What Is the Federal Budget?

Definition and Example of the Federal Budget

The U.S. federal budget is the amount of spending and revenue for the next fiscal year of the U.S. government. It runs from October 1 through September 30. 

The U.S. federal budget has two categories of spending that are unusual. The mandatory budget pays for benefits established by prior acts of Congress. These include Social Security, Medicare, Medicaid, and other such benefits. This budget estimates the costs to administer the benefits. It cannot be changed without another act of Congress.

The interest on the national debt must also be paid, although it's not part of the mandatory budget. If the interest is not paid, then the United States has defaulted on its debt.

The other category is discretionary spending. Typically, most of this goes toward the military budget, and the rest funds management of all other government agencies. These include Health and Human Services, the Department of Justice, and the U.S. Treasury. Congress determines current discretionary spending for each fiscal year.

The Deficit

The federal government has run a deficit since 2002. The president and Congress are engaging in expansionary policy. The large current U.S. budget deficit is a result of five major factors:

1. Rising mandatory spending on Social Security, Medicare, and other entitlement programs
2. Increased military spending that was kicked off by President Bush’s War on Terror
3. The 2001 recession and the 2008 financial crisis, which slowed growth and cut tax revenue
4. The 2009 Economic Stimulus Act, which ended the Great Recession
5. Three tax cuts by Presidents Bush, Obama, and Trump, which cut revenue

You can argue over which president contributed the most to the deficit. The truth is that they all did. The current U.S. federal budget breakdown explains how the combination of budget components and the national deficit impacts the U.S. economy.

Congress Determines the Federal Budget

The Constitution gives Congress power over the federal budget. Article 1, Section 9, states, "No money shall be drawn from the Treasury, but in Consequences of Appropriations made by Law."

The president's role is to submit a budget proposal to Congress. The president asks all federal agencies to submit their budget requests. The Office of Management and Budget (OMB) compiles these requests. The president submits a budget to Congress. Congress usually follows this budget as a guideline to create its own budget resolution. That is used to create the appropriations bills, which allocate funds for different categories of government agencies.

The budget process lasts 18 months. It was set into law by the 1974 Budget Control Act. Congress doesn't always follow the schedule, though. When that happens, it submits a continuing resolution to keep the government running until a budget is approved. When that doesn't happen, the government shuts down.

How Does the Federal Budget Work?

The revenue for most governments—including the United States—comes from tax revenues. These taxes include those on family incomes, business profits, and imports, such as customs duties and tariffs. They also include sin taxes on activities the government wants to discourage, such as cigarette smoking and alcohol use. The government imposes taxes on gasoline to pay for related activities, like building roads and bridges.

Pigouvian taxes impose costs on those who pose damages to society. One example would be a tax on manufacturers that pollute rivers. The U.S. does not impose many of these types of taxes, preferring to use regulations known as "command and control rules."

Some countries derive revenues from state-owned businesses, such as oil companies. The revenue from these companies supplies revenue directly to these governments. The state-owned U.S. entities include—most notably—the U.S. Postal Service, the Federal Home Loan Banks, the Farm Credit Banks, and the Corporation for Public Broadcasting.

Federal Spending

Federal spending is wide, varied, and huge. The 2020 U.S. federal budget was roughly $7 trillion—for one fiscal year. Efforts have been made to curtail spending, but an election here and a war there, and before you know it, the budget has grown again. The 2020 budget was heavily impacted by relief spending tied to the pandemic,

Almost all governments spend on public safety and defense, transportation, and trade. Most also provide some social welfare payments for unemployment insurance, retirement, and healthcare. The amount spent reflects the values and priorities of society.

The National Priorities Project (NPP) a non-partisan, nonprofit research organization, finds that in fiscal year 2021—their most recent year with analyzed data—around $5.2 trillion of the federal budget went to mandatory spending items, $1.6 trillion was discretionary spending, and $.02 trillion went to interest on the federal debt.

The Largest Line Items

The largest line item in the mandatory spending arena is Social Security, unemployment, and government labor. The second-largest is Medicare and health spending. The remaining mandatory funds go to food and agriculture, veterans benefits, transportation, and other activities that promote the public good.

Many would assume that military spending—for tanks, submarines, manpower, and might—would be a part of the mandatory pie. However, this spending falls into the discretionary category. Discretionary government expenses and education round it out.

Deficit and Debt

When the government spends more than it takes in, it's known as "deficit spending," which creates a budget deficit. A reduction of revenue with tax cuts also creates deficits. Each year's deficit is added to the sovereign debt—what a government borrows in the form of Treasury bonds, bills, and notes. Both deficit and sovereign debt are tools of expansionary fiscal policy. They expand the economy by pumping more money into it.

The money is borrowed from the future through the sale of Treasury bonds. If done right, an expansionary policy will boost the economy enough to easily pay off the debt when it comes due. If done poorly, it will saddle future generations with an unsustainable debt load. As mentioned earlier, in 2020, $.02 trillion of the federal budget went to servicing this borrowing in the form of interest payments.

You can find out whether a country has a sustainable debt load by looking at its debt-to-GDP (gross domestic product) ratio, which measures each year's total economic output. A healthy debt-to-GDP ratio should be 77% or less, according to the World Bank. According to the Federal Reserve of St. Louis Economic Data (FRED), the third quarter of 2020 U.S. debt as a percent of GDP was 127.36%.

Federal Budget Surplus

Spending that's lower than revenue creates a budget surplus. Tax increases can also create a surplus. Both are used in contractionary fiscal policy to slow economic growth. That removes money from the current economy in return for paying off future debt.

A budget surplus heads off a dangerous bubble when the economy is in the boom phase of the business cycle. It's also needed when the debt-to-GDP ratio is greater than 100%. Another term for the contractionary policy is "austerity measures." 

According to the FRED, since 1901 the largest U.S. surplus was in 2000.