Introduction

Each year, families and individuals pay taxes to the government and receive back a wide variety of services and benefits. A fiscal deficit occurs when the benefits and services received by one group exceed the taxes paid. When such a deficit occurs, other groups must pay for the services and benefits of the group in deficit. Each year, govern­ment is involved in a large-scale transfer of resources between different social groups.

Fiscal distribution analysis measures the distribution of total government benefits and taxes in society. It pro­vides an assessment of the magnitude of government transfers between groups. This paper provides a fiscal distri­bution analysis of households headed by persons without a high school diploma. It measures the total benefits and services received by this group and the total taxes paid. The difference between benefits received and taxes paid rep­resents the total resources transferred by government on behalf of this group from the rest of society.

The first step in an analysis of the distribution of benefits and taxes is to count accurately the cost of all benefits and services provided by the government. The size and cost of government is far larger than many people imagine. In fiscal year (FY) 2004, the expenditures of the federal government were $2.3 trillion. In the same year, expendi­tures of state and local governments were $1.45 trillion. The combined value of federal, state, and local expenditures in FY 2004 was $3.75 trillion.[1]

The sum of $3.75 trillion is so large that it is difficult to comprehend. One way to grasp the size of government more readily is to calculate average expenditures per household. In 2004, there were some 115 million households in the U.S.[2] (This figure includes multi-person families and single persons living alone.) The average cost of govern­ment spending thus amounted to $32,706 per household across the U.S. population.[3]

The $3.75 trillion in government expenditure is not free but must be paid for by taxing or borrowing economic resources from Americans or by borrowing from abroad. In general, government expenditures are funded by taxes and fees. In FY 2004, federal taxes amounted to $1.82 trillion. State and local taxes and related revenues amounted to $1.6 trillion.[4] Together, federal, state, and local taxes amounted to $3.43 trillion. At $3.43 trillion, taxes and related revenues came to 91 percent of the $3.75 trillion in expenditures. The gap between taxes and spending was financed by government borrowing.

Types of Government Expenditure

Once the full cost of government benefits and services has been determined, the next step in the analysis of the distribution of benefits and taxes is to determine the beneficiaries of specific government programs. Some pro­grams, such as Social Security, neatly parcel out benefits to specific individuals. With programs such as these, it is relatively easy to determine the identity of the beneficiary and the cost of the benefit provided. At the opposite extreme, other government programs (for example, medical research at the National Institutes of Health) do not neatly parcel out benefits to individuals. Determining the proper allocation of the benefits of that type of program is more difficult.

To ascertain most accurately the distribution of government benefits and services, this study begins by dividing government expenditures into six categories: direct benefits; means-tested benefits; educational services; popula­tion-based services; interest and other financial obligations resulting from prior government activity; and pure pub­lic goods.

Direct Benefits

Direct benefit programs involve either cash transfers or the purchase of specific services for an individual. Unlike means-tested programs (described below), direct benefit programs are not limited to low-income persons. By far the largest direct benefit programs are Social Security and Medicare. Other substantial direct benefit programs are Unemployment Insurance and Workmen's Compensation.

Direct benefit programs involve a fairly transparent transfer of economic resources. The benefits are parceled out discretely to individuals in the population; both the recipient and the cost of the benefit are relatively easy to deter­mine. In the case of Social Security, the cost of the benefit would equal the value of the Social Security check plus the administrative costs involved in delivering the benefit.

Calculating the cost of Medicare services is more complex. Ordinarily, government does not seek to compute the particular medical services received by an individual. Instead, government counts the cost of Medicare for an individual as equal to the average per capita cost of Medicare services. (This number equals the total cost of Medicare services divided by the total number of recipients.)[5] Overall, government spent $840 billion on direct benefits in FY 2004.

Means-Tested Benefits

Means-tested programs are typically termed welfare programs. Unlike direct benefits, means-tested programs are available only to households below specific income thresholds. Means-tested welfare programs provide cash, food, housing, medical care, and social services to poor and low-income persons.

The federal government operates over 60 means-tested aid programs.[6] The largest of these are Medicaid; the Earned Income Tax Credit (EITC); food stamps; Supplemental Security Income (SSI); Section 8 housing; public housing; Temporary Assistance to Needy Families (TANF); the school lunch and breakfast programs; the WIC (Women, Infants, and Children) nutrition program; and the Social Services Block Grant (SSBG). Many means-tested programs, such as SSI and the EITC, provide cash to recipients. Others, such as public housing or SSBG, pay for ser­vices that are provided to recipients.

