As discussions about the “fiscal cliff” continue, it might be helpful to step back and take a broader view of federal spending – where your money goes. The “fiscal cliff” refers to tax increases that would take effect at the end of the year when many provisions of the tax code expire. It also includes automatic, across-the-board spending cuts set to begin under current law in January 2013. This newsletter will summarize federal spending; the next issue will summarize taxes. For more detail on what changes at the end of the year, see my previous newsletter.
Direction of Spending
Most Americans know that federal spending has been increasing in recent years. But I suspect that few understand how historic the spending increases have been. The chart below shows federal spending over time as a percentage of the economy. In 2012, federal spending was nearly $3.8 trillion, which is 27 percent more than when President Obama took office.
What is your money spent on?
Federal spending is generally divided into three categories: mandatory, discretionary, and net interest.
Mandatory Spending – Nearly two-thirds of annual federal spending is used for mandatory spending programs, also known as entitlements. Mandatory spending means that once the program is established, everyone who qualifies receives the benefit. It does not require the government to allocate a certain amount of money; the payments are made automatically without any further votes by Congress. It includes programs like Social Security, Medicare, Medicaid, and food stamps. Interest payments on our debts are also considered mandatory since they must be paid.
The chart below shows total federal spending and highlights the portion that is in mandatory programs. As you can see more than 60 percent of federal spending is devoted to mandatory programs and interest payments.
Discretionary Spending - Discretionary spending is provided through annual appropriations bills and must be approved by the Congress each year. It is often further divided into defense and non-defense categories. According to the Congressional Research Service, 47 percent of the total budget was discretionary spending in 1962, and it remained the largest portion of federal spending into the 1970's. Since then, mandatory spending has increased at a much faster rate than discretionary spending. Today, discretionary spending makes up less than 40 percent of the entire budget.
Net Interest - Net interest is the only part of future spending that cannot be reduced by legislative action because it is money that must be paid to service the U.S. debt. Net interest payments today make up over six percent of the federal budget, but that percentage could increase if interests rates rise. Unfortunately, many economists predict that those rates could rise dramatically over the next decade.
With no changes, spending on Medicare, Medicaid, and Social Security will continue to rise and consume more of the federal budget. The future cost of these programs is being driven by a combination of several factors:
All of this will leave future generations with a crushing debt burden.
- Families are having fewer children, which means fewer taxpayers;
- 78 million baby boomers are hitting retirement age and collecting entitlement benefits;
- New retirees are living longer lives;
- And health care costs continue to rise.
Some people may believe that they are just receiving the Medicare benefits they have paid for with their taxes. However, according to a 2011 study by the Urban Institute, a couple with two earners making an average wage receives benefits worth three times what they paid into Medicare over their working life. If there is only one earner in the family, the couple receives a benefit that is nearly six times what was paid through taxes.
In fact, Medicare costs have jumped over 65 percent over the last ten years, more than any other major program.
It is often said that Social Security does not contribute to the federal deficit, but this is not true. Since 2010, Social Security has had to pay more money out in benefits than it receives in tax revenue. To make up for this shortfall, Social Security redeems IOUs from the federal government that are being paid back with additional interest. In 2011, Social Security IOUs earned $114 billion in interest. The only way to redeem these IOUs is through taxes and borrowing from general revenue.
This year, it is projected the general fund will add about $53 billion to payroll tax income in order to pay Social Security benefits. Even then, after all of the IOUs have been turned into cash and paid in benefits, the trust fund becomes insolvent in 2033. After 2033, Social Security tax income would only be able to cover about three-quarters of the benefits owed to seniors.
Defense is the first job of the federal government, and I think the first money the federal government spends should be for national security. Of the $1.2 trillion in automatic spending cuts set to begin in January, half will come from domestic programs and the other half from defense. This means that while it makes up only 19 percent of the federal budget, nearly 50 percent of the deficit reductions will come from defense. These $500 billion in cuts would come on top of $486 billion in defense cuts already set to begin in January.
Even if the government eliminated all spending on defense, foreign aid, federal salaries, and all other discretionary spending, we would still have a deficit this year of several billion dollars. In other words, all of the money that goes into the federal government in taxes is not enough to pay for the entitlement programs.
A more detailed look at how the federal government spends your money can be found below.
The next newsletter in this series will include an overview of where the federal government gets the money it spends. As always, I am interested in your feedback and your suggestions on this topic or any other that matters to you. I hope you will contact me with your opinion via phone, email, letter, website, or Facebook.
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