US Government Spending and Job Cuts: Muted Effects on the Wider Economy

President Trump has instituted a far-reaching revamp of US Federal Government spending, with some agencies shuttered and letters going out to millions of Federal employees asking for resignations. What will the broader implications be for the US jobs market and economy? This paper notes that federal employment, excluding the armed forces, is small, under 2 per cent of total employment (about one and a half per cent excluding the postal service), which is low by international standards. It has seen a relatively sharp increase in the last two years. About 75 per cent of jobs in Cabinet-level agencies, totalling just over 2 million, are connected to defence and national security. Trimming employment will not be sufficient to eliminate significant numbers of jobs – substantial cuts will be needed in multiple functions High-profile actions such as closing USAID and the Department of Education may generate more publicity than considerable job cuts, with their employment only around 5,000 and 4,000, respectively. A hypothetical 25 per cent reduction in all federal jobs excluding the US Postal Service would initially reduce total employment by 600,000. Almost half of this reduction is achievable through halting hiring and natural wastage, with further significant reductions possible by terminating employees on probation, who probably number over a quarter of a million. The number of lost jobs over and above normal wastage over a year would be relatively small compared with over 66 million hires and over 2 million net new jobs created in 2024, with more current job openings than unemployed. However, the short-run impact could shock markets, resulting in a fall in February and/or March aggregate payrolls. A similar 25 per cent decrease in real non-defence federal government spending (about 3 per cent of GDP) would be equivalent to about three-quarters of a percentage point. However, the impact on the aggregate economy would be less than this since expenditure cuts are likely to finance lower taxes and because the impact will be cushioned by lower savings, imports, and automatic fiscal stabilisers, with GDP reduced in the first year by only around 0.3 to 0.4 per cent. Some federal spending cuts might lead to higher state and local government spending. The effect could be even less than this estimate since CBO figures suggest that the economy is operating beyond capacity, so cutting government expenditure could "crowd in" private spending. After five years, model-based estimates suggest no impact on the macro aggregates since the supply side dominates over that period, not demand.