Fiscal cliff follies and defense

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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National Security

Canaries in the defense budget coal mine

The chattering class and the political voices are nattering on about the fiscal cliff. Meanwhile, the best canaries in the defense budget coal mine are the people keeping an eye on the long-term trends. With or without cliff diving, the defense budget is in a secular decline and they have known it for a while. And they know that this long-term decline will change the face of the industry.

The latest bit of evidence that the industry is working to get ahead of the game comes from a document called "2013 Defense Industry Perspective," provided yesterday by strategic consulting firm Booz and Company.

The six-page comment makes no mention of the fiscal cliff, but it does say "the defense sector is undergoing the kind of correction that happens once every 20 or 30 years." That is the right timeframe, and, as I have written before, procurement is always the first to go in a defense drawdown. In the defense drawdown of the 1980s and 90s, part of which I spent at OMB, DOD procurement spending fell 50 percent over ten years, while the overall budget was only going down 30 percent.

Booz and Co. point out that this process is already under way, and has been since Fiscal Year 2008. The budget for procurement and R&D has already fallen roughly 30 percent since that year and is projected to grow only minimally over the next five years. Moreover, if this drawdown is consistent with prior ones after Korea, Vietnam, and the end of the Cold War, a deeper reduction is likely. Falling off the fiscal cliff would reinforce that trend.

The Booz canary says something else interesting: the defense industry is changing, and will change even more as DOD spending goes down. The industry is no longer dominated by large companies that sell almost exclusively to the Pentagon; Booz points out that what they call "nontraditional companies" are succeeding in selling to DOD. Companies like Accenture, Airbus, Apple, Cisco, Dell, Eurocopter, and Pilatus. Setting aside Cold War systems, Booz says these kinds of commercial, high-technology firms account for nearly 40 percent of U.S. spending on defense acquisition.

As the budget goes down, the defense industry of the future is going to look like the U.S. and global economy. A company like Boeing, which straddles the commercial and defense markets (the new tanker is based on Boeing's commercial 767, and the P-8 patrol plane on the 737), is more nimble in this market. And the other players are not going to put up with an acquisition system that is riddled with paperwork and takes forever to make a decision.

The old defense industrial base is not the same; defense, like everyone else, now draws on the broader, deeper commercial technology base, both American and international. As the budget declines and such programs as cyberoffense and cyberdefense, communications, information technology, and unmanned aircraft grow, this trend can only grow with them.

Interesting to listen to the canaries, sometimes. They tell you when the explosion is coming and what it will be about, something to which the fiscal cliff chatter pays little attention.

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