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A Closer Look: Where Does Your Tax Money Go?

11 Minute ReadTopic: taxes

Editor’s Note: For the most up-to-date information on tax policy and how it affects you, talk to a tax professional in your area.

Hold on to your checkbooks! The 2012 tax year will be a record-setter. According to the Congressional Budget Office, tax revenues will reach $2.7 trillion—the most they have ever been. And, at $17 trillion, America’s debt will also be higher than ever before.

Many Americans side with Sen. Tom Coburn, R-Okla., who says America can thank bad politics for its financial trouble. “It’s the typical trick of the career politician,” he said. “I’ll give you something for nothing—it doesn’t work. Now, we’re at that time where the bill’s due.”

But taxes, debt and spending are tough issues for Americans. While most of us aren’t comfortable with our country’s debt levels and nearly everyone agrees that our government could handle our tax money better, we disagree about who should pay taxes and what taxes should pay for.

So we’ve decided to dive deep into these topics to discover exactly what Americans are paying for and why our nation’s spending seems to be spiraling out of control. Will the facts show that Sen. Coburn and millions of other citizens are mistaken, and that most Americans are actually getting what they want from their taxes?

What Are We Paying For?

Over the past few months, millions of American taxpayers have dutifully filed their federal income taxes. For many families, these taxes are their largest annual expense. Regardless, most will simply fill out the paperwork and pay whatever figure ends up on the bottom line without asking too many questions.

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So what are we really paying for? A sample 2011 tax receipt provided by whitehouse.gov shows the total tax bill for a married couple with two kids making $80,000 was just over $9,000. Here’s the breakdown:

  • Payroll taxes make up about half of the family’s tax bill and pay for Medicare ($1,160) and Social Security ($3,360).
  • About 70% of their income taxes go to three categories: national defense ($1,142), health care expenses like Medicaid ($1,087), and job and family security programs like unemployment insurance and food and housing assistance ($876).
  • The remainder is divided between 12 categories that include education, energy, agriculture and interest payments on the national debt.

On the spending side, federal budget outlays follow our sample tax receipt fairly closely. In 2011, the federal government spent $3.6 trillion: $2.2 trillion was financed by federal tax revenues; $83 billion came from Federal Reserve profits; and $1.3 trillion was borrowed money.

  • Health care expenses made up the largest portion of the budget at $769 billion. This was divided between Medicare, Medicaid and CHIP (Children’s Health Insurance Program) to provide health care to 60 million low-income children, parents, elderly and disabled Americans.
  • Social Security was the next largest expense at $731 billion, providing average monthly benefits of $1,230 to 35.6 million retired workers and 10.6 million disabled workers and their eligible dependents.
  • Defense and International Security Assistance expenses came in at $718 billion and include $159 billion for operations in Iraq and Afghanistan.
  • Safety net programs such as unemployment insurance and food and housing assistance totaled $466 billion.
  • Interest on the debt was only 6% of the budget at $230 billion.
  • The remaining $686 billion goes to programs such as veteran and federal retiree benefits, food and drug safety, education and transportation.

Who Is Paying For It?

If you want to stir up controversy, bring up the topic of who pays taxes and who doesn’t. Presidential candidate Mitt Romney arguably lost the 2012 election due to a remark he made about 47% of the country’s citizens not paying income taxes. What’s the truth behind the numbers?

Our income tax system is progressive, which means people with higher incomes do shoulder a larger portion of the taxes. According to Congressional Budget Office data, this year higher income families will have the highest average tax bills since 1979—the first year the office began tracking taxes.

  • Incomes in the top 20% will pay an average of 27.2% of their income in federal taxes, including income, payroll, corporate and estate taxes.
  • The top 1% will pay an average of 35.5% of their incomes in taxes.
  • The middle 20%, with incomes averaging $46,000, will pay an average of 13.8% of their incomes in taxes. That’s down from an average of about 16% over the last 30 years.
  • The bottom 20% of income earners won’t pay any federal taxes. Many will actually have a negative tax rate due to refundable credits and will actually receive payments from the federal government.

Related: Keep more of your hard-earned cash out of the hands of the government and in your own pocket. Work with a tax pro in your area who will help you do your taxes right!

Politics of Taxes

Republicans and Democrats, of course, view these findings differently. Democrats say wealthier people can afford to pay more because their incomes have grown more than middle- and low-income families’ have grown. Average after-tax incomes for the top 1% increased 155% between 1979 and 2009. Middle incomes increased 32% during the same period, while the lowest incomes grew 45%.

New tax laws passed by Congress January 1 and tax increases included in the Affordable Health Care Act will widen the tax gap for the 2013 tax year.

  • The top tax rate rises from 35% to 39.6% on individual incomes of more than $400,000 ($450,000 for married couples).
  • Lower tax rates are now permanent on incomes less than that amount.
  • Tax breaks for low-income families first enacted in President Obama’s 2009 stimulus package have been extended through 2017.