The value of Medicaid benefits is usually counted in a manner similar to Medicare benefits. Government does not attempt to itemize the specific medical services given to an individual; instead, it computes an average per capita cost of services to individuals in different beneficiary categories such as children, elderly persons, and disabled adults. (The average per capita cost for a particular group is determined by dividing the total expenditures on the group by the total number of beneficiaries in the group.) Overall, the U.S. spent $564 billion on means-tested aid in FY 2004.[7]

Public Education

Government provides primary, secondary, post-secondary, and vocational education to individ­uals. In most cases, the government pays directly for the cost of educational services provided. In other cases, such as the Pell Grant program, the government in effect provides money to an eligible individual who then spends it on edu­cational services.

Education is the single largest component of state and local government spending, absorbing roughly a third of all state and local expenditures. The average per pupil cost of public primary and secondary education is now around $9,600 per year. Overall, federal, state, and local governments spent $590 billion on education in FY 2004.

Population-Based Services

Whereas direct benefits, means-tested benefits, and education services provide dis­crete benefits and services to particular individuals, population-based programs generally provide services to a whole group or community. Population-based expenditures include police and fire protection, courts, parks, sani­tation, and food safety and health inspections. Another important population-based expenditure is transportation, especially roads and highways.

A key feature of population-based expenditures is that such programs generally need to expand as the population of a community expands. (This quality separates them from pure public goods, described below.) For example, as the population of a community increases, the number of police and firemen will generally need to expand in proportion.

In its study of the fiscal costs of immigration, The New Americans, the National Academy of Sciences argued that if service remains fixed while the population increases, a program will become "congested," and the quality of service for users will deteriorate. Thus, the NAS uses the term "congestible goods" to describe population-based services.[8] High­ways are an obvious example of this point. In general, the cost of population-based services can be allocated according to an individual's estimated utilization of the service or at a flat per capita cost across the relevant population.

A sub-category of population-based services is government administrative support functions such as tax collec­tions and legislative activities. Few taxpayers view tax collection as a government benefit; therefore, assigning the cost of this "benefit" appears problematic.

The solution to this dilemma is to conceptualize government activities into two categories: primary functions and secondary functions. Primary functions provide benefits directly to the public; they include direct and means-tested benefits, education, ordinary population-based services such as police and parks and public goods. By con­trast, secondary or support functions do not provide direct benefits to the public but do provide necessary support services that enable the government to perform primary functions. For example, no one can receive food stamp ben­efits unless the government first collects taxes to fund the program. Secondary functions can thus be considered an inherent part of the "cost of production" of primary functions, and the benefits of secondary support functions can be allocated among the population in proportion to the allocation of benefits from government primary functions.

Government spent $662 billion on population-based services in FY 2004. Of this amount, some $546 billion went for ordinary services such as police and parks, and $116 billion went for administrative support functions.

Interest and Other Financial Obligations Relating to Past Government Activities

Often, tax revenues are insufficient to pay for the full cost of government benefits and services. In that case, government will borrow money and accumulate debt. In subsequent years, interest payments must be paid to those who lent the government money. Interest payments for the government debt are in fact partial payments for past government benefits and ser­vices that were not fully paid for at the time of delivery.

Similarly, government employees deliver services to the public; part of the cost of the service is paid for imme­diately through the employee's salary. But government employees are also compensated by future retirement bene­fits. Expenditures of public sector retirement are thus, to a considerable degree, present payments in compensation for services delivered in the past. The expenditure category "interest and other financial obligations relating to past government activities" thus includes interest and principal payments on government debt and outlays for govern­ment employee retirement. Total government spending on these items equaled $468 billion in FY 2004.[9]

Allocation of the benefit of this spending is problematic since the benefits were actually delivered in past years, but a definite portion of spending on interest and employee retirement was generated by past expenditures on behalf of low-skill households. Broadly conceived, spending on behalf of low-skill households includes not only spending for benefits in the current year, but also lagged spending that relates to outlays on such households in earlier years. In this sense, the low-skill households' share of interest and government employee retirement outlays would be pro­portionate to their share of government expenditures in prior years. Although calculating the low-skill households' share of spending in prior years would be very complex, the present analysis approximates this figure by assuming that these households' share of expenditures in prior years is equal to its share of FY 2004 expenditures.

An alternative approach to allocating interest and employee retirement costs would employ the distinction between government primary and secondary functions described in the prior section. If government failed to pay interest on its existing debt, it would be unable to borrow in the future; benefits would have to be slashed or taxes raised steeply. Gov­ernment's honoring of past financial obligations is thus an essential secondary function, a necessary cost of business that enables government to perform its primary functions. The ultimate beneficiaries of this secondary function are the ben­eficiaries of the primary functions that can be continued because government fulfills its debt obligations. The low-skill households' share of expenditures on these secondary functions would equal their share of benefits from primary func­tion expenditures in FY 2004. Both approaches to allocating costs relating to interest and related financial obligations yield the same level of spending on behalf of low-skill households in FY 2004.

