Government spending - History of Business in the U.S.
Definition: Expenditures by federal, state, and local governments
Significance: In addition to its impact on the entire economy, spending by government provides attractive opportunities and subsidies for numerous businesses. Such spending, however, requires revenue that is acquired either by taxation or borrowing, both of which reduce the funds available for private-sector investments. Taxes, moreover, are levied on businesses’ profits and property.
In the United States, government spending occurs at the levels of the national, state, and local governments. As in other modern democracies, public expenditures since the 1930’s have grown substantially more rapidly than the economy as a whole. Not unexpectedly, spending has grown the most dramatically in those program areas that have the greatest appeal for the majority of voters, particularly social programs such as Social Security, Medicare, and Medicaid. In the private sector, the incomes of Americans are quite unequal, but in the political arena, where each citizen has one vote, power is somewhat more evenly distributed. Americans possessing great wealth are outnumbered by those with moderate and low incomes, and on election days, there is a strong tendency for people to vote for candidates and issues according to their perceptions of their particular economic interests. These perceptions may be influenced by advertisements and other forms of political speech available only to the wealthy or to collectively wealthy entities.
Although businesses in the private sector usually express a desire for low taxes, they also demand a variety of services. Because businesses have such different interests, they are unable to present a united front on the issue of government spending. A significant number of industries can exist only by selling their goods and services to government. This is particularly true of those that provide products and research for the military-industrial complex, which President Dwight D. Eisenhower helped name in a cautionary speech delivered as he left office. Producers of agricultural products, both family farms and large agribusinesses, constitute a large sector that is heavily dependent on government subsidies. Many construction firms contract with governments to build roads and public buildings. In the movement toward privatization, moreover, private businesses operate prisons in several states, and some even provide quasi-military operations in Iraq and other areas of conflict.
Growth in Spending
Because of economic growth and inflation over the years, the most significant indicator of government spending is its percentage of the gross domestic product (GDP), which refers to the total amount of money spent on goods and services in the country. Official, nonpartisan statistics since 1929 are available from the Bureau of Economic Analysis, an agency of the U.S. Department of Commerce.
For 150 years, from the time of George Washington until the early 1930’s, government’s share of the economy during peacetime was relatively small and stable. In 1929, spending by the national government was only 2.5 percent of GDP, and total spending by national, state, and local governments totaled about 7.7 percent of GDP. Because the functions of government were very limited, regulatory agencies were few in number, and they did not require large bureaucracies. Although the national government provided modest retirement benefits for veterans, public officials, and civil service employees, it sponsored no general entitlement programs such as Social Security. Americans did not perceive any great threat from abroad, and except for the years of the U.S. Civil War and World War I, the cost of maintaining an army and navy made up a small part of the small national budget.
Government spending, especially at the national level, really began to take off as a result of the Great Depression of the 1930’s. Between 1929 and 1932, federal expenditures grew only modestly, from $2.6 billion to $3 billion, but the GDP declined dramatically, from$103.4 billion to $58.7 billion. As a result, the federal government’s percentage of GDP went from 2.5 percent to 5 percent by the election year of 1932. From1933 to 1938, Congress enacted a host of New Deal programs aimed at the so-called three R’s: relief, recovery, and reform. The programs included public works for the unemployed, subsidies for farmers, numerous business regulations, and entitlements under the Social Security Act. By 1938, the year when the last major New Deal laws were passed, spending by the national government had grown to 8.4 percent of GDP. It was only after 1940, when monthly payments of the Social Security retirement plan began, that the long-termcosts of the New Deal really began take effect.
During World War II, defense expenditures exploded, going from 2 percent of GDP in 1940 to almost half of GDP in 1945. As a result, the total national debt increased from 43 percent of GDP in 1940 to about 120 percent in 1946. Following the war, defense spending came down to 7 percent of GDPin 1947. Other spending also declined, but not to prewar levels. In 1947, federal spending made up 15.3 percent of GDP, whereas the total of federal, state, and local spending represented 19.9 percent ofGDP. Because of the ColdWar, combined with the growth of Social Security and other domestic programs, federal spending by this time was almost equal to the amount spent by state and local governments combined. By the end of the century, federal spending would be almost twice asmuchas state and local expenditures.
The next big jump in government spending occurred during the 1960’s, primarily as a result of Lyndon B. Johnson’s Great Society programs, particularly Medicare, Medicaid, and federal subsidies for education. In subsequent years, additional social programs—such as Supplementary Security Income (SSI), the Cost of Living Adjustment (COLA), and the Earned Income Tax Credit (EITC), among others—further expanded spending, especially by the federal government. Thereafter, an increasing percentage of the budget involved the transfer of income from one group to another. In 1929, transfer programs represented only about 3 percent of all government expenditures, but by 2004, they had increased to almost 44 percent. Defense spending, in contrast, sharply declined, falling from13.8 percent of GDP in 1953 to 6.3 percent in 1988.
Between 1980 and 2007, total government expenditures at all levels remained fairly stable as a percentage of GDP. In 1980, federal spending totaled $591 billion, which constituted 21.6 percent of the GDP (which stood at about $2.8 trillion). In 2007, the federal government spent $2.9 trillion, which represented some 22 percent of GDP (which had grown to $13.8 trillion). Total government spending that year was $4.6 billion, about 33.3 percent of GDP. Because of the aging of the population, however, many financial experts predicted that paying for entitlement commitments, especially Medicare and Medicaid, would become difficult by the third decade of the century.
