Historical Overview of Federal Spending: Major Categories

This post continues my review of recent federal government financial history, based on this spreadsheet, that began with this background post and continued with this post on federal revenues. The discussion that follows here is on the major categories of federal expenditures, the ones that really matter, the ones that account for the most money. The federal government has been described as a social “insurance company that also has an army.” And Social Security, Medicare, Medicaid, National Defense and Veteran’s Benefits, and interest on the national debt accounted for 71.9% of federal spending in FY 2011 – and 65.4% of federal spending in FY 1979 at the start of this analysis.

In terms of what the federal government actually does, moreover, it is actually an army, a post office, and a bunch of bureaucrats sending money to others who actually do things. Most Medicare and Medicaid-funded services are provided by the private sector or public facilities run by state and local governments. Social Security and interest on the debt are simply cash taken in, and cash sent out. The smaller categories of spending, to be discussed later in a separate post, generally involve payments to state and local governments, which do the actual work. Since money in and money out is the nature of most federal finances, activities by others funded by “spending” is little different than activities by others induced by tax preferences. Those “tax expenditures,” not tabulated in the spreadsheet, cost the federal government an estimated $1.1 trillion in FY 2011, according to the Statistical Abstract of the United States for 2012 (Table 477). Total federal “spending” tabulated as such was an estimated $3.8 trillion that year.

Before moving on to what matters, let’s talk about what doesn’t. In FY 2011 U.S. federal foreign aid equaled 0.19% of GDP. That is an increase from the past, when it was about 0.11% of GDP in equivalent years, but it is not much – just 0.75% of federal spending, three quarters of one percent. I’m willing to bet a substantial share of the increased foreign aid was part of the financial bailouts, of which the domestic component was much greater. In the past, Republicans blamed federal financial problems on “welfare,” cash benefits for poor minorities, immigrants, and other residents of older central cities. Federal spending on traditional cash “welfare” programs equaled just 0.14% of GDP in FY 2011, and had equaled just 0.23% of GDP in FY 1993, at the start of the Republican anti-welfare crusade.

While Republicans like to bleat on about foreign aid and welfare, Democrats like to pretend that there would be plenty of money for everything were it not for the two wars. While National Defense spending does indeed account for a large share of total federal spending, however, that is not strictly a result of the two wars. In FY 2004, with the two wars on, federal spending on this category equaled 3.85% of GDP. Not surprisingly that was more than the 3.67% of GDP in FY 1995 under Clinton, when the U.S. was cashing in the “peace dividend” from the end of the Cold War, and less than the 5.94% of GDP in FY 1983, during the Reagan defense spending boom. What stands out for me, however, is that FY 2004 defense spending under George W. Bush was lower as a share of GDP than it was in FY 1979 under President Jimmy Carter, at 4.54%. Then, to hear the Republicans tell it at the time, in FY 1979 the military was on the brink of collapse due to de-funding in the wake of Vietnam.

I suggest looking at the line chart on federal spending, ignoring for a minute the dashed line representing “everything else.” The real surge in National Defense spending as a percent of GDP, according to the chart, took place much later, from fiscal 2007 to fiscal 2011. At first some of this could be explained by falling GDP as much as by rising defense spending, but from FY 2009 to FY 2011 there was a massive jump in defense spending – by $100 billion or 16.2% -- even as GDP was rising slowly. Much of the increase in spending, therefore, is very recent, beyond what occurred because of the two wars. In FY 2011, National Defense spending equaled 5.1% of GDP.

Defense spending is easy to resent, because instead of making anyone’s life better, its goal is to prevent someone or something else from making their lives worse. Like the police, the courts, the lawyers, the regulators, the public accountants, and much of insurance, it is a deadweight cost of the dark side of human nature. There is another side to the military, however. At a time when young, less educated men are increasingly marginalized and unproductive, the military has an unrivaled record of turning such men into productive (or at least not destructive) citizens. Thus there is a “training” component to the military that it not generally given credit for, one that is particularly valuable in a deep recession. For many, particularly those growing up in non-affluent families between the coasts, it has been the only opportunity available.

Even without the wars, the U.S. would still have many soldiers on bases, and defense contractors would continue to lobby for more spending on advanced weapons. Where the wars have made a difference is in veterans’ benefits, the cost of which has increased due to the need to care for injured soldiers. The wars in Iraq and Afghanistan are small, in death and injury, compared with Vietnam and Korea, let alone the huge conflict in World War II. As former military personnel from those wars died off, the cost of Veteran’s benefits fell from 0.78% of GDP in FY 1979 to around 0.50% of GDP in FY 1995 and FY 2004. There was even talk, in some circles, of eliminating the separate, federally-run VA health and hospital system all together, and replacing it with private insurance. By FY 2011, however, the cost of veterans’ benefits had increased to 0.94% of GDP.

