Chap10 Fundamental Economic Concepts

If you borrow money

because you spend

more than you earn, you run a

deficit. In Chapter 10, you will

learn how federal deficits and

surpluses impact the U.S.

economy. To learn more about

government spending, view the

Chapter 16 video lesson:

Government Spending

Chapter Overview Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 10—Chapter Overview to previewchapter information.

Government expenditures are usedto maintain transportation systemsand protect the environment.

http://epp.glencoe.com

The Economics ofGovernment Spending

Main IdeaThe role of the federal government has grown,making it a vital player in the economy.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to this one by listing rea-sons for the increase in government spending sincethe 1940s.

Key Termsper capita, public sector, private sector, transferpayment, grant-in-aid, distribution of income

ObjectivesAfter studying this section, you will be able to:1. Explain why and how government expenditures

have grown since the 1940s.2. Describe two kinds of government expenditures.3. Describe how government spending impacts the

economy.

Applying Economic ConceptsTransfer Payments Read to find out how transferpayments serve as one of the tools used to promotethe goal of economic security.

Cover Story

Raising the Stakes in the Budget

GameThe $1.35 trillion tax

cut Congress passed last

month was supposed to

leave ample room for

such goodies as higher

defense and education

spending, a prescription

drug benefit, and even

some buybacks of government IOUs. It’s quickly

becoming clear, however, that the wish lists of the

White House, Congress, and federal agencies may need

a heavy edit.Congress is already on track to spend more than the

White House wants: Last week, a Republican-

controlled House Appropriations committee volun-

teered $150 million more for payments to apple farm-

ers and an added $814 million for a natural resources

bill. Meanwhile, a senate-passed education bill calls for

$15 billion above the White House’s request. . . .

—U.S. News & World Report, June 25, 2001

House Budget chair, Rep. Jim Nussle

G overnment is big business in America. Infact, all levels of government in the UnitedStates spend more than all privately owned

businesses combined. Government is a major playerin our economy due to its enormous expenditures.

Government Spending inPerspective

In 2003, total expenditures by federal, state,and local governments collectively amounted

to nearly $3 trillion. On a per capita, or per person,basis, this amounts to almost $10,300 for every man,woman, and child in the United States.

Spending in the public sector—the part of theeconomy made up of federal, state, and local govern-ments—did not begin to rise significantly until the1940s. Several reasons account for this increase. Thefirst was the huge amount of spending requiredbecause of World War II. The second reason was thechange in public opinion that gave government alarger role in everyday economic affairs. After the

Rise ingovernment

spending

Reasons

CHAPTER 10: GOVERNMENT SPENDING 255

255_GLENEPP 10/17/03 11:39 AM 55

Great Depression, government was called upon toregulate banks, public utilities, and many otheractivities.

A third reason was the success of large-scale public works projects like the TVA, which broughtlow-cost electricity to millions in the rural South dur-ing the mid-1930s. The events of the 1930s and early1940s set the stage for the unprecedented growth ofgovernment spending shown in Figure 10.1.

Over time, many Americans have acceptedincreased government expenditures as the inevitableconsequence of progress. Still, some people questionhow many goods and services government shouldprovide—and, therefore, the level of revenue collec-tion required to support these expenditures.

Others question what services the governmentshould provide and what services the private sector—the part of the economy made up of privateindividuals and privately-owned businesses—shouldprovide.

Two Kinds of SpendingIn general, government makes two broadkinds of expenditures. The first is the pur-

chase of goods and services. As Figure 10.2 shows,all levels of government combined consume nearlyone-third of the nation’s output. The second is inthe form of payments to disadvantaged Americansand other designated groups.

Goods and ServicesThe government buys many goods, such as

tanks, planes, ships, and even space shuttles. Itneeds office buildings, land for parks, and capitalgoods for schools and laboratories. The govern-ment also needs to purchase supplies and hire peo-ple to work in its agencies and staff the military.Payments for these services include the wages andsalaries paid to these workers.

256 UNIT 3 MACROECONOMICS: INSTITUTIONS

Figure 10.1Figure 10.1

Using GraphsUsing Graphs Total expenditures at all levels of government have increased significantly over time. Even when adjusted for inflation, per capita expenditures have increased by nearly 800 percent since 1940. Does the graph show any extended period of decreased government spending?

Total Government Expenditures Per Capita, Adjusted for Inflation

As a

per

cent

age

of 1

940

300%

400%

500%

600%

700%

800%

900%

100%

0%

200%

1940

1950

1960

1970

1980

1990

2000

Source: Bureau of Economic Analysis and the Department of the Census, various forms

2002

1990s Lower rate ofspending by the federal

government contributes to overallslowdown in spending.

1945 Per capitaspending nearly quadrupled

during World War II.

Visit epp.glencoe.com and click onTextbook Updates—Chapter 10 foran update of the data.

256_GLENEPP 10/17/03 11:40 AM Page 256


The government uses goods, services, and otherresources to provide the public goods and servicesthat most Americans enjoy. In general, the morethe government provides, the more goods andservices it consumes in the first place.

Transfer PaymentsThe second kind of government expenditure is

a transfer payment—a payment for which the gov-ernment receives neither goods nor services in return.Transfer payments to individuals include SocialSecurity, welfare, unemployment compensation, and

aid for people with disabilities. People normallyreceive these payments solely because they needassistance.

There are different kinds of transfer payments. A transfer payment one level of governmentmakes to another is known as a grant-in-aid.Interstate highway construction programs are an example. The federal government grantsmoney to cover the major part of the cost, whilethe states in which the highways will be built pay the rest. The construction of newpublic schools also can be financed throughgrants-in-aid.


Using Graphs Using Graphs The circle graph shows that all levels of government combined account for about 28 percent—nearly one-third—of the nation’s total output. The bar graph shows that federal spending accounts for nearly two-thirds of all government spending, or 18 percent of the total output. Do state and local governments derive most of their monies for expenditures from revenues or from federal grants?

Government Spending as a Percent of Total Output

Source: A Citizen’s Guide to the Federal Budget, FY 2002 (Variations due to rounding.)

Government28%

Total GovernmentSpending in the U.S.

28%

Federal Grants toState and LocalGovernments

2%

Total FederalSpending

18%

Total State andLocal Spending

12%

Private72%

Spending FromState and Local

Revenues9%

Spending for DirectFederal Programs

16%




Impact of Government SpendingThe enormous size of the public sectorgives it the potential to affect people’s daily

lives in many ways. Several of these effects areexamined below.

Affecting Resource AllocationGovernment spending decisions directly affect

how resources are allocated. If the governmentspends its revenues on projects such as missile sys-tems in rural areas rather than on social welfareprograms in urban areas, economic activity is stim-ulated in rural areas as resources are shifted there.The allocation of resources can be affected indi-rectly as well. In agriculture, the decision to sup-port the prices of milk, grains, or peanuts keeps thefactors of production working in those industries.

Redistributing IncomeGovernment spending also influences the

distribution of income, or the way in which incomeis allocated among families, individuals, or otherdesignated groups in the economy. The incomes ofneedy families, for example, can be directly affectedby increasing or decreasing transfer payments.

Incomes are affected indirectly when the gov-ernment decides where to make expenditures. The

decision to buy fighter planes from one factoryrather than from another has an impact on thecommunities near both factories. Many businessesnot linked to either company will feel the effectswhen workers are laid off or get new jobs and altertheir spending habits. These situations are notmerely hypothetical. The military base closings ofthe 1990s had a devastating impact on incomes inlocal communities that had come to depend on themilitary installations.

On the positive side, government can providetemporary income support for selective groups. In1999, for example, the Department of Agriculturepurchased millions of pounds of pork in anattempt to support low pork prices for farmers.

