11
FEDERAL SPENDING
________________________________________________________________________
CHAPTER OUTLINE
A Primer on the Constitution and Spending Money
Using Our Understanding of Opportunity Cost
Using Our Understanding of Marginal Analysis
Budgeting for the Future
Summary
LEARNING OBJECTIVES
LO1: Describe the process that goes into creating the federal budget of the United States.
LO2: Show that mandatory spending—the portion of the budget that is devoted to spending on items for which no
annual vote is taken—has steadily increased because of various entitlement programs and interest on the national
debt.
LO3: Summarize how 30 percent of the federal budget is allocated almost equally to domestic spending and
defense, with a relatively small amount going for foreign aid and for dues to international organizations such as
the United Nations.
LO4: Explain how to use marginal analysis when looking at federal spending.
LO5: Distinguish between current-services and baseline budgeting.
LO6: Conclude that the idea of opportunity cost is at the heart of federal spending.
KEY TERMS
Logrolling- The trading of votes used to generate sufficient support for projects that are not in the general interest
of the country.
Continuing resolution- A bill passed by Congress and signed by the president that allows the government to
temporarily spend money in a fashion identical to the previous year.
Crowding out- The opportunity cost of government deficit spending is that private investment is reduced.
Mandatory spending- Budget items for which a previously passed law requires that money be spent.
2
Chapter 11
Discretionary spending- Budget items for which an annual appropriations bill must be passed so that money can
be spent.
Entitlement- A program where if people meet certain income or demographic criteria they are automatically
eligible to receive benefits.
Baseline budgeting- Using last year’s budgeted figure to set this year’s budgeted figure.
Current-services budgeting- Using an estimate of the costs of providing the same level of services next year as
last.
DISCUSSION QUESTIONS
1. Review the major steps in the budget process, and explain why a newly elected president may not be able to
keep all of the campaign promises for various government programs.
2. Define a continuing resolution. Under what circumstances would it have to be passed? What are the other
options for solving this crisis?
3. Many believed that the borrowing to finance the huge federal deficits of the early 1990s caused the crowding
out of a significant amount of private investment. Use the marginal benefit and marginal cost (opportunity
cost) concepts to explain why deficit reduction may have generated a net benefit for the country.
4. Reexamine Figure 11.4. Use the concept of opportunity cost to discuss how the percentage of GDP spent by
the federal government has changed over the latter part of the twentieth century. Consider the buildup of the
Cold War in the 1960s, the Vietnam War, the military buildup under President Reagan, the collapse of the
Soviet Union in 1991, and the attacks of September 11, 2001.
5. Explain why increased spending on a budget item according to baseline budgeting may still result in a
decrease in spending according to current services budgeting. Which criteria do you think gives a more
accurate view of a change in the budget? Defend your answer.
6. Define entitlements. Give some examples of federal entitlement programs.
7. When compared with the period of the late 1960s and the 1970s, government spending on entitlements, such
as, Medicare and Medicaid, grew rapidly during the 1990s, and this growth is expected to continue through
the early 2000s. Explain why this is so.
8. Use the concepts of baseline budgeting and current services budgeting to explain how the Republican and
Democratic parties attempted to define their own positions on Medicare in 1995 during the debate over the
1996 budget.
9. Use the tools of marginal analysis to explain why budget items added by members of the conference
committees, by chairs of the appropriations subcommittees, and by chairs of the full appropriations
committees in the House and the Senate may not be in the best interest of the country.
10. How does the distribution of the Obama tax cuts differ from the Bush tax cuts? Why do they differ?
Federal Spending
3
THE WEB-BASED QUESTION
Detailed historical data from 1940 through 2012 (estimated) are available on various budgetary items in:
Historical Tables, Budget of the United States Government, Fiscal Year 2009, Office of Management and Budget,
Executive Office of the President of the United States, Washington: U.S. Government Printing Office, 2009.
The information on the U.S. budget is also available at the following website:
www.whitehouse.gov/omb/budget/fy2009/pdf/hist.pdf.
a. Section 3, Table 3.1, “Outlays by Superfunction and Function,” contains federal spending data on the
following superfunctions expressed as a percentage of total outlays:
National Defense
Human Resources (Social Security, health, veterans’ benefits, education, etc.)