The cost of veteran’s benefits may go up for a while longer, but eventually it will begin to fall as a share of the economy if there are no more wars. And there seems to be a consensus that if nothing else the very large and very recent surge in national defense spending should be rolled back. A federal spending decrease of 1.0% of GDP or more on the military is likely over the next ten years, if the U.S. doesn’t get involved in another major war and GDP increases at even a modest rate. Our federal financial problems will probably come from elsewhere.

The cost of Social Security for U.S. seniors needs to be placed in a global context. As a result of birth rates falling below the replacement rate of slightly more than two births per woman, developed countries such as those in Europe, Canada and Japan, middle-income countries such as Russia and Korea, and even an increasing number of developing countries such as China, face a demographic crisis. There will be far fewer people working in younger generations to support those needing care in older generations, as the population at first stabilizes and then shrinks. In some places, such as China, this crisis follows the opposite crisis, with far more children born than could be fed, kept healthy so their development is not stunted, educated and productively employed, a crisis still faced by Africa, many Arab counties, and parts of South Asia. These are real, serious problems that other parts of the world are having to face.

And the United States does not have either of those demographic problems. Our birth rate has been right around replacement for some time. What we have is a self-inflicted wound as a result of the short-sighted and self-interested behavior of older generations, and the end to a demographic bonus. The U.S. went from, typically, one worker per married couple household to two workers per married couple, and the number of workers relative to the number of retired remained high despite increasing lifespans. Social Security payments were 4.06% of GDP in 1979, and FY 4.18% of GDP in FY 2004. These where the fat years for Social Security, when money should have been set aside for the time when that demographic bonus was ended. Instead, as described in my previous post, while extra payroll taxes have been collected over those years, they were spent to offset lower federal income taxes and rising spending on something else – detailed below.

What shouldn’t have even been a problem for Social Security has been exacerbated by a long-term trend and the Great Recession. The long-term trend is falling wages for most workers. The U.S may not have fewer working age adults than in the past, but its working age adults earn less than those who came before, those over 55 who are retired or will be retiring. China’s one-child policy might mean that an urban couple will have to support four older adults, but those older adults will be living inexpensively in some rural area on rice and some coal on for the coldest winter days, while the couple will be earning a much higher income in some city. In the U.S., in contrast, demands by those over 55 to go on living in the way they had promised themselves will end up making poorer younger generations even poorer.

The Great Recession may have accelerated what would have been a gradual increase in the number of old age Social Security beneficiaries due to baby boomer retirement. The baby boom really got going in 1947, 1 ½ to 2 ½ years after the end of World War II. Unlike those born later, who will not be able to receive full benefits until age 67, the early boomers are eligible at age 65, which means the first of them are reaching that age in 2012. By fiscal 2011, however, Social Security payments had already jumped to 4.96% of GDP, and the so-called Social Security Trust Fund started running deficits years earlier than had been predicted. It is likely that many workers, finding themselves unemployed and with no other prospects of income, accepted a lower payment rate and started collecting at 62 instead of waiting until 65 or later. In dollars, there was a 20.9% increase in Social Security payments from FY 2008 to FY 2011.

There was also a 22.8% increase in Social Security disability payments over those years. That is because in marginal cases, disability is an economic situation as much as it is a physical condition. Imagine someone who is obese, slow moving, requires frequent rest, and is often out of work sick. Or someone who is suffering from mental illness, who during occasional bouts engages in erratic behavior that alarms customers and co-workers. Or someone who is mildly retarded, and requires extensive effort and time to train to do simple tasks. All of these people are capable of working, and businesses will hire workers like these during economic booms, when labor is scarce. But they will not hire such workers when young, healthy, fast moving, quick learning, attractive college graduates are available at the minimum wage (or as “freelancers” without benefits for less), as has been the case for the past four years.

Social Security, like the military, may have been where some additional spending as a share of GDP has gone in the past few years. But it is not a cost that has been advancing ever upward as a share of GDP for three decades, for the federal government, state and local governments, and the private sector.

That cost is health care, and as the line charge shows federal spending on Medicare and Medicaid has rising as a share of GDP in all but the biggest boom years, when GDP briefly managed to keep up. Looking only at the years chosen as roughly comparable, spending on Medicare and Medicaid increased from 1.83% of GDP in FY 1979 to 3.45% of GDP in FY 1993, when President Clinton said “our competitiveness, our whole economy, the integrity of the way the government works and, ultimately, our living standards depend upon our ability to achieve savings without harming the quality of health care.” Absent substantial reforms, however, federal Medicare and Medicaid spending increased to 4.3% of GDP in 2004. 