Pure Public Goods

Economic theory distinguishes between "private consumption goods" and pure public goods. Economist Paul Samuelson is credited with first making this distinction. In his seminal 1954 paper "The Pure Theory of Public Expenditure,"[10] Samuelson defined a pure public good (or what he called in the paper a "collective consumption good") as a good "which all enjoy in common in the sense that each individual's consumption of such a good leads to no subtractions from any other individual's consumption of that good." By contrast, a "private consumption good" is a good that "can be parceled out among different individuals." Its use by one person precludes or diminishes its use by another.

A classic example of a pure public good is a lighthouse: The fact that one ship perceives the warning beacon does not diminish the usefulness of the lighthouse to other ships. Another clear example of a governmental pure public good would be a future cure for cancer produced by government-funded research. The fact that non-taxpayers would benefit from this discovery would neither diminish its benefit nor add extra costs to taxpayers. By contrast, an obvious example of a private consumption good is a hamburger: When one person eats it, it cannot be eaten by others.

Direct benefits, means-tested benefits, and education services are private consumption goods in the sense that use of a benefit or service by one person precludes or limits the use of that same benefit by other. (Two people cannot cash the same Social Security check.) Population-based services such as parks and highways are often mentioned as "public goods," but they are not pure public goods in the strict sense described above. In most cases, as the number of persons using a population-based service (such as highways and parks) increases, either the service must expand (at added cost to taxpayers) or the service will become "congested" and its quality will be reduced. Consequently, use of population-based services such as police and fire departments by non-taxpayers does impose significant extra costs on taxpayers.

Government pure public goods are rare; they include scientific research, defense, spending on veterans, inter­national affairs, and some environmental protection activities such as the preservation of endangered species. Each of these functions generally meets the criterion that the benefits received by non-taxpayers do not result in a loss of utility for taxpayers. Government pure public good expenditures on these functions equaled $628 billion in FY 2004. Interest payments on government debt and related costs resulting from public good spending in previous years add an estimated additional cost of $67 billion, bringing the total public goods cost in FY 2004 to $695 billion.

Although low-income households that pay little or no tax do benefit from pure public good programs, their gain neither adds costs nor reduces benefits for others. Thus, the benefit gleaned by non-taxpayers from these pure public good functions does not impose an extra burden on society. However, households that pay little or no tax are "free riders" on public good programs in the sense that they benefit from government activities for which they have not paid. (For a further discussion of pure public goods, see Appendix B.)

Summary: Total Expenditures

As Table 1 shows, overall government spending in FY 2004 came to $3.75 bil­lion, or $32,706 per household across the entire U.S. population. Direct benefits had an average cost of $7,326 per household across the whole population, while means-tested benefits had an average cost of $4,920 per household. Education benefits and population-based services cost $5,143 and $5,765, respectively. Interest payments on gov­ernment debt and other costs relating to past government activities cost $3,495 per household. Pure public good expenditures comprised 18.5 percent of all government spending and had an average cost of $6,056 per household.

A detailed breakdown of expenditures is provided in Appendix Table A-1 for federal expenditures and Appen­dix Tables A-2A, A-2B, and A-2C for state and local expenditures.

Taxes and Revenues

Total taxes and revenues for federal, state, and local governments amounted to $3.43 trillion in FY 2004, with an aver­age cost of $29,919 per household across the whole population. A detailed breakdown of federal, state, and local taxes is provided in Appendix Table A-3. The biggest revenue generator was the federal income tax, which cost the taxpayers $808 billion in 2003, followed by Federal Insurance Contribution Act (FICA) taxes, which gathered $685 billion.

Property tax was the biggest revenue producer at the state and local levels, generating $318 billion, while general sales taxes gathered $244 billion.

Summary of Estimation Methodology

This paper seeks to estimate the total cost of benefits and services received, and the total value of taxes paid, by households headed by persons without a high school diploma. To produce this estimate, calculations were per­formed on 50 separate expenditure categories and 33 tax and revenue categories. These calculations are explained in detail in Appendix A and presented in Appendix Tables A-4 and A-5. The present section will briefly summarize the procedures used.

Data on receipt of direct and means-tested benefits were taken from the U.S. Census Bureau's Current Popula­tion Survey (CPS). Data on attendance in public primary and secondary schools were also taken from the CPS; stu­dents attending public school were then assigned educational costs equal to the average per pupil expenditures in their state. Public post-secondary education costs were calculated in a similar manner.

Wherever possible, the cost of population-based services was based on the estimated utilization of the service by low-skill households. For example, the low-skill households' share of highway expenditures was assumed to equal their share of gasoline consumption as reported in the Bureau of Labor Statistics Consumer Expenditure Survey (CEX). When data on utilization of a service were not available, the estimated low-skill households' share of popu­lation-based services was assumed to equal their share of the total U.S. population.

The share of public goods received by low-skill households was assumed to equal their share of the total U.S. population. The low-skill households' share of the cost of interest and other financial obligations relating to past gov­ernment activities was assumed to equal their share of current expenditures on direct and means-tested benefits, education, population-based services, and public goods.

