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| Issues: The Federal Budget
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FY 2006 Budget (last updated February 9, 2005) (back to top)
President George W. Bush's budget proposal for the fiscal year beginning in October 2005 (FY 2006) calls for $2.57 trillion in spending that would result in a $390 billion deficit, roughly 3.5 percent of the U.S. gross domestic product. However, the budget deficit is likely to grow even more because of ongoing operations in Iraq and Afghanistan. The budget deficit would grow even more if Bush is successful in his proposal to divert some payroll taxes from Social Security into newly created personal retirement accounts.
Of the $2.57 trillion budget proposed on February 7, 2005, Bush only has discretion over a third of it; most of the annual budget goes to mandatory programs such as Social Security. Of the $840 billion over which Bush has discretion, he is allotting about half to defense spending. The budget calls for $448 billion for national defense, $545 billion for Social Security, $346 billion for Medicare, and $211 billion in net interest payments on the federal debt.
Bush hailed the budget on Feb. 7 as "lean" and as a budget that "focuses on results" and "reduces and eliminates redundancy."
Many have questioned some of the spending cuts, especially in various popular programs.
Another concern is whether the current estimates will hold up. All four budgets in Bush's first term ultimately ran budget deficits larger than expected, a result only partially attributable to economic factors such as the impact of the September 11, 2001 attacks. The following graph and table compare estimated budget surpluses and deficits to actual results, along with breakdowns of the differences as reported by the White House's Office of Management and Budget (Table 20-6 of Analytical Perspectives).
| Fiscal Year
| Initial Budget Surplus or Deficit Projected
| Budget Surplus or Deficit after Year End
| Difference due to Enacted Legislation
| Difference due to Economic Factors
| Difference due to Technical Factors
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| 2002
| +231
| -158
| -104
| -201
| -84
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| 2003
| -80
| -378
| -86
| -34
| -177
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| 2004
| -307
| -412
| -122
| -22
| +39
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| 2005
| -364
| -427
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| 2006
| -390
| ?
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Bush's proposed budget is just the beginning of an annual process that prepares the budget for the fiscal year beginning about 18 months later (fiscal years for a year (2005) start on October 1 of the previous calendar year (2005) and end on September 30). Congress will now consider Bush's proposals and approve, modify or disapprove them. Congress generally passes a budget resolution setting the overall budget totals by April 15, and then passes appropriation bills by the beginning of the fiscal year or within extensions enacted by Congress and the White House. If Congress and the White House did not pass appropriation bills by the time all deadlines expired, then the government would "shut down" and discretionary spending would have to stop.
Background
The federal budget now involves the receipt and spending of around $2.5 trillion a year, and is the source of much political battle and controversy. In 1998, the budget was balanced for the first time in 29 years, thus ending a battle over deficit spending but opening a new debate over what to do with the budget surplus. That debate ended as the federal government went again into deficit spending by the end of 2001, in part due to an economic recession, President George W. Bush's tax cut enacted in the summer of 2001, and the war on terrorism.
Historically, the federal government generally avoided large deficits from World War II until the late 1970s and early 1980s, when economic recession was followed by President Ronald Reagan's efforts to increase defense spending while cutting taxes. The annual deficit peaked in the mid-1980s ($311 billion in 1983, in constant 1996 dollars) and again in 1992.
Deficits began to fall during the Clinton administration, in part due to economic growth and to Clinton's economic plans. In 1993, Clinton narrowly enacted a five-year deficit reduction plan (218-216 in the House, and 51-50 in the Senate, with Al Gore casting the tie-breaking vote). In May 1997, just months after a long season of government shutdowns and budget crises, the Clinton administration and Congress agreed to balance the federal budget within five years, and actually did so in August 1997, years ahead of the schedule set in 1993.
Budget deficits turn into federal debt, on which interest must be paid. The federal government plans to spend about $211 billion on net interest payments in FY 2006, almost half of what the federal government plans to spend on national defense.
Source: The White House's Office of Management and Budget has the FY 2006 budget on-line here and also has information on past budgets and analyses. A February 7, 2004 briefing by OMB Director Josh Bolten is on-line here.
Budget Debt (last updated February 12, 2002)
Budget deficits turn into federal debt, on which interest must be paid. As shown below in how the federal government outlays its budget, the federal government's outlays for net interest on the federal debt has grown immensely over the past two decades, more than tripling in current-value dollars since the early 1980s. In 2000, the federal government spent $223.2 billion on net interest payments, nearing the amount paid on national defense ($294.5 billion). Deficit and debt reduction would thus reduce the money now spent on interest payments.
