Fixing America’s Finances: The Rub on Reducing Federal Spending

For the better part of six decades, the U.S. government, like a household that regularly fails to balance its budget, has spent more than it earns. The Trump administration has wasted no time trying to rein in federal spending through a downsizing of the federal workforce and other headline-grabbing moves.

But making meaningful spending cuts will be an uphill battle, both in the short and long term. In this week’s Markets in a Minute, we take a look at the challenge of lowering federal spending, and why it matters even more than just a few years ago.

Back to the Future

When the federal government spends more than it collects in taxes and other revenue, it must borrow to cover the gap, or the deficit.

With the exception of select years, the U.S. has run a deficit since 1960, particularly during national crises. The deficit widened significantly during the Global Financial Crisis and the pandemic, when the federal government unleashed massive stimulus spending and tax revenue plunged.

While we’ve seen some improvement since those crises, the deficit remains wide on a historical basis. Today, it’s almost double its long-term average and nearly equivalent to where it stood at the height of the Cold War in 1983.

United States Deficit / Surplus (% of GDP)

Source: Kestra Investment Management with data from FRED. Data from 1929-2024

The Price of Overspending 

Recurring deficits have come at a steep cost. Government borrowing to cover yearly budget holes has fueled a dramatic increase in our national debt, both on a relative and absolute basis. In fiscal 2024, the national debt topped 120% of gross domestic product (GDP), nearly double what it averaged between 1940 and 2023. (See how the U.S. compares to other countries on debt to GDP, an indicator of a nation’s ability to repay its debt.)

What are the opportunities to make meaningful spending cuts or other reforms? As a starting point, it helps to understand how we, as a country, spend most of our money. 

The Elephant in the Room: Mandatory Spending

The cost of entitlement programs, including Medicare, Medicaid and Social Security, represents a whopping two-thirds of the federal budget. Stated differently, 83% of every dollar the government collects is spent on these programs.
 
The aging of the U.S. population, or the so-called Silver Tsunami, has been a major driver of spending on Medicare and Social Security and is expected to put a bigger strain on these programs. Immigration policy will also impact their financial health since it affects the supply of younger workers who can pay into them. 

The conversation around reforming entitlement programs is starting to change, but, generally speaking, both parties have consistently said they don’t plan to touch the programs, particularly Medicare and Social Security. 

Interest on the National Debt  

For the last 20 years, interest costs on the national debt declined even as overall spending grew. So, in a sense, it didn’t matter that we kept borrowing greater amounts to cover yearly deficits. But now that rates are higher – and the near-term prospects for Fed rate cuts have diminished – the surging cost of servicing the national debt is quickly becoming a difficult problem to manage. 

Interest expense as a percentage of federal revenue was 18% in 2024, nearly double what it was in 2020. In fiscal 2024, the federal government spent more on interest costs than it did on defense or Medicare. Defense spending, by the way, is the largest single category of discretionary spending and is also likely to go untouched because of growing geopolitical risks and other factors. In addition, defense spending accounts for just under 4% of GDP—the lowest level since 1947—making further cuts unlikely.

Interest Expense as a % of Federal Revenues

Source: Kestra Investment Management and Peter G. Foundation with data from Congressional Budget Office and Office Management and Budget. Data as of January 22, 2025. Projections may not come to pass.

The Trump Plan: Less Spending, Faster Growth   

The Trump administration aims to reduce the deficit to 3% of GDP (roughly half of where it stands today) through a combination of cost-cutting measures and pro-growth strategies, including deregulation, tax reform and stimulating energy production. The plan hinges on hitting what may prove to be ambitious targets, including reaching a sustained 3% GDP annual growth rate. 

In the meantime, President Trump’s Department of Government Efficiency (DOGE), tasked with cutting spending, has garnered headlines and political pushback for its efforts to shrink the federal workforce, cancel contracts and more. That said, from a budgetary perspective, DOGE can only do so much. The scope of its work is limited to non-defense discretionary spending, which represents only about 14% of the federal budget. 

The Budget and the Market  

Federal budget negotiations are also front and center. Last week, President Trump signed a continuing resolution to extend the government’s budget through the end of September. Still, lawmakers appear a long way off from consensus for a longer-term solution.

As the process unfolded, the stock market shrugged off the budget negotiations. Right now, investors are far more preoccupied by the fledgling trade war, inflation and other issues with shorter-term economic implications. 

Indeed, addressing government overspending and borrowing won’t be a quick or easy process. But it’s worth doing thoughtfully. As I’ve noted before, it’s an American problem, not a party problem. 
 

 
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Investment Services, LLC, and Bluespring Wealth Partners, LLC. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by any entity for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Investment Services, LLC, and Bluespring Wealth Partners, LLC. Does not offer tax or legal advice.