Transcript Chapter 10 Government Spending Splash Screen

Chapter 10
Government Spending
Introduction
• Government is big business in America. 
• In fact, all levels of government in the
United States spend more than all privately
owned businesses combined. 
• Government is a major player in our
economy due to its enormous
expenditures.
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Did You Know?
• Between 1962 and 1993, federal transfer
payments to people eligible for benefits
because of poverty rose from under 1
percent of the nation’s Gross Domestic
Product (GDP) to just about 2.5 percent.
In contrast, at the height of World War II
(the early 1940s), federal spending on
defense was 40 percent of GDP. In 2001
the total government expenditures at all
levels amounted to about 30 percent of
GDP.
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Government Spending in Perspective
• Total government expenditures at all levels
was almost $3 trillion in 2003—about
$10,300 for every American. 
• Government spending did not begin to
increase until the 1940s for three reasons:
(1) high costs of World War II; (2) the
Great Depression changed public opinion
about the government assisting in
everyday economic affairs and in
improving Americans’ economic welfare;
and (3) the success of large-scale public
works projects.
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Government Spending in Perspective
(cont.)
• Debate continues over the role
government should play in the economy.
Government promotes the broad social
and economic goals of Americans, but the
benefits of a government policy should
outweigh its costs.
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Government Spending in Perspective
(cont.)
Figure 10.1
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Two Kinds of Spending
• Government spending is for the purchase
of goods and services and payments to
disadvantaged Americans. 
• Goods and services that the government
buys includes everything from tanks for the
nation’s defense to paper and soap for its
employees.
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Two Kinds of Spending (cont.)
• Transfer payments include Social Security,
welfare, and unemployment compensation.
Two kinds of transfer payments exist. If the
payment is made from one level of
government to another, it is called a grantin-aid. Subsidies are payments made to
individuals or entire industries to encourage
or protect a certain economic activity.
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Two Kinds of Spending (cont.)
Figure 10.2
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Impact of Government Spending
• Government spending affects resource
allocation because purchase decisions,
subsidies, and transfer payments either
stimulate economic activity or affect the
factors of production. 
• Government spending influences income
distribution when transfer payments
increase family incomes, federal projects
provide or take away jobs, and subsidies
give income support to American workers.

• Government spending creates competition
with the private sector.
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Introduction
• Taking action on spending bills is but one
step in the preparation of the federal
budget — an annual plan outlining
proposed revenues and expenditures for
the coming year. 
• Approximately two-thirds of the federal
budget consists of mandatory spending—
spending authorized by law that continues
without the need for annual approvals of
Congress.
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Introduction (cont.)
• Mandatory spending includes interest
payments on borrowed money, Social
Security, and medicare. 
• The remaining one-third of the budget
deals with discretionary spending–
programs that must receive annual
authorization. 
• Discretionary spending decisions include
how much to spend on programs such as
the military, the Coast Guard, and welfare.
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Establishing the Federal Budget
• The federal budget consists of (1)
mandatory spending, which includes
interest payments on borrowed money,
Social Security, and medicare (two-thirds of
the budget); and (2) discretionary spending,
which includes programs that congress
must approve annually (one-third of the
budget). 
• The government’s fiscal year is from
October 1 to September 30.
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Establishing the Federal Budget (cont.)
• The second step is House action—Congress
has the power to approve, modify, or
disapprove the president’s proposed budget.
The House sets budget targets for each
category of the discretionary budget, then
assigns appropriations bills to various
subcommittees where subcommittee
members study and debate each bill. If the
bill is approved in subcommittee, it is sent to
the full House Appropriations Committee. If
approved there, it goes to the entire House
for a vote. All these congressional steps
must be completed by September 15 each
year.
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Establishing the Federal Budget (cont.)
• The third step is Senate action—the
Senate may approve the House bill or it
may draft its own version. If differences
exist, a joint House-Senate conference
committee works out a compromise bill. 
• The last step is final approval—the House
and Senate send the bill to the president
for his approval or veto. Once signed, it
becomes the official budget for the new
fiscal year.
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Major Spending Categories (cont.)
• Mandatory spending categories include:
Social Security; income security; medicare;
interest on the federal debt; some health
programs; and veterans’ benefits. 
• Discretionary spending categories include;
education, employment, social services,
transportation, administration of justice,
natural resources, and the environment.
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Major Spending Categories
Figure 10.4
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Introduction
• State and local levels of government, like
the federal government, also have
expenditures. 
• Like the federal government, these
governments must approve spending
before revenue dollars can be released. 
• The budget process at the state and local
levels can be just as complicated as it is at
the federal level.
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Approving Spending
• Most states approve their budgets using a
process similar to the federal government’s
process. 
• Some states have a balanced budget
amendment that requires annual spending
not to exceed revenues. 
• Local governments empower
representatives—the mayor, city council, or
county judge—to approve the budget.
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State Government Expenditures
• Eight percent of state spending is directed
toward intergovernmental expenditures,
public welfare, insurance trust funds, higher
education, highways, hospitals, and interest
on the public debt. The other 20 percent is
spent on a variety of expenses, such as
corrections, health, natural resources, and
utilities.
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State Government Expenditures (cont.)
Figure 10.5
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Local Government Expenditures
• Local governments include counties,
municipalities, townships, school districts,
and other special districts. 
• The largest categories of spending (about
two-thirds of the total) include: elementary
and secondary education; public utilities;
hospitals; police protection; interest on
debt; public welfare; and highways. The
other third includes such expenses as
housing and community development, fire
protection, and parks and recreation.
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Introduction
• In 1998 the federal budget had its first
surplus in 29 years. 