Source: Data taken from historical tables for the FY 2002 budget (see table 7.1 and 3.1), available through the White House's Office of Management and Budget, on-line here.
Where does the federal government get its money (budget receipts)? (last updated February 27, 2002)
How the federal government has funded itself has changed over the country's life. In 1934, the federal government got almost half of its money from sales taxes, and about a quarter from individual and corporate income taxes combined. In 2000, the federal government got nearly half its money from individual income taxes alone, a third from social insurance taxes, and less than four percent from sales taxes.
The federal government funded itself from its beginning to the Civil War primarily through customs duties, supplementing that income in the 19th century with the sale of public lands. From the 1860s to the early 1940s, sales taxes (particularly on alcohol and tobacco) became the major source of federal funds.
Since 1913, when the Sixteenth Amendment empowering the federal government to tax individual and corporate income was enacted (for the text, go here), income taxes have become a significant federal receipts source, providing nearly 80 percent of the federal budget in 1944. After World War II, individual income tax receipts have continued to make up about 45 percent of the federal budget, though corporate income tax receipts have dropped as a share of federal receipts, falling from 35 percent in 1945 to about 10 percent in 2000.
As corporate income tax receipts have fallen, social insurance taxes - such as Social Security taxes - have brought in a larger share of federal receipts, now about a third of the federal government's annual budget. Estate taxes, which are being gradually phased out as a result of President George W. Bush's 2001 tax cut legislation, never comprised a huge part of the federal budget; they comprised 5.4 percent of federal receipts in 1940 and 1.4 percent in 2000.
Source: Data taken from historical tables for the FY 2002 budget (see table 2.1), available through the White House's Office of Management and Budget, on-line here.
Tax Plans : Bush's 2001 and 2003 Plans (last updated February 20, 2003) (back to top)
President George W. Bush justified his 2001 tax cuts because of the then-existing budget surplus, and called for an expanded tax cut in 2003 to help stimulate a slow economy (by this time, the federal government was again spending more than it took in). Some Democrats opposed both plans as depriving the government of necessary revenue and for unfairly benefiting the wealthiest.
Bush's 2001 tax-cut plan, which Bush officials estimated at the time would cut government revenues by $1.6 trillion, gradually reduces the tax rates for taxpayers within most tax brackets by about 1 percentage point a year from 2001 to 2006; Bush's 2003 proposal would accelerate these reductions so that they would be fully effective in 2003. Bush's 2001 tax cut plan also created a new lower tax bracket for those with the least taxable income, but it actually did not reduce the tax rates for those at the high end of what used to be the lowest income-tax bracket.
"Across the board tax relief does not happen often in Washington, D.C. In fact, since World War II, it has happened only twice: President Kennedy's tax cut in the '60s and President Reagan's tax cuts in the 1980s. and now it's happening for the third time, and it's about time," Bush said in signing the 2001 tax cut into law. "This tax cut is principled. We cut taxes for every income taxpayer. We target nobody in, we target nobody out. And tax relief is now on the way."
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| Taxpayer by Marital Status, Taxable Income
| Pre-2001 Code
| Bush Plan by 2006 (or possibly 2003)
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| Single, $0-6,000
| 15%
| 10%
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| Single, $6,000-27,050
| 15%
| 15%
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| Single, $27,050-65,550
| 28%
| 25%
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| Single, $65,550-136,750
| 31%
| 25%
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| Single, $136,750-297,350
| 36%
| 33%
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| Single, $297,350+
| 39.6%
| 33%
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| Married, Joint Filing, $0-12,000
| 15%
| 10%
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| Married, Joint Filing, $12,000-45,200
| 15%
| 15%
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| Married, Joint Filing, $45,200-109,250
| 28%
| 25%
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| Married, Joint Filing, $109,250-166,500
| 31%
| 25%
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| Married, Joint Filing, $166,500-297,350
| 36%
| 33%
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| Married, Joint Filing, $297,350+
| 39.6%
| 33%
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Tax rates for those with the highest taxable income are now lower than they have been since 1993, but are still higher than in the late 1980s and early 1990s. Tax rates for those with the lowest taxable income are now lower than they have been since 1941. The following graph tracks the rise and fall in the tax rates for those in the highest and lowest income brackets.