Competing With the Private SectorWhen the government produces goods and

services, it often competes with the private sector. Inthe area of higher education, many public collegesand universities compete with more expensive pri-vate ones. In many cases the cost difference is due tothe subsidies received by the public institutions.

In the area of health care, the government runsa system of hospitals for military veterans. Taxpayerdollars fund these facilities, which compete withhospitals in the private sector that offer similarservices.

Checking for Understanding1. Main Idea Using your notes from the graphic

organizer activity on page 255, describe whygovernment spending during the Depressionincreased.

2. Key Terms Define per capita, public sector,private sector, transfer payment, grant-in-aid,distribution of income.

3. Describe the per capita growth in govern-ment spending since 1940.

4. List two kinds of government spending.

5. Identify three ways that government spend-ing may impact the economy.

Applying Economic Concepts6. Transfer Payments Do you think that transfer

payments, such as unemployment compensa-tion, are a successful or unsuccessful way toaccomplish the goal of economic security?Defend your answer.

7. Making Generalizations Is governmentspending too much? Interview five peopleto learn their views on this question.Summarize their views in a short paper.

Practice and assess key social studies skills withthe Glencoe Skillbuilder Interactive Workbook,Level 2.



Using E-MailElectronic mail, or E-mail, refers to communicating at a distance through theuse of a computer. A computer is ready to “talk” to other computers aftertwo things are added to it: (a) a modem—or device that allows communica-tion through a telephone line, and (b) communications software, which letsyour computer prepare and send information to the modem.

Practicing the SkillSelect a current issue in economics to research.

Possible topics include, What is the effect of the debt onthe ecomony? and, What steps can be taken to reduce thedebt? Then browse the Internet to obtain the E-mailaddress of a federal official concerned with the issue. E-mail the official, sharing opinions about the issue,asking questions about the issue, and requestinginformation.

Learning the SkillTo send an E-mail message, complete the

following steps:

• Select the “Message” function from your commu-nications software.

• Type in your message, and proofread it for errors.

• Type in the E-mail address of the recipient andselect the “Send” button.The E-mail system places the message in the

receiver’s electronic mailbox. He or she may read themessage at any time, and send you a return message.When you receive E-mail, the sender’s address is onthe message—add it to your electronic address bookat that time.

E-mail a classmate. Forward the information youreceived from the government official concerningthe issue above. Working together, write a summaryof the E-mail correspondence with the official.

After you type in yourmessage, you may send it,forward it, and even save it to a folder.

Federal Government Expenditures

Main IdeaThe federal government’s budget supplies money formany services and programs.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below thatdescribes the different types of government spending.

Governmentspending

Mandatoryspending

Discretionaryspending

Cover Story

The FederalBudget

WASHINGTON—

President Bush sent

Congress a federal

budget framework on

Wednesday that would

curtail and even reverse

the growth of many

domestic programs while plowing savings into tax

relief and debt reduction.

Over a 10-year period, Bush pledged to slash the

national debt by $2 trillion, set aside funds to protect

Medicare, cut taxes by $1.6 trillion and establish a

new reserve fund for unexpected needs.

Bush argued that his approach was “compassion-

ate,” “responsible” and “reasonable.” The plan, he

said, presumes “a federal government that is both

active to promote opportunity and limited to preserve

freedom.”—The Los Angeles Times, March 1, 2001

President George W. Bush

Key Termsfederal budget, mandatory spending, discretionaryspending, fiscal year, federal budget surplus, federalbudget deficit, appropriations bill, medicaid

ObjectivesAfter studying this section, you will be able to:1. Explain how the federal budget is established.2. Describe the parts of the federal budget.

Applying Economic ConceptsMandatory Spending Remember those FICA taxesdeducted from your paycheck? The government doesnot save your FICA taxes until you retire. As soon asthis money is collected from you, the governmentspends it as Social Security payments to others, whichis why they are called transfer payments.

T aking action on spending bills is but one stepin the preparation of the federal budget—anannual plan outlining proposed revenues

and expenditures for the coming year.Approximately two-thirds of the federal budget

consists of mandatory spending—spending author-ized by law that continues without the need forannual approvals of Congress. Mandatory spendingincludes interest payments on borrowed money,Social Security, and medicare. The remaining one-third of the budget deals with discretionary spending—programs that must receive annualauthorization. Discretionary spending decisionsinclude how much to spend on programs such asthe military, the Coast Guard, and welfare.

Establishing the Federal BudgetThe federal budget is prepared for a fiscalyear—a 12-month financial planning

period that may or may not coincide with thecalendar year. The government’s fiscal year startson October 1 of every calendar year and expireson September 30 of the following year.

260

Executive FormulationThe first step in the process of developing the

budget is executive formulation. This means thatthe president establishes the general budget guide-lines for a multiyear period, with the primaryfocus on the upcoming fiscal year.

As part of the preparation, the president con-fers with government agencies, other executiveoffice units, and the Office of Management andBudget (OMB), the division of the executivebranch primarily responsible for assembling thebudget under presidential guidelines.

By law, the federal budget must be sent to bothhouses of Congress by the first Monday inFebruary. President Bush’s federal budget for fiscalyear 2004, pictured in Figure 10.3, lists $1,922 bil-lion of revenues and $2,229 billion of mandatoryand discretionary spending. The figure also shows afederal budget deficit—an excess of expendituresover revenues—of $307 billion. Or, if expenditureshad been less than revenues, there would havebeen a federal budget surplus equal to the differ-ence. Whether or not these numbers turn out to beaccurate depends on a number of factors, includingthe health of the economy and, more importantly,the cooperation of Congress.

Action by the HouseThe president’s budget is only a request to

Congress. Congress has the power to approve,modify, or disapprove the president’s proposedbudget—the most difficult and time-consumingpart of the budget process. However, the Housedoes not debate all budget expenditures, only thediscretionary spending, which amounted toapproximately $819 billion in that year.

First, the House sets initial budget targets for dis-cretionary spending. For example, the House mightdecide that the projected expenditures for agricul-ture are too high and spending on internationalaffairs is too low, and then set different targets.

Once the budget targets are set, the Houseassigns appropriations bills to various House sub-committees—effectively breaking the entire budgetdown into 13 smaller ones. An appropriations billis an act of Congress that allows federal agenciesto spend money for specific purposes. House

sub-committees hold hearings on each bill anddebate the measure. If the bill is approved, it issent to the full House Appropriations Committee.If it passes there, the bill is sent to the entireHouse for approval.

The deadline for completing this part of theprocess is September 15. However, individualappropriations bills are often delayed, or changed ina way that makes them incompatible with the over-all budget targets. Part of the problem is that indi-viduals in Congress often try to get appointed tospecific budget appropriation committees so thatthey can secure funds to help their home districts.

Action by the SenateThe Senate receives the budget after the House

approves it. The Senate may approve the bill assent by the House, or it may draft its own version.If differences exist between the House and theSenate versions, a joint House-Senate conferencecommittee tries to work out a compromise bill.

During this process, the House and the Senateoften seek advice from several government bureausand offices, including the Congressional BudgetOffice (CBO). The CBO is a congressional agencythat evaluates the impact of legislation and projectsfuture revenues and expenditures that will resultfrom the legislation.

Using TechnologyIn an attempt to improve performance andreduce bureaucratic costs, the Social SecurityAdministration is modernizing its computersystem. Electronic “kiosks,” with touch-sensitive TV monitors, are being constructed inmalls and public buildings. The kiosks aredesigned to be a user-friendly place wherepeople can apply for Social Security cards oradministration benefits. One kiosk in Arizonais programmed to speak the Navajo language.These kiosks will be connected to SocialSecurity computers so that people can accesstheir own accounts.


