Election 2014: What's Next for Defense?
The results of election 2014 carry high stakes for the national security policy establishment and industrial complex. With Republicans poised to increase their majority in the House and take over the U.S. Senate, the defense industry is viewed as one of the beneficiaries of the power shift.
A big question on the minds of Pentagon officials and defense industry CEOs is whether the new balance of power in Washington will mark a turning point after four years of fiscal turbulence fueled by partisan warfare. Analysts have predicted that a Republican majority will tip the scales in favor of larger military budgets and possible relief from the 2011 law that set strict spending caps.
Another unknown is whether the new Republican leadership will change course on defense and foreign policy issues given voters' unhappiness with President Obama's management of international crises. GOP defense hawks will seize on voters' discontent and the perception of American weakness to push for higher military spending. They will face resistance, though, from hardcore anti-spending Republicans and from outside groups that don't believe the Pentagon deserves a get-out-of-sequester free card.
Chance for a Budget Deal?
The accepted wisdom up until a few months ago held that a Senate flip to the GOP would not change the entrenched political polarization that has paralyzed Washington for the last four years and has flustered the Pentagon and the defense industry. That thinking changed as seemingly unforeseen crises flared up over the summer and fall, including Russia's invasion of Ukraine, the rise of the Islamic State and the Ebola outbreak.
Analysts warned that voters have become increasingly intolerant of games of chicken and brinkmanship, and they will expect the new Congress to work with the administration in resolving these crises.
Pro-defense lawmakers and Pentagon contractors have been disappointed by congressional Republicans' anti-spending agenda that led to the 2011 Budget Control Act, which imposed caps on discretionary programs that would slash funding by more than $1 trillion from 2012 through 2021. Critics have blasted the BCA for targeting discretionary spending but failing to take any action to control the rising costs of mandatory entitlement benefits that are the fastest growing piece of the federal budget pie.
Defense insiders see a post-election environment that favors increased military spending.
"Up until this year, national security was pretty low on voters' radars," said Eric Edelman, a former U.S. ambassador and undersecretary of defense for policy. Congress has now gotten the message that voters don't want to see the United States project weakness, Edelman said last month at the Bipartisan Policy Center.
Congress now ought to feel compelled to do something about the sequester, said Edelman. "This is a moment perhaps when we can have this debate."
Not having a comprehensive budget deal is "becoming a national security issue," he said. "Perceptions of American decline are created abroad," he added. "It will take a huge effort on the part of the White House and Congress to get to some kind of deal beyond a one-off budget."
The Defense Department is now operating under a temporary funding measure that expires Dec. 11. That gives the lame duck Congress just a month to pass a full fiscal year 2015 appropriations bill when it returns Nov. 12. The defense top line was already set at $496 billion under the Ryan-Murray bipartisan budget deal in January. The Pentagon is seeking an additional $56 billion for emergency war spending.
Lame Duck Scenarios
The expectation is that both the appropriations and authorization bill will be completed by the December deadline. It will be up to the new Congress to take on the much more contentious fiscal year 2016 budget. In the absence of a new bipartisan deal, the Pentagon would have to cut spending by $36 billion when the new fiscal year starts Oct. 1. Military officials have insisted that the cut is too steep, would cripple force readiness and wipe out key modernization programs.
Former Missouri GOP Sen. Jim Talent said there are straws in the wind that suggest the defense top line will be going up. Besides the GOP wins in Congress, there are other factors that are shaping the environment, such as increased frustration from all sides about the direction of U.S. foreign policy. "We have failed to deter threats around the world, and threats are growing. ... This is becoming extremely visible," Talent told a defense industry gathering. "There is a strong chance that the president's budget next year will be higher than the BCA levels," he said. And if the president doesn't submit a bigger defense budget, it is possible that Congress "may take the bull by the horns," Talent said. "A lot of people in town on both sides of the aisle, on both ends of Pennsylvania avenue, know that we realistically can't go on the way we're going."
Even if there is no comprehensive budget deal or grand bargain, Congress can increase the defense top line if it wanted to, said Talent. "When they want to do something, they can generally figure out ways around the procedures and get it done, particularly in the House."
