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Government Spending Economics Chapter 10 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 1940’s), federal spending on defense was 40 % of GDP. In 2001 the total government expenditures at all levels amounted to about 30% of GDP. Government Spending in Perspective Total government expenditures at all levels was almost 2.9 trillion in 2001 – about $10,300 for every American. Government spending did not begin to increase until the 1940’s for three reasons: 1. the high costs of WWII, 2. the Great Depression changed public opinion about the government assisting in everyday economic affairs and in improving American’s economic welfare; and 3. the success of large-scale public works projects. (pg. 239) Debate continues over the role the government should plan in the economy. Government promotes the broad social and economic goals of Americans, but the benefits of a government policy should outweigh its costs. What government services do you think might be better provided by the private sector? (see pgs. 244-245, and 248) 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. 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 grant-in-aid. Subsidies are payments made to individuals or entire industries to encourage or protect a certain economics activity. Impact of Government Spending The federal budget consists of mandatory spending which includes interest payments on borrowed money, Social Security, and Medicare (two-thirds of the budget); and discretionary spending, which includes programs that Congress must approve annually (1/3 of the budget). The government’s fiscal year is from October 1 to September 30 toward adopting a budget is executive formulation – the president confers with his advisors and drafts a budget which he submits to Congress. is House action – Congress has the power to approve, modify, or disapprove the president’s proposed budget. The house sets budget targets for for each category of the discretionary budget, then assigns appropriations bills to various subcommittees where subcommittee members study and debate each bill… Establishing the Federal Budget – part II : 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 of each year. 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. Major Spending Categories 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. 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 major, city council, or country judge – to approve the budget. State Government Expenditures 80% 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% is spent on a variety of expenses, such as corrections, health, natural resources, and utilities. What state universities does our state budget support? Local Government Expenditures Local governments include counties, municipalities, townships, school districts, and other special districts. The largest categories of spending (about 2/3s 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. (pg. 250) 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. 1998 the federal budget had its first surplus in 29 years. Historically, the largest federal deficits happened during WWII. The budget, however, had a surplus by 1947, which lasted until the 1980’s, 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. 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. From the Deficit to the Debt – part 2 The total federal debt had grown to 5.6 trillion by 1999. About $1.9 trillion is trust fund money the government owes itself, which economists do not include in the total as economically significant. 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 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 payment are to foreign investors). (pgs. 254-256) What is the difference between the federal deficit and the federal debt? Impact on 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 collect. 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. (pg. 258) Taming the Deficit Congress tried to mandate a balanced budget in 1991 through the Gramm-Rudman-Holling 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. 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. Taming the Deficit – part II 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. The caps caused problems several years later, in 1999, when Republicans in Congress wanted to increase defense spending and cut taxes; as a consequence, they had to cut popular programs such as health, education, and veterans’ programs.