Will Federal government spending be slashed in 2025?

Summary

The next administration and Congress will take office in January, and one of the numerous policy changes under discussion is reducing federal spending. In this report, we take a deep dive into the composition of federal government spending and employment. We also discuss how the political process works to affect changes in these areas.

The federal government spent $6.8 trillion in fiscal year 2024, of which "mandatory" spending accounted for roughly $4.1 trillion. Because mandatory spending is determined by various eligibility requirements, such as age or income, it is more or less on "auto-pilot" from year to year. Social Security spending totaled $1.4 trillion in FY 2024 with Medicare tacking on another $900 billion. Other key mandatory spending programs include Medicaid ($600 billion), certain veteran benefits and retirement benefits for civilian employees and members of the military ($200 billion).

Reductions in mandatory spending are possible, but we are skeptical they will occur at a major scale given the enduring popularity of many of these programs, most notably the two largest, Social Security and Medicare.

Zeroing out the $950 billion in interest payments on the national debt is not a realistic option unless the government defaults on its debt.

The remaining $1.8 trillion of spending is deemed "discretionary" since it is funded via the annual appropriations process. Defense spending represented nearly one-half of total discretionary spending in FY 2024 and amounted to 3.0% of GDP—more or less a post-Cold War low. In our view, a major reduction in what Congress allocates to the Pentagon does not seem likely in today's geopolitical environment.

Nondefense discretionary spending includes a variety of government operations and services that often jump to mind when thinking about the federal government. Examples include border security, the Transportation Security Agency (TSA), the National Aeronautics and Space Agency (NASA), the Internal Revenue Service (IRS) and some veteran benefits. The ratio of nondefense discretionary spending to GDP is currently about as low as it has been in recent decades.

The compensation of federal employees represents less than 6% of spending, and federal government employment is just 1.5% of nonfarm payrolls. A bit more than half of federal employment is concentrated in just three departments (the Departments of Defense, Veterans Affairs and Homeland Security) in which significant headcount reductions may be difficult to achieve.

Generally speaking, it takes an act of Congress to materially increase or decrease federal spending, and in many cases these changes need to clear a de facto 60 vote threshold in the Senate due to the filibuster. The president can take some unilateral actions on spending, but not nearly enough to close the projected $26 trillion cumulative budget deficit that the Congressional Budget Office projects over the next 10 years, assuming a Tax Cuts and Jobs Act extension.

We think some reductions in federal spending and employment on the margin are plausible over the next couple of years, but probably not on the scale that they will have large implications for a U.S. economy that has almost 160 million nonfarm employees and nearly $30 trillion of annual GDP.

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