The federal budget isn't just about money, it's about values and priorities. The question of what services the government provides, and who pays for them, goes to the heart of our choices as a nation. Unfortunately, the federal government is facing long-term trends that could mean big problems for the government's finances.
The government ran a $1.3 trillion deficit in 2010, on top of a 2009 deficit of nearly $1.5 trillion. That's largely because of the global financial crisis and "Great Recession" of 2008-2009. But even after the recession goes away, the government faces huge financial challenges as the baby boom generation retires, health care costs rise, and the Social Security and Medicare systems start to feel the strain. In fact, if current trends continue, the national debt will be larger than our entire gross domestic product in about a decade.
All three of the government's budget agencies -- the Government Accountability Office, the Congressional Budget Office and the White House Office of Management and Budget – use the same word to describe the federal budget: unsustainable. The good news is most economists and budget analysts argue that there is a wide range of practical solutions to the government's budget problems. But actually putting them into practice requires taking on a lot of hot-button political issues.
Deficits, Debts and Decisions
Whenever the federal government spends more than it takes in, it runs a deficit. To pay the bills, the government borrows money by selling Treasury bonds. That borrowing adds to the national debt, which is the total amount the government owes to banks and other governments. For example, the budget for fiscal year 2010 had a deficit of roughly $1.3 trillion, and by the end of the year the total national debt is expected to reach $14 trillion.
Realistically, the government almost always runs a deficit during a recession. Revenue goes down, because bankrupt businesses and laid-off workers don't pay taxes, and government spending usually goes up to help the unemployed and create jobs. One group of economists says deficits are the nation's best strategy when the economy is in bad shape. Deficits can stimulate the economy, as the government either spends money on projects and creates jobs directly, or cuts taxes to give people more money to spend themselves. The Obama administration's $787 billion "stimulus" program is just the latest attempt to create jobs and cut the Great Recession short.
That said, it's become pretty routine for the federal government to run a deficit, in good times and bad. In fact, the budget has only been balanced in four of the last 40 years. Other experts argue that it's a bad idea for anyone, including the government, to borrow money to pay year-to-year bills. When deficit spending gets too big or goes on for too long, that government borrowing can raise interest rates, increasing the cost for such things as car loans and home mortgages, while making it more difficult for businesses to borrow money for expansion. Long-term deficits also cramp the government’s ability to create new programs and respond to new circumstances.
Still another set of economists, though, argues that surpluses and deficits mean little in such a huge economy, and that an undue focus on red ink leads to program cuts or higher taxes, which do greater damage.
The national debt raises several concerns, but they're more long-term. One is simply making the payments. Interest payments on the debt now account for more than 5 percent of the total federal budget, and are projected to rise along with our total debt. That's money that has to be paid out (it's like the minimum balance on your credit card) and so it isn't available for anything else.
The other concern is that much of the U.S. debt is held by foreign countries, particularly China, who consider Treasury bonds a safe place to park their money. Some foreign policy experts worry that this gives a potential rival too much leverage over the U.S. economy. Others argue that the Chinese economy is dependent on exports to the U.S. and so China can't afford to hurt American consumers.
One of the dangers in a rising national debt is that, if it becomes too large in proportion to the rest of the economy, bondholders will decide a country is a bad investment and stop loaning money to a government, that is, stop buying bonds. That's basically what happened to Greece in 2010, setting off a European debt crisis and prompting other European governments to cut their budgets before something similar happened to them. The United States is in a much better position than Greece, with a significantly larger and stronger economy, so this isn't likely to happen soon.
Discretion and Entitlements
Not every government program is created equal. In fact, the federal government spends most of its money on just a few programs. Some programs, such as Social Security and Medicare, are "mandatory" programs (sometimes called "entitlements") that the government is obligated by law to provide. Other services, ranging from national defense to national parks, may be vitally important but, for budget purposes, are still considered "discretionary" (and are therefore easier to cut). In the early 1960s, two-thirds of the budget was considered discretionary spending. But entitlements have grown dramatically since then, and now only about a third of the federal budget is discretionary spending. That trend is likely to continue, since entitlement costs are rising faster than most other areas of the federal budget.
Social Security and Medicare are popular programs that millions of older Americans depend on, but they face two major challenges. One is the sheer size of the baby boom generation: 78 million people. The first baby boomer started drawing Social Security checks in 2008. These programs have "trust funds" designed to buy them more time, but even so, there simply won't be enough workers paying into the systems to cover the costs of retirees who need help.
The second problem is that health care costs keep increasing, and are projected to double in the next decade. The costs for Medicare and its sister program for the poor, Medicaid, are linked to trends in the overall health care system -- so the more everyone pays for health care, the more these programs will cost. Budget experts say the combination of rising costs and demographics makes Medicare by far the most problematic part of the federal budget.
It isn't that programs like Medicare are completely untouchable -- Congress could raise the taxes dedicated to these programs, change eligibility rules, or revise the formulas by which benefits are spent. But reforming such popular programs is complicated, unpopular and politically dangerous. In effect, today’s budget choices are greatly influenced by budget choices that were made decades ago.
The health care reform plan passed in 2010 is a case in point. One reason President Obama pushed for the law was to control the costs of Medicare and Medicaid, and the latest reports say the law should improve Medicare's financial situation. But the plan is still controversial, and much of the impact will depend on how (and whether) all the plan's provisions are implemented. (For additional context, see Public Agenda's issue guides on Social Security and Medicare).
Riding Off Into the Sunset
One crucial decision is whether to extend the tax cuts enacted in 2001 and 2003 under President Bush. Many of these cuts will expire ("sunset," in congressional jargon), at the end of 2010. For example, the federal estate tax was gradually reduced until it disappeared entirely in 2010 -- and is to return, at its old level, in 2011 unless Congress votes again to remove it.
Why put a sunset provision in a tax law? In general, it's been a compromise between those who believe that tax cuts are the best way of stimulating the economy and those who fear cuts will run up the federal deficit. By making the cuts expire, the government theoretically gets the short-term economic benefit while avoiding the long-term problems. It also reduces the federal government's projections of long-term deficits, since budget officials presume those taxes will come back – even if practical politics makes that unlikely.
The debate over the Bush tax cuts divides those who argue that adding more taxes is the worst thing for a weak economy versus those who believe we need at least some of that revenue to close the budget gap. Overall, making the Bush tax cuts permanent would add about $3.7 trillion to the deficit over the next ten years. However, the Congressional Budget Office projects we will have more than $6 trillion in deficits even if the tax cuts expire, so more will need to be done.
The Public's View
Surveys show the public is divided on some basic questions regarding the federal budget. They are divided, for example, on whether the country's economic agenda should be focused on tax cuts or reducing the deficit. Americans tend to favor increased government spending on domestic programs over holding down the budget deficit, and they are willing to pay more in taxes for some of these programs. In fact, the number of who say taxes are "too high" has declined since the 1990s, and most say the amount they pay is "fair."
In any case, most Americans do seem to focus more on what the government does than how much it spends. Most say wealth should be more evenly distributed but are divided on whether the government should step in with heavy taxes on the rich. Surveys show Americans are split over whether President Bush’s tax cuts should be allowed to expire or made permanent. And government waste is another key issue for the public; Americans, on average, say about half of every tax dollar is wasted.
Public Agenda's focus group report, Facing Up to the Nation's Finances: Understanding Public Attitudes about the Federal Budget, found that while the public was uninformed on federal budget issues, they required relatively little information to appreciate the magnitude of the problem. But when it comes to solving the problem, the public's deeply felt cynicism about government is a major barrier that must be addressed before progress can be made.