Budget May Be Safe For Now, But Weapon Makers Should Worry

By Sandra I. Erwin
If the current discourse over defense spending were a self-help bestseller, it would be titled, “How to Live in Denial About Being Broke.”

To their credit, senior Defense Department leaders have called out the obvious: The Pentagon’s budget over the past decade has been a runaway gravy train that has to slow down sooner, rather than later, as the nation drowns in debt.

Defense, however, continues to be spared from the big knives. The 2012 funding request still has the United States spending more on defense than at the height of the Cold War. The proposed $553 billion base budget for 2012 — which does not include war costs — would be slightly higher than in 2011. By 2015, the estimated base budget would be $643 billion. The real decline is supposed to happen after 2015.

Just three months ago, the Obama administration’s bipartisan deficit-reduction panel unveiled a proposal to tackle the nation’s $14 trillion debt. Among the recommendations were cuts of more than $200 billion to the defense budget. But the proposals were rudely ignored.

“Forget the fiscal commission. … It’s irrelevant and passé at this point,” says Stan Collender, budget analyst at Qorvis Communications, in Washington, D.C.

Defense will see some nominal reductions, but nothing significant, Collender says. Politicians are calling for Washington to spend more responsibly, but when it comes to defense, it’s still business as usual.

“We’re not in a period in U.S. history when the United States can gut the military,” he says. For the defense industry, nonetheless, the news is bad, because the Pentagon’s contracting and hardware-buying powers could diminish considerably. With a flat budget, the Pentagon will have to dip into procurement and contract-services accounts to cover rising personnel and health care costs. Medical coverage for active-duty forces and retirees, which today consumes 9 percent of the defense budget, is growing faster than any other account. Payroll and fringe benefits combined make up 45 percent of the entire Pentagon’s budget.

For the defense industry, the 2012 budget is likely to be looked at as a turning point, says Collender.

Until the Pentagon starts taking significant numbers of people off the payroll, it will be nearly impossible to make major cuts to the budget. But as long as unemployment remains at 9 percent, politically, it is a non-starter. Any reductions in defense will come from non-personnel accounts. As a result, this is likely to be an “extremely challenging time for defense contractors,” Collender says.

Defense Secretary Robert Gates has been trying to avert a people-vs.-hardware fiscal fight by asking the services to cut overhead, terminate wasteful programs and shift money to modernization accounts. But that could take years, particularly if Congress stands in the way. Gates’ “efficiencies” already have set off bickering by lawmakers from both sides of the aisle who fear losing jobs in their districts.

Experts fear that the current budget trends point toward a technological decline in the U.S. military. “We are spending $2 billion a week in Afghanistan. But we’re not buying any new warships or airplanes,” says Charles J. Dunlap Jr., a retired Air Force major general. The industry is down to six major defense contractors, he notes. The system that has “allowed our troops in the field to have the best equipment, I think, is in jeopardy today.”

In the coming years, as proposals to cut entitlement programs gather steam, the Pentagon also will have to contend with a war-fatigued public that may no longer support large defense budgets if programs such as Social Security or Medicare are targeted.

“For the first time in a decade, we’re seeing public attitudes changing,” Collender says. Recent polls revealed that more than 50 percent of Americans would approve reductions in defense if that is what it takes to protect retirement or medical benefits. “Those are pretty powerful changes,” he says. Only a few years ago, less than 30 percent of the public would have taken that stance.

At some point, the administration and Congress are going to have to come to grips with the fairness issue, says Michael S. Lewis, a defense industry analyst at Lazard Capital Markets. Every other federal agency is being asked to pull back, and if entitlement programs come under fire, people will begin to seriously question why defense budgets are being sheltered.

The status quo can probably be maintained for a few more years, but that only will delay the inevitable. Under optimistic scenarios, by 2020, the federal budget will only be able to fund five items: Social Security, Medicare, Medicaid, interest on the debt and defense. With a debt-to-GDP ratio of 120 percent, “We’ll be Greece,” Lewis says.

Gates has been warning the Pentagon to stop living like money is no object. But his influence only goes so far. “One of the problems with the whole defense establishment is that they’re thinking about now, now, now, without thinking about the repercussions in five to 10 years,” Lewis says.

For contractors, the current paralysis in decision-making should be cause for real concern. The longer tough calls are delayed, the more the Pentagon is likely to delay or cancel weapons procurement and research programs in order to keep up with “must pay” personnel and health bills, Lewis says. “Defense will continue to push the useful life out of existing programs, spiraling in new technologies, keep them going as long as they can.”

Topics: Defense Department, DOD Budget

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