Income tax is the primary source of revenue for the federal government but it has three separate categories that contribute to its cash flow. Individual and payroll taxes are two categories with the third being corporate income tax.

In 2020, individual and payroll tax revenue accounted for 85% of the government’s revenue. This was the same for 2019. Income tax made up 55% of the 85%. So overall, income tax from individuals does contribute to the majority of revenue and this can translate to a majority of the spending as well.

Who Pays Income Taxes?

Sources and Amounts of Government Tax Receipts
Tax Source (billions of dollars) 2019 2020
Individual Income Taxes 1,718 1,609
Payroll Taxes 1,243 1,310
Corporate Income Taxes 230 212
Other Receipts 271 289
Total 3,462 3,420
Source: https://www.cbo.gov/system/files/2020-11/56746-MBR.pdf

Paying a portion of income to the government is a mandatory obligation. Any individual or company that earns income must allocate a portion of that income to the federal government as designated by U.S. tax law. Any gaps between the government’s spending and its revenue from taxes are covered by borrowing which also represents the deficit.

Government Spending

All U.S. government spending can be divided into three categories: mandatory spending, discretionary spending, and interest on the federal debt. Each year’s budget is submitted by the president of the U.S. and approved by both the Senate and the House. The federal budget is publicly provided on the website of the Congressional Budget Office here. Below is a breakdown of the U.S. government’s three main spending categories for 2020 and 2021, estimated as of September 2020.

Government Spending
Government Outlays (billions of dollars) 2020 2021
Mandatory 4,617 3,184
Discretionary 1,651 1,593
Net Interest 338 290
Total 6,606 5,067
Source: https://www.cbo.gov/about/products/budget-economic-data#3

Mandatory spending accounts for the greatest portion of total spending followed by discretionary spending. Then, because government spending exceeds government revenues, which requires the government to cover the gap with debt, the $338 billion went towards interest on the federal debt.

Breaking down the three main categories further provides some deeper insight.

Mandatory

Mandatory spending consists primarily of Social Security, Medicare, and Medicaid. Several welfare programs are also included, like food stamps, child tax credits, child nutrition programs, housing assistance, the earned income tax credit, and temporary assistance for needy families. Other programs include unemployment benefits, student loans, and programs for veterans.

This spending is considered mandatory because the programs are permanent and the government does not set a dollar amount that it wishes to spend in each of these categories. Instead, it creates eligibility rules by which individuals qualify to receive payments from the government through these programs.

Thus, any eligibility program can be expected to fall in the mandatory spending category. The only way to increase or decrease mandatory spending is to adjust the eligibility requirements so that individuals receive more or fewer benefits. Examples of some mandatory spending categories and their amounts are described in the table below.

Mandatory Spending Categories and Amounts
Mandatory Spending (billions of dollars) 2020 2021
Social Security 1,091 1,142
Medicare 862 810
Medicaid 466 537
Income Security Programs 1,132 499
Federal Civilian and Military Retirement 173 179
Veteran's Programs 122 132
Source: https://www.cbo.gov/about/products/budget-economic-data#3

Discretionary

Discretionary spending includes spending that is appropriated annually. Overall, this part of the budget can be broadly broken out into defense and nondefense.

Discretionary Spending Categories and Amounts
Discretionary Spending (billions of dollars) 2020 2021
Defense 757 752
Nondefense 1,139 668
Source: https://www.cbo.gov/about/products/budget-economic-data#3

When further granulated it covers the following U.S. departments:

Defense

  • Department of Defense
  • State Department
  • Homeland Security  

Nondefense

  • Education
  • Veterans Assistance 
  • Housing and Urban Development

The Bottom Line

Mandatory spending has historically represented the greatest portion of government expenditures at over 60%. Each year a federal budget is submitted by the president of the United States outlining plans for mandatory and discretionary spending overall.

While the president’s federal budget submission kicks off the process for agreeing on a federal budget, this budget must still be voted on and approved by Congress which leads to several changes and iterations.

The final signing of the annual budget must be done by September 30 to maintain orderly operations of the government since its fiscal year runs from October 1 to September 30. If Congress and the president cannot agree on a final budget the government will shut down or spending will be based on temporary measures.