Background on Budget & Economy

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.
• Spending Freeze: Sen. John McCain proposed in the first presidential debate to freeze "everything but Defense, Veterans Affairs and entitlement programs". "Entitlements" means Social Security, Medicare, and Medicaid. "Defense spending" includes both the general defense budget plus "supplemental spending" on wars. One can therefore observe from the chart above that those three seemingly small items total 88% of the budget, leaving only the 12% of the budget, or $348 billion of "other discretionary spending", to be "frozen". McCain's statement is a typical politicians' attempt to muddy the water on budget discussions -- it was a non-answer to a question about where he would save $700 billion for the financial bailout (since the total proposed "freeze" only added up to half of the $700 billion), Voters should listen for other (very common!) attempts at muddying the water, by looking at what are the actual underlying amounts being discussed.

  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 $9 trillion. We pay interest in that debt -- amounting to $244 billion in 2008.
• Entitlements: The largest budget spending items, totalling $1.2 trillion in 2008, 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 $302 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 pretend that the wars in Iraq and Afghanistan pose unexpected expenses. Therefore they are 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.
• 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.’

  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 $1.2 trillion i npersonal 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 2008 debates as ‘raising the cap.’ In theory, each person's individual FICA funds their own retirement, so the tax is "capped" at income of $92,500 in 2008. Income above $92,500 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 $246 billion in 2008. 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 2008 budget has a deficit of $246 billion, which means that expenditures exceeded revenue by that amount.

The accumulated borrowing is the ‘National Debt’ that the government must repay in the future. The current federal debt stands at over $9 trillion, which is the equivalent of roughly $30,000 per person. The federal government pays over $200 billion in annual interest on the national debt.

• 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, th e budget deficit has returned in full force -- to $246 billion.

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 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).
• ‘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.