How Much Money Should the Government Spend?

>> Joshua Rauh: So here is the first question. It's gonna appear up here and also on your phone. And the question is approximately what percent of the us economy was government spending in 2021? All right, so for non economists out there, the way you think about this is you think about all of the dollars that were spent I in the economy in 2021.

Think about for every $1, how many cents of that dollar was spent by the government, the federal, state or local governments of the United States. Okay, so I'll give some time, I can see that the people are voting. Don't give it too much thought, don't Google, I just wanna know what your impressions are.

It's not a right or wrong thing, I mean, I just wanna know about 105, 108 people have answered. Okay, three, two, one. Okay, we're gonna move on. Okay, and let's see what the responses are. All right, so 35% of you said approximately 44% was government spending. You're adjusting it, come on, come on.

Don't do that lock, I've locked it on you now, okay? I can't even read off the answers without people starting to adjust things. All right, so the modal answer is 44%. Okay, and then you can see the sort of distribution of answers around that. I can see that if I can do the math in my head that a little over 50% of you thought that it was 11%, 22% or 33%, and then 36% obviously said 44%, 11% said 55%.

The answer is actually 44%, so this is something where the majority actually got it right here. And that does surprise a lot of people, because usually people think of this as the United States, the land of the free, the home of the brave, the land of small government, of brutal, unbridled capitalism.

And in fact, the answer is 44%. Now, this is a little bit elevated relative to previous years, actually not nearly as much as 2020, in 2020, it hit 48%. But I'll show you what it is both in the US and across countries relative to previous years. This graph actually only goes through 2020 because it's the cross country comparison data from the OECD, and they take a while to compile all that.

But for 2021, the US is gonna be 44%, and the US is in red here. And so you can see that there was a big spike up around 2020 due to the government's response to Covid. But it was hovering around upper thirties through the late 1990s and early two thousands.

Then it spiked up quite a bit here around 2008, 2009, took a while to get back down and then spike back up again. Okay, so obviously what happened in 2020? Well, that was the government had a massive fiscal response to Covid. That's what John Cochrane is talking about with all of the creation of money, borrowing and sending out of those stimulus checks.

And many other programs were expanded, like unemployment insurance, various other government programs. What happened in 2008, 2009? What was this great recession or global financial crisis? So what was all this government spending going on there? What was the US and all these other countries doing? What were they doing?

Bailouts, is like bailing out car company, major car companies, bailing out other industry, bailing out banks and financial institutions in particular, and also expanding unemployment insurance and putting on expansions into the social safety net. Okay, so very good. Okay, so now where is the money coming from for government spending?

Where do governments get the money? What are the options that are available to them? We heard about some of them in the previous lecture. So why doesn't somebody just raise their hand and tell me what the options are available for government spending? Yeah, for financing it. How do they do it?

Okay, so you can tax or you can borrow. Those are two of the big things. What else? We heard about one other one in John Cochrane's talk, printing money, otherwise known as seigniorage. Is there anything else that a government could do to raise money? So there's one other thing, which is number two up here.

See, we got three out of the four pretty quickly, which is fees for the use of public services. So if any of you attend a state university and you pay tuition to the university, last I checked, state universities are not free. They're much cheaper than private universities, but those are fees for services.

Similarly, if you ride on public transportation, you're paying a fee for service. So these are often called usage fees, and they're gonna be an interesting part of how we think about the ways that government might finance its activities. Great, so the word seigniorage is just a fancy, fancy name for creating money.

And there are many different ways that the Federal Reserve has been financing government spending. It's interesting, in the old days, seigniorage used to be the idea that a government could do something like literally print a dollar at a very, very low cost, like, say, two cent, and then they would go spend that dollar.

And because they were able to spend a dollar in the economy, that was then they then created, poof, out of thin air, $0.98 out of the dollar that they had printed. More recently the way that it works would be if the Central Bank is buying debt directly from the US treasury.

So basically giving the US treasury money, and the US treasury then goes and spends it. There's a little bit of a debate out there about how much money is the Fed really printing, because the Fed doesn't actually do that. What happens is the treasury issues debt to primary dealers in financial markets.

These are big companies like Citigroup and Goldman Sachs. And then the Fed immediately then goes and buys those securities from those primary dealers with newly created printed money. So there's a little bit of a circuitous route there. But really it's the same thing, it's seigniorage, it's money printing.

All right, so those are ways that the government raises money. This is a graph that shows government spending and different ways that the government raises money, particularly with respect to taxes, comparing tax receipts to total federal expenditures. And you can see the difference between the green line and the purple line here is the deficit.