Former Undersecretary of Defense for Policy Michèle Flournoy said the new Congress should consider the long-term implications of defense cuts. "The biggest risk we are taking is in our preparation for the future," she said at the Bipartisan Policy Center. "Others are investing in capabilities to counter U.S. strengths," she said. "The Defense Department is doing a lot to try to protect the seed corn, but if sequestration persists, I don't' see how we close that gap."
The last several years of political stalemate, partisan showdowns and temporary budget measures have been hugely damaging to the Defense Department, said Flournoy. The Army last year wrote seven different budgets, she said. In the current environment, "you don't have a lot of bandwidth to plan your future," she said. Congress needs to let military leaders "lift their gaze beyond day-to-day survival."
Defense industry officials cheer the prospect that Congress might revisit the spending caps. "It is nice to see that more people are talking about sequestration levels of spending as being something that puts [the military's strategy] and their ability to respond to world events in jeopardy," David Melcher, CEO of Exelis told analysts during a conference call. "We're trying to work with our colleagues in the Department of Defense to get that message up to the Hill."
Another Continuing Resolution?
Some analysts are not optimistic that the new Congress will act on next year's budget until the new debt ceiling increase is settled sometime in the spring or summer.
A GOP majority in the Senate should be positive for defense spending, but there are no guarantees, said industry analyst Roman Schweizer, of Guggenheim Securities. The Budget Control Act remains the law of the land, he noted, although there is a "growing chorus that believes increased defense spending will be needed to address emergent and resurgent threats."
Schweizer doubts that the lame duck Congress will pass a full-year appropriation. Republicans probably want to wait until the next session to re-craft some of the appropriations decisions to their own liking, he wrote in a note to investors. "That means another lengthy continuing resolution could be in store for appropriations until, possibly, the end of March."
If the new Congress fails to stop the sequester in 2016, the bad news for defense industry is that the Pentagon will cut programs. The silver lining, though, is that 2016 is the last year of the trough according to the BCA profile. Growth, albeit meager, is scheduled to return in fiscal year 2017, and the spending cap would go up about 2.6 percent the year after.
If the new GOP leadership in Congress decides to soften the sequester blow, said Schweizer, a two-year deal to finish off the Obama administration is conceivable.
Committee Leadership Shuffle
Changes in the leadership of defense committees could have implications for major defense contractors. If Rep. Mac Thornberry, R-Texas, succeeds at winning the chairmanship of the House Armed Services Committee, companies like Bell Textron and Lockheed Martin would benefit, said Schweizer. If his challenger prevails — seapower subcommittee chairman Rep. Randy Forbes, R-Va. — it would be good news for Navy shipyard Huntington Ingalls and for shipbuilding in general.
The retirement of Senate Armed Services Committee Chairman Sen. Carl Levin, D-Mich., is a blow to General Dynamics’ Land Systems unit in Sterling Heights, Schweizer noted. The incoming leader would be Sen. John McCain, R-Ariz., who has not been a friend of the defense industry. "We think McCain’s ascendancy to the chair would mean some rough sledding for Lockheed Martin — the Joint Strike Fighter and Littoral Combat Ship programs have been frequent targets of his criticism." McCain has also beaten up the Navy about the $13 billion price tag for Huntington’s latest aircraft carrier, the USS Gerald Ford.
Taking over the Senate Appropriations Committee would be Mississippi Republican Sen. Thad Cochran, and that could also benefit Huntington Ingalls, he said. "Lockheed Martin and Boeing would see some minor dings due to the demotions of current chairwoman Sen. Barbara Mikulski, D-Md., and defense subcommittee chairman Sen. Dick Durbin, D-Ill."
Macro Trends Bad for Defense
A team of defense industry analysts from the trade group TechAmerica predicted in a recent study that, regardless of the political winds, it is unrealistic to expect defense spending will rise above the BCA caps.
The math does not add up. Social Security, Medicare, Medicaid and other mandatory expenses plus interest payments collectively will account for 79 percent of federal outlays by fiscal year 2024, leaving only a small slice for discretionary expenditures. "We don't see an increase in defense even though there's some agitation coming from the office of the secretary of defense," said a TechAmerica official speaking on background. There could be modest growth in the out years, he said, but no major change in the overall budget dynamics.
Watchdog groups will seek to make the case that increasing the defense budget is unnecessary considering the nation's fiscal situation and the simple fact that the U.S. military, even under the BCA caps, spends far more than all its major adversaries combined.
