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Breaking Down the Federal Budget and How the Government Spends Money

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Like households, the federal government must live within the confines of a budget. However, those confines are much, much larger than the spending limits of the average household — or any household, for that matter.

How large? The federal government is projected to spend $5.7 trillion in 2021, according to the Congressional Budget Office. If you’re wondering where that money comes from and where it goes, here’s what you need to know about the federal budget and how it impacts you.

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How the Federal Budget Process Works

If you think staying on top of your household budget is tedious, consider the process the federal government must go through each year. Actually, the process takes more than a year. The U.S. government doesn’t budget for the calendar year starting on Jan. 1 but rather a fiscal year starting on Oct. 1 and going through Sept. 30 of the following year. The process for creating the budget begins a year and a half before the fiscal year begins.

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Step 1: Government agencies start compiling their spending proposals in the spring (1 1/2 years before the fiscal year begins) to submit to the White House Office of Management and Budget.

Step 2: Using the agencies’ request, the OMB and president create a budget request that typically is submitted to Congress by the first Monday in February.

Step 3: The House of Representatives and Senate budget committees draft budget resolutions. Then a House-Senate conference committee resolves the differences between the two resolutions to create one budget resolution that both the House and Senate are supposed to approve by April 15. If Congress fails to pass a resolution, then the previous year’s resolution stays in effect.

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Step 4: The House and Senate appropriations committees must draft bills to fund discretionary agencies and programs — those that aren’t mandated by law to be funded.

Step 5: The full House and Senate vote on appropriations bills. A conference committee then combines the two bills and both the House and Senate vote on it. If it passes, it goes to the president to be signed.

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Step 6: If an appropriations bill isn’t passed by Sept. 30, the president must sign a continuing resolution to temporarily fund government agencies. If a continuing resolution isn’t signed, there will be a lapse in funding and parts of the government will shut down. There have been several government shutdowns — the most recent of which was Dec. 21, 2018, to Jan. 25, 2019. 

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Where the Money Comes From

The bulk of the federal government’s money comes from individual, corporate and payroll tax revenues. In 2021, the federal government is expected to bring in $3.5 trillion in tax revenue — with nearly half of that coming from income taxes paid by individuals, according to the Congressional Budget Office. In short, your tax dollars help fund the federal government.

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However, because the federal government often spends more than it takes in, it has to borrow money by issuing Treasury securities such as savings bonds and Treasury bills. The deficit (difference between revenues and outlays) in 2021 is expected to be $2.3 trillion, but the total federal debt is expected to reach $22.5 trillion this year.

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The debt is expected to continue to rise if the federal government doesn’t adjust its fiscal policy by raising taxes or reducing spending. Of course, raising taxes could impact you. But doing nothing also could hurt the economy and you. “High and rising federal debt makes the economy more vulnerable to rising interest rates and, depending on how that debt is financed, rising inflation,” according to a Congressional Budget Office report. “The growing debt burden also raises borrowing costs, slowing the growth of the economy and national income, and it increases the risk of a fiscal crisis.”

Where the Money Goes

The federal government’s budget covers mandatory outlays, discretionary outlays and interest on its debt. Think of mandatory outlays as fixed expenses, bills that must be paid. Discretionary outlays are more like a household’s variable expenses, such as food purchases. 

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Mandatory Outlays

The majority of the federal government’s budget goes toward mandatory outlays — programs with spending amounts mandated by law such as Social Security, Medicare and Medicaid. The Congressional Budget Office projects that $3.8 trillion — about 65% of the budget — will be spent on mandatory outlays in 2021.

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Projected mandatory outlays for 2021:

Discretionary Outlays

About one-third of the federal budget goes toward discretionary outlays that are subject to annual review and approval by Congress. Most defense, education and transportation department programs fall under discretionary spending. The government is projected to spend $1.7 billion on discretionary outlays in 2021.

Projected discretionary outlays for 2021

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Interest Payments

About 5% of the government’s budget — $303 billion — will go toward interest on its outstanding debt. Although the federal government’s debt has grown to historically high levels, the interest on that debt has remained relatively low because interest rates have been low.

As the debt level grows and interest rates rise, the government’s interest costs are expected to rise, according to the Congressional Budget Office. More spending on interest could mean less spending on programs that benefit Americans and the economy.

This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.

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Last updated: Feb. 25, 2021