Understanding the federal budget through your paycheck

What does the federal budget have to do with your paystub? Quite a bit, actually…. The average American household pays about $30,000 a year in taxes to support government-funded programs that have a direct effect on our lives. We all have a huge stake in our country’s fiscal sustainability, yet few people understand what these programs are or how they affect the economy and our own financial circumstances—now and in our future.

Most Americans don't realize what their own earnings and payroll deductions have to do with government spending and financing. We're here to change that. Learn how much the average American contributes to military spending each year, how much you can expect to receive in Social Security benefits, and more.
This line shows taxes that fund Medicare, the second-largest federal spending program, which provides subsidized medical care for the elderly.
This line shows taxes that fund Social Security, the largest federal spending program, which pays benefits to retired and disabled workers and their families.
These are income taxes withheld from your paycheck, based on your expected annual wages and salaries adjusted for certain exemptions and deductions.
These are taxes withheld for state-level personal income taxes.
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Most families have monthly budgets but know little about where their tax dollars are spent.

We want you to understand what's at stake when policymakers in Washington debate over government tax and spending policy. Let's start by looking at what your tax dollars "buy" in terms of different types of government programs.
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Lesson 1:

Government Spending

The federal taxes we pay go toward many different categories of federal government spending. Besides the fact that these taxes come out of our paychecks, the government-provided goods, services, and programs themselves affect our lives, both directly and indirectly.

Where does the government spend its money?

The many different types of federal government spending can be separated into three major categories: mandatory spending, discretionary spending, and net interest.

  • "Mandatory" spending is government spending where permanent laws establish what’s spent; these programs are essentially on "auto pilot" unless the laws are changed.
  • On the other hand, Congress must vote to approve the items under “discretionary” spending each year. So this is spending that can change from year to year, without a change in existing laws.
  • “Net interest” is like regular old interest, but it’s owed by the government on the national debt. (We’ll learn more about the national debt in later lessons).

Of every tax dollar spent...

63¢

mandatory

30¢

discretionary

net interest

$4,000,000,000,000 ($4 Trillion)

The total amount the government spent in 2017.

Which category of spending accounts for the country’s military and foreign operations?

or

A common misconception is that we spend more money on our military and foreign operations than anything else. This is actually untrue. We spend the most money on mandatory spending which includes Social Security, health care, retirement, income security, and veterans’ programs.

Although military operations are nearly half of our discretionary budget, we spend the most money on mandatory spending which includes Social Security, health care, retirement, income security, and veterans' programs.

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63¢ of every tax dollar goes toward mandatory spending.

Breakdown of Mandatory Spending

The government spends a lot of money on Social Security and health care programs such as Medicare and Medicaid. 24 cents of every tax dollar spent on Social Security amounts to about $939 billion per year. You will see later on that the government spends more on Social Security and health care than on any other program.

These items are called “mandatory” because spending is based on existing laws, not decided by Congress each year. So if Congress wants to change the amount spent on Social Security, it would have to go change the laws that determine the eligibility rules for that program.

Apart from Social Security and health care, mandatory spending also encompasses income security programs, retirement for federal employees and military personnel, and other veterans’ programs. Income security consists of programs like unemployment compensation and food stamps.

Breakdown of where our 63¢ goes:

30¢ of every tax dollar goes toward discretionary spending.

Breakdown of Discretionary Spending

Totals for “discretionary” spending are decided on by the President and Congress each year. Discretionary spending is typically split into two large categories: defense and non-defense.

What is defense spending?

Defense spending is exactly what it sounds like – this is the amount of money the Pentagon puts towards our military operations. This includes paying our soldiers and investing in the technologies and products necessary to support our national security strategy (reflected in the “procurement” category). As you can see, we spend a big chunk of change on defense – approximately half of our discretionary spending – yet still not as much as we spend on Social Security and health care.

$138,000,000,000 ($138 Billion)

The total amount the government spent on military personnel in 2017

What is non-defense spending?

Non-defense discretionary spending is basically everything else --education, foreign aid, infrastructure, environmental protection, national parks – anything you can think of that we haven’t covered so far is funded by the remaining 15 cents left from our tax dollar. Roughly 2 cents each are spent on transportation, veterans’ programs, income security, and health, with one penny going towards justice and international affairs (like humanitarian programs). The 3 cents you see in the “other” category must be split among everything else: spending for the environment, general science and space programs, energy, housing credit programs, and more. We only spend about 1 cent on foreign aid, much less than most people think.

What does this all mean for me?

