Federal Budget Components and Mandatory Spending

The federal budget operates under constraints that most investors don't fully appreciate. More than 70% of federal spending is mandatory—legally required payments that Congress cannot easily change through the annual appropriations process. This structural reality explains why fiscal policy shifts slowly and why debt trajectories are difficult to alter quickly.

Understanding budget mechanics helps investors anticipate Treasury issuance patterns, assess fiscal sustainability debates, and evaluate claims about spending cuts or tax policy changes.

Budget Structure Overview

The federal budget divides into three main categories:

The key insight: Discretionary spending—the part Congress debates annually—represents barely a quarter of the budget. Defense and non-defense discretionary combined total about $1.7 trillion in FY2024, while mandatory programs exceed $4 trillion.

Mandatory Spending Components

Social Security (OASDI)

FY2024 spending: ~$1.5 trillion (23% of total budget)

Social Security operates as an entitlement: anyone who meets eligibility criteria receives benefits automatically. The program is funded primarily through payroll taxes (12.4% split between employer and employee, up to the wage base of $168,600 in 2024).

Investor relevance: Social Security trust fund exhaustion (projected 2033 under current law) would trigger automatic benefit cuts of ~23% unless Congress acts. This creates political pressure for either tax increases or benefit adjustments.

Medicare

FY2024 spending: ~$850 billion (13% of total budget)

Medicare covers hospital insurance (Part A), physician services (Part B), and prescription drugs (Part D). Part A is funded through payroll taxes; Parts B and D are funded through premiums and general revenues.

Growth driver: Per-beneficiary costs rise with healthcare inflation, while the beneficiary population grows as Baby Boomers age. CBO projects Medicare spending to reach 5% of GDP by 2034, up from ~3.5% today.

Medicaid

FY2024 spending: ~$600 billion (9% of total budget)

Medicaid is jointly funded by federal and state governments, with the federal share averaging 60-70%. Eligibility expanded under the Affordable Care Act, though some states declined expansion.

Economic sensitivity: Medicaid enrollment rises during recessions as more people qualify based on income. This automatic stabilizer increases federal spending when tax revenues fall.

Other Mandatory Programs

• Income security: ~$500 billion (unemployment, SNAP, SSI, refundable tax credits)
• Federal retirement: ~$200 billion (civilian and military pensions)
• Veterans benefits: ~$150 billion

Net Interest: The Growing Constraint

FY2024 spending: ~$870 billion (13% of total budget)

Net interest payments depend on two factors outside annual control:

1. Total debt outstanding: ~$35 trillion (debt held by public ~$27 trillion)
2. Average interest rate: Rising as low-rate debt matures and is refinanced

The math: Each 100 basis point increase in average borrowing costs adds ~$270 billion in annual interest expense on current debt levels.

CBO projections: By 2034, net interest could exceed $1.6 trillion annually—more than current defense spending—if rates remain elevated.

Debt-to-GDP: The Sustainability Metric

Current level: ~123% of GDP (debt held by public)

Economists disagree on what debt-to-GDP level becomes unsustainable, but most agree the trajectory matters more than the level. The US is on a rising trajectory.

Source: CBO Long-Term Budget Outlook, 2024

Investor implication: Higher debt-to-GDP ratios historically correlate with higher term premiums on Treasury securities, though the US has maintained lower rates than pure debt metrics would suggest due to dollar reserve currency status.

Discretionary Spending Reality

Defense

FY2024: ~$886 billion (51% of discretionary)

Defense spending is set through annual appropriations and includes:

• Military personnel costs
• Operations and maintenance
• Procurement of weapons systems
• Research and development

Non-Defense Discretionary

FY2024: ~$850 billion (49% of discretionary)

This category covers everything from education to transportation to the court system. Major components:

Budget constraint reality: Proposals to "balance the budget through spending cuts" face arithmetic problems. Eliminating all non-defense discretionary spending would not close the current deficit (~$1.8 trillion in FY2024).

Worked Example: Deficit Reduction Math

Scenario: Congress proposes to reduce the deficit by $500 billion through discretionary cuts.

Current discretionary spending: ~$1.7 trillion total

Required cut: $500 billion / $1.7 trillion = 29% across-the-board reduction

Practical impact:

• Defense: Cut from $886B to $629B (30% reduction)
• Non-defense: Cut from $850B to $604B (29% reduction)

Reality check: A 29% cut to defense would reduce military personnel, procurement, and readiness. A 29% cut to non-defense would impact air traffic control, border security, federal courts, and veterans hospitals.

The point: Large deficit reduction through discretionary cuts alone is politically and operationally implausible. Meaningful fiscal adjustment requires addressing mandatory programs or raising revenues.

Budget Process Timeline

Investor watch points:

• Budget resolution conflicts: Signal potential appropriations delays
• Continuing Resolutions: Indicate dysfunction; typically extend prior-year funding
• Shutdown threats: Create short-term uncertainty but limited market impact

Common Pitfalls

Pitfall 1: Treating budget projections as forecasts

CBO projections assume current law continues. Tax cuts with expiration dates are assumed to expire; spending programs are projected at current law levels. Actual policy often differs.

Pitfall 2: Ignoring baseline adjustments

Budget "savings" are often measured against inflated baselines. A program growing 5% instead of 7% is scored as a "cut" even though spending increases.

Pitfall 3: Conflating deficit and debt

The deficit is annual shortfall. The debt is cumulative. A smaller deficit still adds to debt. Even a balanced budget doesn't reduce debt outstanding.

Pitfall 4: Assuming rate normalization

Projections using historical average interest rates (~5%) look very different from projections using recent rates (~3%). Rate assumptions dramatically affect long-term fiscal outlook.

Checklist for Fiscal Analysis

When Evaluating Budget Proposals

• Separate mandatory from discretionary impacts
• Check time horizon (10-year scores can hide front-loaded or back-loaded effects)
• Compare to CBO baseline, not current policy
• Assess political feasibility of mandatory changes
• Note interest rate assumptions

Monthly Monitoring

• Track Treasury issuance announcements (quarterly refunding)
• Monitor CBO budget updates (monthly and quarterly)
• Note Congressional Budget resolution progress
• Watch debt ceiling timeline if applicable

Related Articles

• Discretionary Spending vs. Automatic Stabilizers
• Budget Deficits, Surpluses, and Debt-to-GDP
• Treasury Issuance Schedules and Auctions

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References

Congressional Budget Office (2024). The Budget and Economic Outlook: 2024 to 2034.

Congressional Budget Office (2024). The Long-Term Budget Outlook: 2024 to 2054.

Office of Management and Budget (2024). Budget of the U.S. Government, Fiscal Year 2025.

U.S. Treasury Department (2024). Monthly Treasury Statement.