Federal and state income taxes were calculated based on data from the CPS. FICA taxes were also calculated from CPS data and were assumed to fall solely on workers.

Sales, excise, and property tax pay­ments were based on consumption data from the Consumer Expenditure Survey. For example, if the CEX showed that low-skill households accounted for 10 percent of all tobacco product sales in the U.S., those households were assumed to pay 10 percent of all tobacco excise taxes.

Corporate income taxes were assumed to be borne partly by workers and partly by owners; the distribution of these taxes was estimated according to the distribution of earnings and property income in the CPS.

A fundamental rule in the analysis was that the estimated expenditure for each program for the whole population had to equal actual government outlays for that program. Similarly, total revenue for each estimated tax had to equal total revenue from the tax as reported in government budget documents.

CPS data are problematic in this respect since they generally underreport both benefits received and taxes paid. Consequently, both benefits and tax data from the CPS had to be adjusted for underreporting. The key assumption in this adjustment process was that households headed by persons without a high school diploma (low-skill house­holds) and the general population underreport benefits and taxes to a similar degree. Thus, if food stamp benefits were underreported by 10 percent in the CPS as a whole, then low-skill households were also assumed to underre­port food stamp benefits by 10 percent. In the absence of data suggesting that low-skill and high-skill households underreport at different rates, this seemed to be a reasonable working assumption.

Costs of Benefits and Services for Low-Skill Households

The focus of this paper is the benefits received and taxes paid by households headed by persons without a high school diploma. (Throughout the paper, these households are also called low-skill households.) In 2004, there were 17.7 million such households in the U.S. Appendix Table A-4 shows the estimated costs of government benefits and services received by these households in 50 separate expenditure categories. The results are summarized in Charts 1 and 2.

Overall, households headed by persons without a high school diploma (or low-skill households) received an average of $32,138 per household in direct benefits, means-tested benefits, education, and population-based ser­vices in FY 2004. If expenditures for interest and other financial obligations relating to past government activities are added to the count, expenditures rise to $36,989 per household. If the cost of public goods is added, annual total expenditures on benefits and services come to $43,084 per low-skill household.

Chart 2 gives a more detailed breakdown of the immediate benefits and services received by low-skill households. Means-tested aid came to $11,963 per household, while direct benefits (mainly Social Security and Medicare) amounted to $10,026. Education spending on behalf of these households averaged $4,891 per household, while spending on police, fire, and public safety came to $1,999 per household. Transportation added another $778, while administrative support services cost $1,273. Miscellaneous population-based services added a final $1,208.

It is important to note that the costs of benefits and services outlined in Chart 2 are a composite average of all low-skill households. They represent the total costs of benefits and services received by all low-skill households divided by the number of such households. It is unlikely that any single household would receive this exact package of benefits; for example, it is rare for a household to receive Social Security benefits and primary and secondary edu­cation services at the same time. Nonetheless, the figures are an accurate portrayal of the governmental costs of low-skill households as a group. When combined with similar data on taxes paid, they enable an assessment of the fiscal status of such households as a group and their impact on other taxpayers.

Taxes and Revenues Paid by Low-Skill Households

Appendix Table A-5 details the estimated taxes and revenues paid by low-skill households in 31 categories. The results are summarized in Chart 3. As the chart shows, total federal, state, and local taxes paid by low-skill households came to $9,689 per household in 2004. Federal and state individual income taxes comprised only 20 percent of total taxes paid. Instead, taxes on consumption and employment produced the bulk of the tax burden for low-skill households.

The single largest tax payment was $2,509 per household in Federal Insurance Contribution Act (FICA) tax. (Workers were assumed to pay both the employee and employer share of FICA taxes.) On average, low-skill house­holds paid $1,486 in state and local sales and consumption taxes. The analysis assumed that a significant portion of property taxes on rental and business properties was passed through to renters and consumers; this contributed to a $1,371 property tax burden for the aver­age low-skill household. The analysis also assumed that 70 percent of corpo­rate income taxes fell on workers; this contributed to an average $704 corporate tax burden for low-skill households. Low-skill households are frequent partic­ipants in state lotteries, with an estimated average purchase of $686 in lottery tick­ets per household in 2004.

Balance of Taxes and Benefits

On average, low-skill households received $32,138 per household in immediate government benefits and services in FY 2004, including direct benefits, means-tested benefits, education, and popula­tion-based services. Total benefits rose to $43,084 if public goods and the cost of interest and other financial obliga­tions are added.

By contrast, low-skill households paid only $9,689 in taxes. Thus, low-skill households received at least three dollars in benefits and services for each dollar in taxes paid. If the costs of public goods and past financial obligations are added, the ratio rises to four to one.

