Federal Budget

Since World War II the federal budget deficit has risen almost continually, regardless of which political party has occupied the White House, and regardless of which party has held a majority of seats in the House of Representatives or Senate. As table 1 indicates, in each of the last four decades, the average size of the federal budget deficit relative to GNP has approximately doubled. Due to the extraordinary string of budget deficits, the national debt is now equivalent to over forty thousand dollars for every family in the United States.

The existence of chronic budget deficits during the postwar years stands in stark contrast to the pattern of federal finances during previous periods in America’s history. For most of our history prior to 1940, the federal budget was balanced, except in years of war or economic recession.

The causes of persistent federal budget deficits during the last forty years are not well understood. Many observers believe that the cause of the deficit lies in unique policy mistakes during the eighties, such as the simultaneous reduction in taxes and increase in defense spending. But this explanation ignores the persistence of budget deficits for the three decades prior to eighties. It also ignores the fact that since 1981, expenditures on nondefense programs grew almost as rapidly as those on defense, and that the federal tax claim on the country’s gross national product (GNP) is currently higher than it has averaged during any preceding decade (see table 1).

Other observers claim that deficits persist because the American public demands more in government benefits than it is willing to pay for in taxes. Although this explanation has intuitive appeal, it fails to explain why the American public’s preferences have changed. Why did Americans previously want the same amount of benefits as they were willing to pay for in taxes?

The Budget Process and the Commons Problem

The congressional budget process itself has contributed mightily to persistent budget deficits. The most important feature of the current budget process is its decentralized nature. At no point in the process does anyone decide on the total amount the federal government will spend. Instead, responsibility for individual legislative bills that determine the total amount of spending is divided up among fifteen separate committees in the Senate and seventeen committees in the House of Representatives. The Appropriations Committee has jurisdiction for nonentitlement programs covering about 40 percent of the total federal spending. The remaining 60 percent is made up of entitlement programs, which are handled by various other standing committees. The agriculture committees have authority over farm price supports, food stamps, and other rural programs. The tax-writing committees in the House and Senate are responsible for Social Security and Medicare. The House Energy and Commerce Committee has jurisdiction over Medicaid and shares responsibility for Medicare with the Ways and Means Committee.

This decentralization of spending authority creates powerful incentives for deficit financing. By spreading responsibility for spending authority among so many committees, the Congress has created a situation known as “the tragedy of the commons” (see The Tragedy of the Commons). This type of situation arises when numerous claimants compete for a commonly owned resource. The tragedy is that the inexorable forces of competition for the resource lead to overconsumption and eventual exhaustion of the resource.

To understand the commons problem, imagine a publicly owned forest that is open to all logging companies that desire access to it. No individual company would have any reason to restrain its logging activities. In fact, each company would have every incentive to cut down as many trees as it could before a competitor did so. On a more personal level imagine that a mother sends her family to the store, tells her husband to buy beer, her teenage daughter to buy magazines, and her ten-year old son to buy candy. Imagine, moreover, that she sets no limits on how much each can spend. Each family member would then overspend on the various items.

Congress is like that family. From the individual committee standpoint the commonly owned resource is federal revenues, raised primarily from taxes levied on individuals and corporations. The consumers of this resource are the congressional committees. The common resource is “overconsumed” when government spending repeatedly exceeds tax revenue—that is, when chronic budget deficits occur.

An Historical Sketch

An historical look at government spending and the budget process reveals the powerful role the commons problem has played in producing budget deficits. When the budget process has been highly centralized, spending has been held in check and the budget has been balanced. When the process has been decentralized, the growth in spending has outpaced the growth in revenues, and chronic budget deficits have resulted.

During the first ninety years of U.S. history, spending authority was concentrated in a single committee in each house of Congress, and budgets were balanced except during recessions and wars. But in 1885 the House stripped the Appropriations Committee of much of its spending authority and gave it to numerous authorizing committees. This period of decentralized budgeting lasted until just after World War I.

At the time, some observers recognized the consequences of decentralization. Congressman Samuel Randall, chairman of the Appropriations Committee and a former Speaker of the House, warned in 1884, “If you undertake to divide all these appropriations and have many committees where there ought to be but one, you will enter upon a path of extravagance you cannot foresee the length of or the depth of until we find the Treasury of the country bankrupt.”

