Government Taxation, Spending, and Debt

Taxation

There are three main sources of federal tax revenue: individual income taxes, payroll taxes, and corporate income taxes. Individual income taxes accounted for just over half of all federal revenues in 2021. After this was payroll taxes at 31 percent, followed by corporate income taxes at nine percent. The remaining nine percent includes excise taxes, the estate tax, customs duties, and other taxes and fees.

Individual income taxes, which totaled about $2 trillion in 2021, come out of your paycheck. The amount of income tax you pay is determined by seven different tax brackets with rates of 10, 12, 22, 24, 32, 35, and 37 percent respectively. The more money you make, the higher a tax bracket you fall into. The range of each bracket varies depending on whether you file as single, married, or head of household. 

These tax rates are also marginal, which means that you only pay the percentage that falls into each range of your income as you move higher up the list of brackets. For example, for single filers, the first bracket taxes all of their income between $0 and $9,950 at 10 percent. For example, let’s say you have $10,150 in taxable income. The first $9,950 of your income is subject to the 10 percent rate. After that, only the remaining $200 is subject to the tax rate of the next bracket (12 percent). This way, you are not punished with a higher tax rate for having a higher income. Even someone making $1 million still only pays 10 percent on their first $9,950, then 12 percent, 22 percent, and so on all the way up to 37 percent.

In most cases, filing as married or as head of household when possible will give you an advantageous tax rate. Single people who don’t have a spouse or child or dependent, however, must file as single. 

Payroll taxes go to fund Social Security and Medicare. You’ve probably seen these on your paycheck, where half of the tax is typically paid by your employer, and the other half by you. 

The portion of these taxes dedicated to Social Security goes to two trust fund accounts: the Old Age and Survivors Insurance Trust Fund (OASI) and the Disability Trust Fund (DI). These accounts provide workers and their families with retirement, disability, and survivor's insurance benefits.

Like Social Security, Medicare has two accounts that are funded by payroll taxes: the Hospital Insurance Trust Fund (HI), also known as Medicare Part A, and the Supplementary Medicare Insurance Trust Fund (SMI). These accounts provide funds for hospitals, home health, skilled nursing, and hospice care for the elderly and disabled.

Payroll taxes as a whole are regressive. This means they collect a higher percentage of total earnings from lower-income workers than from higher-income ones. That said, if one steps back and looks at the big picture of benefits provided as well as taxes collected for Social Security, Medicare, and unemployment insurance, these programs are progressive and benefit lower-income workers more. 

Finally, corporate income taxes, as their name suggests, are collected from corporate profits. This revenue source has been trending downward in recent years due to changes and reforms to the tax code. 

The federal tax code has both progressive and regressive components, but overall it is progressive. According to estimates from the Tax Policy Center, in 2020 the lowest-income 60 percent of households paid about 8 percent of their incomes in federal taxes, while the top 1 percent paid 30 percent, on average. Whether this is enough to address wealth inequality or fair to those in the highest income brackets is a subject of intense debate and disagreement in American politics across both sides of the political spectrum.

Spending

In total, the federal government spent $4.829 trillion in fiscal year 2021. That’s down from the $6.6 trillion it spent the year before (which was a historic high due largely to relief measures in response to the Covid-19 pandemic). Aside from 2020, however, the current budget is as large as it’s ever been. 

In the ten years leading up to the 2008 Great Recession, the government kept federal spending below 20 percent of gross domestic product (GDP). GDP is the sum of all goods and services produced within a nation’s borders. It grew at roughly the same rate as the economy, two to three percent every year. During the recession, however, spending jumped to a record 24.4 percent of GDP in 2009 even as economic growth slowed. Congress managed to trim spending back down to 20.4 percent of GDP in 2015. But since then spending has risen every year and shows no signs of slowing down. 

Federal government spending is composed of three broad categories: mandatory spending, discretionary spending, and interest payments. 

Mandatory spending is by far the largest piece of the budget “pie,” costing $2.97 trillion in 2021. It is composed of outlays for Social Security benefits ($1.2 trillion), Medicare ($722 billion), and Medicaid ($448 billion), as well as outlays for income support programs like food stamps, Unemployment Compensation, Child Nutrition, Child Tax Credits, Supplemental Security Income, and Student Loans ($645 billion). 

