Government Spending

Types of government spending

Government expenditure refers to the amount spent by the government to manage the economy and ensure its smooth functioning. It is a crucial part of public finance and is categorized into different types based on the nature and purpose of the spending.

Current Expenditure

Current expenditure (public sercixes) refers to the day-to-day operational expenses incurred by the government. This includes the salaries of public servants, maintenance of government offices, interest payments on debt, subsidies, and pensions. This type of expenditure is regular and recurring in nature. Current expenditure is crucial for the smooth functioning of government operations and services.

Capital Expenditure

Capital expenditure is the spending on the creation of assets or a reduction in liabilities. This includes investments in infrastructure projects such as roads, schools, hospitals, and public transportation. Other examples are the purchase of machinery, equipment, or property. Capital expenditure leads to the creation of physical or financial assets or a decrease in financial liabilities. This type of spending is often seen as an investment in the country's future, promoting economic growth and development.

Transfer Payments

Transfer payments involve the redistribution of income. The government collects taxes from certain sections of society and redistributes them as payments to other sections, usually in the form of subsidies, pensions, and social security benefits. These payments are called "transfer" because they are moved from one group to another without any goods or services being received in return. Transfer payments are crucial in addressing income inequalities and supporting vulnerable groups within society.

By understanding the different government expenditure types, you can better understand how public funds are used and allocated. Each category serves different needs and priorities within the economy, contributing to the overall welfare and development of the country.

Government spending breakdown

Understanding the breakdown of government spending can help provide insight into a country's priorities, economic policies, and fiscal health. Each country has its own unique approach to allocating resources, reflecting its specific needs, challenges, and goals. Let's delve into the breakdown of government spending in the United Kingdom (UK), the European Union (EU), and the United States (US).

UK government spending breakdown

In the fiscal year 2023-24, the UK's public spending is projected to be around £1,189 billion, equivalent to approximately 46.2% of the national income or £42,000 per household. The largest portion of this spending, at 35%, goes towards the day-to-day running costs of public services, such as health (£176.2 billion), education (£81.4 billion), and defence (£32.4 billion).¹

Capital investment, including infrastructure such as roads and buildings and loans to businesses and individuals, accounts for 11% (£133.6 billion) of the total expenditure. Welfare system transfers, predominantly to pensioners, account for a significant portion at £294.5 billion, with state pensions alone estimated at £124.3 billion. The UK government is expected to spend £94.0 billion on net interest payments on the national debt.¹

EU government spending breakdown

In 2021, the EU’s largest spending category was ‘social protection’, accounting for €2,983 billion or 20.5% of GDP. This figure rose by €41 billion compared to 2020, predominantly due to an increase in 'old age' related expenditures.

Other significant categories were ‘health’ (€1,179 billion or 8.1% of GDP), 'economic affairs' (€918 billion or 6.3% of GDP), ‘general public services’ (€875 billion or 6.0% of GDP), and ‘education’ (€701 billion or 4.8% of GDP).²

US government spending breakdown

In the US, the federal government distributes its budget across various domains. The largest category of spending is Medicare, which accounts for $1.48 trillion or 16.43% of total expenditure. Social Security follows, with an allocation of $1.30 trillion or 14.35%. National Defense receives $1.16 trillion, accounting for 12.85% of the total budget, and Health receives $1.08 trillion, equating to 11.91%.

Other significant allocations include Income Security ($879 billion, 9.73%), Net Interest ($736 billion, 8.15%), and Education, Training, Employment, and Social Services ($657 billion, 7.27%).

Remember that the table below shows the percentage of the total federal budget, not the country's GDP.

Factors that affect government spending

There are numerous factors that may affect the level of government spending. Some key factors that impact how much the government spends include the following categories.

The country's population

A country with a large population will have higher government spending than a smaller one. Additionally, the structure of a country's population can impact government spending. For example, an aging population implies that more people are claiming state-funded pensions. Older people also have a higher demand for healthcare services, which the government funds.

Fiscal policy measures

Governments can use fiscal policy measures to address some economic problems.

Other government policies

Governments may also impose various policies to encourage income equality and income redistribution.

Advantages of Government Spending

Government spending, as a critical instrument that drives a nation's economic and social development has many advantages. It funds public services, enables infrastructure development, and supports income security measures, among many other things. The there main benefits of governments spending are: economic growth stimulation, reduction of inequality and provision of public goods and services.

Stimulation of Economic Growth

Government spending often serves as a stimulus for economic growth. For instance, investment in infrastructure like roads, bridges, and airports creates jobs, boosts various industries, and enhances the ease of doing business.