Randall’s statement proved prophetic. Immediately after Congress splintered the budget process, federal spending grew at an unprecedented rate. By the mid-1890s federal spending (excluding interest payments) was 50 percent larger than it had been in 1886, and by 1916 it had risen an additional 45 percent.

This explosive spending growth produced deficits that were more frequent and larger than ever before in peacetime. In the five years immediately preceding the change to decentralized budgeting in the House, annual revenues exceeded annual expenditures by 40 percent. The subsequent expenditure growth turned this sizable budget surplus into record peacetime deficits in the mid-1890s. Deficit spending persisted throughout the remainder of the decade. During the first fifteen years of the twentieth century, the budget was in deficit half the time.

Much like today, from 1886 to 1916 all growth in spending relative to GNP occurred in programs under the jurisdiction of the authorizing committees. But unlike today, Congress recognized its problems and took decisive steps to correct them. The House acted first. In 1919 it established a select committee on the budget, which quickly recommended that the House adopt a budget process reform that “centers on one Committee… the authority to report all appropriations.” The House accepted this recommendation and voted to strip the seven authorizing committees of their power to appropriate. The Senate followed two years later.

The corrective step worked. From 1921 until the onset of the Great Depression (1930), expenditures relative to GNP were held constant and the budget was balanced. Unfortunately, decentralization returned during the depression. The process moved slowly at first, but accelerated significantly in the sixties and seventies as Congress created new programs and placed spending jurisdiction for them in an ever increasing number of congressional committees. Deposit insurance legislation, enacted in 1934, provided a federal government guarantee for certain deposits in banks and savings and loan institutions. Social Security legislation, enacted a year later, provided pensions to persons age sixty-five and older and guaranteed matching payments to state governments for the cost of welfare programs. In 1956 the Social Security disability program was created to provide federal cash assistance to disabled persons. In the sixties the food stamp program (1964), Medicare (1965), Medicaid (1965), and the Guaranteed Student Loan program (1965) were created. In 1974 the General Revenue Sharing and the Child Support Enforcement programs began.

By the midseventies the process of decentralizing budget decision making by creating new programs was largely complete. The forty-year process had a profound impact on the degree of committee spending authority. In 1932 the Appropriations Committee had jurisdiction over more than 90 percent of all programs. No other committee had more than 1 percent. By the early eighties the Appropriations Committee controlled only about 40 percent. Seven other committees shared an additional 55 percent.

This return to decentralized decision making once again introduced the “commons” problem into the congressional budget-making process as it had in the past. The inevitable forces of the commons drove government expenditures upward at a rate far in excess of government revenues. The chronic federal budget deficits described in table 1 were the result.

This two-hundred-year review of the relationship between the congressional budget process and the existence of persistent deficits demonstrates the critical role that institutional rules play in determining outcomes. Although other factors, such as a defense buildup or a savings and loan crisis, may be important in contributing to deficits, it is the institutional rules that create incentives for particular forms of behavior and drive decision making over the long run. An understanding of these rules and the way in which they affect behavior is a necessary first step toward correcting the structural problem of the budget deficits.

John F. Cogan is the Leonard and Shirley Ely Senior Fellow at Stanford University’s Hoover Institution and a professor in the Public Policy Program at Stanford University. Formerly deputy director of the Office of Management and Budget, he now directs a project to build a consistent record of government spending decisions since World War II.

Related Links

Scott Sumner, Understanding Modern Monetary Theory: Part I, at Econlib, February 2021.

Hennessey on the Debt Ceiling and the Budget Process, EconTalk podcast, July 25, 2011.

Geoffrey Brennan and James M. Buchanan, The Power to Tax: Analytical Foundations of a Fiscal Constitution. 

Robert P. Murphy, The Costs of Government, at Econlib, April 2010.

Dwight R. Lee, Reducing Real Output by Increasing Federal Spending, at Econlib. January 2012.

Richard B. McKenzie, Popcorn as Political Pork, at Econlib, December 2012.