of Economic Advisers 1962, 207, 272).16 During World War II, tax revenue funded about 45 percent of U.S. federal expenditures (R. A. Gordon 1974, 85).17
The Postwar Era and the Cold War
At the conclusion of prior U.S. military conflicts, the federal government reduced defense spending and lowered tax rates. This process took place after World War II, but to a lesser extent than had been the case before. Beginning in 1945, the federal government downsized but remained larger than it had been just before the war, and much larger than before the Great Depression. This expanded government was partly because the New Deal had created several permanent federal spending programs and regulatory agencies. The other major cause was change on the international political scene.
When World War II ended, the Soviet Union’s Red Army occupied Eastern Europe. As a counterweight to the communist threat, the United States maintained military bases in Western and Southern Europe. The United States also maintained a presence in the Pacific, with bases in various locations, including Japan and Okinawa. U.S. concerns over communist aggression proved correct when in 1949 the Soviets cut off West Berlin from West Germany, which precipitated the Berlin Airlift. Also that year, the communists won the Chinese civil war. The following year, the North Korean communists attacked South Korea, which ignited the Korean War. The Cold War was on, and it would require a permanently large U.S. military.
Table 2.1 contains data on federal employment, both total employees and the number of federal workers employed in national defense. In 1929, the U.S. federal government employed 579,500 workers, and during the Great Depression, the number expanded because of the New Deal programs. Defense employment grew slightly faster than overall federal employment, rising from 18 to 21 percent of federal employment. World War II caused a surge in the number of federal employees, largely for defense. At the war’s end in 1945, the federal government had 2.6 million defense workers, the vast majority of them in uniform, which constituted 69 percent of all federal employees. The military was then reduced, but by 1949 it still accounted for 42 percent of federal employment. During the Korean War (1950–1953), defense employment expanded to about 50 percent of federal workers, then remained above 40 percent during the ensuing Cold War era.
Table 2.1 FEDERAL EMPLOYMENT IN SELECTED YEARS, 1929–1964 (THOUSANDS OF PAID EMPLOYEES)
| Year | Federal Employment | Federal Defense Employment | Defense as % of Total |
| 1929 | 579.5 | 103.1 | 18 |
| 1933 | 603.6 | 101.2 | 17 |
| New Deal | |||
| 1934 | 698.6 | 133.1 | 19 |
| 1939 | 953.9 | 196.0 | 21 |
| World War II | |||
| 1941 | 1,437.7 | 556.1 | 39 |
| 1942 | 2,296.4 | 1,291.1 | 56 |
| 1945 | 3,816.3 | 2,634.6 | 69 |
| Post WWII | |||
| 1949 | 2,102.1 | 879.9 | 42 |
| Korean War | |||
| 1951 | 2,482.7 | 1,235.5 | 50 |
| 1953 | 2,558.4 | 1,332.1 | 52 |
| Post Korean War to Pre-Vietnam War | |||
| 1958 | 2,382.5 | 1,097.1 | 46 |
| 1960 | 2,398.7 | 1,047.1 | 44 |
| 1964 | 2,500.5 | 1,029.8 | 41 |
SOURCE: U.S Bureau of the Census (1975, p. 1102).
The permanently larger government provided a reason to maintain the World War II tax rates, although the Republicans did try to lower them. They took control of Congress after the 1946 elections and promptly passed tax rate reductions. But President Truman vetoed these changes, citing as his reasons the budget deficit and concerns that unemployment and inflation would rise after the war (Witte 1985, 131–44). Congress was unable to override his veto. By 1948, however, a postwar depression had not appeared, and the federal government was running a budget surplus. With two of Truman’s reasons no longer valid, congressional Republicans were able to attract enough Democratic votes to override another Truman veto and enact a modest tax reduction.
Despite these reductions, tax rates were still much higher than they had been during the 1920s. These higher rates, combined with the expanding postwar U.S. economy, provided the funding for another major expansion of the federal government.
The Growth of Transfer Payments
Figure 2.3 shows U.S. federal outlays from 1929 to 2009. The series that excludes transfer payments (the dotted line) consists of outlays for defense, the post office, foreign affairs, general government, and spending on infrastructure (roads, harbors, airports, etc.). The solid line includes transfer payments, which are primarily Social Security and Medicare benefits, but also federal poverty programs (including Medicaid) and interest on the debt.
Figure 2.3 FEDERAL GOVERNMENT OUTLAYS INCLUDING AND EXCLUDING TRANSFER PAYMENTS, NOMINAL VALUES, 1929–2009
SOURCE: Federal Reserve Bank of St. Louis, FRED data set.
As Figure 2.3 makes clear, the major growth in federal spending during the past several decades has been in transfer payments, which reflects the rise of the welfare state. The two series diverged in the 1950s, and the gap continued to widen during the decades that followed. Major sources of transfer payments’ growth have been Medicare and Medicaid, both created in 1965, and Social Security benefits, which became more generous during the 1960s and 1970s. More recently, increased numbers of retiring baby boomers (with millions more in the pipeline) have led to further expansion of transfer payments.
The data plotted in Figure 2.3 are not adjusted for inflation, nor do they account for the fact that the U.S. economy has expanded over time. Figure