Government spending is divided into three major types: purchases of goods and services for current use; purchases of goods and services intended to provide future benefits, as in entitlements and research; and transfer payments, as in Social Security and antipoverty programs. Government spending is also separated into discretionary and mandatory spending. Discretionary spending, which makes up about one-third of federal spending, applies to components such as national defense, education, and highway projects. Each year, Congress has the option of determining how much money to spend on these programs. Programs with mandatory spending, which accounts for two-thirds of government spending, are authorized by permanent laws. They include entitlements like Social Security, Medicare, and Medicaid, in which individuals receive benefits based on age, income, or other criteria. Spending levels for these programs depend on how many people qualify for the benefits.
The federal government’s fiscal policies—which include policies governing taxes, expenditures, and borrowing—have a profound impact on the economy. Early each year, the president, working with the Office of Management and Budget (OMB), presents a proposed budget to the Congress, which has the constitutional authority to approve, reject, or change the various proposals. Surpluses, which occur when revenues are greater than expenditures, have been rare since the 1930’s. Deficits, which occur when expenditures exceed revenues, become a part of the national debt.
Keynesian economic theory, named after British economist John Maynard Keynes, has been the dominant liberal paradigm since the 1930’s. The theory is based on the premise that government can help maintain growth and stability within a mixed capitalistic system. Because the aggregate demand for goods tends to be insufficient in periods of recession or depression, the result is a growth in unemployment and a loss of potential output. Keynes therefore emphasized that government spending, even if it results in a deficit, should be increased during downturns to expand aggregate demand, thereby stimulating economic activity and reducing unemployment. The theory suggests that government spending might be reduced during periods of prosperity. Experience has demonstrated, however, that it is easy for government to increase spending at any time, but that reductions are always difficult to achieve. For this reason, some economics view Keynes’s theory on stimulation as a valid guide for periods of slowdown but irrelevant in good times.
A significant number of economists, especially those with conservative tendencies, do not agree with Keynes’s theories. Libertarians, distrustful of governmental meddling in the economy, generally advocate minimal public spending under all circumstances. Milton Friedman, the most influential libertarian economist of the second half of the twentieth century, opposed the use of fiscal policy as a tool to manage aggregate demand. His school of economic thought, called monetarism, holds that a stable supply of money is the key to obtaining longtermprosperity. A related theory, called supply-side economics, developed by economist Arthur Laffer, holds that when too much of the nation’s income is collected in taxes, the inevitable consequence is too little money left for purchases and investments in the private sector. Although proponents of supplyside theory focus on taxes much more than on spending, experience has forced them to admit that tax reductions will require some restraints in spending to prevent huge deficits.
Deficits and Debt
Economists sharply disagree about the extent to which deficit spending and the resulting national debt are problems. It is difficult to deny, nevertheless, that large deficits have two negative results: They tend to promote inflation, and paying for the interest on the resulting debt limits the money available for other purposes. The majority of economists, therefore, advocate avoiding deficits, except during periods of economic slowdown.
From the end of World War II until the 1980’s, budget deficits were usually less than 2 percent of GDP, and as a result the national debt, as a percentage of the GDP, significantly declined. During the 1980’s, however, because of increases in defense spending without comparable reductions in other areas, the deficit rose to between 3 and 5 percent of GDP, so that the national debt, which stood at $909 billion in 1989, grew to $2.87 trillion in 1989. During the early twenty-first century, tax reductions combined with the War on Terrorism again expanded the national debt. By the end of 2007, the national debt, which was slightly more than $9 trillion, equaled 66 percent of GDP.With growing entitlement commitments from retiring baby boomers, some economists predicted that annual federal deficits by the mid-twenty-first century would perhaps grow to 9 percent of GDP.
Bittle, Scott, and Jean Johnson. Where Does the Money Go? Your Guided Tour to the Federal Budget Crisis. New York: HarperCollins, 2008. Compelling and straightforward analysis of fiscal policies, warning against the harmful consequences of large deficits.
Konigsberg, Charles. America’s Priorities: How the U.S. Government Raises and Spends $3 Billion. Bloomington: AuthorHouse, 2008. Clearly written and informed guide to the complexities of the federal budget, finding that the growth rate of entitlement programs must be reduced.
Peterson, Peter G., and Neil Howe. On Borrowed Time: How the Growth in Entitlement Spending Threatens America’s Future. Washington, D.C.: Resources for the Future, 2004.Warns that if major reductions are not made in entitlement benefits, the nation will face catastrophe in the years after 2018.
Rubin, Irene. The Politics of Public Budgeting: Getting and Spending, Borrowing and Balancing. Washington, D.C.: CQ Press, 2005. Considers federal, state, and local budgeting within a comparative framework, with the thesis that short-term partisan goals often trumplong-termpublic interest;
Schick, Allen. Federal Budget: Politics, Policy, Process. Washington, D.C.: Brookings Institution Press, 2007. Explains budgeting at each stage of executive and legislative action, and assesses how the budget effects social issues.
Wildavsky, Aaron, and Naomi Caiden. The New Politics of the Budgetary Process. 5th ed. New York: Longman, 2004. Standard textbook arguing that budgetary decisions are based on power, with separate chapters on entitlements, defense, reforms, and deficits.
Yarrow, Andrew. Forgive Us Our Debts: The Intergenerational Dangers of Fiscal Irresponsibility. New Haven: Yale University Press, 2008. Discussion of how Social Security, Medicare, and other programs have increased the federal debt, warning of harmful effects if spending is not brought under control.
See also: U.S. Congress; Constitution, United States; Federal monetary policy; U.S. Presidency; United States Department of the Treasury.