Where’s all that government spending really going?

August 27, 2012, 8:01 PM UTC

FORTUNE — It’s well-known that government spending has grown rapidly in the three-and-a-half years since Barack Obama succeeded George W. Bush as president. It’s also clear that since GDP hit bottom in early 2009, economic growth has proven exceedingly weak compared with the rapid ascent from past downturns.

Now, a debate is raging over whether the big jump in outlays filled a hole that saved economy from a cataclysm, as everyone from columnist-economist Paul Krugman and Obama himself argue, or merely stunted the “recovery” by diverting job-creating, growth-enhancing capital from America’s businesses.

Although it’s impossible to settle the issue definitively, it is enlightening to examine where all that new spending is going. In crunching the numbers, I was amazed that most of the increase isn’t flowing into goods and services the government provides, and nor is it fulfilling the fabled priority for building and upgrading our roads, tunnels and bridges.

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So where are the new trillions in spending really going? To find out, let’s start with the total increase in outlays. Since the fourth quarter of 2008, total government spending — federal, state and local — has risen by 17.8%, to $6.3 trillion. That’s 12.6% adjusted for inflation. In those 11 quarters, outlays have swelled from 37.9% to 40.3% of GDP, the highest number since the mid-1940s.

The official GDP accounts, assembled by the government’s Bureau of Economic Analysis (BEA), show how much of that almost $1 trillion increase actually flowed into government services and investments. It’s important to recognize that the government spending included in GDP is not total spending, but the expenditures on two categories. The first is called “government consumption,” consisting of payments that provide such products and services as education and national defense, and encompassing everything from salaries for teachers, to pay for soldiers to costs for running state DMVs.

The second category is “government investment,” mainly comprising outlays on construction and maintenance of America’s infrastructure from federal, state and county highways to school facilities to dams. From late 2008 until today, spending on government goods and services rose just .1% annually, adjusted for inflation. The real shocker is investment: It dropped 3.71% a year in real terms. So the almost 18% rise in spending failed to provide substantially more government services, and furnished a lot less money for the highly touted necessity of rebuilding America’s infrastructure.

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The extra spending — the difference between the total and the shrinking share going to services plus investment — went to an explosive category called “transfer payments.” Government transfer payments are defined as expenditures for which no good, service or upgrade in infrastructure is expected in return. The government collects the money in the form of taxes and new borrowing, then writes the checks to consumers and, to a lesser extent, companies in the form of subsidies. Naturally, all of the money funding the rise in transfer payments has come from new borrowing, since the U.S. is running gigantic deficits.

By the way, the transfer payments do get counted indirectly in GDP, chiefly as “personal consumption” of cars, TVs, restaurant meals and sundry other expenditures by the folks who get the checks.

Since late 2008, transfer payments have ballooned by 34% or almost $800 billion a year, rising from 17.3% to 20.1% of GDP. Remember, we’re not counting programs that were part of the Obama “stimulus” and have since expired, such as the Making Work Pay program. We’re looking at the net of what’s been added and subtracted since 2008, and it’s a big positive. The largest category of transfer payments, of course, consists of the three major entitlements: Medicare, Medicaid and Social Security. Indeed, they rose in total by 28% since the fourth quarter of 2008. What’s surprising is that other transfer payments, all told, rose even faster, by 38%, and accounted for over half of the total increase.

Among the fast-growing categories: unemployment insurance and food stamps, which together expanded by 120% to $211 billion, and environmental and energy spending, including subsidies for solar panels, windmills, ethanol and other green products, which grew 76% combined to $61 billion. Job training, housing subsidies and many other line items also saw rapid increases.

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The big question is whether all the new spending on transfer payments made the economy grow faster than if that spending had been far more modest. Two leading economists are highly skeptical, John Cochrane of the University of Chicago, and John Taylor of Stanford. “The Keynesians will tell you that except for the ‘multiplier magic’ of all the spending, the private economy would have been even worse,” says Cochrane. He counters that the money for those transfer payments had to come from somewhere else, specifically by shrinking the savings available for private companies. “To do all that spending, the government has to borrow the money, and the people who bought government bonds would otherwise have provided companies with more capital for expansion by purchasing their bonds or stocks.”

The GDP accounts give credence to his argument. Private investment is lagging. Since the start of the downturn in 2008, spending on plant and equipment fallen by 6.3% adjusted for inflation. The most recent CBO report concludes that “net investment as a fraction of GDP remains unusually low.”

Taylor agrees that “all the borrowing is crowding out private investment.” But he cites a second, generally overlooked problem as well: the damaging impact on public investment. “It’s clear that budget constraints on state and local governments are squeezing the amount available for investment,” states Taylor. “The result is that both private and public investment is getting crowded out by government spending.” Among the transfer payments hammering state and local budgets are public pensions, which once again, provide neither government services nor improvements to roads or tunnels.

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Taylor insists that “the economy would be growing a lot faster without all the spending.” It’s certain that America is now swamped with the debt that financed that spending, without getting much extra torque in return. Was the great splurge worth it? The voters will register their opinion on November 6th.