By Wayne Winegarden, Ph.D.

Now that we are at the end of the presidential election cycle, it is helpful to judge each candidate’s spending plans within the context of the actual spending history.  President Obama’s spending plans calls for more spending on teachers and, based on the current implementation of the Patient Affordable Care Act, spending hundreds of billions of dollars more on health care. 

Governor Romney argues against cutting expenditures on defense, would repeal the Affordable Care Act, thereby avoiding the health spending increases, and is more circumspect when it comes to general spending increases.

To oversimplify each candidate’s position: President Obama wants to increase the growth in federal spending, Governor Romney wants to decreases the growth in federal spending.  Understanding the overall budget trends provides perspective regarding the wisdom of each candidates approach.

How Much Does the Federal Government Spend?

Currently, the federal government spends $239 of every $1,000 produced by the U.S. economy (measured as Gross Domestic Product or GDP).   In total, fiscal year 2011 federal government expenditures were $3.6 trillion. Outside of World War II, the current size of the federal government relative to the size of the economy is the second highest ever. 2009 was the highest. 

As Figure 1 shows, the current size of federal government expenditures relative to the size of the U.S. economy is 20 percent higher than the historic average between 1962 and 2011.

Figure 1

Government Spending as a Percentage of GDP

1962 -2011

 

 

Figure 1 also shows the trends in government spending. Between 1965 and 1983 there was a clear upward trend in the size and role of government expenditures in the economy. But then beginning in the early 1980s and accelerating in the mid-1990s, government grew at a slower rate than the economy, which caused total federal government expenditures to trough at 18 percent of the economy in 2000 – during this period, government played a declining role in the economy.

From this trough in 2000, the growth in government spending was faster than the growth in the overall economy. In 2009, the growth in government expenditures increased at an unprecedented rate relative to the size of the U.S. economy, and government expenditures are now at their largest share of the U.S. economy since the end of World War II.

A Historical Review of the Composition of Federal Spending

Not only has the relative size of government varied over time, the services provided by the federal government has changed significantly as well. Figure 2 provides a quick synopsis of the breakdown of government spending programs as a share of the total budget between 1962 and 2011.

 

Figure 2

Government Spending by Category as a Share of the Federal Budget

1962 -2011

 

In 1962, about one-half of the federal budget – 49 percent – was devoted toward defense expenditures (the black shaded area in Figure 2). Following the end of the Vietnam War, defense expenditures plummeted to 23 percent of federal government expenditures by 1980. However, during this period total government expenditures as a share of the economy increased from 18 percent to 21 percent, implying that spending in other areas of government grew significantly.

Social Security and Medicare almost doubled their share of total federal expenditures, going from 13 percent in 1962 (pre Medicare) to 26 percent in 1980. Income Security programs (e.g. unemployment compensation and food and nutrition assistance) also grew rapidly over this time period as part of President Johnson’s Great Society Programs, rising from 9 percent of the budget in 1962 to 15 percent of the budget in 1980.

“All other Functions” of government – science, agriculture, international affairs, education, energy – (denoted as “All other Functions” going forward) saw a slight increase in their share of the budget rising from 21 percent to 24 percent.

This was a time of rapid transformation in the role of government. In 1962 approximately 70 percent of the budget was devoted toward defense and “All other Functions” (whether those services were valued or performed efficiently is a separate question). Around 6 percent of the budget had to be used to pay the interest on the debt, leaving the remaining 23 percent to be spent on retirement programs and transfer payments.

By 1980 budgetary spending on defense and “All other Functions” had dropped to 47 percent. Due to the growing debts, interest payments increased to 9 percent, which meant that retirement programs and transfer payments now took up roughly 44 percent of the budget.

The budgets under President Reagan changed this pattern slightly. Defense expenditures grew as a share of the budget (the bulging black area visible during the mid-1980s in Figure 2); however, expenditures on “All other Functions” continued to decline as a share of the budget.

By 1988 defense expenditures plus expenditures on “All other Functions” accounted for 41 percent of the budget. Persistent budget deficits continued to increase interest payments over this time period as well, causing the interest on the debt to rise to 14 percent of the budget.

Payments to retirees and transfer payments maintained a constant share of the budget – accounting for 44 percent of expenditures in 1988 – as declining income support payments (due to the strong economy) were offset by rising medical expenditures.

