What your taxes actually fund (what’s in the federal budget?)

With the government bringing in trillions of dollars in revenue every year, it’s sometimes shocking to see just how much you’re paying, how little is being paid by the richest in society, how much of it goes towards the military, and more.

Just what exactly is your money being used for? Is everyone paying their fair share or is that a lie? And when the government does have the money, who gets to choose how it’s distributed?

Watch the video of this post here!

Who’s Paying?

Let’s start by figuring out exactly  who is paying the government. Most of the government’s revenue comes from individual income taxes, followed by payroll taxes, so it stands to reason that the people with the highest income would be the ones that pay the most in taxes. In some ways, this is true.

People quickly realize that as their earnings increase, so do their income taxes. This is because we have a progressive tax system, which says that as you make more money you owe more money. The average American pays most of their income taxes from the earnings they get from their paycheck every two weeks.

In contrast, the wealthiest Americans generate most of their income from their various investments, such as businesses, real estate, or stocks and bonds. Because these are investments and not pure cash, they are taxed under capital gains tax instead of income tax.

Capital gains tax is more flexible than income tax because how high it is doesn’t depend on how much you have, but instead on how long you have it. Because the government wants to incentivize investment in the marketplace, capital gains tax is higher when you sell investments in the short term and lower when you sell investments in the long term.

In this way, you can see how the government is neutral towards earned income but penalizes or incentivizes your choices when it comes to investment income.

This is why it’s so important to look at net worth when it comes to evaluating the wealthiest Americans and how much in taxes they’re paying because they’re not like you and me whose income is entirely cash-based, aka liquid.

The wealthiest Americans’ true income is highly dependent on their investments and assets. This is why billionaires and trillionaires like Elon Musk, Warren Buffett, or Jeff Bezos don’t need to pay themselves $100,000 a year salaries— their wealth is in investments, not income. And investments are not taxable until those assets are sold. As long as they don’t sell, they can grow their wealth tax-free.

If your net worth is $100,000, you are only richer than 14% of Americans. Wealth is mostly concentrated above the 50% mark, which is about $585,000 a year. At this level, you can see higher-income individuals who have real estate and are likely married. This is where most of us place the American dream: a house in a nice neighborhood, kids, and a dog.

Things get more interesting when we look at the higher levels of wealth, at the top 10%, the top 5%, the top 2%, and the top 1%. To qualify as part of the top 1% in the US, you must have at least $10,815,000 in net worth (Kiplinger).

In 2020, this top 1% of taxpayers paid for more income taxes than the bottom 90% of taxpayers combined. The 90% of Americans paid $450 billion dollars in taxes, while the top 1% paid $723 billion dollars in income taxes.

This was a slight increase from 2018, where the top 1% paid 2% less.

But despite this massive discrepancy in who is paying, the White House admitted that the richest families in America were actually paying a lower income tax rate than the average American. In 2018, the federal individual income tax rate for the average American was 14.2%, while the wealthiest 400 families were only taxed at 8.2%.

A ProPublica report looking at the wealth income and taxes of the richest men in the country between 2014 and 2018 realized that they were effectively paying less than 5% in fed income taxes.

• Elon Musk saw his wealth grow by 24.3B, of which he reported $1.52B in income and paid $455M in income taxes… equaling to a tax rate of 3.27% ($455M/$24.3B)
• Jeff Bezos’ wealth grew by $99B, he reported $4.22B in income and paid $973M in taxes, setting a tax rate of 0.98%
• Warren Buffet had the lowest true tax rate of 0.1%. His wealth grew by $24.3B between 2014 and 2018. He reported an income of $125M, and paid just $23.7M in federal income taxes.

Should the Rich Pay More?

When people realize just how much more proportionally they are paying taxes compared to the wealthiest people on the planet, it’s unsurprising that frustration mounts. Over the years, there have been more and more calls for increased taxes to the millionaires and billionaires of America, saying that they are not paying their fair share into the system.

In 2023, Pew Research surveyed American taxpayers and found that 60% felt that the wealthy were not paying their fair share and believed that increasing income taxes for households that made more than $400,000 a year would be the best course of action.

Even Warren Buffett told CNBC that the rich in America aren’t paying enough taxes. (Jump to 59:55 – 1:00:55)

Buffett suggested that expanding the Earned Income Tax Credit would probably be the best way to go because it helps people with lower incomes support themselves and their families.