Long-time budget analyst and beltway insider Stan Collender, of Qorvis MSLGROUP, has predicted a GOP-controlled Congress will be a boon for the military because Republican fiscal hawks are less fixated on the deficit. A lower-than-expected deficit will give Congress room to increase spending, Collender wrote. Pressure to raise the BCA caps for the military also will drive the debate, he said. "The military community was pushing for bigger budgets even before ISIS. Now that there are actual hostilities, that pressure is intensifying even further."
The central question, though, is whether Congress and the Obama administration are willing to increase military spending without also bumping up domestic spending. "With the White House holding the ultimate trump card — the veto that neither house of Congress will have the enough votes to override — the chances are that an increase for the Pentagon will also mean an increase for domestic agencies."
Others disagree. A Bloomberg Government forecast of post-election defense spending does not see a Republican Congress backing away from fiscal discipline. "After calling for smaller government and lower taxes throughout the election campaign, Republicans’ first act after gaining control of Congress can’t be saying yes to higher taxes or more deficit spending to funnel more money to the Pentagon," Bloomberg analysts wrote. "Many Democrats won’t be willing to increase defense spending unless nondefense programs also get budget relief. Hence, defense spending will still be caught in a quagmire of deficit and debt issues."
Budget Gimmicks Expected
Even without a grand bargain, Congress will still be able to boost Pentagon spending by using budget gimmicks, such as adding money to the overseas contingency operations war budget that is not subject to the BCA caps. Another accounting trick, Bloomberg Government noted, would be to extend the caps beyond 2021 to take credit now for hypothetical future cuts.
Pentagon critics are hoping that Congress will stop what they consider an abuse of the OCO account. The war budget is already "tens of billions of dollars larger than what is needed to wind down the war in Afghanistan," said William D. Hartung, of the Center for International Policy. "There is so much money there that the Pentagon is seeking to buy six new F-35s with war funding."
Flournoy noted that the OCO fund has become a convenient mechanism for Congress to avoid tough decisions such as allowing base closures and other cost cutting measures proposed by the Defense Department. "Congress has to stop throwing money at problems and allow Defense Department to reform," she said. Congress has consistently blocked efforts to close bases, reform military benefits and retire aging aircraft. "There are smart things the Defense Department wants to do" but it needs help, said Flournoy. "There needs to be stronger oversight to press on reform and efficiencies."
The Defense Business Board, an advisory panel, has estimated the Pentagon could save $27 billion to $37 billion annually by adopting business practices from the commercial sector.
The new Congress might not be keen on business reform, but will be taking an active role in overseeing the Pentagon's weapons acquisition process. It is clear that the Pentagon needs to figure out how to manage procurement programs "more intelligently," said Edelman. Many lawmakers have questioned why so many Pentagon projects fail after burning through billions of dollars. Members of Congress have been hesitant to support bigger budgets for the Defense Department given that the Army, for instance, spent tens of billions of dollars on modernizations programs that never materialized such as the Comanche helicopter, the Future Combat Systems and the Ground Combat Vehicle. "That's a hard question to answer to voters," said Edelman. "It's a big hurdle we have to get over."
Future debates on Capitol Hill about military modernization, he said, should also factor the state of the U.S. industrial base. "As a nation we have not had to think about that very much for a long time." But the industry is shrinking fast, and there are fewer competitors in defense programs, which diminishes innovation and puts the nation's military superiority at risk Edelman said. "I expect that in the new Congress that will be a concern."
Will Anyone Pay Heed to Bob Gates?
One of the Obama administration's most prominent cabinet members, Defense Secretary Bob Gates, tried and failed to shame Congress into passing budgets. In his latest book tours, he has reminded audiences that political gridlock in Washington poses an even bigger menace to national security than Russia or China. As defense secretary from 2006 to 2010, Gates said the “most dispiriting experience I had was dealing with Congress.” Between fiscal years 2007 and 2011, Gates prepared five budges for the Pentagon, and "not once was a defense appropriations bill enacted before the start of the new fiscal year." Congress has for years abdicated its constitutional duty to appropriate funds, Gates said last week. Will anything change in the next Congress?
Probably not, he lamented. And he does not see sequestration going away. “Hawks and isolationists on the right, and old-school liberals on the left believe further cuts to defense are tolerable and advisable.”