Physical Resources (natural resources, energy, commerce, etc.)
Net Interest
b. Table 3.1 also contains total federal outlays expressed as a percentage of GDP.
Select data points at five-year intervals. Create two charts, one examining our choices in federal spending by
superfunction and one examining our choice between federal spending and other output. In the context of U.S.
history since the beginning of World War II, analyze the two charts and discuss the choices that have made as a
nation on the level of federal spending and on how to allocate federal funds.
(If you are skilled with a spreadsheet program, you may find it easier to download the entire data set. You can
easily create the charts on the spreadsheet. Print the charts, trim off the excess paper, and insert them in your
study guide with tape.)
Chapter 11
O UTLA Y S B Y F UN CTI O N
As Percentage of Total Outlays
100
80
60
40
20
0
1960
1950
1940
1970
1980
1990
2000
2010
1940-2010 (est)
TOTA L F E D E RA L OUTLA Y S
As Percentage of GDP
50
40
Percentage of GDP
Percentage of Total Outlays
4
30
20
10
0
1940
1950
1960
1970
1980
1940-2010(est)
1990
2000
Federal Spending
5
ANSWERS TO STUDY QUESTIONS
SUGGESTED ANSWERS TO THE DISCUSSION QUESTIONS
1. The major steps include:





President proposes the budget.
Congress develops its own budget.
The budget is broken up into parts and reviewed by the subcommittees and the full appropriations
committees of the House and Senate, who make recommendations to the full House and Senate.
Each House passes a bill, and the conference committee works out a House-Senate compromise.
The president either signs or vetoes the bill.
The president has no guarantee that the proposed budget will become the actual budget, as Congress makes
the decisions on spending. Even a presidential veto can be overturned.
2. A continuing resolution is a bill, which has been passed by Congress and signed by the president, and this bill
permits the government to continue to temporarily spend money in an identical fashion to the spending of the
previous year. A continuing resolution is necessary when Congress does not meet its October 1 deadline to
pass a new budget. The other available options are: the president giving into the wishes of Congress,
Congress giving into the wishes of the president, or the government shutting down all nonessential services
because of lack of federal funds.
3. Many people, including Alan Greenspan, the Federal Reserve Chairman at the time, thought that the high
level of federal borrowing to finance the deficits of the early 1990s created a crowding-out effect. This means
that significant levels of funds were absorbed, and that they could not be used to finance private investment.
By reducing the federal deficit, we incurred the marginal cost (opportunity cost) of the foregone federal
programs, which were curtailed to reduce the budget. On the other hand, we received the marginal benefit of
increased private investment, which contributed to the dramatic economic growth and expansion of the 1990s.
It seems clear that this choice generated a net benefit for the country.
4. During the Cold War, the expanding control of the Soviet Union and the People’s Republic of China caused a
general fear throughout the country. The federal defense expenditures on the Korean War, the Vietnam War,
and the military buildup under President Reagan were more valued than the private goods and services that
were foregone. The collapse of the Soviet Union in 1991 lowered the value of American military spending,
and the percentage of federal funds used for defense fell. There was an increased focus on nonmilitary
expenditure, as this was now more valuable than the foregone military spending. After the attacks of
September 11, 2001, Americans again considered the spending on defense and Homeland Security extremely
important.
5. The increase in spending according to the baseline budgeting may not be sufficient to cover the higher
expenses if the costs per person increase or if the number of eligible people increase. This means that there is
a decrease in spending according to current services budgeting, since the quality and level of service to
eligible recipients has fallen.
Opinions will vary as to which criterion gives a more accurate view of a change in the budget.
6. People are entitled to entitlement benefits according to the programs outlined in the existing legislation.
Examples of federal entitlement programs include Social Security, Medicare, and Medicaid.
6
Chapter 11
7. When compared with the period of the late 1960s and the 1970s, government spending on entitlements, such
as, Medicare and Medicaid, has grown dramatically during the 1990s. This growth is expected to continue
through the early 2000s because of the aging population. As the Baby Boomer generation reaches retirement
age, there will be increased spending on Social Security and higher health care costs.