• The surplus did not last long, however, as
the recession of 2001 reduced tax receipts
while politicians simultaneously opted for
tax cuts rather than debt reduction. By
2002, federal deficits were back.
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From the Deficit to the Debt
• Throughout United States history, the
federal government has practiced deficit
spending, or spending more than the
revenues it collected. In 1998 the federal
budget had its first surplus in 29 years. 
• Historically, the largest federal deficits
happened during World War II. The
budget, however, had a surplus by 1947,
which lasted until the 1980s, when the
Reagan administration increased defense
spending and cut taxes. It was not until
after the Omnibus Budget Reconciliation
Act of 1993 that the deficit began to shrink.
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From the Deficit to the Debt (cont.)
Figure 10.6
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From the Deficit to the Debt (cont.)
• When the budget runs a deficit, the
Treasury Department sells bonds to the
public to raise money. The federal debt is
the total amount the government has
borrowed from investors to finance its
deficit spending over its long history. 
• The total federal debt had grown to $6.74
trillion by 2003. About $1.9 trillion is trust
fund money the government owes itself,
which economists do not include in the total
as economically significant.
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From the Deficit to the Debt (cont.)
Figure 10.8
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From the Deficit to the Debt (cont.)
• The federal debt differs from private debt
because: (1) we owe most of the federal
debt to ourselves, whereas private debt is
owed to others; (2) private debt typically
has a repayment deadline, but federal debt
does not; the government just issues new
bonds; (3) private debt means individuals
give up their purchasing power as they pay
down their debt; but when the federal
government repays a debt, the funds
transfer to others who gain purchasing
power (unless payments are to foreign
investors).
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From the Deficit to the Debt (cont.)
Figure 10.7A
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From the Deficit to the Debt (cont.)
Figure 10.7B
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From the Deficit to the Debt (cont.)
Figure 10.7C
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Impact of the National Debt
• The federal debt causes a transfer of
purchasing power from the private to the
public sector. The larger the federal debt,
the larger the interest payments, and the
more taxes the government must pay. 
• If taxes are increased to make the federal
debt’s interest payments, it may diminish
incentives for Americans to work, save, and
invest. 
• In selling bonds to raise money, the federal
government competes with the private
sector for scarce resources, leading to
higher-than-normal interest rates.
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Impact of the National Debt (cont.)
Figure 10.9
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Taming the Deficit
• Congress tried to mandate a balance
budget in 1991 through the Gram –
Rudman-Hollings Act. GRH failed because
Congress passed spending bills in spite of
the law. 
• The Budget Enforcement Act required that
Congress must “pay as it goes.” It must
offset any new spending with making
reductions elsewhere. BEA failed.
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Taming the Deficit (cont.)
• The Omnibus Budget Reconciliation Act
of 1993 only succeeded in reducing the
rate of growth of the deficit, not the total
deficit. The act combined spending
reductions with tax increases, leading to
the surplus by 1998.
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Taming the Deficit (cont.)
• Congress gave the president a line-item
veto, but the Supreme Court found it
unconstitutional. The Balanced Budget
Agreement of 1997 followed, with rigid
spending caps so Congress could balance
the budget by 2002. In 1999 congress
increased defense spending and cut
taxes; as a consequence, they had to cut
popular programs such as health,
education, and veterans’ programs. 
• The federal government faces rapid
growth of entitlements.
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Section 1: The Economics of
Government Spending
• Government spending takes the form of
expenditures on goods and services, most of
which are public goods, and on transfer
payments such as grants-in-aid for which the
government receives nothing in return. 
• Government spending influences the private
sector by affecting the allocation of resources, the
distribution of income, and by competing with
the private sector for scarce resources.
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Section 2: Federal Government
Expenditures
• The president is responsible for developing the
federal budget for the fiscal year, which begins
on October 1. When the budget is complete, the
budget is sent to the House of Representatives. 
• The House only deals with discretionary
spending. Mandatory spending is not part of the
annual budget process, although Congress can
deal with it separately. 
• Discretionary spending is broken down for action
by various committees that propose
appropriations bills. The budget is reassembled
and voted on by the House and the Senate.
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Section 2: Federal Government
Expenditures (cont.)
• If differences between the House and the Senate
emerge, a compromise bill is developed on which
both vote. 
• The largest components of the federal budget are
Social Security, national defense, income security,
medicare, net interest on the federal debt, and
health.
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Section 3: State and Local
Government Expenditures
• State budgets go through an approval process
that varies from state to state. The largest state
spending categories are intergovernmental
expenditures, public welfare, insurance trust, and
higher education. Others include highways,
hospitals, and interest on state debt. 
• The largest single category of spending for local
governments is elementary and secondary
education. Public utilities, hospitals, police
protection, interest on debt, public welfare, and
highways follow.
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Section 4: Deficits, Surpluses, and
the National Debt
• Federal budget deficits existed from 1970 until
1998 when the budget finally had a surplus. 
• Deficits add to the federal debt, and the total debt
reached $5.7 trillion in fiscal year 2001,
approximately $3.3 trillion of which is held by the
public. 
• The debt affects the economy in several ways:
Taxes are needed to pay the interest on the debt;
the distribution of income is altered; purchasing
power is transferred from the private sector to the
public sector; and incentives to work, save, and
invest may also be altered.
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Section 4: Deficits, Surpluses, and
the National Debt (cont.)
• Despite recent budget surpluses, the overall
federal budget would show a deficit if not for the
surpluses in the Social Security Trust Fund. 
• The rapid growth of entitlements are still a threat
to future budget surpluses.
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