totaled $7.8\%$ of GDP ($1.6$ trillion).     * Defense: $3.4\%$ of GDP ($714$ billion).     * Non-defense: $4.4\%$ of GDP ($914$ billion). These outlays cover programs related to health, transportation, education, veterans' benefits, housing assistance, and other activities.

• Net Interest: $1.6\%$ of GDP ($345$ billion).

Overview of Federal Spending in 2023

By 2023, federal spending levels shifted as pandemic-specific programs wound down. Total outlays accounted for $22.7\%$ of GDP, totaling $6.1$ trillion dollars.

• Mandatory Spending: $13.9\%$ of GDP ($3.8$ trillion).     * Social Security: $5.0\%$ of GDP ($1.3$ trillion).     * Medicare: $3.1\%$ of GDP ($839$ billion).     * Medicaid: $2.3\%$ of GDP ($616$ billion).     * Income Security Programs: $1.7\%$ of GDP ($448$ billion).     * Other Mandatory: $1.9\%$ of GDP ($502$ billion).

• Discretionary Spending: $6.4\%$ of GDP ($1.7$ trillion).     * Defense: $3.0\%$ of GDP ($805$ billion).     * Non-defense: $3.4\%$ of GDP ($917$ billion). These funds support veterans' health care, education, transportation, and certain health/income security programs.

• Net Interest: $2.4\%$ of GDP ($659$ billion).

Growth Trends in Federal and State Spending

Federal spending has generally fluctuated between $18\%$ and $22\%$ of GDP over recent decades, with 2020 being a distinct outlier due to emergency spending. While the total percentage of GDP remains relatively stable, the internal categories of spending have shifted.

State and Local Spending:

• While less than federal spending, it remains significant and has increased over past decades.

• The largest spending category at the state and local level is public education.

• Case Study (Colorado 2021): Colorado's per capita expenditures were compared against national and regional (Mountain region: Arizona, Colorado, Idaho, Minnesota, New Mexico, Nevada, Utah, and Wyoming) averages. Categories include K-12 education, Public welfare (including Medicaid), Higher education, Health and hospitals, Highways and roads, Police, and Corrections.

Federal and State Taxation Systems

Federal Revenue Sources

Federal tax revenues have historically remained between $15\%$ and $20\%$ of GDP. In 2020, total revenues were $16.3\%$ of GDP ($3.4$ trillion).

• Individual Income Tax: Based on all forms of income received by individuals. In 2020, this was $7.7\%$ of GDP ($1.6$ trillion).

• Payroll Tax: Based on pay received from employers; funds Social Security and Medicare's Hospital Insurance. In 2020, this was $6.2\%$ of GDP ($1.3$ trillion).

• Corporate Income Tax: Imposed on corporate profits ($1.0\%$ of GDP or $212$ billion in 2020).

• Excise Taxes: Levied on specific goods such as gasoline, tobacco, and alcohol.

• Estate and Gift Taxes: Levied on assets passed to the next generation during life or after death.

• Other Revenue: Includes customs duties, remittances from the Federal Reserve, and miscellaneous fees/fines ($1.4\%$ of GDP or $289$ billion in 2020).

Tax Structures and Categories

• Proportional Tax: A flat percentage regardless of income level.

• Progressive Tax: Collects a greater share of income from high-income earners. The U.S. income tax is progressive.

• Regressive Tax: High-income earners pay a smaller share of their income. Examples include sales tax and excise taxes on tobacco or gasoline.

2018 United States Income Tax Brackets (Single Filers):

• $0$ to $9525$: $10\%$

• $9526$ to $38700$: $12\%$

• $38701$ to $82500$: $22\%$

• $82501$ to $157500$: $24\%$

• $157501$ to $200000$: $32\%$

• $200001$ to $500000$: $35\%$

• $500001+$: $37\%$

State and Local Revenues

State and local governments derive revenue from sales taxes, property taxes, federal government transfers, personal/corporate income taxes, and various fees.

• Colorado Revenue History: Over a 20-year period, Colorado's tax revenue has included General Fund revenue and Cash funds revenue, derived from sources like Marijuana taxes, Gaming tax, Severance tax, and Insurance Premium tax.