261_GLENEPP 10/17/03 11:45 AM Page 261

Final ApprovalIf everything goes as planned, the House and the

Senate approve the compromise bill and then sendit to the president for signature. Because Congressliterally took apart, rewrote, and put back togetherthe president’s budget, the final version may ormay not resemble the original proposal.

If the budget was altered too much, the presi-dent can veto the bill and force Congress to comeup with a budget closer to the president’s originalversion. Or, if Congress fails to pass a budget intime for approval by the Senate, the governmentcan shut down briefly—as it did in late 1995 and early1996. However, it is more likely that Congress and

the president would agree to continue to operate atthe previous year’s spending levels.

Once signed by the president, the budgetbecomes the official document for the next fiscalyear that starts on October 1 and ends onSeptember 30. The budget shown in Figure 10.3 iscalled the fiscal year 2004 budget because nine ofthe 12 calendar months fall in that year.

Major Spending CategoriesThe thousands of individual expenditures inthe federal budget can be grouped into the

broad categories shown in Figures 10.3 and 10.4.

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E Figure 10.3Figure 10.3

Using Graphs

The Federal Budget for Fiscal Year 2004

Source: The Economic Report of the President, FY 2003*Other includes Agriculture, International Affairs, General Government, Community and Regional Development,Commerce and Housing Credit, and Energy.

Corporate Income Tax 7.6%Excise Taxes 3.2%

Estate and Gift Taxes 1.0%Customs Duties 0.9%

Miscellaneous 1.1%

Social Insurance & Contributions 34.3%

Individual Income Tax 38.1%National Defense 17.5%Income Security 14.6%Medicare 11.6%Health 11.1%Interest on Debt 7.9%Education, Training & Social Services 3.8%Transportation 2.8%Veterans’ Benefits 2.8%Administration of Justice 1.8%Natural Resources & the Environment 1.4%General Science, Space & Technology 1.0%Other* 1.4%

Social Security 22.3%Expenditures $2,229 billion

Deficit 13.8%Deficit $307 billion

Revenues $1,922 billion

Using Graphs The federal budget for fiscal year 2002 projected revenues of about 1.9 trillion and expenditures of more than $2.2 trillion. From what source does the federal government receive most of its revenues? Visit epp.glencoe.com and click on

Textbook Updates—Chapter 10 foran update of the data.


262_GLENEPP 10/17/03 11:45 AM Page 262



Using GraphsUsing Graphs The major categories of federal government expenditures show some change from 1980 to 2004. The three largest federal spending categories in 2004 were Social Security, national defense, and income security. How has spending for Social Security changed during the period from 1980 to 2004?

11.1%

11.6%

7.9%

1.4%

3.8%

2.4%

2.8%1.8%

2.8%

22.3%

14.6%

17.5%

Federal Government Expenditures, 1980–2004

1990 20041980

SocialSecurity

NationalDefense

Medicare

Natural Resources &the Environment

Education, Training,Employment & Social Services

Net Interest on Debt

Other

Veterans’ BenefitsAdministration of Justice

IncomeSecurity

Health

Transportation

Source: Economic Report of the President, various years

2.4%

3.1%

23.9%23.2%

20.6%

15.0%

9.1 %

5.6%

5.3%

4.0%

6.9%

19.8%

14.7%

11.7%

7.8%

4.6%

7.4%

1.2%1.1%

2.3%

3.7%

1.9%1.0%

3.7%



263_GLENEPP 10/17/03 11:45 AM Page 263


Payments to aged and disabled Americansthrough the Social Security program make up thelargest category of federal spending. Retired persons receive benefits from the Old-Age andSurvivors Insurance (OASI) program. Thoseunable to work receive payments from disabilityinsurance (DI) programs.

Because Social Security is one of the mandatoryspending categories, Congress simply takes theamount to be spent as a given that is dependent onthe number of people eligible for Social Securitypayments.

For much of the late 1900s, national defensecomprised the largest category of spending,although it is now second to Social Security.National defense includes military spending by theDepartment of Defense and defense-related atomicenergy activities, such as the development ofnuclear weapons and the disposal of nuclearwastes. This is the largest single discretionary cate-gory whose spending is approved annually.

Income security includes expenditures for retire-ment benefits to railroad workers and disabled coalminers, civil service retirement and disability

programs, and retirement benefits for the military.Subsidized housing, child nutrition, and food pro-grams for low-income families also fall under thiscategory. Most of these expenditures are manda-tory, and are therefore not authorized annually.

Medicare, a health-care program available to allsenior citizens regardless of income, began in 1966.The program provides an insurance plan that cov-ers major hospital costs. It also offers optionalinsurance that provides additional coverage fordoctor and laboratory fees, outpatient services, andsome equipment costs. This is another of themandatory programs that does not require annualfunding approval.

GOVERNMENT SPENDINGOur government certainly spends a lot of money,but other nations spend even more. A compari-son of the total government spending as a per-centage of total output, or Gross DomesticProduct, is shown in the graph.

Using this method, we can get a generalimpression of the size of the economic role of dif-ferent governments. France and Italy are amongthe biggest spenders—with total governmentoutlays exceeding 50 percent of their GDP.Germany and Canada are not far behind. Duringthe time period shown on the graph, Japan andthe United States generally spent between 30 and40 percent.

1. Analyzing Information Which nations’expenditures stayed at a level between 30and 40 percent of their GDP?

2. Drawing Conclusions Would you agreewith the statement that governmentspending by the United States “follows aconsistent trend?” Why or why not?

Critical Thinking

Student Web Activity Visit the Economics: Principlesand Practices Web site at epp.glencoe.com and clickon Chapter 10—Student Web Activities for an activ-ity on the federal budget.

Spen

ding

as

aPe

rcen

t of

GDP

’89 ’91 ’93 ’95 1997

60%

50%

40%

30%

0%

Canada

FranceItaly

Japan

Source: A Citizen’s Guide to theFederal Budget, FY 2000

United Kingdom

United States

Germany


264_GLENEPP 10/17/03 11:45 AM Page 264


When the federal government spends more thanit collects in taxes and other revenues, it borrowsmoney to make up the difference. Interest on thefederal debt made up the sixth largest category offederal spending for fiscal year 2004. The amountof interest paid varies with changes in interest ratesand is a mandatory expenditure.

Health-care services for low-income people, dis-ease prevention, and consumer safety account forthis part of the federal budget. One popular pro-gram in this category is medicaid, a joint federal-state medical insurance program for low-incomepersons. Another is the Occupational Safety andHealth Administration (OSHA)—a federal agencythat monitors occupational safety and health in theworkplace. Still others include AIDS and breastcancer research, substance abuse treatment, andmental health service programs. Some programssuch as medicaid are part of mandatory expendi-tures, although many others are considered to bediscretionary.

Other broad categories of the federal budgetinclude education, training, employment, andsocial services; transportation; veterans’ benefits;administration of justice; and natural resources andthe environment.

Checking for Understanding1. Main Idea Using your notes from the graphic

organizer activity on page 260, write a defini-tion of mandatory spending.

2. Key Terms Define federal budget, mandatoryspending, discretionary spending, fiscal year,federal budget surplus, federal budget deficit,appropriations bill, medicaid.

3. Describe the three stages required to estab-lish the federal budget.

4. List the five largest components of federalgovernment spending.

Applying Economic Concepts5. Mandatory Spending Contact your local Social

Security office to find out about a person’s

eligibility to receive Social Security payments.Ask about the age, other eligibility require-ments, and the amount of the Social Securitypayments.

6. Understanding Cause and Effect People areliving longer, and families have fewer mem-bers. How will the combination of thesetwo factors affect transfer payments, suchas Social Security, in the future?

7. Finding the Main Idea When the federalgovernment spends more than it collects, how does it make up the difference?


Federal Expenditures

Natural Resources Biologists and conservationspecialists release a farm-raised alligator intowetlands. What percentage of federal expendi-tures went to natural resources and the environment?


