Loading images...
X

Welcome

This page is an attempt at graphically breaking down three elements - namely Taxes, Deficits and Entitlements - of current discussions on the state of the economy and what is to be done about it.

I am not an expert on economics. Consequently, the ideas presented are based on public data and simple logical inferences. Things are often not as simple as they seem, so you are encouraged to write to me with any corrections that you believe are necessary to make this page more accurate.

Navigation

Click anywhere on this message to dismiss it and return to the chart. When you are viewing the main chart, click anywhere on the chart to advance to the next step in the presentation.

All data in this presentation are based on figures for the year 2010, unless otherwise noted.
These are the taxes that the US government collects, excluding the payroll tax.

Why exclude payroll tax from this pie chart?

As will be explained later in this presentation, payroll taxes are collected primarily for the purpose of funding entitlement programs such as Social Security and Medicare. Here the attempt is to understand where the money collected for general government spending goes.

Don't employers pay half of FICA taxes?

FICA (Federal Insurance Contributions Act) is at times used as a short-hand term to denote the payroll taxes (that the act authorizes) that fund Social Security and Medicare.

Employers do pay half of the payroll taxes (however, this is not part of corporate tax). This is mostly a procedural matter. If employers were not required to pay an equal amount of payroll taxes as paid by the employee, then that would result in a higher paycheck and larger tax for the employee (or so it is supposed to work, in the free market).

Wait... discretionary? What's that?

In the previous section we excluded Payroll Taxes from the listed taxes because those funds are technically committed to paying for certain entitlements like Medicare and Social Security. This is why these programs are called "entitlements" - recipients are entitled to them because they have paid into these programs.

Such programs for which the government collects targeted taxes, are hence - naturally - mandatory or non-discretionary spending. The relevant taxes (FICA) and spending (Social Security, Medicare) cancel each other out for the purpose of this chart - the purpose being to find out how the government spends the money it collects in taxes, when it (the government) has a choice. Such spending is discretionary spending.

The government does use certain tricks to impact the payout of entitlement benefits, which we shall examine later in this presentation.

Defense Spending

As you can see, about one out of every two dollars that the government collects in taxes that it can spend freely, it spends on defense.

But your picture is different from this standard one:



The above is indeed the standard fare when it comes to depicting government spending. However, this gives the wrong impression that each slice of the pie is the same kind of spending as the others. But we know, from the examination of mandatory vs discretionary spending earlier, that they are not the same at all. Mandatory spending is a commitment for which the government has already collected specific taxes (and continues to do so).

To borrow the commonplace metaphor of a family's budget, mandatory spending can be seen as equivalent to the mortgage, while discretionary spending is equivalent to eating out.

In fact, my chart underrepresents defense spending. Factoring in cost of wars and other defense related costs, the share of defense outlays jumps to 58% of federal discretionary spending. See here.

Another look at where your money goes

As explained, if we ignore the payroll taxes that are returned to you in future retirement benefits, the chart to the left graphs income taxes and defense spending side by side.

To be clear, income taxes are not earmarked for defense spending. However, defense costs are paid for out of the pot into which income taxes go. And as the Taxes chart depicts, the bulk of the money in this pot come from income taxes.

To put it in numbers, we pay about 900 billion dollars in income taxes into a pot to be used by the government for discretionary spending. About 700 billion of these dollars are spent on defense.

But defense spending pays our troops!

Indeed, it does. About 23% of defense spending goes to personnel. Next we will look at where the rest of the money goes.

But where does that 73% go?

It goes to all sorts of things, including paying for current wars. A good chunk of it goes to paying corporations to build high-tech gadgets. Here are some examples from the 2011 budget (courtesy Wikipedia):

F-35 Joint Strike Fighter $11.1 billion
Ballistic Missile Defense $9.9 billion
Virginia class submarine $5.4 billion

So who gets paid to make all these machines?

And these companies are immensely profitable!

But this generates jobs! It trickles down!

All spending can generate jobs. The public works projects that were part of the New Deal, instituted by Franklin Roosevelt during the last great economic crisis (1930s), generated jobs through massive spending on development projects such as construction of dams, bridges, schools, and libraries.

It is a matter of public choice on where and how we create jobs when using public funds: building fighter jets or building schools and libraries.

At any rate, if defense money trickles down, at least some evidence points to it not trickling very far!

But what about protecting the nation?

It's worth noting here that spending on Homeland Security, the national security apparatus (NSA, NSC, so on), the FBI, foreign aid and so on - all of which aim to decrease the threats to national security from within and without - are not included in defense spending.

Despite that, if we wish to retain a military force (unlike nations like Costa Rica that have dispensed with militaries as a vestige of the 20th century), it might be instructive to compare our defense spending to that of other nations. That information is provided in the chart below.

Not only do we far outspend other nations when it comes to defense, but in fact, our spending is greater than that of the next 10 nations taken together!

Okay, we get it. Social Security and Medicare are mandatory government spending because the recipients have paid for it in prior taxes.

But I heard that Social Security and Medicare are insolvent

In lumping mandatory spending with discretionary ones many federal budget documents implicitly assign equal (or proportional) blame to all outlays when there is a deficit.

But how much do Social Security and Medicare really contribute to the current federal deficit?

The current federal deficit has nothing to do with Entitlements

Our current federal budget deficit is fairly large, about $1.4 trillion. But almost none of that is due to entitlement programs like Social Security and Medicare. Both these programs are running small deficits right now, as reported, but in the case of Social Security, that is because interest earned on the Social Security surplus is excluded from the calculation (and yes, you did read that right: Social Security funds have run surpluses in the recent past).

So then, what's the cause of the deficit? The next chart breaks that down.

But still, what about future Social Security and Medicare deficits?

Contrary to current news reports, there is no imminent crisis for entitlement programs. In fact, the projected date of exhaustion for the excess amount of $2.6 trillion that the trust holds today is the year 2036.

What happens then?

Long term prospects of Social Security and Medicare

Reports by the trustees of the Social Security Administration paint a disturbing picture when the long-term (75 year) future of these two programs is considered. The reports encourage immediate action, claiming that no plausible scenario exceeds a 95 percent confidence level for Social Security to stay solvent beyond 2050. However, the American Academy of Actuaries (as reported by FactCheck) is critical of such long-term projections:

[T]he Committee begins its analysis by noting that the results of the 75-year statutory valuation are themselves subject to extreme uncertainty. Consider the situation of actuaries or economists in the year 1928 attempting to project demographic and economic parameters 75 years into the future - to 2003. They likely would have missed the Great Depression, World War II, the baby boom, the influx of women into the labor force, etc. Nobody, no matter how intelligent or educated, could have anticipated these very significant events.

If the threat of large Social Security or Medicare deficits is alarming enough to warrant immediate action, such action can take any of a number of forms; such as an increase in payroll taxes (a hike of less than 2% can retain solvency of Social Security upto and beyond the SSA's 75-year projection). Such a payroll tax hike could be offset by tax cuts and reduced spending in other areas. Another option is to reverse the Bush tax cuts.

If we continue to spend on defense at current rates, the total amounts spent over the next 75 years on the military will far exceed the projected Social Security and Medicare deficits (should they materialise). More equitable programs like Medicaid, which offer some meagre support to those left behind in economic stratification, can benefit from the redirection of monies as well.

Links