Stay tuned this week for the Defense Department to shuffle those budgetary cards and deal them in new ways. Every year, the DOD encounters new needs and changing old needs and submits an altered spending plan to the Congress -- it's called "reprogramming" or "transfers." And every year, it shifts additional funds around without having to notify the Congress.
In addition, thanks to the sequester, the Pentagon may well take full advantage of the special, supplemental war budget it has asked for every year to recover as much as it can from budget cuts.
The Pentagon starts from a high spending base. Even after the cuts of the last three years, defense spending is a good $150 billion above the average for the last 60 years.
The DOD has some unusually generous opportunities to shift funds around. This year, they have a $7.5 billion opportunity -- the amount of funding they can legally reprogram across the budget to meet emerging needs, so long as they seek the approval of the armed services committees and their defense appropriators in Congress.
And this week, the DOD may well come forward with a proposal as to how they intend to use the notification part of that flexibility. Their draft proposal for fund-shifting was leaked to Inside Defense last week, not clear by whom.
The Air Force might have had a reason to leak the draft, since they are paying a heavy bill for the Army's profligate spending on operations in Afghanistan. It seems the Army has underestimated the costs of moving things around in that country, as well as the costs of bringing it home (particularly given the Pakistani border shutdown, which throttled any deliveries via road for a few months). A whole run of Air Force programs may get a spring haircut to pay for these problems, including space-based infrared radar, modifications to the Reaper drone, and a number of other space and missile programs.
My conversations in the Pentagon suggest that neither the Navy (less impacted) nor the Air Force are all too happy about picking up the Army's tab. Mind you, it is war-cost estimates, in addition to the sequester dilemma, that's creating the need to shuffle money around.
Beyond the congressionally notified reprogramming, the DOD has substantial flexibility to move even more money around without telling Congress, so long as they stay within specific accounts and below certain monetary thresholds. Over the past 12 years, they have used this internal flexibility to shift around an average of $14.5 billion a year, according to the Pentagon's own budget execution tutorial. No reports, as yet, as to how much of that is taking place this year.
And right behind the reprogrammings, the Pentagon intends to send Congress a war supplemental -- known as the budget for Overseas Contingency Operations (OCO) -- and it's likely to be a whopper. Back last year, the Pentagon put a 2013 budget plug in for the war, which amounted to $44 billion. Then, this spring, when the DOD sent up its budget, they decided to hold back on sending the OCO budget.
So now we're waiting on yet another budgetary card to be dealt. And given the Army's bad checkbook and the squeeze that the sequester is putting on Pentagon spending this year, the temptation to use the OCO to fix things may just be too great. After all, the war budget is not subject to the DOD ceiling mandated by the Budget Control Act, which leaves room for a major reshuffle of the spending cards.
According to Comptroller Robert Hale, "the placeholder [for OCO] is $88.5 billion. I don't think we'll be above that. I don't know yet how much we will be below that."
Before the final reprogramming and the OCO budget get sent to the Congress, it behooves the Office of Management and Budget to take a good look at the details. The sequester, as I have said, is a lousy way to manage a budget, but the best opportunity the DOD has had in years to set the right priorities and bring some budgetary discipline to the Pentagon, something it has not had for more than a decade.
No dealing from under the deck should be permitted in this game.
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Senator Harry Reid is about to become a magician. Next Tuesday he plans to introduce a bill that would eliminate the FY 2013 sequester, paying for it using ghost-like savings from the declining budgets for the Afghan war. And it sounds like the White House might just go along.
It's another parlor trick in a budget process full of such tricks, conjuring up savings and then, in this case, adding to the deficit by spending them. Let me explain, because it is all about scoring, but not about real money.
The Congressional Budget Office projects budgets into the future. When it does so, it has to start from something. Since this is a very conservative (small "c") organization, it properly starts from what is called "current law," or what the last appropriation was for something.
In this case, it is the last appropriation for the war. The Overseas Contingency Operations account, which funds the wars, was very high in the past -- nearly $180 billion at one point. The last time it was appropriated, in March this year, it was around $87 billion. So that is the current law number.