Republicans argue that raising taxes on higher incomes hurts long-term economic growth by reducing incentive to save and invest. In the 100-year history of the federal income tax, the top individual tax rate has been as high as 91% according to research compiled by the Heritage Foundation. But no matter how high or low income tax rates have been, the revenue produced by the income tax has remained steady, averaging 8% of gross domestic product, and never exceeding 10.2% of GDP.

Higher tax rates, Republicans point out, push taxpayers to find ways to shelter their income rather than use it to invest in the economy. “Recent increases in the top rate will do almost nothing to reduce deficits and debt,” Curtis Dubay said in his commentary published by the Heritage Foundation. “But it will cause considerable damage to the fragile economy.”

What Is Driving Spending?

The website usgovernmentspending.com compiles government spending and revenue data using Census Bureau reports, federal budgets and local government finance reports.

  • According to this data, total government spending as a percentage of GDP has increased 11.47% between 1972 and 2009.
  • In the same time period, spending on defense, infrastructure and government services has kept pace with GDP growth, even declining slightly as a share of GDP.
  • However, entitlement spending—which includes expenses for Medicare, Medicaid, CHIP, Social Security, welfare and social insurance programs—increased from a total of 6.02% of GDP in 1972 to nearly 20% of GDP in 2011.

Research released in the New York Times confirms that nearly all the growth in federal spending as a share of GDP has come from increased expenses in entitlement spending. According to the New York Times calculations, total government spending rose about 9% between 1972 and 2011, equal to $1.3 trillion per year in current dollars. In 1972, spending on entitlement programs was $500 billion. If it had increased at the same rate as GDP, it would now be $1.4 trillion. Instead, it is $2.9 trillion, $1.5 trillion above GDP growth.

In the report “Federal Spending by the Numbers” published by the Heritage Foundation, growth of the three main entitlement programs—Medicare, Medicaid and Social Security—combined with $1.7 trillion in new spending related to the Affordable Healthcare Act will force all other government programs like national defense, veterans programs, transportation, etc. to be paid for entirely with borrowed money by midcentury.

Here again, Republicans and Democrats differ in how to solve this problem. Democrats are generally in favor of preserving these benefits as they are, and are more likely to consider raising revenue through increased taxes. Republicans often propose spending cuts, including cuts to benefits, and oppose tax increases to fund additional spending.

Another Spending Issue—Waste

But, Sen. Coburn, however, says waste in the federal budget is the real problem. In 2011, Coburn presented his deficit reduction plan, Back in Black, which cut a total of $9 trillion from federal expenditures and would have balanced the budget in 10 years. The majority of his spending cuts focused on wasteful spending not only on entitlements, but throughout the federal budget.

“As long as we keep concentrating only on entitlement programs or fixed programs, you miss the third of the rest of the budget in the non-defense discretionary budget that’s wasted,” Sen. Coburn said.

Coburn believes we can get control of our spending, including entitlement spending, by examining and eliminating waste. “We can keep our promises (made through Social Security, Medicare and Medicaid),” he said. “What we can’t keep doing is telling people they’re fine when in fact, from a financial standpoint, they’re bankrupt.

“All the problems in front of us are solvable, but everybody’s going to be required to sacrifice­—the very wealthy and the not wealthy,” Coburn said. “We can’t borrow enough money to get us out of debt. We can’t tax our way out. The only way we can is to reform our way out of it. And the reform ought to be about growing the economy and growing prosperity and growing jobs by putting more capital into productive things rather than putting more capital into government.”

Are Taxpayers Getting What They Want?

Now that we’ve seen what we’re paying for and how much we’re paying for it—and how much more we’re not able to pay for, we’ve come down to the final question: Are taxpayers getting what they want? Do Americans believe it’s worth the expense to support government involvement in so many areas of our lives?

There is some research that suggests they do. A survey conducted by Head Research for TD Ameritrade shows that Americans’ top three priorities for government are affordable health care, job creation and improving public education. Investing in U.S. defense, a core government responsibility, came in eighth on the list.

Another study by American Progress says Americans tend to disagree with “big” government in principle, but at the same time, they embrace a wide range of federal government programs and initiatives. The survey also found:

  • 62% of survey respondents say their priority is to make government more efficient and effective over reducing the size of government.
  • Even the 27% of respondents who say the government should not do more to solve problems also say they want to see government improved rather than downsized in areas like energy development, education, reducing poverty and access to affordable healthcare.

“There’s a hole in that philosophy that everyone knows, but no one will admit,” Sen. Coburn said in response to these numbers. “It’s enticing to think that government can do things, but there’s not one program in the federal government that’s both highly effective and efficient.

“The more money the government spends, that means there’s less money in the private sector,” he continued. “Government can’t spend money and create wealth. Only the private sector can. So the bigger the government, the less the share of the GDP there is to produce wealth, which will promote increasing incomes for the private sector.”

Keep more of your hard-earned cash out of the hands of the government and in your own pocket. Work with a tax pro in your area who will help you do your taxes right!

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