When Tesla CEO Elon Musk bounded onto the stage as President-elect Donald Trump's sidekick in the campaign's final stretch, the MAGA movement's anti-Washington mission suddenly broadened from taking down the "deep state" to slaying big government.
Putting up a target of at least $2 trillion in annual government spending cuts — one-third of federal outlays, excluding interest on the debt — Musk said living within our means would require that everyone "take a haircut." Accepting "temporary hardship," he said, would ensure long-term prosperity.
The call for austerity seemed out of place while campaigning for Donald Trump. In his first term, he blew up the U.S. budget deficit — even before the Covid crisis — with big tax cuts and a hands-off approach to Social Security and Medicare. Trump's 2024 proposals offered much the same. They would boost red ink by an additional $7.75 trillion over the coming decade, according to the Committee for a Responsible Federal Budget.
Yet starting with his embrace of Elon Musk as his government efficiency champion, President-elect Trump has made a surprising turn to fiscal sustainability. That pivot, which is helping to fuel the postelection S&P 500 rally, has come at a critical time. Once publicly held debt crosses 100% of GDP, as it's set to do next year, it introduces a risk of spiraling interest costs and economic harm.
At stake is whether Trump will be able to renew his 2017 tax cuts and pay for new proposals without breaking an overstretched federal budget. The 10-year Treasury yield, which surged before and after Trump's election sweep, has retreated from 4.5%. Breaking above that level might flash an early warning sign on the fiscal trajectory, some market tacticians say.
That suggests the "bond vigilantes" — the bond traders who can make Washington pay for fiscal excess by driving up Treasury yields — have Trump on a short leash. But they're giving him the benefit of the doubt for now.
Can Elon Musk Tame The U.S. Budget?
Elon Musk has blazed a trail that few imagined possible at Tesla and SpaceX. So Wall Street isn't just hoping that he'll add taming the federal bureaucracy to his legend. It's half-expecting him to do it.
Musk "generally does what he says," wrote Jefferies economist Thomas Simons, even if his ultimate success comes on a slower-than-promised timetable. "He showed with his reorganization at X that he can quickly identify and eliminate excess to improve efficiency."
Yet Musk's private-sector downsizing may not be all that relevant for the public sphere, Brian Riedl, senior fellow at the conservative Manhattan Institute, told Investor's Business Daily.
"Musk was able to save a lot of money at Twitter by firing employees, but federal costs aren't driven by employment," Riedl noted. "They're driven by writing checks."
Still, faith in Elon Musk was a key reason for investment strategist Ed Yardeni's bullish market call on Nov. 10, lifting his 2030 S&P 500 target to 10,000 from 8,000.
"We expect that better economic growth will boost federal government revenues and that Elon Musk will succeed in slowing the growth in federal government spending," Yardeni wrote. "GDP growth might actually keep pace with mounting government debt."
Close Enough For Government Work?
Importantly, Yardeni's definition of success suggests that the Trump administration needn't come close to Musk's goal of $2 trillion in government spending cuts to satisfy investors.
Scott Bessent, the hedge fund manager who Trump has tapped to lead Treasury, reportedly wants to cut the federal budget deficit to 3% of GDP by 2028. That's vs. a projected level of nearly 7% of GDP if current policies stay in place. Getting there might require $1.25 trillion in annual budget cuts.
A somewhat less daunting goal would be stabilizing the debt-to-GDP ratio, a key to Yardeni's more bullish S&P 500 case. That would still be a heavy lift, requiring about $900 billion in annual deficit reduction.
The hope is that faster economic growth, aided by deregulation and strong productivity gains, can carry some of the load. Yet that's uncertain, especially if steep budget cuts, a trade war and stepped-up deportations act as headwinds to growth.