With the end of the Cold War, the 1980s defense build-up was reversed throughout the 1990s. Defense expenditures peaked at 28 percent of total federal government expenditures in 1987 before falling to a low of 16 percent of expenditures in 1999. Some of this peace dividend was used to shrink the size of government expenditures relative to the size of the economy (government expenditures as a share of GDP went from 21 percent in 1988 to a low of 18 percent in 2000). Some of the peace dividend was reallocated to other spending priorities – particularly an increase in income security programs.

Curiously, the increased share of the federal budget devoted toward income security programs continued during the late 1990s, when the economy was booming. Theoretically, this is the time when income support program expenditures should be falling at least in relative terms (as a share of the budget) if not in absolute terms.

The share of the budget devoted toward income support programs fell slightly during the mid-2000s but has since expanded to new highs due to the recession of 2008 and the subsequent weak economic recovery. When coupled with the continued growth in Social Security (due to the retiring baby boom generation), Medicare (due to the retiring baby boom generation plus health care inflation), and Health expenditures (for health care inflation reasons), there has been a complete reversal in the types of services the government provides.

While70 percent of the federal government’s budget in 1962 was devoted toward defense and “All other Functions” of government, only 30 percent of the budget was devoted toward these services in 2011, as illustrated in Figure 3.

Figure 3

Government Spending by Category as a Share of the Federal Budget

 

                                          1962                                                                              2011

 

Future Implications

The federal government budget is at unprecedented highs compared to the size of the U.S. economy. And, because implementation of the Patient Affordable Care Act has not begun, these expenditures do not include the increased federal expenditures that, under current law, will occur due to the Patient Affordable Care Act. 

Due to the Affordable Care Act, as well as the growth built into Social Security, Medicare and Inflation, the majority of current federal spending will continue to outpace growth in the economy if explicit actions to change the path are not made.Social Security and Medicare will expand their share of the budget as the baby boomers retire.  Healthcare in general(and the new Patient Affordable Care Act in particular) will require even more federal expenditures.

This growth can only occur if: (a) expenditures geared toward defense and “All other Functions” are cut drastically;(b) an even larger share of the economy is devoted toward the government through higher tax revenues; or (c) there is a significant increase in the rate of economic growth.

Because the federal budget will continue to skew away from defense and “All other Functions”, effective budget management cannot be achieved by simply reducing expenditures on defense or “All other Functions”.  Controlling federal government expenditures necessitates controlling Social Security, Medicare, expenditures for the Patient Affordable Care Act, and transfer payments.

There is an additional future problem hidden in Figure 3.  Figure 3 illustrates that share of the budget spent on interest payments is still at 1962 levels (6 percent of the budget) but the national debt is significantly larger. Interest payments can remain so low only because the Federal Reserve has engineered exceptionally low interest rates and the federal government continues to borrow money with short maturities (well under 1 year). Future problems will arise should interest rates increase from their historic lows because the borrowing costs for the debt will increase significantly.Net interest costs on the debt could easily double as a share of the budget under these circumstances.

So What of the Candidates Plans? 

Judged on their campaign promises, the candidates are offering two stark choices. 

President Obama’s plan establishes a new trend.  President Obama’s vision grows the average federal expenditures share of the economy further from the historical pattern and expands the share of the budget devoted toward transfer payments’ (broadly speaking).  Referring back to Figure 1, under President Obama’s vision, a new historical pattern will emerge where the federal government’s expenditures will be at least 25 percent of the economy.

Governor Romney’s vision returns the size of the federal government relative to the size of the economy back to the historical average of 20 percent.  Under Governor Romney’s vision transfer payments’ (broadly speaking) will continue to be a majority of the budget, but they will be smaller than under President Obama due to the promised repeal of the Patient Affordable Care Act.

In choosing a candidate in this election, voters are deciding between two different visions regarding the proper size and role of the federal government in our economy.  Historically, has the federal government’s role been too small?  Or, has the federal government’s role grown too large over the last 12 years? 

Reference:

Graphs: Table 3.2—OUTLAYS BY FUNCTION AND SUBFUNCTION: 1962–2017 from the OMB Historical Tables; Whitehouse.gov

 

One Response to Dividing the Spoils: A Government Spending Primer

  1. Fiona says:

    It’s nearly impossible to find experienced people on this topic,
    however, you seem like you know what you’re talking about!
    Thanks