265_GLENEPP 10/17/03 11:46 AM Page 265

A New Economics:

John MaynardKeynes

(1883–1946)

John Maynard Keynes is widelyregarded as the most influentialeconomist of the twentieth cen-tury. He wrote numerous booksand articles that focused on short-run problems, instead of the long-run equilibrium solutionsprevalent at the time. Keynesdefended his short-run approachon the grounds that “in the longrun, we are all dead.”

His most famous and influen-tial work is The General Theory ofEmployment, Interest, and Money(1936). The book, written duringthe depths of the Great Depression,offered new insights in the midstof a crisis. The policy recommen-dations derived from his theoriessoon took the world by storm.

ECONOMIST, TEACHER

Keynes attended Eton, and thenCambridge University. After gradu-ation, Keynes returned toCambridge as a lecturer. In addi-tion he served, at various times, aseditor of the famous EconomicJournal, on the staff of theTreasury, and as a director of the

Bank of England. He wasinstrumental in the plan-ning of the World Bank. Forhis service to Great Britain,Keynes was knighted in 1942.

INFLUENCE

Keynes’s General Theory dividedthe economy into four sectors—consumer, investment, govern-ment, and foreign. Keynes arguedthat the health of the economy isbased on the total spending of allthe sectors. He hypothesized that afall in spending by the businesssector could have a magnifiedimpact on other sectors of theeconomy. Increased governmentspending could offset this process.These ideas stood in stark opposi-tion to classical economics, whichemphasize laissez-faire policies.They have been dubbed the NewEconomics, or, more frequently,Keynesian economics.

The theories were revolutionaryand they provided much needed

insight into the workings of adepression-era economy. Soon, thelabel Keynesian economics stood forany spending and taxing policiesdesigned to stimulate the privatesector.

The influence of Keynes wassuch that it led, in part, to thedevelopment of our nationalincome and products accounts(NIPA) that are used to measureGDP and GNP.

Examining the Profile1. Synthesizing Information Write a

brief description of Keynesian econom-ics and compare it with one of classicaleconomics to explain why the formerwas labeled “the New Economics.”

2. For Further Research Find out inwhat ways countries today followKeynesian economic policies.


State and Local GovernmentExpenditures

Main IdeaLike the federal government, state and local govern-ments have budgets that provide money for manyprograms and services.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by listingand describing the components of the categories thataccount for more than 10 percent of local spending.

Key Termsbalanced budget amendment, intergovernmentalexpenditures

ObjectivesAfter studying this section, you will be able to:1. Explain how state and local governments approve

spending.2. Identify the major categories of state government

expenditures.3. Identify the major categories of local government

expenditures.

Applying Economic ConceptsHuman Capital is one of the most important invest-ments we can make. Read to find out how state andlocal governments support this investment.

10% or more

Cover Story

Hard Choices Await State

LawmakersThe May revision of

the governor’s budget is

due within the fortnight.

Lawmakers in Sacra-

mento are waiting to see

whether Gov. Gray Davis

holds fast to the $104.7

billion plan he unveiled in

January or proffers a truly

revised budget that reflects that the state’s economic

outlook has taken a turn for the worst.

There are suggestions in the state capital that the

looming budget problem is mostly attributable to

California’s electricity-supply crisis. Solve the electricity

crisis, the argument goes, and the state’s budget prob-

lem goes away.

– The San Diego Union-Tribune, May 9, 2001

Gov. Gray Davis

S tate and local levels of government, like thefederal government, also have expenditures.Like the federal government, these govern-

ments must approve spending before revenue dollarscan be released. As the cover story shows, the budgetprocess at the state and local levels can be just ascomplicated as it is at the federal level.

Approving SpendingApproving spending at the state level can takemany forms. In most states, however, the

process is loosely modeled after that of the federalgovernment.

Some states have enacted a balanced budgetamendment—a constitutional amendment thatrequires that annual spending not exceed rev-enues. Under these conditions, states are forcedto cut spending when state revenues drop. Areduction in revenues may occur if sales taxes orstate income taxes fall because of a decline in thegeneral level of economic activity.


At the local level, power to approve spendingoften rests with the mayor, the city council, thecounty judge, or some other elected representativeor body. Generally, the amount of revenues col-lected from property taxes and other local sourceslimits the spending of local agencies. If state andlocal governments are unable to raise the revenuethey need, they must deal with having inadequateresources to hire teachers, police officers, or otherstate and local workers.

State Government ExpendituresThe major types of state governmentexpenditures are shown in Figure 10.5.

Seven of the most important categories, account-ing for nearly 80 percent of all state spending, areexamined next.

The largest category of state spending is intergovernmental expenditures—funds that onelevel of government transfers to another level forspending. These funds come from state revenuesources such as sales taxes, and they are distributedto towns and other local communities to cover avariety of educational and municipal expenditures.

The second largest category of state expendituresis public welfare. These payments take the form ofcash assistance, payments for medical care, spend-ing to maintain welfare institutions, and othermiscellaneous welfare expenditures.

Many states have their own retirement fundsand insurance funds for state employees. Moneyin these funds is invested until such time as peo-ple retire, become unemployed, or are injured onthe job. Contributions to these funds make thiscategory a significant expenditure.

Generally a large category, higher education is atraditional responsibility of state governments withtheir networks of state colleges and universities.Local governments spend less in this area, usuallyto support community colleges and universities.

Highway construction and road improvementexpenditures represent a significant portion ofstate expenditures. The federal government buildsand maintains much of the interstate highway sys-tem, but states maintain state roads and otherhighways that generally link smaller communitieswith larger ones.

Local Government ExpendituresLocal governments include counties, munic-ipalities, townships, school districts, and other

special districts. The largest categories of spending bylocal governments include elementary and secondaryeducation, utilities, hospitals, police protection,interest on debt, public welfare, and highways.

Local governments have primary responsibilityfor elementary and secondary education.Expenditures in this category include teachers’ andadministrators’ salaries, textbooks, and construc-tion and maintenance of school buildings. Thiscategory accounts for more than one-third of localgovernment spending.

Many public utilities, such as water and sanita-tion, serve local needs. For most local governments,

Are you good at analyzingand comparing data?Budget analysts developfinancial plans and providetechnical advice aboutbudgeting.

The WorkBudget analysts research,

analyze, develop, and execute annual budgets. Workingwith managers and department heads, they seek newways to improve a company’s efficiency and increaseprofits. Reviewing financial requests, examining pastand current budgets, and researching developmentsthat can have an effect on spending are additionalresponsibilities.

QualificationsBudget analysts need strong analytical skills and mustbe knowledgeable in mathematics, statistics, and com-puter science. Because of their frequent interactionwith others and the obligation to present budget pro-posals, budget analysts must possess strong oral andwritten communication skills.

Budget Analyst


268_GLENEPP 10/17/03 11:50 AM Page 268


Using Graphs Using Graphs Education is the main expenditure for local government. What are the three largest spending categories for local govern-ments? For state governments?

Expenditures by State and Local GovernmentsState: $1,084,097 million Local: $996,266 million

30.2% Intergovernmental Expenditure

18.3% Public Welfare 3.5%

9.7% Insurance Trust 2.0%

Elementary & Secondary Education 36.3%

10.4% Higher Education 2.2%

5.7% Highways 4.0%

3.0% Hospitals 4.4%

2.7% Interest on General Debt 4.1%

3.0% Corrections 1.6%

3.1% Governmental Administration 4.7%

2.5% Health 2.4%

1.0% Utilities 10.1%

Fire Protection 2.3%

0.8% Police Protection 4.8%

0.4% Parks and Recreation 2.1%

Housing & Community Development 2.4%

8.8% Other 13.1%

Source: Bureau of the Census, August 2003 (Variations due to rounding)

Visit epp.glencoe.com and clickon Textbook Updates—Chapter 10for an update of the data.


