Government Spending

Do you find yourself curious about the financial workings of a country? The cornerstone of this vast system is government spending. It's a broad term that covers many aspects, from the detailed government spending breakdown to the fluctuations of increase and decrease in government spending. Curious about the types of government spending and the array of factors that affect government spending? You're in the right place. We're set to clarify the government spending definition and its many facets. Prepare to delve into an in-depth review of government spending. This exploration is ideal for students seeking to understand public finance and anyone interested in how a nation's financial systems function. 

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Table of contents

    Government spending definition

    Government spending (expenditures) is the total sum of money a government uses to finance its activities and functions. This can range from infrastructure development and public services like healthcare and education to defense and social security. It's essentially how a government uses its budget to support and improve society.

    Government spending is the aggregate expenditure by local, state, and national governments on goods and services, including salaries of public employees, public infrastructure investments, welfare programs, and national defense.

    Government spending as a percentage of GDP varies widely across the globe, reflecting the diversity of economic structures and governmental roles. As of 2022, developed countries like Sweden (46%), Finland (54%), and France (58%) tend to have higher ratios, reflecting their extensive public services and infrastructure. Conversely, less developed nations like Somalia (8%), Venezuela (12%), and Ethiopia (12%) usually exhibit lower ratios. However, there are exceptions like the highly developed yet smaller countries of Singapore and Taiwan, with ratios around 15% and 16% respectively. This demonstrates the varied economic policies and unique factors influencing government spending across countries.

    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

    Government Spending UK Government Spending Chart StudySmarter

    Fig. 1 - UK Government Spending Projection for Fiscal Year 2023/24. Source: Office for Budget Responsibility

    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

    Table 2. UE government spending breakdown
    CategoryExpenditure (€ billion)

    % of GDP

    Social Protection298320.5
    Health11798.1
    Economic Affairs9186.3
    General Public Services8756.0
    Education7014.8

    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.


    Table 3. US Federal Government Spending Breakdown
    CategoryExpenditure ($ billion)

    % of Total Budget

    Medicare1484

    16.43

    Social Security129614.35
    National Defense116112.85
    Health107611.91
    Income Security8799.73
    Net Interest7368.15
    Education, Training, Employment, and Social Services6577.27
    General Government4394.86
    Transportation2943.25
    Veterans Benefits and Services2843.15
    Other8138.98

    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.

    During a recession, the government may pursue an expansionary fiscal policy. This would allow for an increase in the levels of government spending to boost aggregate demand and reduce a negative output gap. During these periods the level of government spending is generally higher than during periods of economic contraction.

    Other government policies

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

    The government might spend more on welfare benefits to redistribute income in society.

    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.

    A transfer payment is a payment for which no goods or services are provided in return.

    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.

    Educated and skilled workers may find jobs more easily, reducing unemployment and increasing overall productivity in the economy.

    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.

    For further insight into how the progressive taxation system is used in the UK, check out our explanations on Taxation.

    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.

    A budget deficit occurs when the current expenses are higher than the current income received through standard operations.

    A budget surplus occurs when the current expenses are lower than the current income received through standard operations.

    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.

    The national debt is the accumulation of budget deficits in the long term over multiple periods.

    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.

    As a reminder, take a look at StudySmarter's explanations on exchange rates and the 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.

    If higher tax rates are levied on individuals’ income, a larger percentage of that income is spent on taxes. This reduces their disposable income and thus their ability to spend more on other goods and services.

    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.

    The golden rule follows the idea that the public sector should only borrow to fund capital investments (like infrastructure) that encourage future growth. In the meantime, it cannot increase borrowing to fund current spending. As a result, the government must maintain the current budget position in a surplus or a balance.

    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.

    Government Spending - Key takeaways

    • Public expenditure is an important tool that governments can use to achieve their economic objectives.
    • Some key factors that impact how much the government spends include:
      • The country's population
      • Fiscal policy measures
      • Policy measures to redistribute income
    • Governments often use fiscal policy to reduce the poverty levels. Addressing poverty in a country can be done by:
      • Increasing government spending on transfer payments
      • Providing goods and services for free
      • Progressive taxation
    • A budget deficit implies that government revenues are lower than government spending.
    • A budget surplus implies that government revenues are higher than government spending.
    • Some problems associated with running a budget deficit include demand-pull inflation, an increase in public sector debt, debt interest payments, and higher interest rates.
    • Some problems associated with a budget surplus include high taxation, higher household debt, and lower economic growth.
    • Governments can use fiscal rules in order to avoid overspending.

    References

    1. Office for Budget Responsibility, A brief guide to the public finances, 2023, https://obr.uk/docs/dlm_uploads/BriefGuide-M23.pdf
    2. Eurostat, Government expenditure by function – COFOG, 2023, https://ec.europa.eu/eurostat/statistics-explained/index.php?title=Government_expenditure_by_function_%E2%80%93_COFOG#EU_general_government_expenditure_stood_at_51.5_.25_of_GDP_in_2021
    3. USAspending, FY 2022 spending by Budget Function, https://www.usaspending.gov/explorer/budget_function
    Frequently Asked Questions about Government Spending

    What are examples of government spending?

    Examples of government spending include spending on education, healthcare, or welfare benefits.

    What is government spending?

    Simply put, government spending is the public sector spending on goods and services like education or healthcare.

    What is the purpose of government spending?

    The purpose of government spending is to encourage economic growth, reduce income inequality, and reduce poverty levels.

    What are the three types of government spending?

    The three main types of government expenditure include public services, transfer payments, and debt interest.

    Test your knowledge with multiple choice flashcards

    A government can address poverty by ___________

    A budget deficit occurs when the current expenses are ___________ than the current income received through standard operations.

    A budget surplus occurs when the current expenses are lower than the current income received through standard operations.

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