A Recent History of the Federal Budget
Surplus. The federal budget was in a surplus for four years, 1998-2001. A surplus is not necessarily the best thing for the country (why shouldn’t we borrow money to make important investments in our future, just like businesses and households do?) but it is important if we are trying to pay down debt.
The Bush Tax Cuts and Rising Expenditures: In 2001 and 2003, Congress passed what have come to be called the Bush Tax Cuts. Income and other taxes were cut in ways that largely favored the wealthy. The 2001 tax cut phased in significant reductions in income tax rates, reduced and eventually repealed the estate tax, and provided additional tax breaks for saving, education, families with children, and married couples. Legislation in 2002 significantly reduced the taxes on new business investments. The 2003 tax cut substantially reduced the taxation of dividends and capital gains, and accelerated the phase-ins of the 2001 tax cuts. The Bush tax cuts were phased in over multiple years and all were scheduled to end (“sunset”) at the end of 2010. This was done largely to reduce the 10-year cost of the bills when they were passed and disguise the true long-term costs of the tax cuts. But once enacted, it was assumed these tax changes would be very hard to reverse.
At the same time that taxes were cut, the U.S. also initiated two wars – in Afghanistan and Iraq – without raising taxes to pay for them. Congress also passed a much-needed prescription drug benefit for Medicare without providing funding. The budget surplus (which had exceeded $236 in 2000) became a deficit in 2002 and every year thereafter, reaching as high as $437 billion even before the economic downturn.
The Economic Downturn. When the downturn hit, declines in household incomes and corporate profits reduced federal government revenue received from the personal and corporate income taxes. At the same time, spending rose due to an increased use of unemployment insurance, food stamps, Medicaid, and other safety net programs. The government also spent a total of $2.5 trillion to shore up banks, an insurance company (American International Group), and the auto industry, and to backstop the market for commercial paper and support the public-private mortgage backers, Fannie Mae and Freddie Mac, to name just some of the bailout beneficiaries. (See Adding Up the Government’s Total Bailout Tab)
In an effort to stimulate the economy, the Bush tax cuts, scheduled to end in 2010, were extended for two years and the worker-paid portion of the payroll tax was temporarily reduced by two percentage points.
Efforts to Reduce the Deficit. In 2011 Congress passed the Budget Control Act of 2011 as part of the resolution of the debate to raise the debt ceiling. This bill had a number of components.
- Cut $1 trillion in discretionary spending over 10 years.
- Established the congressional “Super-Committee” to recommend $1.2 trillion in additional spending cuts. As an incentive to find an agreement, the bill stipulated that if Congress could not approve at least $1 trillion in deficit reduction (over 10 years), then automatic cuts in discretionary spending (called a “sequester”) would begin in January 2013 with half the money coming from the military and half from non-military functions. The Super-Committee was not able to reach agreement, so the sequester was implemented with the cuts scheduled to begin in January 2013.
The Fiscal Cliff – December 2012. There were three things scheduled to happen in January 2013. First, the sequester would have cut $100 billion in discretionary spending from the budget in 2013 and in each year thereafter for 10 years. Second, the Bush tax cuts, extended in 2010 for two years, were due to end in December 2012 so taxes would have risen significantly. Third, the two percentage point reduction in the worker-paid portion of the payroll tax was also scheduled to end. The combination of tax increases and spending cuts would have reduced the deficit by $500 to $700 billion (experts disagreed on the exact amount but the higher figure was probably more accurate). The nonpartisan Congressional Budget Office and many other experts predicted that such a large reduction in the deficit would spark a recession in 2013. This was the so-called “fiscal cliff.” In addition in late December, 2012, the federal government reached the limit on its authorized borrowing. So early in 2013, Congress needed to raise the debt ceiling.
Note: any reduction in spending is seen by firms as a decrease in demand. They respond by cutting back production and laying people off. Changes in military spending have a smaller effect on employment than do changes in spending on other things like clean energy, education, or health care.
On January 1, 2013, Congress reached an agreement to avoid the fiscal cliff. Congress decided to reduce the deficit by a smaller amount: to allow only some taxes to rise (as tax breaks were ended) and to postpone most major spending cuts so alternatives could be considered.