Trump Election Shifts Fed Rate-Cut Outlook
Trump-Era GOP Won't Target Entitlements
So how might Donald Trump, Elon Musk and Republicans in Congress go about cutting the U.S. budget deficit? Probably nothing like former House Speaker Paul Ryan's failed frontal attack on the spiraling cost of Social Security, Medicare and Medicaid.
The Trump-era GOP hasn't shown Ryan's fervor for taking on the so-called "entitlement state." That raises doubts about their ability to make deep cuts. But they do have a variety of ideas for shrinking the deficit, including some unorthodox ones.
GOP presidential candidate Vivek Ramaswamy, who Trump named as Musk's co-chair at the Department of Government Efficiency (DOGE), has talked about firing 50% or even 75% of federal employees.
"A drastic reduction in federal regulations provides sound industrial logic for mass headcount reductions across the federal bureaucracy," Musk and Ramaswamy wrote in the Wall Street Journal on Nov. 20.
They contend that the percentage of dismissed federal workers "should be at least proportionate to the number of federal regulations that are nullified."
Big Job Cuts, Small Budget Savings
But that ignores the reality of what most federal workers actually do. Of 2.3 million federal civilian employees, 1.45 million, or 63%, work for the Pentagon, Homeland Security or Veterans Affairs. Those are parts of the U.S. budget that Republicans tend to want to spend more on — not less.
Social Security Administration employment of 60,000 is near a 25-year low, even as the number of beneficiaries has surged 50%. The result hasn't just been long wait times and bad service, but improper payments that contribute to government waste.
The Internal Revenue Service has boosted staffing to 90,000 over the past couple of years, thanks to increased 10-year funding of $80 billion. CBO initially said the extra resources would boost tax revenue by $200 billion over a decade. Republicans later clawed back more than $20 billion of those funds. But the budget scorekeeper says that will cost $43 billion in lost revenue, adding to deficits.
Discretionary Government Spending Real Target
DOGE's focus on cutting jobs in the bureaucracy may be mainly a way to target the nondefense discretionary budget. Yet that's what Republicans will take aim at through the regular appropriations process, and it's a thin slice of the overall budget pie. Congress authorized $928 billion in nondefense discretionary spending for fiscal 2025. That's 3.1% of GDP, or just 14% of overall federal government spending.
Further, much of the nondefense budget won't be tasty targets for the GOP. The biggest portion, 19%, goes to transportation and economic development, followed by veterans' medical care at 14%. Law enforcement, including the Border Patrol, accounts for 10%.
Donald Trump's New Tariff Hikes
Before Elon Musk changed the subject, Donald Trump's big idea to cure every federal budget and economic problem was to rake in revenue from imposing tariffs much more broadly than he did in his first term.
That still appears to be part of the plan. On Nov. 25, Trump announced that he'll impose 25% tariffs on imports from Mexico and Canada, and an extra 10% on Chinese imports, on his first day in office.
Trump made the move sound temporary, until Mexico and Canada keep migrants from crossing the border and all the countries stop the flow of drugs. But it could be the first step toward his campaign plan of a 20% universal tariff and a 60% tariff on Chinese imports. That would be far more than most Wall Street firms have anticipated.
Such tariffs could add about $380 billion to tax revenue in 2028, factoring in negative economic feedbacks, estimates by the Budget Lab at Yale University indicate. However, broad-based retaliation by trading partners could lower that to around $250 billion.
The uncertainty caused by Trump's first trade war slowed the economy and led the Fed to cut interest rates. Yet with inflation already above target and tax cuts on the agenda, another bump in prices as businesses partially pass tariffs onto consumers could put further Fed rate cuts in doubt.
Still, the S&P 500 took the tariff threat in stride Tuesday. Wall Street seems more sanguine about trade wars than it was in Trump's first term.
"We see President Trump ultimately getting his way, fairly quickly," Marko Papic, chief strategist at BCA Research, wrote on Nov. 14.
