December 3, 2003 | Backgrounder on Federal Budget
The 2003 fiscal year mercifully concluded on September 30. Reckless spending by Congress and the President made it a year in which:
This paper examines the colossal expansion of the federal government since 1998. That year, a temporary tax revenue boom brought the first budget surplus in over a quartercentury. Abolishing the budget deficit also eliminated one of the most effective arguments for spending restraint, and the spending floodgates swung wide open. By 2001, the budget surplus was quickly evaporating because tax revenues, back to their historical levels, could no longer keep pace with runaway spending. The 9/11 terrorist attacks then necessitated new spending on national security. But by that point fiscal responsibility was a distant memory, and lawmakers steadfastly refused to balance these new highpriority security costs with savings elsewhere in the budget. As 2003 closes, the nation finds itself burdened by runaway federal spending and massive looming structural budget deficits.1
Federal spending grew by 7.3 percent in 2003, slightly slower than the 7.9 percent growth rate in 2002. The slower growth rate is encouraging; yet, Chart 1 shows that government is still growing significantly faster than it did in the 1990s. In fact, the 7.6 percent average annual growth over the past two years more than doubled the 3.4 percent average annual growth from 1993 to 2001.2
The total amount of federal spending $2,156,536,000,000 is too large to fully comprehend (in $1 bills, it would stack halfway to the moon, weigh 10 times as much as the Sears Tower, and blanket the state of New Jersey). A more relatable statistic is federal spending per household, which allows families to measure the costs and benefits of government in their own lives. Throughout the 1990s, real federal spending remained slightly under $18,000 per household. From 1998 through 2003, federal spending jumped by $2,500 to reach $20,300 per household marking the first time since World War II that federal spending has topped $20,000 per household (see Chart 2 and Table 1).3
For that amount of government, Americans paid $16,780 per household in federal taxes in 2003 a staggering tax burden indeed, but only the beginning. Federal revenues are still $3,520 per household less than federal spending. That difference represents the perhousehold cost of the $374 billion budget deficit. Since all federal spending must eventually be paid for in taxes, the $3,520 per household represents higher future taxes that must be collected to fund the full $20,300 per household that Washington spent in 2003.
The reality that all spending must eventually be paid for in taxes cannot be overemphasized. Despite its current popularity, the "biggovernment conservative" model of coupling tax relief with rapid spending increases is not sustainable in the long run. If Washington continues to spend $2,500 per household more than it did in the 1990s, then taxes must eventually rise by $2,500 per household per year. Budget deficits can delay, but not ultimately avoid, the tax collector. Permanently higher levels of spending require permanently higher taxes.
Where the Money Went
Table 2 shows that real federal spending surged by $353 billion between 1998 and 2003. defense and Social Security combined for nearly half of that increase, which is not surprising given their historically large budgets. However, they did not grow as fast as other categories. For example:
Lawmakers have also substantially increased spending for air transportation (100 percent), community and regional development (92 percent), and international affairs (87 percent), but a significant portion of those spending hikes resulted from the 9/11 attacks.
The Role of defense and 9/11
Any analysis of recent spending trends must take into account the budgetary effects of the 9/11 attacks. Certainly, Americans want Washington to spend whatever resources are necessary to prevent further terrorist attacks. Lawmakers know this, which is why they have been classifying everything from levitating trains to farm subsidies as "defense" or "homeland security." A more evenhanded examination reveals that most new federal spending is not related to defense and the 9/11 attacks.
What would federal spending look like if the defense budget and all 9/11related costs were excluded? Chart 8 shows that the portion of the budget unrelated to defense and 9/11 grew by 11 percent from 2001 through 2003 the largest twoyear increase in a decade. Thus, not only did Congress and the President refuse to cut unrelated programs to fund the war on terrorism, but they also actually accelerated their growth rates. Although a convenient scapegoat, defense and other 9/11related costs do not sufficiently explain why government is expanding so rapidly.