As we’ve seen the government spends most of its money on Social Security and healthcare. These are categories sometimes called "entitlement" spending, because people are “entitled” to these benefits based on their family characteristics. When politicians talk about "entitlements" people often confuse that with programs that don’t benefit them, but actually, most "entitlement" spending benefits everyone. Here's the breakdown of what every $100 of federal taxes withheld from our paychecks "buys" across the different categories of federal spending.
Question

Would you trade your family’s Social Security and health care benefits for more military spending?

“I'm learning what my tax dollars buy--and you can, too: http://paystubeducation.org #PEPRally”

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Lesson 2:

Tax Policy

A better understanding of the structure and distribution of the tax burden will only help make you more informed taxpayers who are more willing and even happy to pay your taxes.

Where does the government get its money from?

In the previous lesson, you saw that our government spends a lot of money on many different types of goods and services, and programs that provide direct benefits to each of us (especially in old age), each year. So where does this money come from? The answer is … you! Almost 80% of government funding comes from the two types of taxes that come directly out of your paycheck: income and payroll (“FICA”) taxes.

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This is “FICA Medicare” & “FICA Social Security” on your paystub.
information

"FICA" stands for Federal Insurance Contributions Act

illustration of paystub with Fica taxes highlighted

The Payroll Tax

In the previous lesson, you saw that our government spends the majority of its money each year on Social Security and the government-provided health care programs. It turns out that there is a special tax for these programs – the payroll tax – which is used exclusively to fund Social Security and Medicare. You can find these items on your paystub typically under the labels of “FICA – Social Security” and “FICA – Medicare.” Everybody’s wage and salary income is taxed at the same rate under these payroll taxes:

  • For Social Security, the total tax rate is 12.4% of your earnings, with 6.2% coming from your employer and 6.2% coming from you. But for 2018, Social Security taxes apply only to the first $128,400 that you make, so if you made $129,400 (for example), the last $1,000 of your income wouldn’t be taxed. That means that someone who makes $128,400 pays the same dollar amount of Social Security taxes as someone who makes a million dollars. This is called a “taxable income maximum” (or ceiling).
  • For Medicare, the tax is 2.9% of your earnings, with 1.45% coming from your employer and 1.45% coming from you—and unlike the Social Security tax, there is no income ceiling to which the Medicare tax applies. You’ll learn more about Social Security and Medicare in later lessons.

Did you know?

Everyone who works pays payroll taxes, but not everyone pays income taxes because the first tens of thousands of dollars are exempt from income tax. Most Americans actually pay more payroll taxes than income taxes.

This is “Federal Income Tax” on your paystub.
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Individual Income Tax

For the most part, all other government programs (the small remainder of mandatory spending and all the different categories of discretionary spending) are funded by income taxes paid by individuals and businesses. The "individual income tax" is the income tax you pay personally, based on your household income (wages and salaries, but capital income as well) and your household characteristics (marital status, family size) and economic activities (such as home mortgage, charitable contributions, child care expenses) that may qualify you for reduced taxes. In contrast to the Social Security tax that has an income ceiling, the income tax has an income floor (or "exemption" level), below which no income taxes are owed. In general, the more money you make, the larger the percentage of your income–and not just dollar amount–you pay in income taxes.

"Progressive" tax system

The higher one's income, the larger the share of one’s income that is paid in taxes.

We actually pay less in taxes than we think.

The total income taxes you will owe at the end of the year depend on many factors, such as the various tax deductions and credits (preferences or "breaks" given through the tax system) that you qualify for based on your characteristics. Different households with similar incomes can end up paying very different percentages of their incomes in taxes depending on these other characteristics the tax code differentiates among. If we take Alex Werking as an example and assume Alex and spouse have a combined income of $60k, one might think that their income tax is based on this full amount. However, under the new 2018 tax law, after the standard deduction is subtracted (the minimum value of deductions, since itemizing for a higher value is an option), Alex’s family has a taxable income of only $36,000, putting them in the 12% tax rate bracket. If Alex and spouse also have two children and thus qualify for the $2000 per kid child tax credit, Alex's family will owe just $320 in income taxes--just 0.5% of their total income of $60K.

How has the new tax law changed tax burdens?

Visit the Tax Policy Center ’s website to learn more about how the details of the new tax law (the "Tax Cuts and Jobs Act") determine the distribution of the tax burden across different types of households.

What does this all mean?

The federal tax system isn't just a means to collect the revenue that pays for the different types of government spending. Through the income tax, the government subsidizes certain types of households and their activities–for example, by allowing home mortgage interest or charitable contributions to be deducted from one's taxable income. These breaks–sometimes called "tax expenditures"–are effectively government spending programs that benefit higher-income households far more than lower-income ones. The federal government "spends" more on these forgone tax revenues than on all discretionary spending programs combined. And the more that is "spent" via tax breaks, the higher tax rates need to be to raise the revenue needed to pay for all types of government spending.