Now, when CBO looks into the future, it starts by saying $87 billion is the cost of the war. Since that is current law, the baseline for the future is $87 billion every year, plus inflation. Anything below that amount can be imagined to be "savings."
That's the parlor trick Sen. Reid is using. He is assuming current law, inflated, for the future, and then assuming that reality will be lower. The difference between the two numbers is the "savings ghost."
When Paul Ryan and the administration both used this trick in their budget proposals last year, they scooped up the budget "savings" and applied it, they said, to deficit reduction for the next 10 years.
There's just one problem: These savings are a phantom, a figment of Sen. Reid's imagination. The war is already winding down and everybody, including CBO, knows those numbers are fictitious.
But, ya know, they are easy, just sitting out there in fiction land waiting to be used, instead of knuckling down to the budget discipline the Congress and the White House ought to be enforcing.
And in this case, Sen. Reid doesn't intend to apply these savings to deficit reduction, which is bad enough. He intends to spend them, "fixing" the sequester, and, on the way, adding to the deficit.
It will be hard to resist this temptation; it's too easy. It is also wrong, exactly the kind of conjurer's trick that brings Congress into ill repute. It should be resisted, as the ghost of King Hamlet warned: "O horrible, O horrible, most horrible! If thou has nature in thee, bear it not."
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The Senate appropriators have been struggling all week to complete a companion bill to the one passed in the House last week, providing money for this fiscal year for DOD and several other federal agencies.
The disagreements and more than 100 potential amendments (easier to offer in the Senate than in the House) have delayed consideration into next week, but it looks likely that there will be an FY 2013 appropriations bill for the Defense Department before they adjourn for Easter.
Meanwhile, both the House and Senate Budget Committees have reported out longer-term budgetary plans -- the budget resolutions -- that look at FY 2014 and beyond.
There is a fundamental reality about what the Congress is doing, one on which Secretary Hagel must focus. The signals are clear: The Senate and the House are not going to use the appropriations bills or the budget resolutions to bail out DOD from the sequester and a long-term drawdown in the defense budget. Time to wake up and smell the coffee.
Flexibility to deal with sequestration was one such signal. The House appropriations bill did not give DOD any greater flexibility than it now has to reprogram or transfer monies between accounts. It did increase operations funding, like the administration had requested, which raises the baseline from which sequestration would happen. And it provided some legislative relief from provisions in last year's defense budget, which would have hamstrung DOD unless they got a new bill covering this year.
Sen. Barbara Mikulski made a more direct attack to provide transfer flexibility. But it failed, and the reason for the failure is significant: Unless every agency got that flexibility, it was clear that it was not going to pass. Defense was not going to get special treatment.
Signal two is in the budget resolutions. As I noted earlier this week, Chairman Ryan's bill folded on the hope that DOD might get more funding in the long-term than the Budget Control Act caps passed in August 2011. He tried that last year and it went nowhere -- it wasn't even useful to Mitt Romney, who argued in his campaign that DOD should get four percent of the Gross Domestic Product.
This year, he abandoned that trench for the next one: holding the line at the BCA level for the next 10 years. That's probably the high-water mark, because Sen. Patty Murray's proposal takes another $240 billion out of the BCA funding levels over the next ten years.
The administration is going to send up its budget, one day. Maybe in early April. And it is going to be a mythical beast that ignores the signals. It will hope for the BCA levels, which is just plain unrealistic.
Secretary Hagel is supposed to send out guidance for the Department's next Quadrennial Defense Review next week. If realism is going to set in at DOD, that guidance had better make the QDR a resource-driven effort and start looking at decisions and options at budget levels below the BCA caps. That would send the internal signal the services need to hear.
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There were always two shells in the double-barreled shotgun aimed at the Defense Department. One was sequester. The other -- the one the Pentagon was really worried about -- was the continuing resolution that expires March 27.
Well, now, the Congress has just begun to unload one of the two barrels. Although sequester is still underway, the House has removed a big source of the Pentagon's "sequesteria" by passing a real appropriations bill for the Department of Defense and the Department of Veterans Affairs. (The rest of government will have to make do with the continuing resolution, which the bill prolongs through the end of the fiscal year.)