In 2003, mandatory spending reached its highest level in United States history. After holding between $8,000 and $9,000 per household through most of the 1990s, mandatory spending surged to a record $11,144 per household in 2003, marking the first time that mandatory spending reached 11 percent of the gross domestic product.
Mandatory programs are those whose annual spending totals are not set annually, such as Social Security, Medicaid, and most welfare programs. Policymakers decide who is eligible for a program and what the benefit formula will be. For the next several years, total spending is determined by how many eligible individuals enroll in the program and where they fit in the benefit formula. Consequently, policymakers reject blame for mandatory spending trends that many of them did not vote to create. But elected officials are not forbidden from changing these spending formulas whenever they see fit. In fact, lawmakers have a responsibility to keep mandatory spending levels in tandem with the nation's evolving priorities.
Instead of pulling back these entitlement programs, Congress and the President expanded them. As stated earlier, lawmakers enacted large expansions in farm subsidies and unemployment benefits. They also failed to reform and in 2003, increased funding for Medicaid, the costs of which have jumped 45 percent since 1998. Social Security and Medicare grew by just 13 percent and 16 percent, respectively, in what is the calm before their coming budgetary storm.
The coming crisis in Social Security and Medicare is staggering. These programs will be able to finance themselves through payroll taxes until approximately 2015, when the costs of funding retiring baby boomers will overwhelm the generation still in the workforce. The tax increase needed to fund the Medicare shortfall is projected to reach $1,500 per household by 2020, and nearly $3,000 per household by 2030. Funding the Social Security shortfall will require additional taxes nearly as large as those for Medicare, and neither the payroll tax nor any of these coming tax increases will be set aside for the worker paying all the taxes. All of it will fund current retirees.
Lawmakers' solution to this coming calamity has been to pile yet another entitlement on top of these, without a plan to pay for it. The proposed Medicare drug entitlement would eventually add another $1,125 per household in additional taxes per year.5 With no entitlement reform plans close to enactment and lawmakers having agreed to anchor another unaffordable entitlement onto future generations, the 2003 record of $11,144 per household in mandatory spending may soon seem comparably inexpensive.
Even judging lawmakers solely by discretionary spending trends does not make them appear any more frugal. Since 1998, real discretionary spending has jumped 36 percent, from $603 billion to $820 billion. The half of the discretionary budget for defense and 9/11related costs has surged by 45 percent since 1998. Discretionary spending on programs unaffected by defense and 9/11 has increased 27 percent since 1998.
Chart 9 shows that nondefense discretionary spending has been rising steadily for over a decade. Throughout the 1990s, these nondefense spending increases were balanced by deep defense cuts, leaving discretionary spending levels generally unchanged. The September 11 attacks reversed the downward trend in defense spending and added new costs for homeland security, international security assistance, and rebuilding New York City. Rather than asking nondefense programs to help fund the war on terrorism by sacrificing some of their recent budget increases, lawmakers chose to ramp up the "butter" portion of the budget to match the "guns" portion. As a result, nondefense discretionary spending has reached 3.9 percent of GDP ($3,900 per household) for the first time in nearly 20 years.
The "interest Dividend"
Spending plummeted in one category. From 1998 through 2003, net interest payments on the national debt dropped from $263 billion to $153 billion. Low interest rates, due more to Federal Reserve policy rather than any deliberate congressional policy, brought the $110 billion in savings. This "interest dividend" is as large as the 1990s "peace dividend" following the end of the Cold War. The interest dividend, however, has gone almost completely unnoticed.
Taxpayers did not notice the interest dividend because they never saw a penny of it. Starting out with such an automatic and painless $110 billion spending cut gave budget cutters the wind at their back for the first time in nearly 50 years. They could have directly returned the interest dividend to the taxpayers with a $1,035 per household tax cut, or they could have used these onceinalifetime savings to restrain the growth of government and pay down the national debt.
Instead, Congress and the President allocated all $110 billion to new spending and, when that money ran out, spent $353 billion more on top of it (making the actual increase in programmatic spending $463 billion, rather than $353 billion, as Chart 10 shows). Lawmakers acted like a shortsighted employee who responds to an unexpected $1,000 bonus by immediately going on a $4,500 shopping spree, thus ending up $3,500 in debt.