Reduction of Income Inequality

Through welfare programs and social security measures, government spending can help to reduce income inequality. For example, programs like Medicare and Medicaid in the U.S. provide healthcare services to low-income individuals and families, helping to bridge the health inequality gap.

Public Goods and Services

Government spending allows for the provision of public goods and services such as education, healthcare, and defense, which benefit all citizens. For instance, public education funded by the government ensures that every child has access to basic education.

What are some types of government spending to address the poverty level?

Governments often use fiscal policy to reduce the poverty level. A government can address poverty in several ways.

Increasing spending on transfer payments

Spending on unemployment benefits, state pension, or disability support helps those who are unable to work or to find work. This is a form of income redistribution, which can help reduce absolute poverty in the country.

Providing goods and services for free

Publicly funded services like education and healthcare are accessible for free in most countries. This makes them accessible for everyone, particularly those who would otherwise not be able to access them. Providing these services for free helps reduce the impacts of poverty. This way, the government is indirectly investing in the economy's human capital, which can increase productivity in the economy in the future.

Progressive taxation

This form of taxation allows for the redistribution of income in society by reducing income inequality. The government may reduce poverty levels by attempting to close the gap between low and high-income earners, as high-income earners pay progressively more taxes than low-income earners. The government can also use the tax revenue received to fund welfare payments.

Increase and decrease in government spending

Every national government receives income (from taxation and other sources) and spends on public services. The way these sources of revenue and expenditure are managed can cause budget deficits and surpluses in a given period. If these accumulate over time, there are many possible consequences.

Problems of a budget deficit

Running a budget deficit has numerous impacts on macroeconomic activity. Firstly, additional borrowing leads to an increase in public sector debt.

If the government is running numerous budget deficits, it will have to increase borrowing even further to finance its activities. This further contributes to increasing the national debt.

Another main concern of a budget deficit is demand-pull inflation due to the increase in the money supply caused by increased borrowing. This means that there is more money in the economy than what can be matched by the national output.

Additionally, increasing borrowing leads to higher levels of debt interest payments. Debt interest can be defined as the interest payments the government has to make on the money it previously borrowed. In other words, it is the cost of servicing the national debt which needs to be paid at regular time intervals. As the government runs a deficit and borrows even more causing an increase in already accumulated debt, the amount of interest paid on borrowings rises.

Similarly, interest rates on government borrowing are also likely to rise, as the government has to attract new lenders. One method of attracting new lenders is by offering higher interest rate payments on the amount borrowed. Higher interest rates can discourage investment and make the national currency appreciate (rise in value). This is problematic as it may lead to less competitive exports, harming the country's balance of payments.

Problems of budget surplus

Although running a budget surplus might sound ideal as the government has more financial resources to spend on public services, it can actually lead to various problems. To achieve a budget surplus, government spending, government revenue, or both, have to be manipulated.

A government can achieve a budget surplus by decreasing government spending as a result of budget cuts in the public sector. However, this will only occur if government revenue is higher. This means that the government will have to decrease investment in certain areas of the public sector like housing, education, or health while increasing taxation. Lower investment in public services can have a negative impact on the future productivity and efficiency of the economy.

Government revenues can increase due to higher taxation on household income, excise duties, and corporation taxes, or higher human capital employment levels in the economy. This can have several impacts, like decreased disposable income in the case of individuals, or lower profits to use for investment in the case of businesses.

Higher taxation can also lead to higher household debt if households are forced to borrow to finance their consumption. This leads to lower levels of spending and individual saving in the economy, as consumers are focused on paying off their debt.

Finally, a strong fiscal position, like a budget surplus, can be the result of sustained economic growth. However, the opposite may also take place. If the government is forced to increase taxation and decrease public expenditure to achieve a budget surplus, low levels of economic growth may occur due to the policy's effects of suppressing aggregate demand.

Review of government spending

Recent rule-based fiscal policy in the UK can be broken down into two specific types:

• The deficit rule aims to get rid of the structural part of the budget deficit.
• The debt rule aims to make sure that debt is decreasing as a certain share of the GDP.

Governments can use fiscal rules to avoid overspending. An example of a fiscal rule is the UK government's implementation of the golden rule.

These types of fiscal rules prevent governments from overspending when attempting to encourage growth. Overspending can lead to high levels of inflation and increasing national debt. As a result, fiscal rules help governments maintain economic and inflationary stability.

They can also increase consumer and firms' confidence in the economic environment. Economic stability might encourage firms to invest more, as they perceive the economic environment to be promising. Similarly, consumers might be encouraged to spend more, as their fears of inflation decrease.