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      SOURCE: Federal Reserve Bank of St. Louis, FRED data set.

      Table 2.2 shows various components of federal receipts and outlays during two recent years. In 2007, federal receipts were 19.4 percent of GDP, with the individual income tax accounting for 8.8 percentage points and the Social Security and Medicare taxes comprising 6.6 percentage points. That same year federal outlays for transfer payments—Medicare, Social Security, income security, and net interest—were 11.8 percent of GDP. The 2007–2009 recession caused tax receipts to decline relative to income, to 16.2 percent of GDP by 2010. Meanwhile, a federal spending binge caused outlays to expand to 25.8 percent of GDP, of which 14.8 percentage points were transfer payments. Since receipts were 16.2 percent of GDP while outlays were 25.8 percent, the government borrowed the difference (9.6 percentage points of GDP).

Table 2.2 FEDERAL RECEIPTS AND OUTLAYS AS PERCENT OF GROSS DOMESTIC PRODUCT, 2007 & 2010

      SOURCE: Federal Reserve Bank of St. Louis, FRED data set.

      In other words, in 2010 the federal government collected about 16 cents of every dollar of income produced in the United States, and spent 25 cents (of which 15 cents were transfer payments). This shortfall required federal borrowing of almost 10 percent of GDP produced that year. The federal government has evolved into a monolith that taxes “Peter” (those with jobs or earning high incomes, or both) to pay “Paul” (primarily senior citizens receiving Social Security and Medicare benefits). In effect, this is an intergenerational transfer scheme that taxes workers and pays older retirees. Retirees, of course, feel entitled to these benefits because they have paid taxes into this system while they worked, and the current workers accept the arrangement so long as they believe benefits will be available when they retire.

      The huge expansion of transfer payments has required higher tax rates to help fund them. Recall that in 1937, the original Social Security payroll tax rate for OASDI (old-age, survivors, and disability insurance) was 2 percent. Figure 2.5 shows the payroll tax rates for OASDI and Medicare hospitalization insurance.¹⁸ The Social Security tax has risen more than sixfold (from 2.0 percent to 12.4 percent), whereas the Medicare tax went from 0.7 percent when first instituted in 1966 to the current rate of 2.9 percent. Another difference between the two levies is that the Social Security tax has an annual income limit beyond which the wage earner pays no further taxes (in 2010, the amount was $106,800), whereas the Medicare tax has no income limit.

Figure 2.5 SOCIAL SECURITY AND MEDICARE TAX RATES, 1937–2010