269_GLENEPP 10/23/03 5:29 PM Page 269


spending on utilities amounts to thesecond most important expenditure.

Many hospitals receive some of theirfunding from local governments. Somehospitals are entirely city- or municipal-owned, which makes them a modestbudget item for local governments.

Most localities have a full-time, paidpolice force to protect their commu-nity. As a result, police protection is acost for local governments. Becausethere are far fewer state than localpolice forces, state spending for policeprotection is much lower.

State and local governments, likethe federal government, often borrowmoney to cover capital expendituresfor highways, universities, and evengovernment buildings. As with the fed-eral government, interest expenses vary as interestrates go up and down.

Local governments, like state governments, facepublic welfare expenditures. Local governments,however, spend much less than state governmentson this category.

Local governments also spend money on high-ways, roads, and street repairs. This expenditure

category includes the repair of potholes, theinstallation and repair of street signs, snowremoval, and other street-related items.

The remaining local government expenditures,approximately one-third of the total, are spread overa wide range of categories. Among the most impor-tant are housing and community development, fireprotection, and parks and recreation.

Checking for Understanding1. Main Idea What are some services that state

and local governments provide for in theirbudgets?

2. Key Terms Define balanced budget amend-ment, intergovernmental expenditures.

3. Describe how state governments handle thespending approval process.

4. List seven major categories of state spending.

5. Identify the seven major categories of localgovernment spending.

Applying Economic Concepts6. Human Capital How does the market reward

those who have invested in human capital—

the acquired skills of an individual in the areasof education, training, and work habits? Citespecific examples from your community tosupport your answer.

7. Finding the Main Idea What is the purposeof a balanced budget amendment?

8. Making Generalizations If you were toargue for reduced spending at the stateand local levels, which categories shown inFigure 10.5 would you choose to cut back?Explain the reasons for your choices.


Government Expenditures

Education Local government’s largest spending category isprimary and secondary education. Which level of govern-ment has the major responsibility for higher education?


Creative students are finding new ways togain the financing needed to attend the col-lege of their choice. As you read the article,think about why it is important for studentsto explore many options as they plan forhow to finance their college educations.

Dialing for Dollars

Jonathan Piper, 18, applied to nine top-notchcolleges and got into them all. The Clevelandnative scored in the 95th percentile on his SATsand managed a 3.9 average at prep school whileplaying baseball, singing lead in musicals, and par-ticipating in an engineering society. He’s also anAfrican American. But getting accepted was justthe first step. Next came the money.

Last spring, Piper made call after call to collegefinancial-aid officers. His soft-spoken pitch: “Ihave no idea what I want to do, and I want to seethe best that each of you can offer me.” Universityof Pennsylvania and Princeton University didn’tmove much, but Wake Forest University inWinston-Salem, N.C., raised its annual aid offerfrom $8,000 to $26,000. A freshman there now,Piper is studying poetry with Maya Angelou andhas no regrets. “It would have cost me $15,000 ayear to go to Princeton, vs. nothing for WakeForest,” he says.

Colleges call it “dialing for dol-lars”—the time in March and Aprilwhen parents and students phonethem with better offers from otherschools in hopes of coaxing moreaid out of them. Rare a decade ago,

negotiating is now so much a part of the picturethat some colleges openly encourage it, whileothers are quietly putting away aid dollars formaneuvering at season’s end.

The result is that a classroomnow resembles an airplane. Threepeople sitting side-by-side couldbe paying different prices, andeconomic need has less to dowith it than savvy. Nationally,about half of all students receiveassistance. . . .

It pays to be astute. Tuition and fees haverisen 94% since 1989, nearly triple the 32.5%increase in inflation, according to the Bureau ofLabor Statistics. The sticker price—tuition, fees,and room and board—for a year of undergradu-ate education ranges from $33,000 at Ivy Leagueschools down to $10,500 at state universities. . . .

Cash-strapped students are . . . saving thou-sands by enrolling at a public college and latertransferring to a private college or starting at a jun-ior college (average tuition of $1,500 a year) andmoving on to a state university. . . .

Students are finding other creative ways tosave. High school pupils who take advanced-placement courses can knock off several semestersof college. Some private colleges offer three-yearbachelor’s programs or five-year bachelor’s-master’s degrees. . . .—Reprinted from March 15, 1999 issue of Business Week, by special

permission, copyright © 1999 by The McGraw-Hill Companies, Inc.

Examining the Newsclip1. Finding the Main Idea What change does

the writer discuss regarding financing collegeeducation?

2. Synthesizing Information What methods arestudents using to decrease the cost of college?

N e w s c l i p

271

271_GLENEPP 10/17/03 11:51 AM Page 271

Deficits, Surpluses, andThe National Debt

Main IdeaDeficit spending has helped create a national debt.

Reading StrategyGraphic Organizer As you read the section, describethe growth of the debt before and after 1970.

Key Termsdeficit spending, federal debt, balanced budget, trustfund, crowding-out effect, pay-as-you-go provision,line-item veto, spending cap, entitlement

Rise innational debt

ObjectivesAfter studying this section, you will be able to:1. Explain how the federal deficit is related to the

federal debt.2. Relate the impact of the federal debt on the

economy.3. Describe past attempts to eliminate the federal

deficit.4. Describe entitlements.

Applying Economic ConceptsDeficit Spending When the government must borrowmoney to spend, deficit spending occurs. Read tolearn why American taxpayers must pay the intereston that borrowed money.

Cover Story

Report Warns of Chronic U.S. Deficits

The Bush administration

has shelved a report com-

missioned by the Treasury

that shows the US currently

faces a future of chronic

federal budget deficits total-

ing at least $44.2 trillion.

But the Bush adminis-

tration chose to keep the

findings out of the annual

budget report for fiscal year

2004, published in Febru-

ary, as the White House campaigned for a tax-cut pack-

age that critics claim will expand future deficits.

The study asserts that sharp tax increases, massive

spending cuts or a painful mix of both are unavoidable if

the US is to meet benefit promises to future generations.

—New York Times, May 29, 2003

The White Housecampaigned for more tax

cuts.

In 1998 the federal budget had its first surplus in29 years. The surplus did not last long, however,as the recession of 2001 reduced tax receipts

while politicians simultaneously opted for tax cutsrather than debt reduction. By 2002, federal deficitswere back.

From the Deficit to the DebtHistorically, the federal budget has been char-acterized by a remarkable amount of deficit

spending—or spending in excess of revenues col-lected. Sometimes the government plans deficitspending. At other times, the government is forcedto spend more than it collects because unexpecteddevelopments cause a drop in revenues or a rise inexpenditures.

Figure 10.3 on page 262 shows that the govern-ment projected a $307 billion deficit for fiscal year 2004. Budget projections are based partiallyon assumptions about the direction of the econ-omy. If the economy has strong economic growth,

272

272_GLENEPP 10/23/03 5:30 PM Page 272

the deficit could grow smaller. An upturn in theeconomy means more federal government revenuesand a fall in expenditures such as unemploymentcompensation. Figure 10.6 shows the history offederal budget deficits and surpluses since 1939.Percentages are used so that inflation does not distort year-to-year deficit comparisons.

Deficits Add to the DebtWhen the federal government runs a deficit, it

must finance the shortage of revenue by borrowingfrom others. It does this by having the Departmentof the Treasury sell bonds and other forms of gov-ernment debt to the public. If we add up all out-standing federal bonds and other debt obligations,we have a measure of the federal debt—the total

amount borrowed from investors to finance thegovernment’s deficit spending.