Worse, the interest dividend is likely only temporary. As interest rates rise to normal levels, net interest costs will probably return to their 1998 level. The budget deficit would automatically increase by approximately $100 billion, with no new government benefits to show for it.
Nowhere to Cut?
Several lawmakers have asserted that all new spending is driven by necessities and that no programs could be cut without calamitous consequences. These lawmakers typically emphasize essential spending on defense and homeland security, as well as popular spending on education, health, and unemployment benefits. In reality, Congress and the President are throwing vast sums of money at all types of programs. Lawmakers could easily save taxpayers over $150 billion per year by eliminating:
Furthermore, Congress and the President have not even been able to say no to the lowerpriority programs in Table 3. Every dollar spent on these programs represents one less dollar for tax relief, national security, or deficit reduction.
The Consequences Of Unrestrained Spending
Increased government spending weighs down the economy and requires taxes that hinder working families' ability to make ends meet. A growing economy requires a base level of government spending on defense and justice to enforce the property rights and rule of law necessary for markets to function. Public goods, such as roads, are often important for facilitating trade and aiding economic growth. Yet, they can be difficult for the private sector to provide without at least minimal government oversight. In such cases, limited government involvement can aid economic growth.
Contrary to the fallacy that government spending stimulates the economy, government spending beyond this base level impedes economic growth for three reasons:7
In addition to their high cost, taxes hurt the economy by distorting incentives. Families and businesses work, save, and invest because they expect a financial reward. These productive behaviors also make the rest of the nation wealthier by creating additional economic activity. But burdensome tax rates reduce the financial reward for being productive. Consequently, families and businesses cut back their productive behavior to escape taxes, and the entire economy slows down.
To see the consequences of excessive spending and taxation, one need look no further than Western Europe, where politicians have promised to provide for all of their citizens' needs in exchange for higher taxes and bigger government. Western Europeans have incomes 40 percent below Americans' and unemployment rates twice as high. They also pay 50 percent of their income in taxes.
Budgets are about setting priorities. Each day, millions of households find ways to live within their means. All of them would surely like to spend more money than they have; yet, they understand that separating necessities from unaffordable luxuries, even making unpleasant sacrifices, is required to stay out of the red.
Congress and the President have lacked that belttightening discipline. As new spending requirements have emerged, they have refused to set priorities and make sacrifices in programs less vital to the national interest. This lack of discipline has raised the cost of government to over $20,000 per household for the first time since World War II. In the absence of responsible spending restraint, the economy will struggle under the weight of excessive taxes and runaway federal spending.
Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
1. Unless otherwise noted, all spending totals are in inflation-adjusted 2003 dollars. Calculations were made using data provided by the Office of Management and Budget and the U.S. Department of the Treasury.
4. These short-term growth rates are in nominal dollars. See Brian M. Riedl, "Most New Spending Since 2001 Unrelated to the War on Terrorism," Heritage Foundation Backgrounder No. 1703, November 13, 2003, at www.heritage.org/Research/Budget/BG1703.cfm.
5. See Brian M. Riedl and William W. Beach, "New Medicare Drug Entitlement's Huge New Tax on Working Americans," Heritage Foundation Backgrounder No. 1673, August 13, 2003, at www.heritage.org/Research/HealthCare/bg1673.cfm.
7. This three-category breakdown of the side effects of government spending is from James Gwartney, Robert Lawson, and Randall Holcombe, "The Size and Functions of Government and Economic Growth," Joint Economic Committee, U.S. House of Representative and U.S. Senate, April 1998.
8. Milton Friedman, winner of the Nobel Prize in economics, has argued persuasively that individuals, because they are spending their own money and not someone else's, have better incentives to spend efficiently than do governments. Consequently, allowing families to spend their own money on items such as education and health care will be more effective than having governments tax these families in order to purchase the services for them.