China's economic travails give it little leverage, Papic noted. Yet China may be determined to fight. Tariff hikes would come on top of the Biden administration's efforts to deny China access to advanced chip technology. If Trump carries on that fight, Chinese President Xi Jinping could block exports of key materials like gallium and germanium. That would throw a monkey wrench into global technology supply chains.
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Invest In Bitcoin?
GOP deficit-cutters also have a few new tricks up their sleeves. Rep. Cynthia Lummis of Wyoming has proposed that the U.S. government buy one million bitcoin over five years. That would cost about $92 billion at current bitcoin prices. The idea is to eventually use the winnings to retire outstanding debt.
Donald Trump, during the campaign, called for a strategic bitcoin reserve.
Republicans also seem prepared to try out another idea. In 1974, Congress passed the Impoundment Control Act, banning the Nixon administration practice of refusing to spend money that lawmakers had appropriated. Yet Trump has said that he'll not only seek to have the law repealed, but he'll disregard it on Day One.
Team Trump To Target EV Credits
Whether the GOP Congress will find agreement on deep spending cuts using the regular budget process is unclear. The logical place to start might be President Biden's biggest legislative win, the Inflation Reduction Act.
Subsidies of up to $7,500 per electric vehicle are expected to be on the chopping block. That might reduce government spending by $100 billion over a decade. Trump's transition team reportedly is mulling such a move. Elon Musk has said he favors eliminating EV credits despite the potential impact on Tesla.
But 18 House Republicans wrote House Speaker Mike Johnson last summer to defend a bigger pot of IRA subsidies that helped incentivize clean-energy projects in their districts.
The Affordable Care Act's Medicaid expansion saw the federal government take on 90% of the costs of lifting a state's eligibility threshold to 138% of the poverty level. But that may be another tough target for GOP budget cutters, now that 40 states have signed on.
Federal Budget Reconciliation Key
So where do U.S. leaders go from here? Budget reconciliation is a Senate procedure to get around the need for 60 votes to overcome a filibuster. The party controlling the Senate can use reconciliation once per fiscal year. So the GOP will have two shots to put their stamp on the federal budget before the midterm elections.
The first package, likely due next spring, is expected to extend the 2017 Trump tax cuts that are set to expire at the end of 2025. That will have an annual cost of $450 billion in 2028. Deutsche Bank economists' best guess is that the GOP also will cut the corporate tax rate to 18% from 21%. That would boost S&P 500 profits, at a federal budget cost of about $35 billion a year. An expanded child tax credit and a partial deduction for state income taxes would each cost about $40 billion per year.
Deutsche Bank's expectation is that the new revenue from tariffs would basically only offset the new tax cuts. However, if Donald Trump goes big on tariffs and holds off on other campaign promises — such as ending taxes on tips and Social Security benefits — then the reconciliation package might moderately reduce the deficit (by $125 billion to $250 billion per year) relative to current policies. On the other hand, fewer Fed rate cuts than expected could raise interest outlays, unwinding some of that progress.
Unless Bessent, the incoming Treasury secretary, prevails upon the GOP to slow down and fight for big cuts to Medicaid spending, IRA tax credits and the broader social safety net, most of the heavy lifting on the deficit might be saved for later.
Elon Musk To The Rescue?
That's where Elon Musk and the Department of Government Efficiency will come in. DOGE is being set up as a nongovernment advisory group without any actual power. Still, Donald Trump has tasked Musk and Ramaswamy with making recommendations to "send shock waves through the system," restructure agencies and eliminate waste and fraud. Their role will sunset on July 4, 2026. Musk has said their focus will be on changes that can be made by executive order, not legislation.
Here's the risk for the GOP. Faith in both Musk and Bessent is helping to keep the bond vigilantes calm. That could ease passage of the first reconciliation package. But after that, markets might get nervous waiting for DOGE to save the day.
Barring another Musk miracle, Treasury yields could get unruly, jolting the S&P 500 and putting extreme pressure on Republicans to push through deep government spending cuts with a slim governing majority.