Bill Gates agreed with his sentiment. (Jump to 1:30 – 2:26)

Gates suggested going after the easiest target: the capital gains tax, which would significantly increase how much wealthy people pay on their investments.

In a Reddit Ask Me Anything, Bill Gates said: “I think our system can be a lot more progressive (that is, richer people paying a higher share). A key element is making capital gains taxation more like ordinary income and having an estate tax more like we had in the past.”

But not everyone is in favor of increasing income taxes for the wealthy.

One major argument against this course of action is that the rich already pay a lot more income tax than the average person. In 2018, the rich paid 40% of the nation’s income tax despite making 20% of the nation’s income.

Even if most of their wealth is in non-liquid assets, that’s not an excuse to charge them more than they are already paying. This will only lead the rich to transfer more of their income into non-liquid investments in order to avoid paying increased taxes, further aggravating the issue.

Scott Hodge, President of the Tax Foundation, has noted that social programs have dramatically expanded since the 1980s, with programs like the child tax credit and earned income tax credit delivering $180 billion worth of benefits each year to families who often didn’t pay into the system. In 1980, 21% of taxpayers paid no income taxes because of credits and deductions in the tax system. In 2019, that rose to 34% of taxpayers—equal to 54 million people.

According to Statista, in 2022, 40.1% of American households paid no income tax.

If you fit into any of these categories, you are exempt from federal income tax. But despite not paying into the system, you still have access to all the benefits of the government, such as rule of law, free K-12 education, public transportation, libraries, etc. Not to mention federal programs like SNAP and unemployment.

To simplify the argument: A significant portion of the tax base is paying little to nothing in income tax. Our current system is not only allowing them to avoid paying their fair share, but it is actually redistributing income from the wealthiest taxpayers to the poorest through various government programs.

(I’d like to note that this doesn’t mean you pay no taxes. You’re still liable for payroll taxes, medicare and social security taxes, gas taxes, and more. We’re only focusing on income taxes because that’s where the conversation has been focused on over the years.)

But all of this just begs the question, doesn’t it? The national budget is worth trillions of dollars. If the government is taking in so much money through taxes… just what are they spending it all on, and should we look for change in spending rather than revenue?

What the Government Pays For:

The federal budget affects every aspect of American life, and it’s not too different from the budget you probably have.

You have revenues, fixed expenses and variable expenses: money you bring in, expenses that stay the same each month, and expenses that either increase or decrease each month. You also likely have some form of debt that you need to pay off, like credit card debt or student loans. Any savings you have should bring in some extra cash from interest each month as well.

For the government, it has revenues, mandatory spending, discretionary spending, and interest on debt, which is sort of like your budget.

For now, let’s do a quick overview of what this looks like in real life. I’ll be using the 2022 federal budget for reference. This covers Fiscal Year 2022 (FY 2022), which started October 1, 2021, and ended September 30, 2022.

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2022 Revenues

As mentioned earlier, most of the federal government’s revenue takes the form of federal income taxes. In 2022, the U.S. government brought in $4.9 trillion in revenue. Broken down into billions of dollars, we see that:

• $2,632 came from individual income taxes
• $1,484 from Payroll Taxes
• $425 from Corporate Income Taxes
• $356 from Other Taxes (which include Customs Duties, Estate Taxes, and Miscellaneous Fees/Fines)

The way that the government DECIDES what to spend money on through discretionary spending is as bureaucratic and complex as you’d expect. I’m going to walk you through a very simplified version of this.

1. The President submits a budget proposal to Congress outlining his administration’s spending priorities for the upcoming fiscal year
2. Congress sets up multiple committees (ie House Committee on Appropriations and the Senate Committee on Appropriations) to review the President’s proposal. These committees hold hearings to gather input from agency professionals, subject matter experts, and the public itself
3. Based on these conversations, Congress drafts “appropriations bills,” which cover the specifics of how federal revenue should be spent
4. The House and Senate debate on the specifics of each appropriations bill
5. Congress sends the final versions of the appropriations bills to the President to be signed into law
6. The President can sign it or veto it. Congress can override that veto with a 2/3 majority vote in both chambers.
7. If Congress and the President fails to pass all the appropriations bills by the start of the federal government’s fiscal year (Oct 1), the country can face a government shutdown

In 2022, we didn’t face a government shutdown, so I’m happy to present to you exactly where your tax dollars went!