The debt grows whenever the governmentspends more than it collects in revenues. If the fed-eral government attains a balanced budget—anannual budget in which expenditures equal rev-enues—the federal debt will not change. If the fed-eral budget generates a surplus, the federal debt willbecome smaller.

How Big Is the Debt?The national debt has grown almost continu-

ously since 1900, when the debt was $1.3 billion.By 1929 it had reached $16.9 billion, and by 1940it was $50.7 billion. By mid-2003 the total federaldebt was about $6,740 billion—or $6.74 trillion.


10

5

0

–5

–10

–15

–20

–25

–30

–35

Perc

enta

ge o

f GD

P

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

Years

15

Using GraphsUsing Graphs Federal Deficits occur when the federal government spends more than it collects in revenues. What caused the deficit to return in 2002?

The Federal Deficit as a Percent of GDP

Source: Office of Management and Budget; Congressional Budget Office

Higher marginal tax bracketsand strong economic growth led to federal

budget surplusses during the Clintonadministration.

The largest federaldeficits occurred during

World War II

Tax reductions in 2001and 2003, plus the recession of2001, led to the return of large

federal deficits in 2002.



273_GLENEPP 10/17/03 11:52 AM Page 273



Using GraphsUsing Graphs All three graphs show the total debt held by the public in inflation-adjusted terms. Panel A shows the debt. Panel B shows the total debt on a per-capita basis. Panel C shows the debt as a percentage of Gross Domestic Product. What has happened to the size of the federal debt since 2001?

Three Views of the Federal Debt

$0$500

$2,000$1,500$1,000

$2,500$3,000$3,500$4,000$4,500$5,000

Trill

ions

of

Cons

tant

Dol

lars

$0$2,000$4,000$6,000$8,000

$10,000$12,000

$16,000$14,000

$20,000$18,000

Cons

tant

Dol

lars

0%20%40%60%80%

100%120%

Perc

ent

of G

DP

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Years

Years

Years

AA Total Debt Held by Public

BB On a Per-Capita Basis

CC Total Debt as a Percentage of GDP

Source: Economic Report of the President and Budget of the United States Government, various years



274_GLENEPP 10/17/03 11:52 AM Page 274



Some of this debt is money that the governmentowes to itself. In 2003 approximately $2.8 trillion ofthis debt was held in government trust funds—specialaccounts used to fund specific types of expendituressuch as Social Security and medicare. When the gov-ernment collects the FICA or payroll tax, it puts therevenues in these trust accounts. The money is theninvested in government securities until it is paid out.

Because trust fund balances represent money thegovernment owes to itself, most economists tendto disregard this portion of the debt. Instead, theyview the public portion of the debt—whichamounted to $3.9 trillion in 2003—as the econom-ically relevant part of the debt. Figure 10.7 presentsthree views of the total federal debt held by thepublic. Panel A, which is adjusted for inflation,shows that the debt did not increase dramaticallyuntil the 1980s. Panel B, computed on a per capitabasis, also shows a dramatic increase in the 1980s.

According to this view, the debt on a per capitabasis was approximately $13,400 by mid–2003.

Panel C shows the debt as a percentage of GrossDomestic Product (GDP)—the dollar value of all finalgoods, services, and structures (houses and commer-cial buildings) produced within a country during anyone year. The debt peaked in 1946. By 2003 it wasabout 36 percent.

Public vs. Private DebtHow does the federal debt differ from private

debt? A key difference is that we owe most of the fed-eral debt to ourselves—whereas private debt is owedto others. The federal debt is also different from pri-vate debt in other ways.

One difference is repayment. When private citi-zens borrow money, they usually make plans torepay the debt by a specific date. When the federal


Using Charts The Publicly held portion of the federal debt reached $3.8 trillion in 1997. The total federal debt in that year was about $1.5 trillion higher, and is expected to reach $5.7 trillion by 2000. Why do economists regard the public portion of the federal debt as the economically relevant part of the debt?

Using Charts The publicly held portion of the federal debt was $3.9 trillion in 2003. The total federal debt in that year was about $2.8 trillion higher, so the total debt amounted to $6.7 trillion. Why do economists regard the public portion of the federal debt as the economically relevant part of the debt?

A $1 bill is about 6 inches (15.2cm) long. If 3.9 trillion of these bills were laid end to end, they would form achain 370 million miles (596 km) long—nearlyenough to stretch from thesurface of the earthto the surface ofthe sun andback—twice!

Or, a stack of $1,000bills 4 inches (10 cm)high would make you amillionaire. A $3.9 trillionnational debt represents astack of $1,000 bills 246miles (396 km) high!

Or, suppose you had $3.9 trillion. If each $1 billwere counted 24 hours a day at the rate ofone per second, it would take morethan 123,630 years to count themall. At an average life expectancyof 70 years, that is about1,766 lifetimes!

How Big Is the Public Debt?

$$$$ $$

$$

$$

275_GLENEPP 10/17/03 11:53 AM Page 275

government borrows, it gives little thought to even-tual repayment because it simply issues new bondsand uses the proceeds to pay off the old bonds.

Another difference has to do with purchasingpower. When private individuals repay a debt, theygive up purchasing power. They no longer have thatmoney and so it cannot be used to buy more goodsand services. When the federal government repays adebt, there is no loss of purchasing power becausethe taxes and revenue collected from some groupsare simply transferred to others. The exception is 15to 20 percent of the public debt owned by foreigners.When payments are made to investors outside theUnited States, some purchasing power is temporarilydiverted from the American economy.

Impact of the National DebtEven though we owe most of the federal debtto ourselves, it still affects the economy in

ways that can harm the private sector.The federal debt can have a significant impact on

the distribution of income within the economy. Ifthe government borrows money from the wealthy,and if the burden of taxes falls on the middle classand the poor, taxes would be transferred to the richin the form of interest payments on the debt.

If the government borrows money from the mid-dle class, and if the burden of taxes falls on the rich,

those taxes would be used to make interest pay-ments to the middle class. The federal tax structure,as much as the size of the debt itself, determines thedistribution effects. Given the current progressivenature of the personal income tax, less is taken fromthe lower and middle income classes than would bethe case under a less progressive, or flat tax.

Another consequence of the federal debt is that itcauses a transfer of purchasing power from the pri-vate sector to the public sector. In general, the largerthe public debt, the larger the interest payments and,therefore, the more taxes needed to pay them. Whenpeople pay more taxes to the government, they haveless money to spend on their own needs.

A third impact is that the taxes needed to paythe interest can reduce the incentives to work, save,and invest. Individuals and businesses might feel

INFOBYTEINFOBYTE

Budget Deficits A deficit can be a negative cat-alyst in an economy. Some economists, however,will advocate deficit spending under certain con-ditions, such as a government spending its way outof a recession.

Federal Debt

Effects In the 1990s the federal debt surpassed $5 trillion. How does the federal debt impact theeconomy?


less inclined to work harder and earn extra incomeif higher taxes are placed on them.

Some people feel that the government spends tax-payers’ money in a careless manner. A community,for example, may secure a federal grant to purchaseexpensive equipment that taxpayers in the commu-nity would never have approved. If people feel thattheir taxes are being squandered, they may have areduced incentive to work.

When the government sells bonds to borrowmoney, it competes with the private sector for scarceresources. An example of this competition is thecrowding-out effect—the higher-than-normal inter-est rates that heavy government borrowing causes.

This effect is illustrated in Figure 10.9. If the gov-ernment runs a deficit and tries to raise funds byselling bonds, it will cause the interest rate paid byprivate borrowers to go up.

Taming the DeficitConcern over the size of the federal deficitand the debt has led to a number of attempts

to control it. Several of the more importantattempts are described below.