Bush's 2001 tax plan also began to phase out the estate tax, which taxes the estates of the wealthiest Americans upon their death and which brought in about $35 billion in revenues a year (for more on the estate tax, go here). It did not make any changes in the capital gains tax, which taxes net gains earned from the sale of capital assets (including all property held for personal use or investment, including stocks). Net capital gain (less losses) made up $630.5 billion of adjusted gross income in 2000, and was taxed at rates going up to 28 percent.
Bush's 2003 plan would accelerate the rate-reductions from his 2001 plan, and it would exclude dividends from individual taxable income. While he justified the 2001 tax cuts on the budget surplus ("We recognize loud and clear the surplus is not the government's money. The surplus is the people's money and we ought to trust them with their own money," he said in signing the 2001 cuts into law), he has argued for his 2003 plan as a way to stimulate the economy.
Under the original 2001 plan, tax changes are to be phased in gradually from 2001 to 2010, and will all be repealed in 2011 if not renewed by future Congresses.
- 2001: Income tax rate reductions begin, initially for top rates, with full implementation in 2006. New rate of 10 percent for first $12,000 of taxable income for couples, $10,000 for single parents, and $6,000 for singles. Alternative minimum tax relief begins. Tax "rebates" are sent to all income taxpayers who reported at least $6,000 of taxable income in 2000 (for more on tax "rebates," go here.
- 2002: Top four income rates are reduced. Estate tax exemption rises to $1million and rate begins to decline, with full repeal scheduled for 2010.
- 2005: Changes in deduction for married couples begin to take effect, with full implementation in 2008.
- 2006: All income tax rate reductions are phased in.
- 2009: Estate tax exemption rises to high of $3.5 million, with repeal scheduled for the following year.
- 2010: Estate tax is repealed.
- 2011: If not already renewed by future Congresses, all tax changes are repealed.
Sources: The White House has information on Bush's tax plan on-line here and a detailed agenda with comparative rate tables here. The final legislation, the Economic Growth and Tax Relief Reconciliation Act of 2001, is on-line via Congress's Thomas website, on-line here. Tax statistical data from the Internal Revenue Service, on-line here; tax rates from 1913 to 2002 are available in a PDF file here.
Federal Budget Receipts: Estate Tax (last updated June 19, 2002) (back to top)
The federal estate tax, sometimes called a "death tax" by its critics, taxes the estates of the wealthiest Americans upon their deaths. Under pre-2001 law, it affected about 2 percent of Americans who died each year and it accounted for about $35 billion in revenues (as the chart above shows, it accounts for less than 2 percent of annual government revenue).
Under Bush's tax cuts signed into law in June 2001, estate tax rates will be reduced and more Americans will be exempt from coverage until the tax is fully repealed for one year in 2010, though the estate tax will return in 2011 if not permanently repealed beforehand (such a measure failed to reach the Senate floor in June 2002). The resulting loss of about $300 billion in revenue makes up a significant component of Bush's overall tax-cut package, which has been estimated at around $1.35 trillion.
Estate taxes currently are assessed on the net worth of an individual at death, also counting gifts made before death. Under pre-2001 tax law, there was no tax on the first $675,000 of an individual's net worth (this exempted amount was to rise to $1 million by 2006). Fewer than 48,000 Americans were thus covered under the tax, about 2 percent of annual deaths. Farms and family businesses made up a small percentage of those subject to the tax, but had special protections such as a higher exemption threshold.
Above the exemption threshold, estates were taxed under pre-2001 tax law at rates beginning at 37 percent and rising to 55 percent. This tax has resulted in about $35 billion annually in tax revenue, a small figure when compared to income tax revenues of about $1 trillion and corporate profit tax revenues of about $200 billion, but over the course of the next decade, a large component of Bush's overall tax cut.
The debate over the estate tax resulted in some unusual alliances. In February 2001, a group of wealthy Americans including Warren Buffett, George Soros, and Bill Gates' father publicly came out in favor of retaining the estate tax. In an ad that ran in the New York Times and other papers that month, the millionaires argued that "repealing the estate tax would enrich the heirs of America's millionaires and billionaires while hurting families who struggle to make ends meet." Many of these millionaires contribute to charities which are dependent on the giftgiving that the estate tax is said to encourage.
Nonetheless, the House and Senate passed a package of tax cuts including an estate-tax cut on May 26, 2001. The House vote was 240-154 with 28 Democrats and an independent joining all Republicans. The Senate vote was 58-33 with 12 Democrats joining 46 Republicans; two Republican senators, John McCain and Lincoln Chaffee, voted against the bill. President George W. Bush signed the bill into law on June 7, 2001.
