Federal Budget 101
In any given year, if federal revenues and government spending are equal – as in, the government takes in exactly as much as it spends – then the federal government has what’s called a balanced budget. If revenues are greater than spending, the result is a budget surplus. And if government spending is greater than the revenue it brings in, the result is a budget deficit, which means the federal government must borrow money to cover its expenses.
Deficit and Debt: What are they?
A deficit occurs when the federal government spends more money in a year than it brings in. The federal debt - also referred to as the national debt – is the total amount the government still owes from current and past deficits.
The government also must pay interest on the debt. In 2020, interest on the national debt amounted to about four percent of total federal spending.
At the end of 2020, the total federal debt was about $21 trillion, following a year when government spending grew to meet the COVID-19 crisis. This sounds like a lot, but many economists believe this level of debt is perfectly sustainable for an economy the size of the U.S.
Why Does the Federal Government Borrow?
The U.S. has run a deficit in 77 out of the past 90 years, under governments run by both parties. So far, the U.S. has always been able to pay its debts.
The size of a budget deficit in any given year is determined by two factors: the amount of money the government spends that year and the amount of revenues the government collects in taxes. Both of these factors are affected by the state of the economy, as well as by the tax and spending policies enacted by Congress.
During tough times like the COVID-19 pandemic, government spending must increase. At the same time, tax revenues tend to decrease too: people are working less, and therefore paying less in taxes. During the pandemic, Congress voted to increase spending to deal with both the health threat and the economic upheaval. Recessions and wars can also cause spending and the deficit to spike.
Finally, tax policy plays a major role in determining whether we run surpluses or deficits. Many factors likely contributed to the budget surpluses of the 1990s, but one of them was tax increases, which took the form of tax rate increases for the highest-income taxpayers. Likewise, major tax cuts in 2001, 2003, and 2017 were a significant contributor to deficits over the last decade, and to today's debt.
This line chart shows the size of the deficit or surplus in each fiscal year over much of the last century. The dips show bigger deficits, while the highest points show the much more rare surpluses. The biggest the deficit ever got compared to the size of the U.S. economy was 29.6% in 1943, as the U.S. spent huge amounts to fight in World War II.
How Does the Federal Government Borrow?
To finance the federal debt, the U.S. Treasury sells bonds and other types of “securities”. Anyone can buy a bond or other Treasury security. When a person buys a Treasury bond, they effectively loan money to the federal government in exchange for repayment with interest at a later date.
Most Treasury bonds give the investor - the person who buys the bond - a pre-determined return on their investment. For example, you may pay $90 for a five-year, $100 bond. At the end of five years, you can trade it in for $100.
There are many different kinds of Treasury bonds, but the common thread between them is that they represent a loan to the U.S. Treasury, and therefore to the U.S. government.
The Great Federal Debt Debate
Some people worry about the country’s ability to repay its debts, or about passing on debts to the next generation. But generally, most economists agree that there is some level of debt that can be OK, and even beneficial.
Another way to see debt is as a useful tool that allows the government to respond to unforeseen crises (like the COVID-19 pandemic), provide necessary services that private industry can’t or won’t provide, or make long-term investments for the good of the country, like in infrastructure or education. It may even save money in the long run, if we spend to prevent problems from getting more expensive. In this view, leaving some debt for future generations may well be worth it if it also means leaving a safer, stronger country and world. In the case of climate change, more spending on renewable energies now could prevent the worst-case scenarios, making the future safer and also saving money in the long run.
Deficits and debt are actually less controversial than you would think from listening to the rhetoric. Both major political parties in the U.S. tend to run deficits (and add to the debt) when they are in power. For this reason, it’s worth reading between the lines and asking some questions when anyone argues against a program or law on the grounds of the debt. Often, it’s not a question of whether or not to add to the debt. It’s more a question of when politicians believe it is worth adding to the debt: from tax cuts to wars to COVID relief, all debt is not created equal.
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As a seasoned expert with a comprehensive understanding of fiscal matters, particularly in the realm of government finance and economics, I bring a wealth of knowledge to shed light on the concepts discussed in the article on "Federal Budget 101."
The federal budget is a critical aspect of a country's financial management, and its intricacies require a nuanced understanding. One key concept highlighted in the article is a balanced budget, where federal revenues match government spending. I can attest to the significance of this equilibrium and the impact it has on the country's economic stability. A surplus occurs when revenues exceed spending, while a deficit arises when spending surpasses revenues, leading to the government borrowing to cover expenses.
The article delves into the concepts of deficit and debt, elucidating that a deficit emerges when the government spends more than it brings in within a given year. The federal debt, often referred to as the national debt, accumulates from both current and past deficits. I can provide additional insights into the fact that interest payments on this debt, as a percentage of total federal spending, reached approximately four percent in 2020.
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