Robert J. Stonebraker, Winthrop University
The Joy of
Economics: Making Sense out of Life
Robert J. Stonebraker, Winthrop
University
Government Finances: Just the Facts
Taxes are what we pay for civilized society.
...former chief justice Oliver Wendell Holmes, Jr.
Tables of numbers rarely elicit wide-eyed excitement among students. Too bad. Without a basic overview of the sources and uses of government funds, none of the macroeconomic policy issues that dominate the political landscape can be discussed intelligently. The data referenced all can be found in the latest annual version of The Economic Report of President. Read on.
Federal Government Revenues
The table below lists the revenues of the U.S. federal government for fiscal 2006 All amounts are in billions of dollars.
Personal income tax $1,044 43%
Social security tax 838 35%
Corporate income tax 354 15%
Excise taxes 74 3%
Estate taxes 28 1%
Tariffs 25 1%
Other 45 2%
Total: $2,408 100%
The same three taxes (personal income, corporate income, and social security) have dominated federal revenues for many decades and the personal income tax has accounted for the largest percentage of revenue ever since the end of World War II. In recent decades there has been a gradual increase in the relative importance of social security, and a relative decline in the importance of corporate income taxes.
Federal Government Expenditures
The table below lists the expenditures of the U.S. federal government for fiscal 2006. All amounts are in billions of dollars.
Social Security/Medicare $878 33%
Defense/veterans 592 23%
Income Security 352 13%
Health 253 10%
Interest on debt 227 9%
Education/training 119 4%
Other 234 9%
Total: $2,655 100%
The most significant change in recent decades has been the increase in social security and Medicare spending. After the end of the Cold War, defense spending leveled off and actually fell in real, inflation-adjusted terms. However, social security and Medicare expenses have soared as the population has aged. Prior to the early 1990’s, spending for defense exceeded that for social security and Medicare. Twenty years ago (1984), defense and veterans programs accounted for almost 30 percent of federal spending while social security and Medicare accounted for only about 20 percent.
Interest on debt has accounted for the other significant change. The national debt has doubled over the last 15 years. However, because interest rates have been unusually low in recent years, the net interest being paid on the dept is actually lower than it was in 1989. If, as is likely, interest rates move back up to more typical historic levels, expect interest expenditures to rise rapidly.
Federal Deficits and debt
Remember that the U.S. federal government is not required to balance its budget. It is free to spend more than it receives (a deficit budget) or to spend less than it receives (a surplus budget). Since 1950, deficits have been the rule. We ran deficits during seven of the ten years of the 1950’s, during eight of the ten years of 1960’s, during every year from 1970 until 1998. After four straight years of surplus budgets (1998-2001) we returned to steady deficits in 2002.
Look back at the data above. In fiscal 2006, we spent $2,655 billion, but brought in only $2,408 billion in revenues. In other words, we ran a $247 billion budget deficit (2,655 - 2,408 = 247). If we move the Social Security System (that ran a budget surplus) out of the calculation, the 2006 deficit soars to $434 billion.
How can we do this? How can the government continue to spend more than it collects in revenues? It’s easy. The government borrows; it goes into debt. If Congress wants to spend $10 billion more than it has, the U. S. Department of the Treasury borrows the needed $10 billion by issuing or selling $10 billion of new government bonds. These bonds are nothing more than IOU’s through which the government promises to repay the bond owner with interest at some point in the future. Since these bonds are obligations of the national government, we call the sum of the outstanding government bonds the national debt. Because federal budget deficits require new borrowing, they raise the national debt. Federal budget surpluses can be used to redeem government bonds and reduce the national debt.
State and Local Government Revenues
Although we often focus on federal finances, state and local governments also can be a powerful economic force. The table below lists the revenues of combined state and local governments during 2005. All amounts are in billions of dollars.
Sales and excise taxes: $361 19%
Property taxes: 318 17%
Personal income tax: 215 11%
Corporate profit tax: 34 2%
Grants from federal government 426 23%
Other: 536 28%
Total: $1,890 100%
Although tax structures vary considerably among states and among local governments, three taxes tend to dominate overall: sales and excise taxes (the major source of tax revenue for state governments), property taxes (the major source of tax revenue for local governments), and personal income taxes (which often flow to both state and local governments). State and local governments also receive a significant chunk of revenue through grants from the federal government. There have been relatively few changes in these categories in recent decades.
State and Local Government Current Expenditures
The table below lists the current expenditures of the combined state and local governments during 2004. All amounts are in billions of dollars.
Education $655 34%
Public welfare 340 18%
Highways 118 6%
Other 794 42%
Total: $1,907 100%
State and Local Deficits
The combined state and local governments in the U.S. ran a $17 billion surplus in 2004 [1,907 - 1,890 = 17]. Unlike the federal government, most state and local governments face constitutional prohibitions against running deficits in their current expenditure budgets. Note that there is a difference here. The table above lists only current expenditures at the state and local level. Most state and local governments cannot borrow to support current expenditures, but they can and do borrow to finance long-term capital projects such as the construction of schools and sewage systems. If capital projects were included, state and local government budgets would show deficits as well.
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Testing Yourself
To test your understanding of the major concepts in this reading, try answering the following:
1. Identify the two major sources of federal government revenue in the U.S.
2. Identify the two major expenditure items of the federal government.
3. Explain why the “interest on debt” federal expenditure item has fallen in recent years.
4. Explain the relationship between federal budget deficits, surpluses, and the national debt.
5. Identify the major source of tax revenue at the state government level in the U.S. and at the local government level in the U.S.
6. Identify the major expenditure item of state and local governments in the U.S.