Cutting Through the Federal Budget Fog

Like any budget, the federal budget is merely a plan for revenues and expenditures for the fiscal year. While that may sound simple enough, there’s often a cloud of confusion around the federal budget.

0:00 / 0:00

Transcript PDF

Lawmakers have little “wiggle room” to reduce expenditures. Although cutting federal spending to help balance the budget is frequently a matter of intense debate, the fact is only about a third of government expenditures is discretionary— meaning they can be easily reduced. These comprise spending lawmakers control through annual appropriation acts and can be broken down almost evenly between defense and nondefense expenditures.

The bulk of government spending is actually considered “mandatory,” which is somewhat of a misnomer. These “entitlement” expenditures can, in fact, be reduced, but doing so would be extremely difficult (and probably unpopular).

Government spending exceeds revenue

Increasing Mandatory Spending Will Likely Produce Larger Deficits

Federal deficits hit their highest levels since World War II following the Great Recession. In recent years, the deficit has been getting smaller; however, that trend is expected to change. Why? As the population ages, expenditures on mandatory programs (as a percentage of gross domestic product [GDP]) are projected to increase, and to a lesser extent, net interest on the debt is expected to get larger over time.

In 1966, the government spent 4.5 percent of GDP on mandatory expenses; today, it spends 13.2 percent of GDP on these expenses. As the population ages and lives longer, the Congressional Budget Office (CBO) projects that these programs will grow to represent 14.9 percent of GDP in 2026 if entitlement program payout formulas remain unchanged. And we can expect the costs to continue to rise.

Currently, discretionary spending is constrained by the Budget Control Act of 2011, which placed statutory caps that led to decreased defense and nondefense spending relative to GDP. However, the Bipartisan Budget Act of 2015 modified the automatic spending reductions for 2016 and 2017 and will slow the decrease in discretionary spending relative to GDP over the next couple of years.

Deficits – Not Necessarily a Bad Thing

While federal deficits are definitely a concern, keep in mind that they are an important part of managing through economic cycles. In theory, deficits grow during recessions as the government cuts taxes and increases spending to help stimulate economic activity. During better times, the opposite should occur, resulting in surpluses. However, as the chart shows, the government has run deficits on a fairly consistent basis – in both good times and bad – going back to 1929.

Deficits and surpluses as a percentage of GDP
Download the Full Report

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors, and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector, or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs, and investment time horizon.

Wells Fargo Advisors is registered with the U.S. Securities Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions, or communications made with Wells Fargo Advisors.

Special Reports

A collection of the most recent thematic reports from Wells Fargo Investment Institute that cover varying topics of interest and importance to investors.

Read Our Insights