Strikingly, as Chart 4 shows, low-skill households in FY 2004 had average earnings of $20,564 per household; thus, the average cost of government benefits and services received by these households not only exceeded the taxes paid by these households, but substan­tially exceeded the average earned income of these households.

Net Annual Fiscal Deficit

The net fiscal deficit of a household equals the cost of benefits and services received minus taxes paid. As Chart 5 shows, if the costs of direct and means-tested benefits, education, and population-based services alone were counted, the average low-skill household had a fis­cal deficit of $22,449 (expenditures of $32,138 minus $9,689 in taxes). The net fiscal deficit of the average low-skill household actually exceeded the household's earnings. If interest and other financial obligations relating to past government activities were added as well, the average deficit per household rose to $27,301.

In addition, the average low-skill household was a free rider with respect to government public goods, receiving public goods costing some $6,095 per house­hold for which it paid nothing.

Net Lifetime Costs

Receiving, on average, at least $22,449 more in benefits than they pay in taxes each year, low-skill households impose substantial long-term costs on the U.S. taxpayer. Assuming an average 50-year adult life span for heads of household, the average life­time costs to the taxpayer will be $1.1 million for each low-skill household, net of any taxes paid. If the costs of interest and other financial obligations are added, the average lifetime cost rises to $1.3 million per household.

Aggregate Net Fiscal Costs

In 2004, there were 17.7 million low-skill households. As shown in Chart 5, the average net fiscal deficit per household was $22,449. This means that the total annual fiscal deficit (total ben­efits received minus total taxes paid) for all 17.7 million low-skill households together equaled $397 billion (the deficit of $22,449 per household times 17.7 million households). This sum includes direct and means-tested benefits, education, and population-based services.

If the low-skill households' share of interest and other financial obligations for past activities is added, the total annual fiscal deficit of these households rose to $483 billion. Over the next ten years, the constant dollar net cost of low-skill households (immediate benefits received minus taxes paid) is likely to be at least $3.9 trillion. Policy changes that would expand entitlement programs such as Medicaid will increase these costs at the margin. On the other hand, changes in immigration law that would significantly increase the inflow of low-skill workers and families will increase future government spending dramatically.

Low-Skill Households Compared to Other Households

Chart 7 com­pares households headed by persons without a high school diploma to households headed by persons with a high school diploma or better. Whereas the dropout-headed household paid only $9,689 in taxes in FY 2004, the higher-skill households paid $34,629— more than three times as much. While dropout-headed households received from $32,138 to $43,084 in benefits, high-skill households received less: $21,520 to $30,819. The difference in government benefits was due largely to the greater amount of means-tested aid received by low-skill households.

Households headed by dropouts received $22,449 more in immediate benefits (i.e., direct and means-tested aid, education, and population-based services) than they paid in taxes. Higher-skill households paid $13,109 more in taxes than they received in imme­diate benefits.

Externalities of Benefits

It might be argued that certain government benefits generate positive externalities; that is, they benefit society at large as well as the immediate beneficiary. This is argued most often with respect to education.

An increase in the skill level of each U.S. worker may have a positive feedback effect that increases the produc­tivity and wage of other workers; thus, everyone will gain indirectly as the overall skill level of U.S. workers rises.

Consequently, it might be argued that all Americans benefit economically from the education of children in low-skill families. If so, it might be further argued that it is inappropriate to assign the full per pupil costs of education to children in low-skill households. But if other households benefit indirectly from the education of children in low-skill families, it is equally true that low-skill families benefit indirectly from the education of children in middle- and upper-class families. This is particularly true of the education of high-skill workers who will produce future tech­nological and managerial innovations that lead to productivity increases.

Thus, if it is true that the education of children in low-skill homes produces positive externalities that raise the incomes of more affluent families, it is equally true that the education of children in more affluent homes will produce positive externalities for low-skill households. Rather than attempting to map the reciprocal externalities of education, it appears simpler to assign the full per pupil cost of public education to the child receiving that education.

Education as a Social Investment

It is sometimes argued that the costs of public education should be "off the books" and should not be counted toward the fiscal deficits generated by low-skill households. Proponents of this view contend that publicly financed education for children in low-skill families represents a positive investment for tax­payers because it will increase the wages earned and taxes paid by those children as adults, thereby reducing the future fiscal drag (benefits in excess of taxes) that their children will impose on society.[11] Although this argument obviously has considerable merit, two caveats are in order.

First, even if public education does represent a positive investment for taxpayers, the immediate costs of that investment are real. When children in low-skill families receive public education, other families generally will pay the costs of that education and will be forced to forgo their own economic needs and wants to do so. Consequently, education costs should remain on the ledger when computing the net transfers between social groups.

