Why ending the Afghanistan war doesn't save more money

John Boehner is "appalled" at the president's budget proposal, presented last week by Treasury Secretary Tim Geithner. Sen. Lindsey Graham called it a "joke." As for me, I am shocked, shocked that there are hard lines being taken at the start of a negotiation. And some of the stuff they are starting to talk about is funny numbers, making budget analysts crazy.

When a deal comes, and I believe it will, the numbers are likely to continue to be somewhat funny, because neither side wants to leave itself open to political criticism. In the spirit of badly-needed bipartisanship, let's take two examples.

The Republican side rejects the notion of raising tax rates on the rich and says it has options for increasing revenues without doing so. The administration, and the non-partisan Tax Policy Center, estimate that letting tax rates on incomes over $250,000 return to their pre-Bush tax cut level could raise $1.6 trillion over the next decade, a substantial contribution to reaching the goal of $4 trillion in overall deficit reduction.

Republicans, terrified of the wrath of Grover Norquist, refuse to go there. Instead, they say, with changes in the tax code, particularly the reduction or elimination of tax breaks, they can raise revenues. We're talking here about things like deductions for mortgage interest, state and local sales taxes, charitable contributions, and the tax-free premiums employers contribute toward employee health insurance. Unfortunately, as far as anyone knows, this is a mystery calculation, as they have put nothing specific on the table.

It's pretty understandable that they don't want to be specific; many of these tax breaks help the very middle class families the Republicans claim to be defending. But there is another reason the Republicans are avoiding specifics. Unless those middle class tax breaks are eliminated altogether, the Center on Budget and Policy Priorities estimates that savings from lowering what are called "tax expenditures" will never add up to $1.6 trillion or even a cool trillion. (I love Washington; so much funny language, so little time. One of my former bosses at the Office of Management and Budget hated to call a budget cut a "cut." Instead, the boss would refer to budgetary "plus ups" and budgetary "plus downs." Really!)

So the Republicans' numbers don't add up to much -- not a real contribution on the revenue side. But without details they can claim, "We did too put revenues on the table."

The Obama administration can make things up, too. For example, the president's budget proposal, sent to Congress in February and reiterated by Secretary Geithner, invents budget savings that are not there. Specifically, I am talking about the $800 billion the administration claims as "war savings," or, if you like, a "peace dividend" over the next 10 years. Except, funny thing, the administration's budget does not forecast war spending past the next five years. And the numbers for those five years ($44 billion per year) are notional -- that is, they are not based on any programs or plans for prosecuting the war; they are a placeholder. The administration actually has no idea what war costs will be in the future (the Bush administration used the same budgetary dodge), but we do know that they plan to pull the troops out of Afghanistan. Between leaving Iraq and those plans, war costs have already been falling fast, from nearly $180 billion to just under $160 billion, to just over $120 billion to $88 billion over the past four budgets.

With troops coming home next year, they are likely to continue to fall until they disappear, absorbed into the regular Pentagon budget. The back of my envelope (which is as good as the number the administration uses) says war spending will disappear by the FY 2015 budget submission (that's the year after next). Secretary Geithner tried to argue this was not a gimmick, but it is. (Rep. Paul Ryan used the phony savings, too, in his budget proposal earlier this year.)

In sum, from a budgetary perspective there is no war spending we can "save" over the next decade. But, rather than set the Pentagon on the trajectory toward real reductions that it needs to make, the administration is just pocketing phony savings to get to its goal.

So there we are. The Republicans make up savings for which they provide no details. The administration makes up savings, with details, that don't exist. Maybe that's enough to get us through the "fiscal pothole" we face in January. But it does not bode well for what happens to real federal revenues and spending after that.

Coda: The Republicans put something on the table Monday that they are calling a "counter-offer." But they have provided little detail, so we don't know whether they plan to count the same phony war savings.


National Security

Sequester shadow play: the epilogue

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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