Washington: Where Does the Money Go?

After an election season filled with the usual promises and grand plans, Americans surely need a dose of reality. Some such grounding might emerge from a hard look at how Washington actually spends the taxpayer’s money. The effort, whatever else is turns up, will lead to one inescapable and troubling conclusion: Entitlements – Social Security, Medicare, Medicaid, unemployment insurance, and upcoming outlays under the Affordable Care Act – already overwhelm the budget, and will soon reach proportions sufficient to squeeze out most other spending priorities, whatever candidates, presidents, senators, congress people, and bureaucrats say.

According to the White House’s most recent budget, entitlements already constitute some 70 percent of all federal spending. At 15 percent of the gross domestic product (GDP), more than one dollar in seven of the income generated from everything this country produces gets paid out in one or another of these programs. They have risen inexorably over time, absolutely and as a proportion of the economy, more than tripling proportionally from some 3.4 percent of GDP and 30 percent of the budget in the 1950s.

If President Obama’s rhetoric seems to approve of the trend, his budget plans to break this powerful momentum and hold the proportions spent on entitlements about steady for the next five years. It is an ambitious objective, indeed, given the historic record and the inevitable increase in claims on the federal purse as the Affordable Care Act goes into effect. It is so ambitious, in fact, that it is highly unlikely. The old trend will almost certainly prevail, unless Washington scotches 60-plus years of practice and turns to substantive entitlements reform.

This kind of continuous, rapid relative growth cannot help but impose on other spending priorities. And because the defense budget has shrunk relatively over time, that competition for financing within the budget will only grow more intense. The Pentagon’s share is key in this equation. Though important questions remain on how much the nation should spend on defense, what has happened is clear. The military’s relative take has declined relentlessly for a long time, falling from half of all outlays and almost 10 percent of GDP at the height of the Cold War to just under 3.0 percent of GDP by 2000 and about 16.5 percent of the budget. Pentagon outlays did rise with the War on Terror, but, even then, they topped out at 3.8 percent of GDP, hardly a bump on the long downtrend. Whatever the reasons for it, this relative decline has effectively buffered other federal priorities from the demands of entitlements.

In his budget, the president calls for even larger defense cuts. His figures would reduce actual outlays for the Pentagon 3.0 percent a year over the next five years, pushing spending again below 3.0 percent of GDP. Given the drift of world events, especially in the Middle East, it is unlikely that White House plans in this regard will work out. Even if they did, defense by now has shrunk so far as a portion of the budget that substantive percent cuts there can no longer offset the impositions on the rest of the budget from continued increases in entitlements outlays. These will impinge increasingly on just about everything else, including research and development, the refurbishment of infrastructure, that sort of thing.

Rising interest expenses will compound the pressure. Until now, very low interest rates have held down the burdens imposed by Washington’s obligation to make interest payments on outstanding government debt. Such expenses amount to a mere 0.8 percent of GDP and only some 6.1 percent of all federal spending, well down, for example, from the 1980s, when they constituted 3.0 percent of GDP and 14.0 percent of the budget. But interest rates cannot remain as low as they are indefinitely. The Federal Reserve has already stated its intention to push them upwards. The White House, to its credit, recognizes this reality and expects interest expenses to rise over the next five years to 2.5 percent by GDP and 11.6 percent of all federal outlays. That will eat up any relief even in the unlikely event that defense cuts go forward. Other areas of the budget will have to cope with the greater demands of entitlements.

This combination of effects – from defense, entitlements, and interest expenses – should easily bring the overall economic burden of the federal government up from 21.3 percent of the economy presently to closer to 25 percent. It will then exceed even the 24.4 percent of GDP it reached in the emergency recession year 2009. At such a high, Washington will have a tough time asking the economy for more, however worthy the project, while at the same time, the unavoidable arithmetic of ever-expanding entitlements spending will force everything else government does to subsist on budgetary crumbs. Even in the unlikely event that defense spending were cut in half, it would only buy a few years before Washington would again face this pressure. Without serious entitlements reform, then, Washington and the American public will find themselves trapped increasingly in a financial box.

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