A Deeper Dive into Government Spending

By Bob Peters || November 4, 2024

An Insurance Company with an Army

Every citizen should understand how he/she is taxed and how our government spends those tax dollars.  As mentioned in the blog post, Historical Tax Rates, Government Expenditures and the size of the Federal Deficit: Why it is important to understand, we showed how, since 1918, the top federal tax rate has ranged from a high of 93% and a low of 28%. We might think of our government as an insurance company with an army.  How so?  Let’s see. 

Social Security, Medicare, Defense and Interest on our Debt

The government decides who pays taxes (individuals and corporations), how much each pays and then allocates those tax dollars in three ways: 

1. Paying the interest on our national debt;
2. Paying for our national defense, and 
3. Providing social services (Social Security, Medicare, Medicaid, etc.) 

Let’s take a look at each of these by first taking a look at the chart below.

Public Health and Veterans

Public Health: After many years of relatively very modest spending increases, spending shot up from $63.4 billion in 2019 to peak at $192.6 billion in 2020 at the start of the pandemic before settling down at an elevated level of $102.4 billion in 2023. Spending wisely on Public Health prior to the next pandemic could save lives and hundreds of billions of lost economic value.

Support for Veterans: Beginning in the early 2000’s, spending on Veterans benefits has shown a steady increase from $76.4 billion in 2001 to $299.1 billion in 2023.  This increase reflects the costs associated with both an ageing veteran population and the wars our military has participated in since the early 1990’s.

Interest on our National Debt…watch this closely

This is an important one as the future rate of interest spending will increase at an accelerating rate unless Congress takes action to reduce the debt.  Recall, in the blog post, Better Decision Making Improves Your Life, we showed a chart where the borrowing costs of the government declined for 40 years, depicted by the 10-year treasury declining from 15.84% in 1981 to .62% in 2020.  Now, look at the chart above where interest on the debt went from $233.9 billion to $404.8 billion over the same period.  On an inflation adjusted basis, interest payments increased 73% but the cost of borrowing declined by 96.1%, point to point.  We took on a lot of national debt during that 40-year period but with declining interest costs the impact was fairly muted, until 2021 when the cost of borrowing started to increase.

With interest costs of our national debt rising since 2021 you will want to not only watch this closely but be prepared to form an opinion on how our country can change the trajectory of future debt.

Spending on National Defense…deterence is cheaper than wars

In 1981 spending on defense was $535.4 billion and by 2023 defense spending increased to $820.3 billion.  But two points in time don’t tell the whole story.  As with all of these numbers the Gross Domestic Product of the country was also increasing. 

An analogy might be rent vs income.  If your rent increased from $1,500 to $2,000 you would experience a 25% increase in rent.  However, if your income increased from $4,500 to $9,000, a 100% increase, the percentage of income that you pay towards rent declines from 33.3% to 22.2%.  Rent goes up in actual dollars but goes down in relative dollars. 

So, back to defense spending.  Yes, in actual dollars defense spending increased by 53.2% from 1981 to 2023 but as a percentage of GDP defense spending decreased from 5.65% to 3.5% during the same period.  One more observation about historical defense spending.  In 1943, defense spending represented 43% of GDP.  Wars drive higher defense spending (and higher tax rates) so it’s in our economic interest to invest smaller sums in order to have effective deterrence.

Note: The current geopolitical world is more precarious than it has been since the fall of the Soviet Union and arguably since World War 2.  That is a topic unto itself and best left for another day.  In short, I believe we are facing a period where we will need to spend more on defense to improve the effectiveness of deterence.  Check out the April 2022 blog post, Understanding Geopolitics and History will make you a better investor for a bit more on the topic.

Coming in at #2: Medicare, Medicaid and CHIP

Coming in at the second highest spending category is Medicare.  Medicare along with Medicaid and CHIP provide access to healthcare for certain age groups and lower income folks.  In 2023 Medicare expenses totaled $848.2 billion or 13.8% of total federal spending while Medicaid and CHIP combined were $633.8 billion or 10.3%. Here is a bit about all three:

1) Medicare.  When you turn 65 the federal government gives access to hospital, physician and prescription drugs thru this national program.  Eligible participants pay a monthly premium based on their income.  The higher the income the higher the monthly premium.

2) Medicaid.  Eligibility for Medicaid is determined by each state rather than the federal government.  Between 60-90% of total Medicaid is funded by a transfer from the federal government to each state.  Medicaid provides access to healthcare at no or low cost for lower income eligible citizens.

3) CHIP (Children Health Insurance Program).  This program is similarly funded, as is Medicaid, by both state and federal governments providing uninsured children in families with incomes too high to qualify for Medicaid, but too low to afford private or group health plan coverage.

Social Security is the top federal budget expenditure

In 2023, Social Security is the top federal budget expenditure at $1.35 trillion or 22% of total federal spending. A few comments about Social Security:

-Social Security began in 1935 during the Depression when unemployment was approximately 20% (after three prior years above 20%). Given the extremely harsh era of the Depression, Congress decided to provide a safety net for folks who outlived their expected lifespan.  There were few Defined Benefit Plans (aka Pension Plans), no Defined Contribution Plans (aka 401k/403B Plans) and no IRAs/Roth IRAs or HSA.

-At the inception of Social Security, the average life span of white male and females were 61 years and 65 years, respectively. Today, for those currently 64 or younger, the full Social Security retirement benefits is 67.  Note: Lifespans in 1935 were expected to be less than the age at which you were entitled to receive Social Security benefits.  Today, 67 year old males and females are expected to live an additional 16.5 and 18.9 years, respectively.

-At the inception of Social Security in 1935, eligibility of benefits began at the age of 65.  In 1956, Congress lowered the eligibility age for women from 65 to 62 after which there were subsequent changes to Social Security.

-Social Security is funded by a tax on workers’ payroll.  Currently, your employer pays 6.2% and you pay 6.2% of each paycheck, up to the annual income of $168,600.  Incomes above $168,600 are not subject to these taxes.

-To be eligible for Social Security, you must work for a minimum of 40 quarters (10 years).

-The Social Security Administration estimates that “about half of the population aged 65 or older live in households that receive at least 50 percent of their family income from Social Security benefits and about 25 percent of aged households rely on Social Security benefits for at least 90 percent of their family income”.

It’s a balancing act…

Establishing tax rates that are too high discourage investment which leads to slow growth and higher unemployment.  Conversely, tax rates that are too low, contribute to reduced services, ineffectual preparedness and may lead to growth of the national debt to unsustainable levels.  The tax policy we have today is very complex and offers tax breaks to many constituents who have lobbied elected officials.  It’s a balancing act that requires compromise.

What now?

Well, what now? In a democracy you have a vote and it’s not only a privilege but also your obligation to be heard. There will be plenty folks who will try to convince you on how best to manage national tax and spending priorities.  Before allowing your opinion to be outsourced to others you will be well suited to establish your own view on the facts.