* Biggest reform so far by President Raul Castro (Adds analyst comment)

By Marc Frank

HAVANA (Reuters) - Cuba will lay off more than500,000 state employees by March and expand private employmentto give them work in the biggest shift to the private sectorsince the 1960s, the Cuban Workers Federation said Monday.

Eventually more than a million jobs would be cut and, dueto efforts to increase efficiency in the state sector, therewould be few new state sector openings, the federation said ina statement.

More than 85 percent of the Cuban labor force, or over 5million people, works for the Soviet-styled one-party state,many of them in unproductive work.

"Our state cannot and should not continue maintainingcompanies, productive entities, services and budgeted sectorswith bloated payrolls (and) losses that hurt the economy," thestatement said.

"Job options will be increased and broadened with new formsof non-state employment, among them leasing land, cooperativesand self-employment, absorbing hundreds of thousands of workersin the coming years," it said.

The plan is the most important reform undertaken byPresident Raul Castro since he succeeded his brother FidelCastro in 2008 and the biggest shift to private enterprisesince all small businesses were nationalized in 1968.

The younger Castro indicated last month that reform wascoming to reduce the inefficiency of the Cuban economy.

"We have to erase forever the notion that Cuba is the onlycountry in the world in which people can live without working,"Castro said, upon announcing in general terms his plans to cutstate payrolls and increase self employment in an August speechto the National Assembly.

According to Communist party sources who have seen thedetailed plan to "reorganize the labor force," Cuba expects toissue 250,000 new licenses for self-employment by the close of2011, almost twice the current number, and create 200,000 othernon-state jobs.

The government's definition of self-employment includesmany entities that are essentially small businesses, includingsuch things as family-run restaurants and cafeterias, autorepair shops and jobs in the building trades.

The non-state jobs will include, among other things,workers hired by the small businesses, taxi drivers who willnow lease their cabs from the state and employees of smallstate businesses to be converted to cooperatives.

PINK SLIPS

Cuba watchers said the statement marked the speeding up ofreforms under Raul Castro, which have been gradual so far.

"Today's announcement opens a new chapter, one that has adeadline, that will be felt and seen in every town, and thatpromises to create a much more substantial private sectorinside the socialist economy," said Philip Peters, a Cubaexpert at the Lexington Institute think tank in Washington.

Peters said the half million workers will not findthemselves suddenly on the streets of Cuba because theirworkplaces will likely be converted gradually into cooperativesdriven by private initiative.

"The 500,000 figure is alarming -- it conjures up an imageof 500,000 Cuban workers going home with a pink slip, notknowing where they will go the next morning, and of the economysuddenly needing to create 500,000 new jobs," Peters wrote onhis blog The Cuban Triangle.

"In fact, many workers will go to the same workplace asever, but the business arrangements will be different."

Cuba currently has only 591,000 people working in theprivate sector, a number that includes mostly family farmers aswell as 143,000 self-employed, according to the NationalStatistics Office.

All state businesses and agencies were ordered in Januaryto review payrolls with an eye to trimming unneeded positions.

Laid-off state workers will be offered alternative jobs,and if they do not accept one, will have unemployment benefitsequal to 70 percent of their wages for no more than threemonths, depending on their seniority, sources said.

They will not be totally out in the cold because all Cubansreceive free health care and education, subsidized utilities, asubsidized food ration and automatic adjustment of mortgages to10 percent of the top breadwinner's income.

Many Cubans also receive remittances from family abroadworth far more than the average monthly wage, equivalent to around twenty U.S. dollars.

Castro has fostered discussion in the media and grass-rootsmeetings on what ails the socialist economy, and made mostlyminor changes aimed at boosting productivity by putting moreincentives in the system.

The most important reforms up to now were in agriculture,where state lands have been leased to 100,000 new farmers andthe state's monopoly on the sale of farm supplies includingfuel and fertilizer and produce have been loosened. (Reporting by Marc Frank; Editing by Jeff Franks and AnthonyBoadle)