Why Federal Spending Cuts Won’t Change Our US GDP Forecast

Federal government spending in the US accounts for approximately 23.8% of nominal GDP. The CBO projection does not recognize a big pullback this year. This makes sense since the personnel cutbacks really won’t show up to a significant degree until FY26 given how they were structured, and DOGE program cuts, while splashy for headlines, do not amount to a significant slice of all federal spending. Getting an exact figure is difficult since DOGE is not transparent with the figures and there is apparently some double counting in the tally. At face value, the cuts amount to 2.3% of federal spending.

Addressing Forecast Concerns Amid Headline Federal Reductions in 2025

The federal government’s spending as a percentage of GDP runs around 24%. It was higher during COVID and immediately after because of residual programs. Interestingly, it appears that a hangover effect from the pandemic may be federal government involvement amping up from approximately 22% prior to the pandemic.

The savings that we know about to date may amount to 0.5% of GDP, but not for 2025. Based on the timing of the plans and the potentiality of court decisions, these savings will be for a future GDP (2026 or 2027). We see no reason to change our GDP outlook for 2025 based on the above.

There may be larger spending cuts. We will know more about that after the spending and tax bills make it through the legislative process. We see no point in guessing the details of what will happen. Our broad assumptions are that the tax laws will generally be extended for the bulk of taxpayers and, to the extent that tax changes occur, the dollar amounts will not be meaningful in the context of a $30 trillion economy. While some additional spending cuts may occur, they will not be enough to meaningfully alter the trend in our national debt.

ITR Economics has studied this issue regarding prior administrations going back to Ronald Reagan. It takes one to two years before changes in fiscal policy fully impact the macroeconomy. This is how that could work out in our current circumstances.

For the sake of argument, let’s presume that Medicaid and other medical spending is reduced by the current administration’s proposed $88 billion (approximately) in FY2026. Spending reductions like that combined with the DOGE cuts could lead to a negative multiplier effect upon the economy. We anticipate that the net drag on the economy would be in FY2026 and/or FY2027.

Our analysis of whether we should alter the forecast for 2026 and 2027 partially rests on too much that is unknown, and we already have a soft landing built into our outlook for late 2026 and at least the first half of 2027.

We would think differently if we were one of the countries listed below, as total government spending accounts for a much larger percentage of GDP than is true for the US. Fortunately, here in the US, we are not as reliant upon the government for our GDP compared to our colleagues across the Atlantic.

The numbers and the timeline do not add up for a change to our outlook for 2025 and, based on what we know today, that will be true for 2026 and 2027. However, as always, we will update our analysis as new data becomes available. We will continue to run the numbers and leave emotions out of the equation.

*This is an estimate from the Congressional Budget Office