Profiling Public Expenditures

Classifications of public expenditures help shape the debate about the role of government in the economy. However, current classification schemes featured in the federal budget do not present a national budget in the context of the national economy. As a consequence, they provide a distorted picture of expenditure trends.

In Public Expenditures in the United States: 1952–1993, John Dawson and Peter Stan expand the domain in which public expenditures are usually discussed to include all governments serving citizens. Based on data from the U.S. National Income and Product Accounts from 1952 to 1993, the analysis highlights the major categories of public expenditures that will shape the policy agenda into the next century.

The authors define four complementary schemes for classifying expenditures—function, fund, jurisdiction, and economic type—and integrate them to construct a profile of public expenditures over the past 41 years. The expenditures are expressed as a fraction of gross domestic product (GDP) to indicate how they have behaved relative to the total economy. The profile has three key elements:

• Total public expenditures rose from 26 to 33 percent of GDP—about 7 percent of GDP—over the period.
• This growth is the net result of a more than 8-percentage-point decline in defense expenditures, combined with a 16-percentage-point increase in domestic expenditures.
• Most of the increase can be accounted for by growth in federal social insurance expenditures, state and local expenditures, and federal net interest payments.

The Functions of Public Expenditures

The functional scheme classifies expenditures in the way that usually draws the most attention and public policy analysis⁠—defense, education, health, and so forth. As public expenditures have grown relative to the economy, their allocation across governmental functions has shifted. As Table 1 shows, a relatively small number of categories have participated in this growth and reallocation.

Expenditures on defense peaked during the Korean War (1953) and the Vietnam War (1967); expenditures on veterans' compensation peaked subsequently. Over the past 41 years, their total has fallen by more than 9 percentage points, mostly because the relative burden of defense expenditures has decreased as the economy has grown. With the end of the Cold War, defense expenditures are expected to continue to fall as a percentage of GDP. Whether this expectation will be borne out remains to be seen.

While defense expenditures were declining, all other expenditures increased by 16 percentage points of GDP. Five categories accounted for 13 points of this increase: Social Security, medical care, welfare and social services, public education, and police and corrections. All other expenditure categories competed for the remaining 3 percentage points of GDP, with net interest payments making up one-fifth of this residual amount.

The four expenditure categories showing the most growth had specific beneficiary groups within the U.S. population: the elderly (Social Security and Medicare), the poor (medical, welfare, and social services), and the young (education). Growth in public financing of medical expenses for the poor has been much greater than growth in other forms of assistance for them.

At least to a first order, a small number of factors account for these increases. The successive cohorts of the post-World War II baby boom, along with its subsequent echo, largely shaped expenditures for public primary and secondary education after 1952, and these expenditures dominated education expenditures as a whole. Subsequent encounters of these cohorts with the law enforcement and criminal justice systems, and especially policy decisions leading to tougher sentencing in recent years, drove police and corrections expenditures.

Meanwhile, at the other end of the age distribution, both the pool of those eligible for Social Security benefits and the magnitude of these benefits increased rapidly over the period. Increases in Medicare expenditures also were driven by the larger proportion of elderly in the population, but a more important factor has been the increasing costs of medical care delivery, which some analysts have attributed to enhancements in medical technology.

The Fund That Pays for the Expenditures

Categorizing expenditures by fund draws a distinction between social insurance and regular budget expenditures. For the individual citizen, this distinction reflects two different aspects of governments' responsibilities. The social insurance budget is based on compulsory contributions by employers and employees—for example, the Social Security payroll tax. In return for these contributions, employees are promised certain benefits at a later time. In contrast, the regular budget is funded by all other tax (and nontax) payments to government. The taxpayer may or may not approve of these expenditures but, in any case, has no expectation of getting money back from the government.

Social insurance expenditures are responsible for most of the increase in total public expenditures during the period examined in the study. The bulk of these expenditures occurred at the federal level, with Social Security and the Hospital Insurance component of Medicare accounting for more than 80 percent of the increase. The past rate of growth of these two programs and particularly the approaching retirement of the baby-boom cohorts place these programs in the forefront of policy concern into the next century.

Public debt at all levels of government lies entirely within regular budgets. Net interest payments have increased by 2.7 percentage points of GDP. Other regular budget public expenditures (i.e., excluding grants) have remained essentially constant relative to the economy although, as Table 2 shows, their mix has changed dramatically.

The Jurisdiction That Undertakes the Expenditure

To address contemporary problems, an analysis of public expenditures must include state and local expenditures as well as federal expenditures, because the former make up roughly one-third of total public expenditures and a much larger share of domestic expenditures. In addition, state and local expenditures tend to dominate a number of functional categories, such as education, that are the focus of substantial ongoing policy debate.

Perhaps more important, all levels of government must be analyzed together because federal grants have increasingly linked expenditures across jurisdictions. At the federal level, grants are expenditures that become intergovernmental transfers of resources; at the state and local level, grants are receipts that, to a greater or lesser extent, are fungible when used along with the allocation of other resources. The existence of an additional layer of decisionmakers between the grant and the ultimate expenditure means that substitution effects cast doubt on any accounting of the final ends of federal grants.

The pattern of expenditures from the perspective of jurisdiction mirrors the pattern from the perspective of fund. Federal regular budget expenditures have fallen, but their state and local counterparts have risen to almost half of the regular budget total for all levels of government. The greatest growth at the federal level has been nonprogrammatic: the rise in net interest payments that has accompanied rising debt. Grants have grown almost as much while helping to fuel the rise in state and local expenditures.

Economic Categories of Expenditures

Distinctions among economic types of expenditures are founded on their different economic effects and are standard in the public finance literature. An expenditure's economic type is important for four reasons. First, the type reveals a great deal about the expenditure's effects on other sectors once it is integrated into the economy's income and product flows. Second, the courses of action available to implement policy alternatives differ across economic types of expenditure. For example, providing medical care directly to veterans through purchases results in far more direct control of expenditures than providing Medicare transfer payments. Third, an expenditure's type affects a government's ability to privatize or subcontract provision of the goods or services giving rise to the expenditure; this distinction is perhaps especially important at the state and local level. Fourth, the economic type of an expenditure fundamentally affects the degree of potential and actual expenditure control that a government unit can exercise.

Table 3 shows changes in economic categories of expenditures.

Purchases of goods and services accounted for 18 to 20 percent of GDP over most of the period covered in this study. That is, in those instances where government actually produces and delivers goods and services to its citizens, expenditures have not grown relative to the economy. All of the relative growth in government expenditures has occurred as redistributions of income through transfer and interest payments, mainly to the elderly, the poor, and creditors.

Policy Implications

This analysis suggests that discussion of expenditures in the federal budget should

• Separate federal social insurance and regular budget expenditures, focusing on their very different dynamics.
• Emphasize classification of expenditures by their economic type and highlight the different roles of these types in the economy.
• Include a treatment of aggregate state and local expenditures, focusing on their interdependence with federal expenditures through federal grants.
• Recognize that federal grants-in-aid to state and local governments are "fungible" with other state and local funds.
• Facilitate decisions on the character of federal expenditures by placing them in the context of total public expenditures.

At a more fundamental level, the authors argue it is time to rethink how the federal budget is presented and to do so with attention to the fundamentals of budgetary communication and taxonomy.