The bill, from the chairman of the House Appropriations Committee, Harold Rogers, did not attempt to fix the sequester -- as I predicted last week, that was too high a hurdle -- but it does make it easier for the Pentagon to survive. In writing a full appropriations bill, Rogers gave the Obama administration pretty much all the money it asked for in its request for crucial operational accounts. The bill increases the funds for operations and maintenance by more than $10 billion above the FY 2012 (and, thus, the continuing resolution) level.
That doesn't eliminate the sequester, but it raises the baseline from which sequester is measured for the accounts most directly affected. That gives some relief to the services, easing about 25 percent of the pain they see coming. And, who knows, if there is actually progress on the broader budget negotiations the president is lobbying for, the whole sequester thing itself might become meaningless.
That's the other big takeaway since we moved into sequester-land last Friday. Everybody is suddenly making nice. The president is phoning the Hill, even talking to Republicans. And Barbara Mikulski, the new chair of the Senate Appropriations Committee, wants to write a bill similar to the House legislation, perhaps providing real appropriations language for a few more agencies and departments, rather than just prolonging the continuing resolution for everyone but DOD and Veterans Affairs.
So the March 27 deadline that I argued was the real deal may go away quietly. Some kind of appropriations bill will pass before then, in all likelihood. And the Pentagon seems likely to get the flexibility and additional funds it needs to avoid some of the damage expected from sequester. That has not prevented the "doomsday drumbeat" from continuing at DOD, with sequester threatening everything from readiness to the Asian pivot, to nuclear strategy, to band concerts. But some politics die hard.
Gee, have we entered an era of peace and budgetary harmony? Not likely. Paul Ryan's budget resolution for FY 2014 is coming next week; a Senate version from Patty Murray will follow. They will differ. And the Obama administration will send up its budget someday -- rumor has it either March 25 or April 8. And "Debt Ceiling: The Second Sequel" will hit theaters this summer. Lots of targets if anybody wants to continue to fight.
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The dance performance at the edge of the cliff continues. Boehner offers to let taxes return to their pre-2001 level for the very, very rich. The president counter-offers, putting lower Social Security COLAs on the table, much to the consternation of AARP, who fill the in-boxes of people over 50 with protest (including mine).
Boehner, in theatrical frustration, moves to a Plan B that would have the House vote to raise the millionaire tax and spare the rest. Grover emerges from the dark shadow he lives in to pat Boehner on the back, saying a vote for the millionaire tax would not violate the no tax pledge the Republicans have signed, even though it does.
Meanwhile, in the defense world, nails are being bitten. Secretary Panetta warns of a cataclysm if the president and Boehner fail to agree. Buck McKeon steps to the mike in a redux of the performance he has been executing for 18 months (isn't he tired?), decrying the fact that the Boehner tax bill left the sequester on the table, and our national security open to the barbarians. In response, Boehner added a provision that would protect defense from at least part of the sequester. (Though sequester would take only 10 percent of the resources from one of the highest defense budgets America has seen since the end of World War II.)
A deal will come, but only when the dancers are exhausted with this increasingly embarrassing performance. And when it does, what will really happen to defense? If the White House offer is any indication, not much. Defense and domestic discretionary spending have been a "residual" in the budget negotiations for months, with entitlements and revenues the leading edge of the argument.
In its latest offer, the White House has reportedly said it would make another $200 billion in discretionary spending cuts, over ten years, split 50/50 between defense and domestic discretionary spending. That would be a laughable $100 billion less for defense over ten years from the current budget projection.
Yes, that is a cut, Virginia, as the current projection would give DOD growth at the rate of inflation. But as a budget proposition, it is a joke. Senate and House appropriators regularly, annually, find $5-10 billion tucked away in the defense budget that they can use to fund things the Pentagon did not ask for, but members want.
Where do they find it? In re-estimates of the payout rate on existing contracts, in lower than projected rates of inflation (the hidden secret of defense budgeting -- project high rates of inflation, then save and reprogram the money after you get it), in lower spending for operations and maintenance (just a general O&M cut by another name -- let the Pentagon find the savings), in finding operations savings in Afghanistan because the troops are coming home faster than expected (used that one once already; more to come).