These figures do not even include the state and local funding shares of the Medicaid program, the VA health and hospital system, and the huge cost of private health insurance purchased by the federal, state and local governments on behalf of civilian public employees and retirees. Nor do they include the $173 billion, or 1.15% of GDP in FY 2011, for the largest tax expenditure of all – the exclusion of employer-provided health insurance from taxable income. That tax expenditure provides more federally subsidized health insurance to people the more they earn (and therefore the higher their federal income tax bracket) and the higher the level of health spending. It thus providing the most federal health benefits for the wealthy and for current and retired public employees, who tend to have the richest employer-funded health insurance.

Up until the enactment of Obamacare, more and more publicly funded and subsidized health insurance was going to fewer and fewer people. This was a result of social trends, as more and more private-sector workers lost health insurance and younger workers were hired as “freelancers” without benefits, even as the cost of private insurance – and the federal tax subsidy – soared for those lucky enough to still have it. And it was the result of public policy decisions, as the second President Bush enacted a prescription drug benefit for seniors under Medicare, even though most federal health benefits already went to seniors, ignoring the health needs of non-seniors. Medicare spending jumped from 2.3% of GDP in FY 2004 to 2.7% of GDP in FY 2007 in the face of a good economy and substantial GDP growth, and then exploded to 3.3% of GDP in FY 2011 when GDP growth slowed down. And now the Baby Boomers will start retiring into the program, slowing GDP growth and increasing Medicare expenditures further.

While Medicaid was designed as a health insurance program for the poor, much of is spending is for seniors as well, particularly for custodial care of those seniors unable to take care of themselves and in need of nursing home care, home health care, or personal care. Medicaid is also the de facto national health insurance, as the uninsured soon qualify when they become ill after they have exhausted all their liquid assets. As fewer people have been covered by private businesses, more have ended up having their significant health care costs covered by the program, even as health care costs have continued to increase. This trend was accelerated by Great Recession, as federal Medicaid expenditures jumped from 2.3% of GDP to 3.3% of GDP and matching payments strained state budgets. Since a majority of Americans have no net worth, they have nothing to lose if they are uninsured and the cost of an illness makes them “poor.” Since most are too young, too poor and too powerless to benefit from the huge federal, state and local spending on and subsidies for health care, they will either remain healthy or end up on Medicaid in any event.

Those who read my posts on health care prior to the previous Presidential election know that Obamacare is not what I would have done. It maintained the tie between health insurance and place of employment, discouraging entrepreneurship and labor mobility and keeping health insecurity high. It retained group underwriting as a de facto income redistribution between the young and healthy and the old and sick within the private sector, rather than making the subsidy simple and explicit through varying levels of federal subsidy, and thus retained the insurance gain of profiting by excluding those who actually require health care. And imposed a health insurance mandate in lieu of a tax, even though a mandate is regressive and hits less profitable small firms and working people harder. It did this to copy Republican proposals, placate the politically powerful health insurance industry, and avoid charges of “taxes” and “big government” by using regulations to force changes “off the books” within the private sector. Sued on the grounds that the federal government has no constitutional authority to impose an insurance mandate, the Obama Administration is now forced to argue that the mandate is no different than a tax.

But that is not why many powerful and privileged people have opposed to Obamacare. It is because Obamacare promises to do something, something for working people and younger generations. It imposes some slowdown in the previously unlimited spending on seniors via Medicare. It provides a very weak limit on the cost of the federal health insurance tax break for the richest people with the richest untaxed employer-provided health insurance, including existing and retired public employees. The seniors are in fact objecting not to cuts in total federal health care spending on themselves, but to any limit on future increases. That is what the “small government” Tea Party is really all about. And that’s why the public employee unions, who in general control the federal government, are unenthusiastic about Obama’s re-election.

The fact is that Obamacare did not go far enough in changing public priorities and limiting public spending on and subsidies for health insurance. And Obama did not go far enough in defending his proposals on generational equity and economic survival grounds. In the face of the relentless growth of federal health are spending on seniors and subsidies for the wealthiest and politically powerful, the Republican Party has disgraced itself on health care by pandering to privilege and opposing even spending restraints. Objective fiscal conservatives, such as David Frum, have said so. It is one thing to have a government that redistributes well-being from those who are the best off to those who are the worst off. The extent to which that is justified is a subject for legitimate debate. It is another to have the government forcibly redistribute resources from those who are the worst off to those who are the best off. But that had been the trend in public health care spending and subsidies, the winning political strategy, in the era of Generation Greed.

In summary, over the past 30 years the payroll tax, which hits moderate- and middle-income workers the hardest, has been increased, supposedly to save up money to “Save Social Security.” But all the extra payroll tax money has been blown on lower progressive income taxes and higher health care spending on today’s seniors, who wanted both more benefits and lower taxes. Now the national Republican Party proposes drastic cutbacks in both Social Security and Medicare, but only for those 54 and younger. Basically, there is no reason that anyone who isn’t 54 and younger, or any older person who cares about anyone 54 or younger or the future of the United States, to vote for just about any Republican for national office in 2012. If you want small government and don’t like Democrats, go ahead and write in Ron Paul.