Question

Do you believe that your taxes are too high?

“"#Taxes are what we pay for a civilized society - Oliver Wendell Holmes"”

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Lesson 3:

Deficits and Debt

Now that you understand that your taxes pay for various forms of government spending, it’s important to note that taxes actually fall short of paying for all of the spending. This yearly shortfall is the “deficit” and the accumulated deficits over all years are the “debt.”

What is the government budget "deficit?"

According to the Congressional Budget Office (CBO), in fiscal year 2017 the federal government collected $3.316 trillion in revenue, but spent $3.982 trillion toward the various government programs and net interest. The deficit is yearly spending minus revenue, so in 2017 it was $665 billion. This deficit added to the existing debt to bring the total debt to $14.7 trillion. But trillions of dollars are pretty hard to wrap our heads around.

3.5%

2017 deficit relative to the size of the U.S. economy (as measured by Gross Domestic Product, or GDP)

One way of thinking about the shortfall is that revenues covered only about 83% of spending

Relate this to your own circumstances by imagining you are able to pay for 83% of your current spending out of your current income, but have to borrow to pay for the rest (17%). Whether that 17% that you have to borrow for is “too much” though, depends on your capacity to pay it back. Putting 17% of your expenses on your credit card might make sense (be “sustainable”) if you know your expenses are just temporarily high, or that your income is just temporarily low.

And so it goes for the government’s financial sustainability as well

In theory, there’s nothing wrong with a deficit representing 17% of spending, as long as our collective income keeps pace with our spending needs and wants.

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Did You Know

The annual cost of interest on the federal debt will nearly *triple* as a share of our economy in just ten years?

Why the budget outlook is, in fact, a big deal

Unlike the person who temporarily puts about 15 percent of his or her spending on a credit card because they face an unexpected event, the government is borrowing to cover well-anticipated and ongoing expenses that are only expected to rise relative to our national income.

Remember we saw earlier that the government spends the majority of its money on the major government health programs and Social Security. As it turns out, these programs are the main reason why our deficit will keep growing over time, because most of the benefits of these programs go to the retirement-aged population, which is growing. At the same time, the collection of taxes to pay for government programs will remain fairly stable, and therefore not keep up with the increased spending.

Unfortunately, borrowed money isn’t free money. Just like when ordinary households borrow money on credit cards or loans, the government must pay interest costs on its debt, and interest builds up over time. Borrowing allows more of the costs of government spending to be shifted to the future, but we (collectively) must eventually pay back the money we have borrowed.

There are two main options to control the growth of the debt and reduce deficits. If you have to choose one, which would it be?

or

Either way this means the government's decision to borrow (deficit finance) directly and indirectly affects all Americans: in the future either we will have to contribute more of our earnings toward the government's programs, or we will have to do without some of those programs we have benefitted from thus far.

You clicked Raise Taxes. This could be done by either raising tax rates or reducing the subsidies handed out through the tax code ("tax breaks").

You clicked Cut Spending. This would likely mean reducing Social Security, Medicare, or other health benefits, or military spending, since there is little room to cut the other smaller categories of spending further.

Why should we care?

Families work hard to provide for their kids’ economic future. At the same time, a growing national debt places a heavier economic burden on your kids—often working against your family’s financial goals. The more that future income must go toward paying back debt, the less is available to spend on other things, both government programs and personal consumption. Immediately, deficit-financed government spending claims economic resources that could have been devoted to more productive investments or kept on reserve for emergency spending (responses to economic recessions and natural disasters)--so the "opportunity cost" to all our society is huge and profound. In the next lessons, you will learn more about the two largest categories of federal government benefit spending – Social Security and health care – and you can decide for yourself whether you think these benefits are worth their costs, or how much you are willing to see costs (your tax contributions or the debt burden on future generations) rise to keep benefits at their currently scheduled levels.

“Borrowed money isn't free! Government deficits and debt ultimately reduce economic growth. #PEP”

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Lesson 5:

Health Care

Access to affordable, high quality health care is crucial to the productivity of our nation’s workforce and our overall well-being. As a worker, you both make contributions towards the costs of providing health care to society as a whole, and benefit from various health care programs that the government provides and subsidizes.

