Understanding the Federal Budget

A trillion of anything is a lot no matter what’s being measured—gallons, miles, or dollars. So it’s easy to get overwhelmed when reading about the U.S. federal government’s budget and fiscal policy. Those numbers can quickly reach proportions that are hard to comprehend.

In practice, however, the government’s budget is very similar to one used by a small business or maybe even your own personal finances. This article describes in simple terms how the large flows of money coming into and going out of the government can be easily understood.

How Does the Government Acquire Income?

First, let’s examine the money the government receives annually. According to the Congressional Budget Office (PDF) graphic below, the federal government collected a total of $4.9 trillion in 2024. Almost half of that came from individual income tax collections, which are due on April 15 each year. Another third of that total revenue, approximately $1.7 trillion, came from payroll taxes paid by both employers and employees to the government. Corporations and businesses gave the government about 10% of its revenue through business income taxes. The remaining $250 billion, or 5%, was collected by the government through other revenue sources such as tariffs, fines, excise taxes, and estate taxes. This is the total annual income for the government.

NOTE: U.S. federal government total revenue in 2024 was $4.9 trillion—17.1% of GDP.

SOURCE: Congressional Budget Office.

What Does the Government Spend Its Money On?

Clearly, the government collects an enormous amount of money. But it also spends an enormous amount, sometimes called expenditures or outlays. There are three main categories of how the government spends its money.

The biggest spending category by far is mandatory spending. This is for legislative programs such as Social Security, Medicare, unemployment benefits, and the Supplemental Nutrition Assistance Program (SNAP). These programs have been created by Congress and cannot be reduced without changing current law, and they are outside the scope of the annual appropriations process negotiated by elected officials. The Congressional Budget Office reported that in 2024, mandatory spending made up $4.1 trillion of the $6.8 trillion—or approximately 60%—of what the federal government spent that year.

After mandatory spending, the second largest category is discretionary spending. This outlay in fiscal policy is debated and set through annual budget procedures before the government’s fiscal year begins each October 1. Discretionary spending is generally described as having two major segments: defense spending and non-defense spending. Total discretionary spending makes up about 26% of total government expenditures, according to the Congressional Budget Office.

The third spending category is interest payments the government must pay on its debt. Think of this as paying just the minimum interest fees on credit card debt without paying down the principal. In 2024 the United States paid $881 billion, or about 13% of its overall annual spending, on net interest payments, as shown in the graphic below.

NOTE: U.S. federal government total revenue in 2024 was $4.9 trillion—17.1% of GDP.

SOURCE: Congressional Budget Office.

Annual Deficits, Total Debt, and Fiscal Policy

You don’t have to be an economist to see that, if the U.S. government spent more money ($6.8 trillion) than it took in ($4.9 trillion), its budget was not in balance. It is not unusual for a government to spend more than it earns each year, but it can become problematic.

Unlike an individual managing personal debt, the government views its debt responsibilities in a different way. This is because it’s assumed that the country—its government and economy—will always be there and honor its financial obligations. Congress and the Treasury must always pay its existing bonds when they mature and are redeemed by the holder, as well as pay the interest on the debt, which is calculated annually. The problem enters when the debt becomes very large; an increasingly larger percentage of the budget must be allocated to interest payments—money that could be used to fund other programs if the debt were smaller.

In 2024 the federal government ran an annual deficit of $1.9 trillion. To account for that extra spending, the U.S. Treasury issued bonds to raise money from investors with the promise the government will pay the face value of that bond plus a little more in interest. This works as an incentive to savers who view the government as a trustworthy source that honors its obligations.

If a national government runs annual deficits over multiple years, those deficits are added to the country’s total national debt. Examine the two FRED® graphs below sourced from U.S. Treasury Department data. The first shows the federal government’s annual surplus or deficit since 1995. In 2020, the year of the COVID-19 pandemic, the government spent far more than it took in, which is understandable considering the crisis of that time. But the trend overall has been for the U.S. to habitually operate fiscal policy using deficit spending.