🔎 Market Mysteries

Don't take budgeting advice from politicians. Congress often risks government shutdowns due to disagreements on the annual budget. It consistently spends more than it earns, accumulating debt with increasing borrowing costs. The government is unwilling to cut or restructure the expenses that dominate the budget. It’s time for a more responsible financial plan.

The government earns its income through taxes, taking a share of the money individuals and businesses make each year. Personal income tax provides nearly half of all tax revenue. Social Security and Medicare payroll taxes, the second-biggest source at 36%, are automatically deducted from employees' paychecks and matched by employers. The funds are then used to finance the Social Security and Medicare programs, providing benefits for retired individuals and those who require medical care. Corporate income taxes contribute to about 12% of revenue; estate taxes, trade tariffs, and other things make up the rest.

When the government's desired spending exceeds its income, it borrows money, primarily by issuing Treasury bonds. These bonds are essentially loans that individuals, corporations, and foreign governments give to the US, expecting repayment with interest after a certain period. High demand for Treasury bonds, considered a nearly risk-free investment, means the government credit card is always available.

Congress decides how we spend our tax dollars, and the President approves it. Annual expenses are split into two main categories: mandatory and discretionary spending. Mandatory spending encompasses crucial programs such as Social Security, Medicare, and Medicaid, with annual funding and spending levels established by permanent legislation, subject to change only through amendments to the law. It also includes interest paid on government debt. On the other hand, discretionary spending is subject to the annual appropriations process, when Congress debates how much to spend on things like defense, education, and transportation each year.

Debates about discretionary spending are what can lead to potential government shutdowns. If Congress and the President can't agree on the bills to fund different parts of the government before the start of the fiscal year (October 1), federal agencies have to stop all non-essential functions until a new budget is signed into law. To avoid this, lawmakers might consider passing a Continuing Resolution to keep federal agencies open by extending last year's spending guidelines for a little longer. Shutdowns can be painful, and they're happening more frequently. Some experts blame the decision to shift budgeting power to Congress from the President in the 1970s.

Budget decision drama also comes up when the government hits its debt ceiling. The Treasury basically has a credit card limit that only Congress has the authority to raise. Raising the debt ceiling doesn't approve new spending; it just allows the Treasury to borrow the money to complete approved spending. Nonetheless, it's often a chance for dramatic budget negotiations.

The annual budget debate that risks a government shutdown only concerns a quarter of yearly spending. Most of our tax dollars go towards mandatory spending programs like healthcare and income support programs for older adults. Often called Entitlement Spending, these mandatory social support programs account for two-thirds of all spending, up from one-third in the 1970s. Interest payments on Treasury borrowing accounts for the rest of mandatory spending.

Entitlement spending is vital support for Americans. Around 50% of mandatory spending is allocated to programs primarily designed for senior citizens. Social Security provides monthly retirement income for those over 62, while Medicare covers health care costs for individuals aged 65 and above. Both programs also extend benefits to individuals with disabilities and families of retired, disabled, or deceased workers. Medicaid provides healthcare for low-income individuals. Other mandatory programs include unemployment support, food assistance, and benefits for veterans.

Annual discretionary spending is split pretty evenly between defense and basically everything else. Military and defense spending consistently earns a substantial piece of the budget, roughly 14% this year. America spends more on its military than the following nine biggest defense countries combined, approximately 40% of worldwide defense spending. While the US military is in a league of its own, we're not allocating as much as we used to. As a percentage of our economic output, defense spending has trended downward for the past decade and significantly over the past sixty years.

Non-defense discretionary spending gets the most attention but often the least money. Education, transportation, agriculture, food, water, and other infrastructure and social support all combine for only about the same 14% of the budget as the military. Adjusting for economic growth, its allocation has stayed relatively steady over the past several decades.

It is not. Budgeting challenges have become increasingly severe as lawmakers demonstrate worsening political polarization and a diminishing willingness to engage in bipartisan collaboration. The government has consistently spent more money than it earns in taxes every year for the last two decades, taking on more and more debt to finance it. This year's fiscal deficit, the gap between spending and tax revenue, doubled to $2 trillion. Historically, deficits would grow in periods of economic pain as the government spent more to support Americans while earning less from income taxes. Over the last eight years, the fiscal deficit has trended higher, even in periods of economic strength. It's akin to accumulating more credit card debt despite earning a higher salary.

Mounting debt has become a serious concern amidst higher interest rates. The government isn't immune from the Federal Reserve's efforts to make borrowing more expensive. Over the past decade, the Treasury has been able to borrow money at interest rates so low the money was essentially free. Now, the Treasury has to issue $1 trillion in new debt that costs over 5% per year, when just a few years ago, that rate was 0.1%.

The government risks shutting down because they can't agree to terms on less than a quarter of the budget. They don't seem eager to cut military spending. So, the dysfunctional debate really involves only one out of seven dollars spent. It doesn't bode well for their ability to address the more significant issues.

Government leaders must find a responsible approach to a complicated problem: growing entitlement spending costs. Payments for programs like Social Security and Medicare have ballooned over the last several decades to nearly 3x non-defense discretionary spending, once 1:1 in 1970. Social Security and Medicare's cost of living adjustment alone accounted for a fifth of this year's additional deficit. These are critical programs that face the risk of running out of funding.

The most crucial thing is to demand that politicians get more practical. Hold them accountable by understanding the scale of the numbers they're talking about. The government earns about $4.5 trillion in tax revenue annually but spends more than $6 trillion. Mandatory spending already accounts for more than $4 trillion. So, pretty much every bill for additional spending is going to debt. With rates at 5%, every $1 trillion deficit spending costs another $50B per year until that debt is paid.

We'll dig into the challenges of entitlement spending next week and the potential consequences of our spending problem. Stay tuned.

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Keep fighting,

The Scoop Team