161 Fiscal Policy and the Federal Budget

What you’ll learn to do: identify the major spending categories and major revenue sources in the U.S. Federal budget

Imagine you had trekked all the way to see Yellowstone National Park in the beautiful month of October 2013, only to find it… closed. Closed! Why?

For two weeks in October 2013, the U.S. federal government shut down. Many federal services, like the national parks, closed and 800,000 federal employees were furloughed. Tourists were shocked and so was the rest of the world: congress and the president could not agree on a budget. Inside the Capitol, republicans and democrats argued about spending priorities and whether to increase the national debt limit. Each year’s budget, which is over $3 trillion of spending, must be approved by Congress and signed by the President. Tied to the budget debate was the issue of increasing the debt ceiling—how high the national debt of the U.S. government can be. The House of Representatives refused to sign on to the bills to fund the government unless they included provisions to stop or change the Affordable Health Care Act (more colloquially known as Obamacare). As the days ticked by, the United States came very close to defaulting on its debt. Another shorter government shutdown occurred more recently in January 2018, as legislators debated the budget alongside things like immigration and the Deferred Action for Childhood Arrivals (DACA) policy.

Why does the federal budget create such intense debates? What would happen if the United States actually defaulted on its debt? In this section, you will take a look at where the government obtains its revenue and how the money is spent, so that we can better understand the entire federal budget and fiscal policy.

Fiscal Policy

In this module we will dive into fiscal policy. Fiscal policy is one of two policy tools for managing the economy (the other is monetary policy). While monetary policy is conducted by policymakers at the Federal Reserve, fiscal policy is decided by Congress and the President.

All levels of government—federal, state, and local—have budgets that show how much revenue the government expects to receive in taxes and other income and how the government plans to spend it. Indeed, examining government budgets are a quick way to get a sense of the role of government in the economy. Budgets, however, can shift dramatically within a few years, as policy decisions and unexpected events shake up earlier tax and spending plans.

The discussion of fiscal policy focuses on how federal government taxing and spending affects aggregate demand. All government spending and taxes affect the economy, but fiscal policy focuses strictly on the policies of the federal government. We will begin with an overview of U.S. government spending and taxes. Then we’ll discuss fiscal policy from a short-run perspective; that is, how government uses tax and spending policies to address recession, unemployment, and inflation; how periods of recession and growth affect government budgets; and the merits of balanced budget proposals.