government spending

Financing the operations of the federal government is extraordinarily complex. Annual federal budgets climbed from $250 million a century ago to almost $65 billion in 1955; then, in less than 30 years, they grew tenfold, to nearly $650 billion in 1982. Government revenues have not matched expenditures since the early 1960’s, and deficit spending has become the ordinary way of doing business. Almost 47 percent of the federal government’s revenue comes from personal income taxes, with another 12.5 percent coming from corporate income taxes. Other sources of federal revenue are excise taxes (4.5 percent), interest on deposits (2.25 percent), customs duties (1.5 percent), and estate and gift taxes (1.25 percent). Minor sources of income – from charges for passports to admissions fees to the Smithsonian Institute – amount to less than .2 percent of the federal government’s income. These sources account for nearly 70 percent of annual revenues, and constitute the general fund, which goes to pay the ordinary operating expenses, from welfare to new missiles.

The remaining 30 percent of federal income is designated for specific purposes, including Social Security payments, unemployment taxes, federal employees’ retirement funds, and other retirement and disability funds. These funds are held in trust to provide benefits for those who have paid into the systems. For example, Social Security payments are a major source of income for many retired persons.

The largest portion of expenditures goes to Social Security and related payments (34 percent). Next comes expenditures for the national defense (23 percent), followed by interest on the national debt (11 percent). Health programs account for 10 percent, and other government programs, from veterans’ benefits to agriculture, account for 17 percent. The budgets of Congress, the federal judiciary, and the White House and executive offices combined account for less than half of 1 percent.

As long as the government is able to levy sufficient taxes to meet expenditures, it can maintain a balanced budget and avoid a national debt. This is not always possible, however, because tax revenues as well as expenditures are not perfectly predictable. Unexpected unemployment can result in lower tax revenues and increased transfer payments. (Transfer payments are payments made by the government for which no goods or services are received in return, such as Social Security payments, farm subsidies, and unemployment compensation.) This imbalance between money coming in and going out, called a budget deficit, can be corrected only by borrowing.

The government borrows for other reasons other than to correct imbalances between income and outflow. Large public works projects, such as interstate highways or mass transits systems, produce benefits for society over many years. If the government were to wait until it had sufficient funds to finance such projects, society would meanwhile be deprived of the benefits. Emergencies and unexpected events also force governments to borrow. A war, for example, is a costly endeavor that must be financed immediately. The United States Government also uses deficit spending, spending in excess revenues, to stimulate sluggish economy.

The total of all outstanding financial obligations of the federal government is called the gross federal debt or gross national debt. The net federal debt includes only that debt held by individuals and organizations outside the government. It does not include obligations of one government held by another. Since payments between government agencies have little effect on the economy, the net national debt is the more relevant and reliable measure of indebtedness.

Common beliefs regarding a large national debt are that it decreases the wealth of a nation, adversely impacts the standard of living, and places a financial burden on future generations. The actual effect depends on many factors, including who owns the debt and the size of the debt compared with the gross national product. If U.S. citizens or domestic organizations hold most of the U.S. national debt, it has little effect on the wealth of the nation. When this is true, interest on the debt and principal payments remain, for the most part, within the United States.

Since individuals in the United States do not hold bonds and other government debt instruments in the same proportion as they pay taxes, the debt has the effect of redistributing wealth. The interest that the government pays to those who hold government bonds and other government debt instruments comes from tax revenues. Therefore, if taxpayers do not own any government securities, through taxation, part of their income is transferred to those who do own such securities. Although this affects the relative wealth of some people, it has no effect on the total wealth of the nation.

Although most of the U.S. federal debt is currently held domestically, the percentage held by foreigners has skyrocketed since 1970. If this trend continues, it could become a cause for alarm as interest payments on foreign-held U.S. debt leave the country.

Any debt, whether public or private, must be considered relative to income. An individual who earns $100,000 a year usually afford a higher level of debt than someone who earns $25,000 a year. Similarly, a nation with a high gross national product can sustain a higher level of debt than a nation with a low GNP.

Although budget deficits increased from 1955 to 1980, they increased at slower rate than did the gross national product. Since 1980, however, the national debt has been increasing at an ever-faster rate in relation to the GNP. Despite this, the federal debt as a percentage of gross national product is still fairly moderate. In 1945, after World War II, for example, the net federal debt was $252.2 billion, 119 percent of the GNP. By 1985, although the national debt had increased to almost $1.5 trillion, it represented only about 38 percent of the U.S. gross national product. The national debt is escalating out of control.

There are other fears associated with national debt. Some fear that the federal government may go bankrupt if the debt becomes too large. Although this is technically possible, and some governments have gone bankrupt in the past, bankruptcies have generally been due to declining GNPs relative to federal debts. Most economists believe bankruptcy of the U.S. federal government is not a significant concern, at least at present.

Many people are less concerned about the size of the federal debt than the interest burden imposed on the federal budget as a result of that debt. In 1960 interest payments on the national debt accounted for 9.3 percent of federal expenditures. By 1986 that figure had risen by 15 percent. The main effect of this, as long as most of the debt holders are domestic, is to redistribute income, not reduce it. With so large a percentage of available funds committed to interest payments, less is available for other expenditures.

Since the U.S. national debt began to increase rapidly at roughly the same time that the country was experiencing high levels of inflation, many concluded that the two were interrelated. A large national debt may or may not be inflationary. If, for example, the government sought to pay off its debt by printing and circulating of a large amount of additional money, the increased demand created by this sudden influx of currency would almost certainly be inflationary.

A large government deficit like that of the U.S. when businesses are operating at full capacity might also result in inflation if insufficient investment funds were available, or interest rates were too high to enable capital formation. Lack of investment, which impedes increased productivity, coupled with increased demand resulting from deficit spending, might result in inflation.

Although a large federal debt is of concern to many, few would suggest that the federal budget should always be balanced. The need to stimulate a sluggish economy, fund a needed a public works project, or finance a war may be more important than a balanced budget. The size and rate of growth of a deficit, however, is a major political as well as economic issue.