Federal Deficits, National Debt, and Fiscal Policy

Key Definitions

• Budget Deficit: Occurs when federal spending exceeds tax revenue in a given year.

• Budget Surplus: Occurs when tax revenue exceeds spending in a given year.

• Balanced Budget: When spending and taxes are equal.

• National Debt: The total accumulated amount borrowed over time and not yet repaid. It is the sum of all past deficits and surpluses, represented by the dollar value of all outstanding Treasury bonds. (Deficit is an annual flow; debt is a total stock).

Debt Statistics and Metrics

• 2024 National Debt: Exceeds $35$ trillion dollars.

• Debt-to-GDP Ratio: A metric used to track debt relative to economic size. During the 1960s-1970s, the debt grew more slowly than the GDP.

Fiscal Policy Tools

Fiscal policy involves using government spending and taxation to influence the economy's path.

• Expansionary Fiscal Policy (Fiscal Stimulus): Increases aggregate demand (AD) via spending increases or tax cuts. Used to fight recession and unemployment.

• Contractionary Fiscal Policy (Fiscal Contraction): Decreases AD via spending cuts or tax increases. Used to combat inflation.

Implementation Methods

• Discretionary Fiscal Policy: Explicit law changes (e.g., the 2009 stimulus package) designed to change tax/spending levels.

• Automatic Stabilizers: Pre-existing rules that influence AD without new legislation. During recessions, these increase unemployment benefits and welfare payments while income tax revenues naturally fall.

• Standardized Employment Budget: An estimate by the Congressional Budget Office (CBO) of what the deficit/surplus would be if the economy were at potential GDP (full employment). It filters out the impact of automatic stabilizers. Historically, automatic stabilizers offset about $10\%$ of an initial fall in output.

Practical Problems and the Balanced Budget Debate

Crowding Out

Crowding out occurs when government borrowing increases the demand for loanable funds, thereby increasing interest rates. Higher interest rates reduce private business investment and household consumption. Studies suggest that a $1\%$ increase in the budget deficit can lead to a rise in interest rates of $0.5\%$ to $1.0\%$

Interaction with Monetary Policy:

• In Deep Recession: Increased deficits may stimulate AD without high inflation. The Fed can use expansionary monetary policy to keep interest rates low, minimizing crowding out.

• Near Potential Output: Increased deficits cause inflationary pressure. The Fed may use contractionary monetary policy, further raising interest rates and worsening crowding out.

Time Lags

1. Recognition Lag: Time spent determining a recession is actually occurring.

2. Legislative Lag: Time spent passing a fiscal policy bill through the legislature.

3. Implementation Lag: Time spent dispersing funds to agencies to start programs.

Political Realities and The Balanced Budget Question

Politicians often advocate for pro-cyclical policy (tightening in a downturn, spending in a boom), which is the opposite of the recommended countercyclical approach.

Regarding balanced budgets:

• Requiring a balanced budget every year is widely considered poor policy because it ignores automatic stabilizers and prevents long-term investments in human capital and infrastructure.

• Large budget deficits can build long-term productivity if invested wisely.

International Economic Crises and U.S. Debt Concerns

The Path to Crisis

A series of large budget and trade deficits can cause international investors to fear a sovereign default. If a country cannot borrow in its own currency (as is the case for most nations who must borrow in USD, Euros, or Yen), it may face:

1. Outflow of financial capital.

2. Home currency depreciation.

3. Reduced ability to repay debt.

4. Default, bank failures, and deep recession.

Recent Crisis Examples: Greece (2015), Venezuela (2017), Barbados (2018), Argentina (2020), Ecuador (2020), Lebanon (2020), Sri Lanka (2022), Ghana (2022), Russia (2022), Zambia (2022).

The Status of U.S. Debt

The United States has the world's largest debt but holds a privileged position because it borrows in its own currency. This means it should never be forced to default, though it could choose to (e.g., by not raising the debt ceiling).

Arguments for Concern:

• An aging population will increase spending on Social Security and Medicare, potentially diverting resources from other investments.

• Interest rates may rise, making debt servicing more expensive.

• Printing money to pay off debt could lead to severe inflation.