Gramm-Rudman-HollingsOne of the first significant attempts to control

the federal deficit took place when Congress tried tomandate a balanced budget by 1991. The legislationwas formally called the Balanced Budget andEmergency Deficit Control Act of 1985, or Gramm-Rudman-Hollings (GRH) after its sponsors.

The key to GRH was to set federal deficit targetsfor Congress and the president to meet over a six-year period—targets that resulted in a zero deficitby 1991. Despite high hopes, GRH failed for tworeasons. First, Congress discovered that it couldget around the law by passing spending bills thattook effect two or three years later. Second, theeconomy started to decline in July 1990—triggeringa safety valve in the law that suspended automaticcuts when the economy was weak.

Budget Enforcement Act of 1990In an effort to control future budgetary action,

Congress passed the Budget Enforcement Act

(BEA) in 1990. The BEA’s main feature is a “pay-as-you-go” provision—a requirement thatnew spending proposals or tax cuts must be offsetby reductions elsewhere. If no agreement on thereductions is reached, then automatic, across-the-board spending cuts are to be instituted.

The BEA also has limitations. For one, it appliesonly to discretionary spending. For another, the actcan be suspended if the economy enters a low-growthphase or if the president declares an emergency.

Omnibus Budget ReconciliationAct of 1993

President Clinton’s Omnibus Budget Reconcil-iation Act of 1993 was an attempt to trim $500 bil-lion from the deficit over a five-year period. By 1993the federal deficit had reached such enormous pro-portions that the act was intended to reduce only therate of growth of the deficit, not the deficit itself.


Using GraphsUsing Graphs Crowding out affects the allocation of resources in the economy. What happens to the interest rate when deficit spending increases?

The Crowding-Out EffectCaused by Federal Spending

Inte

rest

Rat

e (%

)

9%

6%

D’D

D’

D

S

S Supply ofmoney

Quantity of Credit

Demand aftergovernmentborrowing

Demand beforegovernmentborrowing


The act featured a combination of spendingreductions and tax increases that made the individ-ual income tax more progressive—especially for thewealthiest 1.2 percent of taxpayers.

Balanced Budget Agreement of 1997Congress gave the president a line-item veto—

the power to cancel specific budget items withoutrejecting the entire budget—in 1996, but theSupreme Court declared it unconstitutional. Thiswas followed by the Balanced Budget Agreementof 1997, which featured rigid spending caps—legallimits on annual discretionary spending—to assurethat Congress balanced the budget by 2002.

Like many bills in Congress, however, most of thepainful consequences of the cap would arise in lateryears rather than right away. Also, the caps requiredpolitically unpopular cuts in many programs likehealth, science, and education.xxxxxxxxxxxxxxxxxxx

Success—then FailureAfter 29 consecutive years of budget deficits, the

United States government finally achieved the 1998budget surplus shown in Figure 10.6. There weretwo reasons for this. First, a strong economy led torecord tax collections. Second, previous efforts tocontrol the deficit led to a reduced rate of federal

spending. The budget surpluses were even projectedto last until 2010 if the economy remained healthyand if federal spending was contained.

Unfortunately, neither happened. First, the 2001recession reduced the amount of tax receipts thegovernment collected from individuals and busi-nesses. Second, the terrorist attack on the WorldTrade Center in the same year led to more govern-ment spending on homeland security, as well asspending for the wars in Afghanistan and Iraq. As aresult, record federal budget deficits returned in2002 and 2003.

In addition, the federal government still faces therapid growth of entitlements—broad social pro-grams that use established eligibility requirementsto provide health, nutritional, or income supple-ments to individuals. These programs are called entitlements because people are entitled to draw ben-efits if they meet the eligibility requirements. Whileentitlements make most of the “mandatory” federalbudget spending, Congress can still revise them.The problem for Congress is that it will be difficultto cut these popular programs.

As we saw in the cover story, massive federaldeficits are all but certain to occur by 2010. If thishappens, control of the federal budget deficit willagain become a major political priority.

Checking for Understanding1. Main Idea What is the difference between

the federal debt and the federal deficit?

2. Key Terms Define deficit spending, federaldebt, balanced budget, trust fund, crowding-out effect, pay-as-you-go provision, line-itemveto, spending cap, entitlement.

3. Describe how the federal deficit affects thedebt.

4. List five ways the national debt can affectthe economy.

5. Identify four recent attempts to bring thefederal deficit under control.

6. Identify three entitlement programs.

Applying Economic Concepts7. Deficit Spending Identify those benefits that

are directly related to entitlement programs.If you were given the task of reducing entitle-ment programs, which ones would you selectto reduce or alter? Provide reasons for yourchoices.

8. Making Generalizations Make a list of fiveways that you or your family directly bene-fit from federal government expenditures.

9. Understanding Cause and Effect How canthe federal debt affect worker incentive?



278_GLENEPP 10/17/03 11:53 AM Page 278

S e c t i o n 1

The Economics of GovernmentSpending (pages 255–258)

• Government spending takesthe form of expenditures ongoods and services, most ofwhich are public goods, andon transfer payments suchas grants-in-aid for whichthe government receivesnothing in return.

• Government spending influences the private sector byaffecting the allocation of resources, the distributionof income, and by competing with the private sectorfor scarce resources.

S e c t i o n 2

Federal Government Expenditures(pages 260–265)

• The president is responsible for developing the federal budget for the fiscal year, which begins on October 1. When the budget is complete, thebudget is sent to the House of Representatives.

• The House only deals with discretionary spending.Mandatory spending is not part of the annual budgetprocess, although Congress can deal with it separately.

• Discretionary spending is broken down for action byvarious committees that propose appropriations bills.The budget is reassembled and voted on by theHouse and the Senate.

• If differences between the House and the Senateemerge, a compromise bill is developed on whichboth vote.

• The largest components of the federal budget areSocial Security, national defense, income security,medicare, net interest on the federal debt, andhealth.

S e c t i o n 3

State and Local GovernmentExpenditures (pages 267–270)

• State budgets go through an approval process thatvaries from state to state. The largest state spendingcategories are intergovernmental expenditures, publicwelfare, insurance trust, and higher education. Othersinclude highways, hospitals, and interest on state debt.

• The largest single category of spending for local gov-ernments is elementary and secondary education.Public utilities, hospitals, police protection, intereston debt, public welfare, and highways follow.

S e c t i o n 4

Deficits, Surpluses, and the National Debt (pages 272–278)

• Federal budget deficits existed from 1970 until 1998 when the budget finally had a surplus.

• Deficits add to the federal debt, and thetotal debt amounted to $5.7 trillionin fiscal year 2001, approximately$3.3 trillion of which is held bythe public.

• The debt affects the economyin several ways: Taxes areneeded to pay the interest on the debt; the distribution of income is altered; purchasingpower is transferred from theprivate sector to the public sector;and incentives to work, save, and investmay also be altered.

• Despite recent budget surpluses, the overall federalbudget would show a deficit if not for the surpluses in the Social Security Trust Fund.

• The rapid growth of entitlements are still a threat to future budget surpluses.


Reviewing Key TermsWrite a sentence about each pair of terms below. The sen-tences should show how the terms are related.

1. public sector, private sector2. transfer payment, grant-in-aid3. distribution of income, deficit spending4. federal budget, fiscal year5. appropriations bill, balanced budget

amendment6. deficit spending, federal debt7. deficit spending, crowding-out effect8. entitlement, balanced budget9. mandatory spending, discretionary spending

10. spending cap, federal budget deficit

Reviewing the FactsSection 1 (pages 255–258)

1. Describe the growth of government spendingsince 1940.

2. Identify two kinds of government spending.

3. Explain three ways that government spending canimpact the economy.

Section 2 (pages 260–265)

4. Identify the three stages of approval required toestablish the federal budget.

5. Identify nine of the most important budget cate-gories in the federal budget.


6. Explain how states model their budget approvalprocess.

7. Describe three major categories of state spending.

8. Describe three major categories of local spending.


9. Discuss the relationship of the federal deficit tothe federal debt.

10. Describe how the debt can affect the economy.

11. List four legislative attempts to deal with the prob-lem of federal budget deficits.

12. Cite at least six examples of entitlement programs.

13. Explain why entitlements are so named.

Thinking Critically1. Classifying Information Examine the major

types of federal expenditures in Figure 10.3 onpage 262. Classify each as to whether they are entitlement or non-entitlement programs. Use achart like the one below to answer the question.