Under the new tax law, the estate tax exemption is raised to $1 million in 2002, four years earlier than originally planned, and continues to rise to $3.5 million by 2009. Rates on those estates still covered are reduced beginning in 2002. As currently planned, the estate tax is to be fully repealed by 2010. However, the phase-out of the estate tax, like all the changes in the Bush tax cut, will expire on December 31, 2010, returning US tax laws to what they were on June 6, 2001, unless renewed or made permanent beforehand. The Democrat-controlled Senate considered a measure to permanently repeal the estate tax in June 2002 but the measure did not have enough support to reach the floor for a vote.
Beyond the estate tax, other tax cuts are also phased in gradually over the next decade and thus could be repealed or expanded by the time they become effective; lower income tax rates do not become fully implemented until 2006, new benefits for married couples not until 2008, and the doubling of the tax credit for children not until 2010.
Sources: Paul Krugman, Fuzzy Math: the essential guide to the Bush tax plan (W.W. Norton & Company, 2001). William Gale and Joel Slemrod, Resurrecting the Estate Tax (Brookings Institution, June 2000). David E. Rosenbaum, Subject to review: Even as President signs tax cut measure, Democrats and GOP talk of revisions, New York Times, June 8, 2001. Citizens for Tax Justice, available online here.
Tax Rebate (last updated April 8, 2002) (back to top)
As part of the Bush tax cut enacted in June 2001, the federal government paid out $36 billion that summer and fall to about 85 million people as an advance refund on their 2001 income taxes. Such downpayments -- which were popularly referred to as "rebates" and which went up to $600 for couples, $500 for single parents, and $300 for other taxpayers -- were designed to help inspire consumer spending and thus help the U.S. economy out of recession.
Advance payments went to people who had paid sufficient income taxes in 2000, with the expectation that such persons would again pay enough income taxes in 2001 and thus be entitled to the rate reduction credit by year's end. For those people who did not already receive the credit for 2001, they could claim the credit on their individual income tax returns and thus get the benefit of it in their regular taxes (see line 47 on Form 1040).
Some economists have given some credit for the improving economy to the tax rebates, saying that it helped put money back into people's hands to do with as they would. The President's Council of Economic Advisers said in its February 2002 report that the tax rebates helped add "significant economic stimulus by boosting consumers' purchasing power during a period of sluggish economic activity." The Council also credited the tax rebates (which it referred to as a "downpayment" on the President's tax cut) with helping to increase real disposable income as well as the personal savings rate.
According to statistics from the Bureau of Economic Analysis, gross domestic product, gross domestic purchases, and personal consumption expenditures (consumer spending on goods and services) all grew at increasingly slower rates over the three quarters of 2001, even though growth rates usually start slow but then increase over the course of the year. In the third quarter of 2001, GDP and gross domestic purchases even fell from the prior quarter. By the fourth quarter of 2001, however, GDP, gross domestic purchases and personal consumption expenditures all showed increasing growth rates again.
The Council of Economic Advisers estimated that the economy would still be rebounding without the Bush tax cut and the $300-600 advance repayment, but that it would be at slower rates than is now being seen. The following graph combines historical data from the Bureau of Economic Analysis with the Council's estimates of the economy had the Bush tax not been enacted, and the next graph shows the growth rate of personal consumption expenditures.
The federal government previously gave a tax rebate in 1975. Unlike the 2001 tax rebate, the 1975 rebate was inversely tied to income, so that lower-income households would receive $200 and higher-income households would receive $100. People receiving Social Security also received a $50 check as well. With a high inflation rate at the time, the timing of the rebates did mean that the rebate was worth more than it would be had it come months later. Critics differ on the effectiveness of the 1975 rebate. According to a New York Times account, studies show that Americans spent between one-quarter and one-third of their 1975 rebates.
Sources: The Economic Growth and Tax Relief Reconciliation Act of 2001 is on-line via Congress's Thomas website, on-line here. The Economic Report of the President, published by the Council of Economic Advisers' Report, (February 15, 2002) is on-line here. Citizens for Tax Justice, 51 million taxpayers won't get full rebates from 2001 tax bill (June 1, 2001), on-line here. David Leonhardt, Rebate history doesn't repeat itself, New York Times, June 24, 2001. David Leonhardt, Putting a tax rebate to use; many are expected to save the money or pay their debts, New York Times, New York Times, June 5, 2001.
Where does the federal government spend its money (budget outlays)? (last updated February 12, 2002) (back to top)
Source: Data taken from historical tables for the FY 2002 budget (see table 3.1), available through the White House's Office of Management and Budget, on-line here.
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