Discretionary spending totalled $1.485 trillion in 2021. It covers everything else other than interest payments. Each year Congress decides how much to appropriate for these programs. Mandatory spending levels are enshrined in law, so discretionary spending is the only thing Congress can cut – outside of passing reforms.

The most significant chunk of the discretionary budget is defense spending. Taken all together, the budgets of the Defense Department, Overseas Contingency Operations, and all the other departments that support national security add up to $915 billion. 

Nondefense spending includes outlays for programs related to transportation, education, veterans’ benefits, health, housing assistance, and other activities. The largest of these is Health and Human Services, which at $88.5 billion is about one-tenth of total military spending.

Lastly, interest payments are outlays that service the national debt. In 2021, the total cost of these payments was about $378 billion. Interest payments aren’t technically a mandatory program, but they must be paid to avoid a U.S. debt default, which almost everyone agrees would have a catastrophic effect on the economy and the government’s ability to borrow more money. The cost of interest payments to simply keep up with the national debt is projected to nearly double to $665 billion within the next ten years.

The National Debt

Almost every year, the United States government spends more than it takes in from tax revenues. To make up the deficit, the government must borrow money. The total amount of debt accumulated by these annual budget deficits is called the national debt. It refers to the total sum of money the federal government owes its creditors. 

There are two ways to calculate the national debt. First is the total amount of money owed. As of Nov. 29, 2021, this figure was $28.9 trillion. A more telling way to measure it, however, is as a percentage of the country’s GDP. If a country’s economy grows, the revenues it collects to pay for its debt grows as well. If the debt-to-GDP ratio is increasing, however, that is a sign that it is on an unsustainable path.

Put another way, a country's ability to pay off its debt (and the effect that debt could have on the economy) depends more on how large the debt is relative to the overall economy, not the total dollar figure. 

One of the concerning trends in America is that the national debt as a percentage of GDP has risen dramatically over the past 15 years, jumping from about 62 percent at the end of 2006 to 125 percent midway through 2021. Prior to the onslaught of the Covid-19 pandemic, that figure was 108 percent.

The U.S. Treasury Department finances the deficit by issuing Treasury bills, notes, and bonds. These products borrow from investors – both domestic and foreign – and are sold to corporations, financial institutions, and other governments around the world. 

Currently the public holds about $22 trillion of the national debt. Of that, a minority is owned by foreign governments, most notably Japan ($1.32 trillion) and China ($1.07 trillion). The rest is owned by U.S. banks and investors, the Federal Reserve, state and local governments, mutual funds, pensions funds, insurance companies, and savings bonds. 

The rest of the national debt, more than $6 trillion, is actually intergovernmental debt. This is money that the government owes itself. Some agencies, most notably the Social Security Trust Fund, take in more money from taxes than they need. Rather than stick all these surpluses under a giant mattress, these agencies invest in U.S. Treasurys. 

The biggest and most consistent drivers of the national debt are predictable structural factors: the aging baby-boomer generation, rising healthcare costs, and a tax system that has been cut in recent decades and does not raise enough revenues to pay for what the government has promised its citizens through entitlement programs like Social Security and Medicare.

There are many possible consequences to growing the national debt that could affect average Americans. One of these is that it increases the risk of the government defaulting on its debt, which many experts say would trigger a shift in federal expenditures that will cause people to experience a lower standard of living. Another possible consequence is an increased cost to borrow money brought on by the yield offered on Treasury securities increasing. This increase in interest rates would push home prices down, reducing the net worth of all homeowners. 

To reduce the debt, the government has a variety of tools at its disposal, some of which historically work better than others. Since America has its own currency, it can simply print more money to pay off debt, a process known as debt monetization, but this can only be done so much before an economy begins experiencing damaging rates of inflation. Other more straightforward measures include cutting spending or raising taxes. Both of these options come with political difficulties, however, and can potentially hamper the economy. 

There is much debate over how much national debt is sustainable and what – if anything – should be done about it. The consensus from many experts, including the nonpartisan Government Accountability Office, is that policymakers will need to make changes to the “entire range of federal activities, both revenue (including tax expenditures) and spending (entitlement programs, other mandatory spending, and discretionary spending).” In other words, every option for reform should be on the table. Given how great of a gap there is between the government’s current debt-to-GDP ratio and a more sustainable target, the GAO says, significant changes will need to be made.