Second, the potential returns to public education often appear exaggerated. When a child from a lower socioeco­nomic class receives subsidized public education, three fiscal outcomes are possible:

1. There is no increase in wages, and the child remains in the same deep fiscal deficit as his parents;
2. The child's income increases, and the magnitude of his fiscal deficit is reduced relative to that of his parents, but the child remains in fiscal deficit when becoming an adult; or
3. Education raises the child's income to the point where he becomes a positive fiscal contributor (taxes exceed benefits over a lifetime).

Simplistic accounts of the gains from education often suggest that schooling will enable children from a lower socioeconomic standing to readily achieve the third outcome. Given the regressive nature of the distribution of ben­efits and the progressive nature of taxation, this seems unlikely. On average, an individual must achieve a fairly high income to become a net fiscal contributor. This does not mean that investment in education is unwise. It simply means that society should be realistic about its expectations with respect to what education can achieve.

Conclusion

Households headed by persons without a high school diploma are roughly 15 percent of all U.S. households. Overall, these households impose a significant fiscal burden on other taxpayers: The cost of the government benefits they consume greatly exceeds the taxes they pay to government. Before government undertakes to transfer even more economic resources to these households, it should have a very clear account of the magnitude of the economic transfers that already occur.

The substantial net tax burden imposed by low-skill U.S. households also suggests lessons for immigration pol­icy. Recently proposed immigration legislation would greatly increase the number of poorly educated immigrants entering and living in the United States.[12] Before this policy is adopted, Congress should examine carefully the potential negative fiscal effects of low-skill immigrant households receiving services.

Politically feasible changes in government policy will have little effect on the level of fiscal deficit generated by most low-skill households for decades. For example, to make the average low-skill household fiscally neutral (taxes paid equaling immediate benefits received plus interest on government debt), it would be necessary to eliminate Social Security, Medicare, all 60 means-tested aid programs and cut the cost of public education in half. It seems certain that, on average, low-skill households will generate deep fiscal deficits for the foreseeable future. Policies that reduce the future number of high school dropouts and other policies affecting future generations could reduce long-term costs.

Future government policies that would expand entitlement programs such as Medicaid would increase future deficits at the margin. Policies that reduced the out-of-wedlock childbearing rate or which increased the real educa­tional attainments and wages of future low-skill workers could reduce deficits somewhat in the long run.

Changes to immigration policy could have a much larger effect on the fiscal deficits generated by low-skill fam­ilies. Policies which would substantially increase the inflow of low-skill immigrant workers receiving services would dramatically increase the fiscal deficits described in this paper and impose substantial costs on U.S. taxpayers.

Robert Rector is Senior Research Fellow in Domestic Policy Studies and Christine Kim is a Policy Analyst in Domestic Policy Studies at The Heritage Foundation. Shanea Watkins, Ph.D., is Policy Analyst in Empirical Studies in the Center for Data Analysis at The Heritage Foundation.

Appendix A: General Methodology

Introduction

This appendix documents the methods used to calculate the spending and tax figures presented in the paper. Throughout, the term "low-skill households" is used as a synonym for households headed by persons without a high school degree.

Data Sources

Data on federal expenditures were taken from Historical Tables, Budget of the United States Government, Fiscal Year 2006.[13] Data on federal taxes and revenues were taken from Analytical Perspectives, Budget of the United States Gov­ernment, Fiscal Year 2006.[14]

State and local aggregate expenditures and revenue data were taken from the U.S. Bureau of Census survey of government finances and employment.[15] Added information on state and local spending categories was taken from U.S. Census Bureau, Federal State and Local Governments: 1992 Government Finance and Employment Classification Manual.[16]

Detailed information on means-tested spending was taken from Congressional Research Service, Cash and Non­cash Benefits for Persons with Limited Income: Eligibility Rules, Recipient and Expenditure Data, FY2002-FY2004. This report provides important information on state and local means-tested expenditures from states' and localities' own financial resources as distinct from expenditures funded by federal grants in aid.[17]

Data on Medicaid expenditures for different recipient categories were taken from the Medicaid Statistical Infor­mation System (MSIS) as published in Medicare & Medicaid Statistical Supplement, 2006.[18] Data on the distribution of benefits and distribution of some taxes were taken from the U.S. Census Bureau's Current Population Survey (CPS)of March 2005 (which covers the year 2004).[19] Additional data on public school attendance were taken from the October 2004 Current Population Survey.[20] Data on household expenditures were taken from the Bureau of Labor Statistics Consumer Expenditure Survey(CEX) for 2004.[21]

Data on Medicaid expenditures in institutional long-term care facilities were taken from Medicare & Medicaid Statistical Supplement, 2006.[22] Data on the education levels of elderly persons in institutional long-term care facilities were taken from the National Long Term Care Survey (NLTCS). [23] Data on the number of individuals residing in nursing homes in the average month and the number of Medicaid recipients in nursing homes were taken from the 2004 National Nursing Home Survey (NNHS). Data on the number of individuals in other types of institutions were taken from Census 2000 Summary File 1.[24]

