Budgeting in Practice
The federal government currently uses an obligations-based budget system. That is, when Congress approves new expenditures pursuant to the Constitution, it gives agencies budget authority to enter into obligations.
Obligations are incurred when an agency enters a contract, executes a purchase order, or otherwise takes action that commits the government to spend money. Outlays occur when the money is actually spent; when it is disbursed by check, electronic transfer, or cash. Put simply, when Congress approves legislation giving an agency new budget authority, it is essentially depositing money into that agency’s account. When the agency incurs an obligation, the money needed to pay it is encumbered. At that point, those funds are no longer available to the agency to be used for other purposes. The agency eventually withdraws the encumbered funds from its account to pay the obligation.
Congress gives agencies budget authority (i.e., deposits money into their account) in one of two ways. Specifically, it may provide agencies with budget authority on a temporary or permanent basis.
Temporary budget authority is referred to as discretionary spending. Congress approves discretionary spending in the annual appropriations process. Appropriation bills give government agencies temporary budget authority to incur obligations, or to conduct the government’s operations, over the course of a fiscal year.
By custom, Congress divides the total amount of discretionary spending that it allocates to the government every year into twelve separate appropriation bills. Yet in practice, Congress rarely considers all twelve bills individually. Instead, Congress routinely approves discretionary spending by passing an omnibus appropriation bill. When Congress fails to pass appropriation bills on time, it typically approves a continuing resolution, which extends the prior year’s temporary budget authority for an amount of time sufficient for its members to complete their regular appropriations work (either by passing individual spending bills or approving multiple bills in an omnibus package). Periodically, Congress uses a continuing resolution to fund the government for an entire fiscal year.
Congress may also give agencies budget authority on a permanent basis. Unlike temporary grants of authority in appropriation bills, Congress approves permanent budget authority in authorization bills.
Authorization bills approve permanent budget authority outside of the appropriations process.
Permanent budget authority is also known as mandatory spending (i.e., direct spending). Entitlement programs like Medicare, Medicaid, and Social Security are the most widely known programs funded by mandatory spending. These programs operate on permanent budget authority given to the agencies that administer them by Congress when they were first created (or in subsequent reforms). Consequently, they are not dependent on future congressional action for funding. Specific funding levels for these programs are instead determined by eligibility criteria and benefit formulas that are either detailed in an authorizing statute or left to the agency to determine pursuant to certain parameters.
While these entitlement programs are the most widely known examples of mandatory spending, all of the government programs that are funded outside of the appropriations process receive permanent budget authority (and are therefore also funded by mandatory spending). Mandatory spending can take one of four forms: entitlement authority (i.e., Medicare, Medicaid, Social Security); borrowing authority; contract authority; authority to obligate and spend offsetting collections.