Health care programs

The government spends its money (your tax revenues) on various programs that serve our health care needs. The two main ways government assists (or subsidizes) our health care are through:

  • Government programs that provide health services to retirement-age people (Medicare) and low-income households (Medicaid and the Children’s Health Insurance Program (CHIP));
  • Government subsidies to our own purchases of health care, through our employer-provided health insurance or through the subsidies for insurance provided by the Affordable Care Act (ACA, also known as "ObamaCare")

This means government involvement in health care benefits all of us, whether we are older or lower-income and qualify for Medicare or Medicaid, are working and have health insurance provided through our employer, or are working but must cover our own health costs.

This chart shows how our nation as a whole purchased health care in 2014, when we spent $2.9 trillion on health care, or 16.6% of our nation’s entire economy (GDP).

Note that the public (government-provided) vs. private spending shares are very close to an even split: public spending was $1.4 trillion, or 48%, and private spending $1.5 trillion, or 52%.

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The largest health care subsidy

What may be surprising to you is that the single largest government subsidy for health care isn’t a government spending program at all, but is delivered through the tax code. Nearly all premiums for employment-based health insurance are excluded from federal income and payroll taxes. In other words, those health care benefits you may be receiving from your employer are neither counted in your own taxable income, nor included in your employer’s taxable profits. According to the CBO, this tax break is estimated to cost the federal government more than $250 billion in foregone revenue in fiscal year 2016 (and over $3.6 trillion over the next 10 years). It also subsidizes roughly 30 percent (gives you and your employer 30% off!) of the average premium for employment-based coverage. Note that the amount the federal government spends (through reduced revenues) to subsidize employer-provided health insurance ($268 billion) nearly matches the amount it spends on the low-income health care programs of Medicaid (including ACA expanded coverage) and CHIP combined (totaling $279 billion). Meanwhile, the ACA subsidies for people who must purchase their own health coverage are estimated to cost about $43 billion in 2016—or 16 percent of the cost of the tax exclusion for employer-provided coverage.

$268,000,000,000

The federal government spends this amount to subsidize employer-provided health insurance, which is nearly as much as it spends on all low-income health care programs combined.

Who benefits from all these subsidies?

We all do, in ways that will vary over our lifetimes as our employment status and economic circumstances change:

  • While we are working, we will likely benefit from employer- provided health insurance and the government subsidy given through the tax break, or from the subsidies provided by the ACA for purchasing individual coverage;
  • When we are retired (above age 65), we will benefit from the health care provided by the Medicare program;
  • If/when we fall into hard economic times, we may qualify for health coverage through the Medicaid and CHIP programs.
This chart shows how many people in the U.S. have health insurance coverage of various types. Some people may have more than one type of coverage—for example, when you are over 65 you might still have an employment-based health insurance policy while you also qualify for Medicare benefits. Like total (private plus public) spending on health care, the cost of all of these government subsidies of health care will grow over time, not just in dollar terms but also as a share of our economy. The CBO says the net total health-care subsidy of $705 billion in 2017 (which is 3.7% of GDP) will reach $1.15 trillion (or 4.0% of GDP) in 2027. Health costs are increasing as a share of our economy for two main reasons:
  • a growing share of our population is older with greater needs and demands for health care
  • the costs of providing health services per consumer or beneficiary are rising.

LEARN MORE

Visit medicare.gov for more information about the benefits you may qualify for

The Uninsured and the Affordable Care Act (ACA/"ObamaCare")

The Census data shown in the coverage chart above tells us that most Americans have health insurance coverage, either through our employment or self-purchase or from government-funded health programs (Medicare, Medicaid, and military health care).

Among the nonelderly population, CBO estimates that about 246 million noninstitutionalized residents of the US will have health insurance in any given month in 2017. That still leaves about 27 million people who will be uninsured, but that figure declined dramatically with the ACA and its expansion of Medicaid coverage and system of mandates and subsidies for health insurance purchases (see chart).

In the ongoing debates over what to do about the ACA, it is important to recognize that expanded coverage comes at a price: 1) the mandates for participation ensure that there are enough people in the health insurance "risk pools" to keep costs for overall participants as low as possible, and 2)the taxes and fees provide revenue to offset the cost of providing coverage to more people.

All of us need to understand and weigh the benefits and costs of the ACA, to consider these in the context of how the government has long subsidized our health care in exchange for the taxes we contribute, and to bring our informed perspectives into the current policy debate.

The bottom line: Why people should care!

Health care is a tough issue. It is a necessity in our lives, and it is crucial to our economic prosperity and overall well-being. But it is expensive and getting more so, and keeping it from getting too expensive and unaffordable for our economy as a whole will require sacrifices in terms of dealing with more management of the marketplace and/or higher taxes and fees.

Figuring out how to best maintain and improve our health under the constraints of household and government budgets will not be easy, but we will have to keep working on it.

“"Govt. health care programs benefit all of us at different stages of life #PEP"”

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