Count of Households

The Current Population Survey (CPS) reports some 113.15 million households in the U.S. in 2004. In addition, in the average month in 2004, some 1.65 million persons resided in long-term care facilities.[25]

These long-term care residents were not included in the population reported in the CPS; however, because these individuals are the beneficiaries of a substantial share of Medicaid expenditure, it is important that they be included in any accounting of fiscal balances and distribution. Consequently, the 1.65 million persons in long-term care facil­ities were included in the present analysis; each individual in such a facility was counted as a separate household, swelling the overall count of households from 113.15 million to 114.8 million.[26]

Calculating Aggregate Federal, State, and Local Spending

Aggregate federal expenditures at the sub-function level were taken from Historical Tables, Budget of the United States Government, FY 2007. These data are pre­sented in Appendix Table A-1. State and local aggregate expenditures were based on data from the U.S. Bureau of Census survey of government.[27]

Two modifications were necessary to yield an estimate of the overall combined spending for federal, state, and local government. First, some $408 billion in state and local spending is financed by grants in aid from the federal government. Since these funds are counted as federal expenditures, recording them again as state and local expen­diture would constitute a double count. Consequently, federal grants in aid were deducted from the appropriate cat­egories of state and local spending.

A second modification involves the treatment of market-like user fees and charges at the state and local levels. These transactions involve direct payment of a fee in exchange for a government service: for example, payment of an entry fee at a park. User fees are described in the federal budget in the following manner:

[I]n addition to collecting taxes…the Federal Government collects income from the public from market-oriented activities and the financing of regulatory expenses. These collections are classified as user charges, and they include the sale of postage stamps and electricity, charges for admittance to national parks, premiums for deposit insurance, and proceeds from the sale of assets such as rents and royalties for the right to extract oil from the Outer Continental Shelf.[28]

In the federal budget, user fees are not counted as revenue, and the government services financed by user fees are not included in the count of government expenditures. As the Office of Management and Budget states:

[User charges] are subtracted from gross outlays rather than added to taxes on the receipts side of the budget. The purpose of this treatment is to produce budget totals for receipts, outlays, and budget authority in terms of the amount of resources allocated governmentally, through collective political choice, rather than through the market.[29]

In contrast, Census tabulations of state and local government finances include user fees as revenue and also include the cost of the service provided for the fee as an expenditure.[30] The most prominent user fees treated in this manner in the Census state and local government financial data are household payments to public utilities for water, power, and sanitation services.

But market-like, user fee payments of this type do not involve a transfer of resources from one group to another or from one household to another. In addition, government user fee transactions do not alter the net fiscal deficit or surplus of any household (defined as the cost of total government benefits and services received minus total taxes and revenues paid) because each dollar in services received will be matched by one dollar of fees paid. Finally, deter­mining who has paid a user fee and received the corresponding service is very difficult.

For these reasons, this paper has applied the federal accounting principle of excluding most user fees from rev­enue tallies and excluding the services funded by the fees from the count of expenditures to state and local govern­ment finances. This means that user charges and fees were removed from both the revenue and expenditure tallies for state and local government. As noted, the inclusion or exclusion of these user fees has no effect on the fiscal def­icit figures for low-skill households presented in this paper.

Appendix Tables A-2A, A-2B, and A-2C show the deductions of federal grant in aid and user fee expenditures that yielded the state and local expenditure totals used in this analysis.

Estimating the Allocation of Direct and Means-Tested Benefits

In most cases, the dollar cost of direct ben­efits and means-tested benefits received by low-skill households was estimated by the dollar cost of benefits received as reported in the Census Bureau's Current Population Survey (CPS). One problem with this approach is that the CPS underreports receipt of most government benefits. This means that the aggregate dollar cost of benefits for a par­ticular program as reported in the CPS is generally less than the actual program expenditures according to govern­ment budgetary data.

To be accurate, any fiscal analysis must adjust for benefit underreporting. This has been done in prior studies; for example, the National Academy of Sciences study of the fiscal costs of immigration, The New Americans, made an adjustment for such underreporting.[31]

The current analysis adjusts for underreporting in the CPS with a simple mathematical procedure that increases overall spending on any given program to equal actual aggregate spending levels and increases expenditures on low-skill households in an equal proportion. Let:

Etx = total expenditures for program x reported in the CPS;

Elx = expenditures for program x for low-skill households reported in the CPS;

Ebx = total expenditures for program x according to independent budgetary sources; and

Hl = number of low-skill households in the CPS.

The share of expenditures reported in the CPS received by low-skill households would equal Elx/Etx. The actual expenditures allocated to low-skill households would be estimated to equal (Elx/Etx) times Ebx.