2022 Mandatory Spending

Mandatory spending is money that is spent based on existing laws tied to specific programs like Social Security, Medicare, and food stamps. No matter what happens, the government is required to pay for these programs because their beneficiaries are entitled to them by law.

Typically, mandatory spending expands during recessions as more people qualify for benefits, and it contracts when the economy recovers as beneficiaries make more money. If you’ve qualified for unemployment assistance, you’ve taken a cut of the government’s mandatory spending.

In 2022, the federal government spent $4.1 trillion in mandatory spending. Of that:

• $1,442 went into Major Health Programs, including:
  • $747 into Medicare
  • $592 into Medicaid
  • $103 into Premium Tax Credits & Other

• $1,213 got sucked into Social Security, which is constituted of:
  • Old-Age & Survivors Insurance ($1,070)
  • Disability Insurance ($143)

• $582 was spent on Income Security Programs
  • Tax Credits: Earned Income, Child, etc ($252)
  • SNAP: Supplemental Nutrition Assistance Program ($149)
  • Supplemental Security Income ($61)
  • Family Support & Foster Care ($47)
  • Child Nutrition ($39)
  • Unemployment Compensation ($34)

• $188 in Student Loan Programs
• $188 in Federal Civilian & Military Benefits
  • Civilian ($116)
  • Military ($72)
• $161 in Certain Veterans’ Programs
  • Veteran’s Income ($140)
  • Other Programs ($21)
• $345 in Other Programs
  • COVID Response Programs ($200)
  • Other Programs ($145)

Social Security has historically been the largest cut of mandatory spending paid for by the federal government, followed closely by Medicare and Medicaid.

The government is also responsible for a variety of safety net programs that are meant to increase the health and safety of the general population. These programs include the COVID relief that we received during the pandemic, housing assistance, foster care, unemployment compensation, and certain tax credits like the earned income tax credits and child tax credits mentioned before.

2022 Discretionary Spending

Discretionary spending varies in price each year because it depends on the politicians who are in office. This includes the education system, the military complex, and various federal agencies like the EPA and NASA.

When we think of what the government pays for, one of the first things we think of is the military. The US Military is the most powerful military on the planet. With over 13,000 aircraft, 983 attack helicopters, hundreds of thousands of soldiers stationed worldwide, and a massive operations staff to support it all, the military is so big that the entire Discretionary Spending section of the federal budget is split into “Defense” and “Non-Defense” spending.

Defense Spending

In theory, Congress could make it so the government pays $0 into the military, but this is highly unlikely. In 2022, the federal government spent $751 billion for defense. Of that:

• $290 was spent on Operation and Maintenance
• $170 went to Military Personnel
• $136 went to Procurement
• $107 went to Research, Development, Testing, & Evaluation
• and $48 went to “Other” which includes:
  – Dept of Energy atomic energy activities
  – Dept of Defense military construction and family housing projects
  – and other “defense related activities” by other agencies (I’m assuming FBI/CIA)

None of this is possible without the millions of military and civilian people that work in the federal government to make sure it runs as smoothly as it does. We don’t give the government as much credit as it deserves for just how much money flows through it and just how little corruption there is in our system… relative to other countries, at least.

Non-Defense Spending

In 2022, the federal government put $910 billion into non-defense spending. Of that:

• $141 was spent on Health
• $132 went to Education, Training, Employment, and Social Services
  • The education system is a rather small discretionary item on the federal budget, but this is because a lot of public school is tied to state and local funds. While the government has a hand in K-12 education, college loans and programs, training programs, and employment services, your local state, town, and city have much more of an impact on these programs than the federal government.
• $113 went to Some Veterans’ Benefits
  – This is because Veterans programs like the GI Bill and health programs are a mix of both discretionary and mandatory spending depending on the situation.
• $112 went to Transportation
• $93 in Income Security
• $71 in International Affairs
• $68 in Administration of Justice
• $46 in Community and Regional Development
  – This includes infrastructure like buildings, roads, power supply lines, and more. Infrastructure expenses tend to be shared between federal, state, and local governments, but it is generally considered discretionary spending.
• $44 in National Resources & Environment
• $37 in General Science, Space, and Technology
• $53 went to Other
  – This includes general administrative costs tied to agriculture, Medicare & Social Security, energy, commerce, and housing credit programs

Putting Defense and Non-Defense spending together, we see that the federal government spent $1.7 trillion in the Discretionary Spending category.