And there's gonna be a lot to talk about government deficits in a future session by John Kogan coming up on Wednesday. He's the government deficit specialist. You can see that at some point there was the late 1990s, there was a small surplus, although this is a bit illusory because the federal government and state and local governments have many different ways of sort of hiding deficits.

Running deficits but not saying they're running a deficit, usually by making future promises to people that they're gonna give them Social Security or medical benefits or pensions, things like that. And then they don't actually set aside money today to fund it. So that's actually like running a hidden deficit.

But anyway, the difference between the purple line and the green line here shows you what the deficit would be. And then the blue line is just what you would think of as being traditional tax receipts, income taxes for both individuals and corporations. Adding on top of that, you get to the purple line.

To get to the purple line, you have to add on top of that the taxes that you pay out of your paycheck for Social Security and for Medicare. I don't know, I mean, many of you have probably had a job where you've seen the deductions that come out of your paycheck for all the various things, for Social Security, for Medic, to pay for Medicare, to pay for unemployment insurance, to pay individual income taxes.

It's often a revelation when you get your first real full time job, just how much actually comes out of there. But either you've experienced that so far or you will experience it when you get there. Another way to look at government spending, this is just federal government spending.

There's also what's called general government, which is federal, state and local. And that's where you get to the 44% number that we polled on. And here there are also very, very big deficits. And you can see that by 2020, in 2020, government overall was spending about $30,000 per person per year.

So these are just some general facts about the size of government and where government spending comes from. Okay, what do they do with the money? What does the us federal government do with the money? So this pie chart shows the revenue, and the revenue is what we talked about on the previous slide.

Individual income taxes are bringing in about half of the federal government's total revenue. Then those Social Security and Medicare taxes. Corporate income tax is really a pretty small slice of the pie, despite all of the talk and focus on corporate income taxation. And then other is a range of different types of revenue raising, including customs duties and excise taxes and things like that.

Then over here, we have the expenditure side. Okay, in 2021, they were spending a lot more money than they were bringing in in terms of revenue. That's that deficit, and they will continue to do so. This is a percentage of the total 24% went to what's called income security.

And this was a number that was probably boosted a lot in 2021 by unemployment insurance, by the social programs that were put in response, the government response to Covid. Next biggest area is Social Security, which for those of you who don't come from a us context or aren't familiar with these institutions.

Social Security means that's the old age pension that you get in the United States. So when you retire in the US, you get a check from the government and the government taxes you while you're working in order to pay for that. They're really actually taking money from people who are working and then sending it out to retirees today.

They're not saving it up in a big pool of money, although sometimes they pretend that they're doing that, but actually they're not really doing that. There are different ways that the government spends money on health and health insurance. So this category here is 11.7%, this is spending that they often, a lot of it is giving money to the states to then pay for Medicaid, which is the program for the poor.

There's also Medicare, which is the program for the elderly. Only around 11% of the federal government's budget is actually going to national defense right now, 5% is going to net interest payments. And remember, 2021 interest rates were still really, really low. As interest rates rise, one of the source of opposition to interest rates rising is that the government realizes, hey, we're gonna have to actually pay more interest.

If interest rates rise, I think that might be a good thing. It would give them some discipline. But net interest is actually quite low because interest rates have been so low for so long. And if they rise, that's gonna be a bigger part of the budget. Okay, and then there's some other categories.

Federal government doesn't spend very much on education actually, educational spending is only by governments. Only 7% of that is federal government spending. The rest of it is state and local government spending. So let's look at what state and local governments do. So we have a federal system in the US, and as the 10th amendment to the Constitution says, all power is not granted to the federal government are reserved for the states.

So here's what states are doing and how they're raising money and how they're spending money. So for states, you know, the big items are property taxes and sales and gross receipts tax. That's how states finance their activities. They do also have individual income taxes in some states, like California, those are very, very high.

The top bracket income tax rate in California, just for California is 13.3%. That's quite high, in a state like Texas, it's zero. So Texas has to rely a lot on some of these other sources like property taxes or sales and gross receipts taxes. And then if we look at what the state, local governments are spending money on, they're spending money on.

There's a lot of welfare, public welfare programs, elementary and secondary education is a big piece. Health and hospitals, higher ed, highways, police protection. So public safety is really actually a pretty low share of the spending. A lot of the spending is going to elementary and secondary education, public welfare and health plans, like the extent to which state governments kick in for Medicaid, for these health insurance programs for the poor, and so on.

Higher aid, big piece of spending there, but again with higher ed, some of that is recouped by fees, by usage fees, tuition fees, for example, but not all of it. Those entities don't actually typically run large surpluses or any surpluses.