2. Making Comparisons Compare the federalexpenditures for the three years included inFigure 10.4. Identify at least three major differ-ences in the expenditures. How do changes inspending reflect the priorities of the administrationthat develops the budget?

Program Entitlement Non-Entitlement

Self-Check Quiz Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 10—Self-Check Quizzes to pre-pare for the chapter test.



Applying Economic Concepts1. Human Capital Which of the categories in

Figure 10.4 reflect an investment in human capital?

2. Deficit Spending If you were a presidentialadviser, what spending cuts would you suggest to balance the budget? Explain your reasoning.

3. Budget Deficits The federal government has madeseveral attempts to deal with the problem of federalbudget deficits. Identify three of the pieces of legis-lation discussed in the chapter, and outline theirmain features and weaknesses in a chart similar tothe one below.

Math PracticeA neighbor spent $20,000 a year for 10 years and hadan annual income of $15,000 during this period. Whatis the neighbor’s total debt?

Thinking Like an EconomistAn economist likes to think in terms of trade-offs andopportunity costs. If you wanted to make changes to abalanced budget in any given year, what would be theopportunity cost of lowering taxes? Of increasing dis-cretionary spending?

Technology SkillUsing a Spreadsheet Review the information onusing a spreadsheet on page 29. If you need addi-tional assistance to help you get started, read theinformation on page 349. Using the Internet, selectone of the states of the United States and downloador print its state budget. Using this information, cre-ate a spreadsheet to record and analyze the followingcategories.

• Name of State• Budget Total• Public Welfare• Higher Education• Insurance Contributions• Highways• Hospitals• Interest on State Debt

Enter the information from the state’s budget intothe spreadsheet.

After entering the information, create a graph forthe state’s expenditures. What conclusions can youdraw from your data? Where is the most moneyallocated? Compare the data for the state you areanalyzing to Figure 10.5, which shows expendituresby all the states. Would you consider that state typi-cal or atypical in where it spends its funds? Using aword processor, create a brief summary of your find-ings. Import your spreadsheet and graphs into thedocument. Print your results and share them withthe class.

Using E-Mail Locate a Web site for yourstate’s government on the Internet. Find outabout current bills that your state legislatureis considering. Using E-mail, compose a letterto your legislator requesting his or her opin-ion about current bills of interest to you thatare being considered.



A.

1. Features2. Weaknesses

B.


C.


Issues in FreeIssues in FreeIssues in FreeIssues in Free

Issues in FreeIssues in Free

The WorldEnvironment Is Threatened

For us, the key limits [in the] twenty-first centuryare fresh water, forests, rangelands, oceanic fisheries,biological diversity, and the global atmosphere. Willwe recognize the world’s natural limits and adjustour economies accordingly, or will we proceed toexpand our ecological footprint until it is too late toturn back? Are we headed for a world in which accel-erating change outstrips our management capacity,overwhelms our political institutions, and leads toextensive breakdown of the ecological systems onwhich the economy depends? . . .

As world water use has tripled since mid-century,overpumping has led to falling water tables on everycontinent. . . .

Since mid-century, the demand for lumber hasdoubled, that for fuelwood has nearly tripled, whilepaper use has gone up nearly six times. In addition,

forestlands are being cleared for slash-and-burnfarming by expanding populations and for com-mercial crop production and livestock grazing. . . .

[In] just the last half-century the oceanic fishcatch increased nearly five times, doubling seafoodavailability per person for the world as a whole.[But] 11 of the world’s 15 most important fishingareas and 70 percent of the major fish species areeither fully or overexploited. . . .

[A]s with fisheries, overgrazing [of rangeland] isnow the rule, not the exception. . . . Yet another ofour basic support systems is being overwhelmedby continuously expanding human needs.

Perhaps the best single indicator of the earth’shealth is the declining number of species withwhich we share the planet. . . . [We] are now in theearly stages of the greatest decimation of plant andanimal life in 65 million years. . .

Even in a high-tech information age, humansocieties cannot continue to prosper while the nat-ural world is progressively degraded.

—Lester R. Brown and Christopher Flavin,Worldwatch Institute

P R O

PROTECTING THE ENVIRONMENT:IS ENOUGH BEING DONE?

One of the sharpest debates of the last three decades has been over the state of the environ-ment. Squaring off are business interests, who often view environmental regulations as unneces-sary and costly, and environmental groups, who see such regulations as key to saving the planet.

Many analysts maintain that the earth is fragile, and that current economic activities are onthe verge of damaging the planet in a fundamental way. Other analysts argue that economicactivity always involves the exploitation of natural resources, resulting in some environ-mental impact. That impact, they claim, is negligible, especially in view of the many benefitsof a thriving economy.

Who’s right? As you read the selections, ask yourself:Is current economic activity putting the earth at risk?


EnterpriseEnterprise

EnterpriseThe AmericanEnvironment Is Improving

Twenty-five years ago, only one-third ofAmerica’s lakes and rivers were safe for fishing andswimming; today two-thirds are, and the propor-tion continues to rise. Annual wetlands loss hasfallen by 80 percent in the same period, while soillosses to agricultural runoff have been almost cutin half. Total American water consumption hasdeclined nine percent in the past 15 years, even asthe population expands. . . . Since 1970, smog hasdeclined by about a third, even as the number ofcars has increased by half; acid rain has fallen by40 percent; airborne soot particles are down 69percent, which is why big cities have blue skiesagain. . . . [Emissions] of CFCs, which depletestratospheric ozone, have all but ended.

Other environmental measures are almost uni-formly positive. Toxic emissions by industrydeclined 46 percent from 1988 to 1996, even aspetrochemical manufacturers enjoyed record U.S.production and copious profits. . . . The forestedacreage of the UnitedStates is expanding,with wildlife numbersup in most areas. . . .Since the EndangeredSpecies Act was passed,only a few U.S. specieshave fallen extinct, notthe thousands pre-dicted, while speciessuch as the bald eagle,gray whale, and pere-grine falcon have recov-ered enough to nolonger require full legal protection. Only twomajor U.S. environmental gauges are now nega-tive: continuing inaction against greenhousegases and continuing loss of wildlife habitats tourban expansion.

An important conceptual lesson is beinglearned: When pollution stops, natural recoverydoes not require ponderous geological time. . . .

[T]echnology has (for the moment, at least)entered a relatively benign phase in which prod-ucts and industrial processes consume steadilyfewer resources and produce steadily less waste. . . .

Because the character of environmentalprogress is nonideological—reflecting well both onfederal initiatives and on business—neither political

camp knows how to extol what’s hap-pened. That no interest group seesitself as benefiting from public aware-ness of environmental success . . . [has]the effect of preventing commentatorsand voters from focusing on the locusof the real environmental emergencies—the developing world.

—Gregg Easterbrook, social issues analyst

C O N

Analyzing the Issue1. What “important conceptual lesson” does

Easterbrook refer to? How might this impactBrown and Flavin’s argument?

2. Do the two selections address the sameissues? Explain.

3. On what issue might Brown and Flavin agreewith Easterbrook?

UNIT 3 MACROECONOMICS: INSTITUTIONS 283

Chap10 Fundamental Economic Concepts

Education

Transcript of Chap10 Fundamental Economic Concepts