Inflation and its Impact on the Federal Budget
Gas prices are at an all-time high. Food prices are on the rise. The cost of eating out at restaurants is increasing. The cost of heating and cooling your home is going up. The cost of airline tickets, rental car rates, and the cost to stay at a hotel are all escalating. Inflation is here, and it is adversely impacting household budgets across America. Keep reading to discover just how consumers, civilian and federal, are adjusting their spending priorities to deal with it.
What is inflation? Inflation is a steady increase in the price level of goods and services over a period and is measured as an annual percentage change. The rate at which price levels change can adversely affect businesses’ bottom lines, the government’s ability to fund programs, and consumers’ ability to make ends meet. When elevated levels of inflation occur, the value of one’s money (also known as purchasing power) erodes.
Businesses spend more money to produce goods and services and then pass on their higher costs to consumers in the form of higher prices. Governments spend more money on programs and then raise taxes or borrow money to pay for them. Consumers are no longer able to buy as many products or services with the same amount of money; they must re-prioritize their wants and needs.
While it may not be as obvious, inflation has the same negative impact on the federal budget as it does on the household budget. It erodes the purchasing power of the same dollar from one year to the next and leads to higher costs and higher debt.
The federal budget provides funding authority to pay for the federal government’s authorized programs and services. Expenses are divided into two categories: mandatory and discretionary spending.
Mandatory spending requires federal government spending on programs mandated by law. Social Security and Medicare are the largest mandatory programs. Also included in this category is net interest on the debt (the federal government’s interest payments on debt held by the public). As of the end of May 2022, the U.S. federal debt held by the public was $23.9 trillion. The federal government’s net interest payments on that debt were approximately $400 billion (Peter G. Peterson Foundation, 2022).
Higher inflation increases the cost of mandatory spending programs. If current tax revenues cannot cover the higher expenditures, the federal government’s deficit, and debt increase. Compounding this problem is the Federal Reserve’s monetary policy to control rising inflation by raising interest rates (the cost of money). As interest rates move higher, they drive up interest payments on the debt, facilitating a more rapid rise in deficits and debt.
Discretionary spending is the second category of federal spending in the federal budget that lawmakers control annually through appropriation acts. Unlike the fixed nature of mandatory spending, discretionary spending is variable. Defense spending covers approximately half of all discretionary spending. Non-Defense spending covers the other half and includes programs related to transportation, education, veterans’ benefits, health, housing assistance, etc. For budget priorities like providing for the national defense, inflation shortchanges the military’s ability to invest in innovative technologies and expand, equip, and train its forces. (Senate RPC 2022)
When will the current inflation rate hike end? That is a question for the economists to answer. Until then, the federal workforce and in particular the financial management community must remain vigilant and fiscally responsible when executing current year budgets and developing future year budgets. Want to learn more about inflation and its impact on the federal budget? Go to the Management Concepts training website: Training Programs & Courses for the Public Sector (managementconcepts.com) and register for a class.
Tom Devine, MBA, CDFM, is the Product Management Director of Financial Management at Management Concepts and has expertise in appropriation law, internal control, auditing, accounting, DoD planning, programming, budgeting, and execution. Tom provided training and management consulting to government and commercial clients for several years after investing more than 30 years as a public service and commercial business leader.
Tom holds a Master of Business Administration (MBA) and a Bachelor of Science in Business Administration, concentrating on finance from Nichols College. He holds a Certified Defense Financial Manager (CDFM) and is a proud member of the American Society of Military Comptrollers (ASMC).