The average per household benefit from the program received by low-skill households would equal:

(Elx/Etx) times (Ebx /Hl)

For example, if the CPS reported that low-skill households received 50 percent of food stamp benefits and the total expenditures on food stamps according to budgetary data were $10 billion, then low-skill households would be estimated to receive $5 billion in food stamp benefits. If there were 20 million low-skill households, then the aver­age food stamp benefit per low-skill household would equal $5 billion divided by 20 million households, or $250.

The key assumption behind this underreporting adjustment procedure is that low-skill households underreport receipt of welfare and other government benefits at roughly the same rate as the general population. For example, if receipt of food stamps is underreported by 15 percent in the CPS for the overall population, the adjustment pro­cedure assumes that the sub-group of low-skill households in the CPS would also underreport food stamp receipt by 15 percent. The average level of food stamp benefits among low-skill households as reported in the CPS is then adjusted upward by this ratio to compensate for the underreporting.[32] Since there is no evidence to suggest that low-skill households underreport government benefits to the Census at a rate different from that of the general popula­tion, this procedure appears valid as an estimating technique.

Estimating the Allocation of Education Expenditures

The average cost of public education services was calculated in a somewhat different manner since the CPS reports whether an individual is enrolled in a public school but does not report the cost of education services provided. Consequently, data from the Census survey of governments were used to calculate the average per pupil cost of public primary and secondary education in each state.[33] The total governmental cost of primary and secondary schooling for each household was then esti­mated by multiplying the number of enrolled pupils in the household by the average per pupil cost in the state where the household resides.

This procedure yielded estimates of total public primary and secondary education costs for low-skill households in the CPS and for the whole population in the CPS. Adjustments for misreporting in the CPS were made according to the procedures outlined above. (This process is described more fully below.) Public costs for post-secondary edu­cation were allocated in a similar manner.

Estimating the Allocation of Medical Expenditures

There is often confusion concerning the calculation of the cost of Medicaid and Medicare benefits by the Census. The Census makes no effort to determine the costs of medical treatments given to a particular person. Instead, it calculates the average cost of Medicaid or Medicare ben­efits per person for a particular demographic/beneficiary group. For example, per capita Medicaid costs for children are very different from those for the elderly. The Census assigns the appropriate per capita Medicaid or Medicare costs to each individual who reports coverage in the CPS, according to the individual's beneficiary class: for example, elderly, children, non-elderly able-bodied adults, and disabled adults.

The present analysis uses the per capita Medicaid and Medicare costs provided by the CPS and then adjusts for underreporting according to the procedures described above. (For more details, see the specific discussion of Medi­care and Medicaid below.)

Medicaid expenditures on persons in institutional long-term care facilities require separate calculations. In the average month in 2004, some 1.65 million persons resided in long-term care facilities;[34] about 62 percent of these individuals received Medicaid assistance.[35]

Individuals in long-term care facilities are not included in the population reported in the CPS. In FY 2004, some $76 billion in Medicaid funds was spent on individuals in nursing homes and other institutional long-term care facil­ities,[36] of which nearly 60 percent was spent on Medicaid recipients without a high school diploma.[37]

Estimating the Allocation of Population-Based Services

Wherever possible, this analysis has allocated the cost of population-based services for low-skill households in proportion to their estimated utilization of those ser­vices. For example, the proportionate utilization of roads and highways by low-skill households was estimated, in part, on the basis of their share of gasoline purchases as reported in the Consumer Expenditure Survey (CEX).

When an estimate of proportionate utilization was not possible, the cost of population-based services was allo­cated on a uniform per capita basis. Some population-based services, such as airports, will be used infrequently by low-skill households; in these cases, the cost of the service for low-skill households was set at zero or at an arbitrary low level.

Estimating the Allocation of the Costs of General Government and Administrative Support Services

Allocation of the costs of general government services such as tax collections and legislative functions presents dif­ficulties since there is apparently no one who directly benefits from those services. Most taxpayers would regard IRS collection activities as a burden, not a benefit; however, while government administrative functions per se do not benefit the public, they do provide a necessary foundation that makes all other government benefit and service pro­grams possible. A household that receives food stamp benefits, for example, could not receive those benefits unless the IRS had collected the tax revenue to fund the program in the first place.

It seems reasonable to integrate proportionally the cost of government support services into the cost of other government functions that depend on those services. Following this reasoning, the expenditures for general govern­ment and administrative support have been allocated among households in the same proportions that total direct benefits, means-tested benefits, education, and population-based services are distributed among households.[38]

Estimating the Allocation of Financial Obligations Relating to Past Government Activities

Year by year, throughout most of the post-war period, U.S. taxpayers have not paid for the full cost of benefits and services provided by government. A portion of annual costs is passed on to be paid in future years.

Government costs are shifted to future years through two mechanisms. First, when government expenditure exceeds revenue, the government runs a deficit and borrows funds. The cost of borrowing is passed to future years in the form of interest payments and repayme