Budget and Spending
The Issue
Federal spending in fiscal year (FY) 2011 reached $3.6 trillion, an all-time record. When adjusted for inflation, spending is more than three times its peak level in World War II ($1.17 trillion in constant 2011 dollars), and it now consumes nearly 25 percent of total economic output (as measured by gross domestic product, or GDP), a post–World War II record. This spending drains away resources that could otherwise contribute to economic growth and is the principal cause of today’s unprecedented budget deficits. But the problem is not only the excess of spending over revenue. Equally important is the trajectory of spending: It is on an unsustainable path that risks disaster for America. While some of this spending is a temporary result of the recession and financial crisis, the current Administration has seized every opportunity to rationalize permanently higher spending, new programs, and an expanded role for government.
The source of this crisis is bipartisan. Generations of politicians from both political parties have invited millions of Americans into greater dependence on the government, promising expensive services without regard to cost, efficiency, or—most important—the proper size and role of government.
The three major entitlement programs—Medicare, Medicaid, and Social Security—account for 43 percent of federal spending, or 10.3 percent of GDP. In the coming decade, each of these three programs will expand much faster than inflation and more rapidly than the entire economy: Social Security will grow by an estimated 5.8 percent per year, Medicare by 6.3 percent, and Medicaid by 9 percent. They will surge from 10.3 percent of the economy to almost 20 percent in just 40 years. To honor in full the promised benefits for just Social Security and Medicare, the government would need to set aside and invest almost $46 trillion of Americans’ tax dollars today to cover the long-term shortfall.
Since 2000, spending has grown across the board. Discretionary spending has expanded much faster than inflation as a result of large war and domestic spending hikes. Other areas receiving large increases since 2000 include: anti-poverty programs (89 percent faster than inflation); K–12 education (219 percent); veterans spending (107 percent); and Medicare (81 percent). Simply put, all parts of government are growing.
Last summer’s debt ceiling showdown produced some initial steps toward getting spending under control—if Congress follows through. But much more is needed. Restoring the nation’s fiscal and economic health requires two fundamental qualities: (1) the will to address the spending issue head-on and start making the tough decisions now and (2) a sustained, long-term commitment to reducing the size and scope of government so that the American economy can prosper.
Recommendations
- Cut spending now and enact spending caps. Congress should begin by repealing Obamacare and the Troubled Asset Relief Program (TARP) and reject further “stimulus,” which has failed to boost the economy or promote job creation and only adds to the dead-weight burden of government spending. In the absence of a constitutional requirement to balance the budget, Members of Congress should reduce spending to at least the levels in the House-passed 2012 budget. This is the only way Congress can force itself to reassess priorities and begin realigning government responsibilities in accordance with the concept of federalism that underlies the Constitution. Beyond this, Congress should enact a firm cap that will bring government spending down to affordable levels. This cap should include enforcement protections to prevent lawmakers from sidestepping the limit.
- Reject tax hikes and aggressively pursue growth-oriented tax reform. There is a growing consensus that a simpler, flatter tax code—one with fewer, lower marginal rates, few if any deductions or exemptions, and a broader tax base—is one of the best ways to promote growth. Heritage favors an even bolder approach with a single rate on non-saved income. In any case, as long as government must tax, it should do so with the least possible burden on and interference with free market choices. Until such a reform is adopted, Congress should retain the 2001 and 2003 tax rates and continue to reject tax increases. Raising taxes only eases the pressure to bring spending truly in line.Furthermore, higher taxes on small businesses and on investment capital weaken the economy under all circumstances. Revenue will grow when the economy grows, and higher spending and taxes will only stifle the process. The most effective way to spur economic recovery is to increase the incentives that drive growth. Especially important are the lower capital gains tax rates, which actually increased capital gains tax revenue in the years after the 2003 tax cut apart from their other positive externalities for the rest of the economy.
- Reform entitlements. The costs of Medicare, Medicaid, and Social Security are on course to overwhelm the federal budget by $46 trillion. Every year of delay raises the cost of reform and gives near-retirees less time to adjust their retirement strategies. Lawmakers should restructure these programs by changing the incentives that drive their excessive spending. Then Congress should take these programs off autopilot and set a 30-year budget for each major entitlement with an obligation to adjust the programs as necessary to keep each within budget and protected from insolvency.
- Empower the states and the private sector. Throughout the 20th century, the federal government’s domestic activities expanded well beyond what the Founders envisioned, leading to ever more centralized government, smothering the creativity of states and localities, and pushing federal spending to its current unsustainable levels. Washington taxes families, subtracts a hefty administrative cost, and sends the remaining revenues back to state and local governments with specific rules dictating how they may and may not spend the money.Instead of performing many functions poorly, Congress should focus on the limited set of functions intrinsic to the federal government’s responsibilities. Most highway, education, justice, and economic development programs should be devolved to state and local governments, which have the flexibility to tailor local programs to local needs. Government ownership of business also crowds out private companies and encourages protected entities to take unnecessary risks. After promising profits, government-owned businesses frequently lose billions of dollars, leaving taxpayers to foot the bill. Any government function that can also be found in the yellow pages may be a candidate for privatization.
- Reform the federal budget process. The federal budget’s focus on just 10 years ahead diverts lawmakers from dealing with the mounting long-term challenges, such as retirement programs. Likewise, the lack of firm budget controls and enforcement procedures makes fiscal discipline very difficult. Reforming the budget process is therefore an implicit part of reforming the budget itself. Congress should estimate and publish the projected cost over 75 years of any proposed policy or funding level for each significant federal program. Any major policy change should also be scored over this long-term horizon. In addition to calculating the costs of proposed congressional actions without regard to the economy’s response to those actions (known as “static” scoring), the government should require a parallel calculation that takes that response into account (known as “dynamic” scoring) to make more practical and useful fiscal information available to Congress when it decides whether to pursue certain actions.Although Congress must make substantial cuts in current and future spending, it must not compromise its first constitutional responsibility: to ensure that national defense is fully funded to protect America and its interests at home and around the globe.
Facts & Figures
- Since 1965, government spending per household has grown by nearly 162 percent, from $11,431 in 1965 to $29,401 in 2010. From 2010 to 2021, it is projected to rise to $35,773, a 22 percent increase.
- Over the past few decades, middle-income Americans’ earnings have risen only 27 percent while government spending has increased 299 percent.
- This past year, more than 40 cents of every dollar Washington spent was paid for with borrowed money.
- President Obama’s proposed FY 2012 budget does little to tackle the root causes of the massive increases in federal spending, as it reserves 58 percent of the budget for entitlement programs. The budget failed by a vote of 97–0 in the Senate.
- To pay off the current debt and future unfunded costs from entitlements, each working American and each of his or her children would owe more than $200,000.
Selected Additional Resources
- Stuart M. Butler, Alison Acosta Fraser, and William W. Beach, eds., Saving the American Dream: The Heritage Plan to Fix the Debt, Cut Spending, and Restore Prosperity, Heritage Foundation Special Report No. 91, 2011.
- Alison Acosta Fraser, “How to Fix the Federal Budget,” Heritage Foundation WebMemo No. 3174, March 1, 2011.
- The Heritage Foundation, “The Checklist,” Heritage Foundation Solutions for America, November 3, 2010.