8. In the debate over the 1996 budget, the Democrats used current services budgeting to claim that the
Republicans wanted to reduce the spending on Medicare because services to the eligible recipients would be
reduced. The Republicans used baseline budgeting to claim that spending would increase on Medicare
because the dollar expenditure would be higher than the previous year.
9. The budget items added by members of the conference committees, by chairs of the appropriations
subcommittees, and by chairs of the full appropriations committees in the House and the Senate may not be in
the best interest of the country. These politicians and their constituents typically receive the majority of the
marginal benefit, while the nation of taxpayers bears the marginal cost. From the viewpoint of the nation, the
marginal benefit does not justify the marginal cost.
10. The Bush tax cuts were distributed as checks, while the Obama tax cuts were distributed as reductions in tax
withholding tables. The Obama administration believed that reductions in withholds would be spent by
households for consumption purposes, rather than using it to pay bills, such as credit card debt.
Federal Spending
7
SUGGESTED ANSWER TO THE WEB-BASED QUESTION
The historical data are plotted in the two charts on the next page.
During World War II, the huge increase in federal spending rose from less than 10% in 1940 to over 40% of GDP.
The majority of these funds went to defense, which claimed as much as 89.5% of federal spending in 1945.
Following World War II, there was a sharp drop in defense spending and overall federal spending, as federal
spending fell back to 11.6% of GDP in 1948. Both rose again in the early 1950s as we entered the Korean War,
and dropped off in the late 1950s. Expenditures on human resources, which includes veteran benefits and services,
increased following World War II, dropped off in the early 1950s, and then began a steady increase. Interest
payments also rose immediately after World War II, and then dropped back to around 6 and 7% of federal
spending until the late 1970s.
During the 1960s, 1970s and early 1980s, there was a gradual increase in federal outlays. By 1984, federal
spending consumed 23.5% of GDP. Defense spending took up less and less of the federal budget during the early
1960s, only to rise again as the Vietnam War intensified, and then drop off again throughout the 1970s. The
percentage of federal funds going to human resources increased throughout the 1960s and early 1970s as
Medicare and the spending on social programs for the War on Poverty began.
Overall, federal spending claimed over 20% of the GDP from 1975 through 1996. It rose to a high of 23.5% in
1984, and it continually dropped since 1992 during the Clinton administration. Following the attack of September
11, 2001, federal spending has increased again, and it is now just about 20% of GDP.
The percentage of federal funds allocated to defense surged under the Reagan administration in the 1980s and fell
off sharply in the early 1990s following the collapse of the Soviet Union. Defense claimed a larger percentage of
federal funds again following September 11, 2001, but the percentage is expected to decline by 2007.
The proportion of funds allocated to human resources decreased during the 1980s and then rose during the 1990s
and early 2000’s. It has recently declined, but it is expected to again increase by 2010.
Spending on interest rose throughout the 1980s, early 1990s, and finally began to drop toward the end of the
century and early in the 2000s. It is expected to increase again during the late 2000s.
Federal spending on physical resources, which includes expenditures on energy, natural resources and the
environment, commerce and housing credit, transportation, and community and regional development, oscillated
after World War II. However, it remained a rather small portion of the budget, ranging from 1.5% (1946) to
11.5% (1978 during the Carter administration). Currently, physical resources claim about 5% of federal outlays
and it is expected to decline to 4% by 2010.
Chapter 11
O UTLA Y S B Y F UN CTI O N
As Percentage of Total Federal Outlays
100
80
60
Natl. Def.
Human Res.
Phys. Res.
40
Net Interest
20
0
1940
1950
1960
1970
1980
1990
2000
2010
1940-2010 (est)
Source: Office of Management and Budget, Executive Office of the President of the United States,
http://www.whitehouse.gov/omb/budget/fy2009/pdf/hist.pdf.
TOTA L F E D E RA L OUTLA Y S
As Percentage of GDP
50
40
Percentage of GDP
Percentage of Total Outlays
8
30
20
10
0
1940
1950
1960
1970
1980
1940-2010 (est)
1990
2000
2010
Source: Office of Management and Budget, Executive Office of the President of the United States,
http://www.whitehouse.gov/omb/budget/fy2009/pdf/hist.pdf.