Oh, there is a lot of slush of this kind in the DOD budget and the appropriators know how to find it all when the "members' requests" come in. So, go ahead, try to tell me that $10 billion a year less than the overall budget projection is tough to manage. It's not; it is a walk in the park.
Defense will be lucky to have this "cut." And, of course, the luck will not last. Every year for the next ten years there will be more nibbles at defense, because defense can "take it" in budgetary terms.
About ten years from now we will turn around and realize how deeply we have cut defense from the peak year (war and base budget) of fiscal year 2010. The way to count that is to take that peak year and draw a line, calculating what the defense budget would have been for the next ten years, had we simply increased that amount by inflation. Then draw another line -- the one that nibbles at DOD's budget every year for the next ten years. The space between those two lines will be more than a trillion dollars.
And if that drawdown is well managed, we will not even notice its impact. The forces will be smaller, but still globally dominant, doing everything we asked them to do. And we will have taken more than a trillion dollars from projected defense budgets, which is what so many "defenders of defense" are rending their garments over today. No sweat.
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We are near the end of the 17-month drama of sequester and the defense industry's special pleading, and its special planning, are in the highest gear. The theater has moved along nicely.
We have been through the Sequester Prologue -- the Budget Control Act of 2011.
Act 1 was the Super Committee, a terrifying, cliff-hanger drama with a predictable outcome: failure.
Act 2 was the primary campaigns for the Republican Party and, especially, the adjunct campaign conducted by the Aerospace Industries Association and their political travelling side show: the McCain-Graham-Ayotte tour of America's most loved defense locations. But the industry failed to scare Americans away from fiscal discipline for the Department of Defense. Predictable outcome, since defense was not an issue in the primaries: failure.
Act 3 was the general election campaign. The industry backed off its warning of layoff notices four days before the election when a savvy administration pointed out that they, of all industries, would be most protected from sequester because they have existing government contracts, already funded, that ensure business would continue. (And as a sweetener, the administration also said the legal costs for any contractor sued because no layoff notice was sent, would be allowable cost under the contract.) Predictable outcome: the political side show sponsors felt undercut when the industry pulled back from playing politics; the president carried all but one of the states in which the side show had opened a tent.
Epilogue: where we are today. Defense budgets are a residual item in a much bigger main event over revenues and entitlements. Likely outcome: the defense budget will go down below the level Panetta proposed last February, to make a deal on everything else happen.
The defense industry has not given up the fight, though. And they are also ready for what may come, because they anticipate the market for defense goods better than anyone. Still girded for battle, defense industry chief executives such as Wes Bush, CEO of Northrop Grumman, and David Hess, president of Pratt and Whitney (United Technologies), will make their case on December 3 at the National Press Club. Perhaps no threat of layoff notices, but doom and gloom likely to be the message.
At the same time, the defense industry has been preparing for a defense drawdown for two years -- a realistic move because the defense budget has already come down for two years. Layoffs at large contractors have already happened. Less promising businesses have been sold (including CEO Bush's spinning off its shipyards last year). And companies are searching for acquisition opportunities in niche businesses that may prosper in the defense downturn: equipment servicing, drones, information technology, and cyber research and development.
Best of all, the industry has been churning up large piles of cash to finance these activities. Brendan McGarry of Bloomberg reported this week that the five largest defense contractors (Boeing, Lockheed Martin, Northrop Grumman, Raytheon, and General Dynamics) have had operating margins that are at a record high, thanks to the generous defense budgets of the last ten years. More to the point, they used these margins to grow their cash holdings by 71% in the final quarter of the 2012 fiscal year, bringing their total cash holdings to more to nearly $21 billion. The average cash holding of the five was over $4 billion, nearly double what it was a year ago. These funds can be used for acquisitions, dividend payments, or held for a rainy day.
Smart thinking, corporate-wise. The rainy day is already on its way. The defense budget is headed down, even with a sequester-preventing deal, and, as Bloomberg's Kevin Brancato put it "Defense companies are likely to see cuts even if there's an agreement to avoid it." That doesn't stop the last-ditch epilogue battle we will see this month -- the show must go on!
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Gordon Adams tracks the budget and the national security establishment for FP.