Alan D. Jagolinzer and Jacob N. Shapiro write that the new Trump administration’s efforts to improve government efficiency through the cancellation of contracts and other promises will inevitably raise costs as businesses and investors demand a risk premium to account for lost trust.
Since his inauguration, President Donald Trump has moved aggressively to reduce the federal budget, particularly by creating the new Department for Government Efficiency (DOGE) to find savings across the federal government. In recent weeks, the administration has cut staff levels significantly at long-standing institutions such as the National Institutes of Health, Department of Justice, the National Oceanic and Atmospheric Administration, and Department of Veterans Affairs, with further cuts in the works. It has also canceled overseas aid contracts, union contracts with members of the Transportation Safety Administration, Fulbright scholarship payments, and lease agreements to host Securities and Exchange Commission regional headquarters.
While DOGE boasts of $1 billion saved (although its accounting is full of obvious errors), this aggressive approach brings significant underlying costs due to breached trust from aggressively cancelling both explicit and implicit contracts. We do not believe that the resulting cost savings will outweigh the future cost of higher contracting fees and interest rates the government will incur as a result.
Since World War II, United States government debt has been considered one of the safest investments in the world. It is treated as a “riskless” asset in most financial contexts. This is because investors don’t question whether the U.S. government will make its payments in full and on time. This creates a unique advantage: the U.S. can borrow at the lowest rates of any large country. This same trust also facilitates government contracting with the private sector.
Two core elements of trust are honesty—the belief that the other party does not misrepresent material facts—and reliability—the belief that the other party will follow through on its commitments. Trust is broken if one perceives that either of these elements has been violated, even if that violation has happened to someone else.
DOGE and the federal government have repeatedly breached trust over the past two months through making inaccurate claims about finding agency fraud, repeatedly changing how they report their activities, abruptly cancelling contracts, erratically firing then rehiring fired employees, unilaterally changing contract terms without engaging in legally mandated processes, and creating uncertainty about whether health services, social security, or other benefits and contract payments will be slashed.
Why does this matter? Because trust is priced into every contract of every business that transacts with the government. And businesses self-protect when they worry that trust may be violated.
In transactions and contracting this happens in several ways—all of which increase costs. Some companies disengage entirely, choosing to take their business elsewhere and not provide needed services or resources, such as lending. Others will reduce the level of services or resources they are willing to risk in the contract, forcing the government to go without or contract with more expensive or poorer-quality partners. Others will demand higher fees from the government as partial insurance against the potential losses they might face with a government breach in contract.
What could these costs look like now that every federal procurement contract is riskier than two months ago? If government contractors impose a risk premium of 5% of total contract costs, which is similar to the risk premium estimated for junk corporate bonds (relative to Treasuries) and consumer credit card securities, that would yield $38 billion in increased expenditures every year, based on the federal government’s 2023 fiscal year purchases of $759 billion in goods and services.
All $36.2 trillion of U.S. government debt may also become more costly. Research shows that the U.S. has long enjoyed a “safe harbor” premium because investors believe its debt to be low risk. When investors see greater political risk—in terms of social dissatisfaction, government influence in the legal system, or acute policy shifts with changes in government—they demand higher rates.
Debtholders can assess that the U.S. government is less reliable now than it has been historically in upholding contracts. They are likely to determine that payments on U.S. government debt are at least somewhat uncertain too. U.S. debt was already under pressure because of Congressional dysfunction and fiscal conditions, and the administration’s lack of commitment to explicit and implicit contracts adds a new dimension to such concerns.
Debtholders’ risk protection could get very expensive. At least $3 trillion of U.S. government debt comes due in 2025 and will need to be refinanced. If debtholders demand even a modest additional risk premium of 0.1% on average, that would cost the U.S. taxpayer roughly $3 billion more per year. There is no good historical precedent for the current situation, so it is hard to know how much rates will rise. However, Congressional leaders broke precedent in 2011 by withholding support for increasing the U.S. debt ceiling as a negotiating tactic over broader budget issues. The resulting crisis cost the U.S. Treasury $1.3 billion for that year alone according to the Government Accountability Office. Using the GAO’s analysis, the Bipartisan Policy Center calculated that Congress’ delay in raising the debt ceiling cost the U.S. $18.9 billion over ten years.
Including these risk-protection costs, the administration’s aggressive cost-cutting process becomes self-defeating. The U.S. government will have to pay more for every other service until it can reestablish trust, which could take decades. Even under a different future presidential administration, a precedent for instability is being set that outside parties will have to consider.
The bottom line is that for the U.S. economy to succeed, contracts need to be credible, and the U.S. government needs to hold true to its commitments, even implicit ones like the tradition of giving veterans preferential treatment in the federal workforce. If priorities change, and the new administration and Congress wish to spend differently, they should make changes through normal process. Breaking trust for short-term cuts will not offer real long-term savings. It will just make everything the government does more expensive, and we will all pay the price for that.
Authors’ Disclosures: The authors reports no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
