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2. Where the Money Comes From—
and Where it Goes

In a typical American household, a father and mother might sit around the kitchen table to review the family budget. They might discuss how much they expect to earn each year, how much they can spend on food, shelter, clothing, transportation, and perhaps a vacation, and how much they might be able to save for their future needs.

If they do not have enough money to make ends meet, they might discuss how they can spend less, such as by cutting back on restaurants, movies, or other entertainment. They also might consider whether to try to earn more by working more hours or taking another job. If they expect their shortfall to be temporary, they might try to borrow.

Chart 2-1. Family Budgeting

On the other hand, if they find themselves with more income than needed to meet their usual needs, they might use some of the extra money to improve their situation in critical areas, such as buying better health insurance, and to pay off the debts they built up in earlier years.

In some ways, the Federal Government plans its budget much like families do. The President and Congress determine how much money they expect the Government to receive in each of the next several years, where it will come from, and how much to spend to reach their goals—goals for national defense, foreign affairs, social insurance for the elderly, health insurance for the elderly and poor, law enforcement, education, transportation, science and technology, and others. Unlike the Government though, a family can’t just decide to take money from its neighbors when it wants to spend more than it takes in.

Also, unlike a family, the Government must keep in mind that it gets its revenue from you, the taxpayer. When the Federal budget is in surplus, the Government debates not only how much of the surplus to invest in new spending, or to pay down past debt, but also how much to return to the taxpayers in the form of tax relief. The Government also debates how its spending and revenue decisions will help the economy grow.

Chart 2-2. National Budgeting

In this chapter, we will discuss these decisions in some detail—that is, how the Government raises revenues and where it spends money.

Revenues

Chart 2-3. The Federal Government Dollar— Where It Comes From

Over 90 percent of revenues come from three major
categories of taxes: individual and corporate income taxes
and payroll-type taxes.

The money that the Federal Government uses to pay its bills—its revenues or receipts—comes mostly from taxes. In the past three years, revenues were greater than spending, and the Government was able to reduce the national debt with the difference between revenues and spending—that is, the surplus.

Revenues come from these sources:

• Individual income taxes will raise an estimated $1,079 billion in 2002, equal to about 9.9 percent of GDP, after reaching an all-time high in 2001. Total taxes, as a percent of GDP, also reached a peace-time high in 2001.

• Corporate income taxes, which will raise an estimated $219 billion, have shrunk steadily as a percent of GDP, from 4.5 percent in 1955 to an estimated two percent in 2002.

• Social insurance payroll taxes include Social Security taxes, Medicare taxes, unemployment insurance taxes, and Federal employee retirement payments. This category has grown from two percent of GDP in 1955 to an estimated 6.7 percent in 2002.

• Excise taxes apply to various products, including alcohol, tobacco, transportation fuels, and telephone services. The Government earmarks some of these taxes to support certain activities—including highways and airports—and deposits others in the general fund.

• The Government also collects estate and gift taxes, customs duties, and miscellaneous revenues—for example, Federal Reserve earnings, fines, penalties, and forfeitures.

Table 2-1. Revenues By Source—Summary

(In billions of dollars)

Chart 2-4. Individual Income Taxes as a Share of GDP at
Record High

Chart 2-5. Constant Dollar Revenue Growth

Chart 2-6. Composition of Revenues

Spending

As noted, the Federal Government will collect around $2.2 trillion and spend nearly $2.0 trillion,¹ which is divided into several categories as shown in Chart 2–7, leaving a surplus of $231 billion in 2002.

• The largest Federal program is Social Security, which will provide monthly benefits to more than 46 million retired and disabled workers, their dependents, and survivors. It accounts for 23 percent of all Federal spending.

• Medicare will provide health care coverage for more than 40 million elderly Americans and people with disabilities. Since its creation in 1965, Medicare has accounted for an ever-growing share of spending. In 2002, it will comprise 12 percent of all Federal spending.

• Medicaid will provide health care services to a little more than 34 million Americans, including the poor, people with disabilities, and senior citizens in nursing homes. Unlike Medicare, the Federal Government shares the costs of Medicaid with the States, paying between 50 and 83 percent of the total (depending on each State’s requirements). Federal and State costs are growing rapidly, although the rate of growth has fallen from the double-digit pace of the late 1980s and early 1990s. In 2002, Medicaid will account for seven percent of the budget.

• Other means-tested entitlements provide benefits to people and families with incomes below certain minimum levels that vary from program to program. The major means-tested entitlements are Food Stamps, Supplemental Security Income, Child Nutrition, the Earned Income Tax Credit, and veterans’ pensions. This category will account for an estimated six percent of the budget.

• The remaining mandatory spending, which mainly consists of Federal retirement and insurance programs, unemployment insurance, and payments to farmers, makes up seven percent of the budget.

• National defense discretionary spending will total an estimated $319 billion in 2002, comprising 16 percent of the budget.

• Non-defense discretionary spending—a wide array of programs that include education, training, science, technology, housing, transportation, and foreign aid—will total an estimated $373 billion in 2002, or 19 percent of the budget.

• Interest payments, primarily the result of previous budget deficits, averaged seven percent of Federal spending in the 1960s and 1970s and rose to a high of 15 percent in 1996. Since 1998, the budget has been in surplus. As a result, interest payments are estimated to drop to less than 10 percent of the budget in 2002.

• Slightly less than 11 percent of your Federal dollar (the budget surplus) will be reserved for contingencies or used to reduce the Federal debt to ensure the continued solvency of Social Security.

Chart 2-7. How Your Tax Dollar Is Used

Chart 2-8. Constant Dollar Spending Growth

Table 2-2. Spending Summary

(In billions of dollars)

Table 2-3. Total Spending by Function

(Outlays, in billions of dollars)

Table 2-4. Discretionary Budget Authority by Agency

(In billions of dollars)

“On” and “Off” Budget

From time to time, you may hear the term “on-budget,” which refers to the budget excluding certain programs that are legally designated as “off-budget.”

Traditionally, the President’s budget has focused on the totals for the unified budget. The unified budget encompasses all of the budgetary activities of the Government, and the unified budget surplus or deficit is the measure that determines how much the Government has to borrow from the public (in the case of a deficit), or how much past borrowing can be repaid (in the case of a surplus).

More recently, the on-budget surplus has received increasing attention. For all practical purposes, the off-budget surplus is the surplus in the Social Security program. This means that the on-budget surplus is the budget surplus excluding the Social Security surplus.²

Social Security is running large surpluses right now, because payroll taxes were raised dramatically in the early 1980s and because the relatively large “baby-boom” generation is big enough to provide the Social Security benefits provided to the relatively small generation of current retirees. These surpluses have held down the unified deficit by offsetting part of the deficit in the on-budget accounts. When the unified budget first booked a surplus of $69 billion in 1998, the on-budget accounts were still in deficit by $30 billion. In 1999, the unified budget ran a $125 billion surplus, nearly all of which was the result of the Social Security surplus. The on-budget accounts were almost exactly in balance. For 2002, $59 billion of the estimated $231 billion surplus comes from the on-budget accounts.

Under the President’s proposals, the entire Social Security surplus would be saved and set aside for Social Security and debt reduction. The President’s overall budgetary framework is discussed in Chapter 5.

Chart 2–9 illustrates the relationship between on- and off-budget items, and the unified budget.

Chart 2-9. On- and Off-Budget Surplus Projections

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