2022 Net Interest Payments

As we saw in the Mandatory and Discretionary Spending charts, every program that the government commits itself to leads to increased spending. Government spending is consistently higher than its revenues, so it runs on a deficit to pay for everything.

The national debt is the sum of money our government owes to intra-governmental holdings and the public as a result of this deficit. By the end of the 2022 fiscal year, September 30, the national debt was about $30.9 trillion.

• Intra-governmental holdings represents money that the government owe itself. For example, Social Security and Medicare trust funds invest their surplus revenues in Treasury securities, effectively lending money to the federal government. The government pays interest to these intra-governmental entities just like it does to the public holders of Treasury securities. In 2022, this accounted for about $6.6 trillion of the national debt.
• Public debt is represents debt securities, like Treasury bonds and notes. These securities are purchased through public auctions conducted by the U.S. Department of the Treasury, and the government pays interest to the holders until the securities mature and the principal is repaid. Buyers are banks, insurance companies, state and local governments, foreign governments, and private investors. In 2022, this accounted for about $24.3 trillion of the national debt.

And just like when you borrow money from the bank, you’re going to owe it back… with interest!

In the federal budget, net Interest represents the government’s interest payments on debt held by the public, offset by interest income the government receives. For 2022, the government paid $475 billion towards net interest.

What does all this result in?

A $1.4 trillion deficit!

And this is trend has been happening year over year since the 1970s.

And we’re inching closer to WWII levels of debt.

And experts expect it to just keep increasing year over year.

…Um…

Let’s do some math to really highlight how insane of a situation we’re in:

In April 2019, the national debt was about $22 trillion. It grew to $34.6 trillion in April 2024.

That’s an increase of $12.6 trillion over just 5 years, or about $210 billion more debt each month.

With the debt at $34.6 trillion as of April 2024, every single person in America (336 million) would need to pay at least $100,000 to pay it down.

I don’t know about you, but I don’t have that kind of money!

What do we do?

So, we’ve learned a lot today. Three big items stand out to me: healthcare, revenue, and spending.

1. Health services are consistently the largest spending categories for the federal government.

America has the largest military in the world, and we spend almost as much on the military ($751 billion) as we spend on Medicare alone ($747 billion). We spend less money on the military than we do on Social Security ($1.2 trillion), and as America ages, this will only become a more difficult weight to bear.

From my perspective, I believe the first thing to address is healthcare. Even though we don’t have universal healthcare like many other wealthy countries, Americans spend an insane amount of money on health services. When we compare the amount of money we pour into health services with the health problems our country faces, we should be one of the healthiest countries on the planet. And yet we’re not.

The Peter G. Peterson Foundation is the best resource I’ve found that goes deeper into the issue of our inefficient healthcare system, so I highly recommend you check them out.

2. The federal government spends more than it makes.

40% of Americans don’t make enough to pay federal income taxes, and the wealthiest Americans avoid federal income taxes through investments that have a far lower capital gains tax. We have more deficits than surpluses.

We could solve this by taxing the rich more. As Bill Gates said, tackling capital gains tax in particular should be the focus of increased taxes on the wealthy, not income tax. If we don’t want to impact the new rich, we could tie increased capital gains tax to net worth rather than just investment profits.

But this doesn’t address the problem of spending. Our tax dollars do a lot of good, but it might make more sense to focus on being more efficient with government spending, rather than cutting programs. I imagine every item on the federal budget has just as many inefficiencies as the health services portions. Which brings us to the final point…

3. 70% of the budget goes into Mandatory Spending, rather than Discretionary Spending.

The entitlements that the government cannot avoid paying eat up most of the budget, leaving other functions of government (ie transportation and veterans’ benefits) in the dust, and giving us less flexibility on new or ambitious programs.

I believe that the tight grip Mandatory Spending has on the federal budget has likely contributed to the stagnation of innovation we see coming from the government. Nowadays, we always assume that innovation has to come from the private sector, but back in the day, the government made plenty of impressive initiatives of its own (NASA, the internet, the interstate highway system, the atomic bomb, GPS). If the government had more money to allocate to Non-Defense Discretionary Spending, I think that would do a lot of good for American society as a whole.

But of course, I’m no expert. Every dollar you make gets taxed, so after seeing just where your money is going, are you happy with the results? Do you think there should be major changes to how we go about taxing people? Should the rich pay more or are the poor not paying their fair share? Let me know your perspective!

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You can learn about the secrets of wealth in America on the Youtube Channel  as well.