Income tax is the primary source of cash flow for the federal government. Income tax includes three separate categories: individual, payroll, and corporate income tax.
In 2020, individual and payroll tax revenue accounted for 85% of the government’s revenue. The percentage was about the same for 2019. Income tax made up 55% of the 85%. So overall, income tax from individuals contributes the bulk of government revenue and this translates to the bulk of its 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|
|Corporate Income Taxes||230||212|
Paying a portion of income to the government is a mandatory obligation. Any individual or company with earned income must hand over 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 represents the deficit.
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. Below is a breakdown of the U.S. government’s three main spending categories for 2020 and 2021, estimated as of September 2020.
|Government Outlays (billions of dollars)||2020||2021|
Mandatory spending accounts for the greatest portion of total spending followed by discretionary spending. Because government spending exceeds government revenues, the government is required to cover the gap with debt. As shown above, $338 billion went towards interest on the federal debt in 2020.
Breaking down the three main categories provides some deeper insight.
Mandatory spending consists primarily of Social Security, Medicare, and Medicaid. Several welfare programs are smaller items, including food stamps, child tax credits, child nutrition programs, housing assistance, the earned income tax credit, and temporary assistance for needy families. Other major programs include unemployment benefits, student loans, and programs for veterans.
This spending is considered mandatory because the programs are permanent and the government cannot set a dollar amount that it wishes to spend for them. Instead, it creates eligibility rules by which individuals qualify to receive payments 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|
|Income Security Programs||1,132||499|
|Federal Civilian and Military Retirement||173||179|
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|
When further granulated it covers the following U.S. departments:
- Department of Defense
- State Department
- Homeland Security
- 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 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 many changes over a number of 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.
Congressional Budget Office. "Budget and Economic Data."