We Have a Budget Deal: What Comes Next?

The passage of the Bipartisan Budget Act of 2013 gave the Defense Department some relief from the sequester and some breathing room to adjust its spending beyond fiscal year 2015 to fit within the budget caps that Congress mandated in 2011.

At press time, Congress was still working on an omnibus appropriations bill for fiscal year 2014. The Bipartisan Budget Act suspended the sequester for fiscal year 2014 and 2015 and increased the Budget Control Act caps for those years. Now we need a budget that complies with those parameters. 

Congress has been working against the legislative markups of the president’s 2014 budget submission. That budget was submitted not in compliance with the BCA caps, but Congress marked it up anyway. Now lawmakers are working to adjust that framework to bring it in line with the BBA. They are collaborating with the services and the office of the secretary of defense to ensure a proper balance in the various accounts, so we expected a budget in January that presents a reasonable approximation of a balanced budget within the new cap limits.

The Defense Department’s base budget for fiscal year 2014 will come in at around $497 billion and approximately $497.8 billion for 2015. It is essentially flat with the fiscal year 2013 level of $496.6 billion, although a decline in inflation-adjusted dollars. These figures are for the base budget, which is roughly 95.5 percent of the larger national defense budget account.

The two-year budget deal should give the services time to make the necessary force structure adjustments before going back under the BCA caps in 2016.

As Defense Secretary Chuck Hagel noted when he unveiled the Strategic Choices Management Review, it is not possible to comply with sequester in any rational way. The cuts needed to be back loaded to do it right. 

The two-year reprieve appears to be satisfactory at least to the Army, which had been under enormous pressure to keep forces trained and ready following the 2013 sequester. Army Chief of Staff Gen. Ray Odierno said he will now be able to reduce force structure in a more measured way to a target of 490,000 by the end of fiscal year 2015 — compared to fiscal year 2017 in the sequester budget. When asked whether he would commit to going down to 420,000, he said that when the Army reached 490,000, it would reevaluate the situation. He insisted that decisions have not been made on further force reductions. 

Interestingly, Odierno addressed the controversial issue of whether he would support increasing the size of the National Guard because guardsmen cost less than active-duty soldiers. The active and reserve components are not interchangeable, but complementary, he said. Further, Odierno noted that the Army is going to 54 percent in the reserve component and 46 percent in the active, but that anything below 490,000 would have to come out of the reserve component.
 
This seems to set up a debate on allocation of amounts and types of forces as this reduction plays out over the next two years. Expect this to be highlighted in the testimony that military leaders — both active and Guard/Reserve — give to Congress in support of the fiscal year 2015 budget.

The Air Force has a similar debate shaping up. There is a National Commission on the Structure of the Air Force that is scheduled to report its recommendations Feb. 1. The panel is assessing alternate force structures. Its charter directs the service to look at the active-duty/Air National Guard mix and relative funding between the two. The commission has interviewed and taken testimony from a variety of sources, with reserve and Guard component advocates being well represented, along wth governors, adjutants general, Congress, state legislators and others.

There will certainly be some active-versus-reserve component back and forth on this issue. Notably, one of the criteria for sizing the active force is to make it big enough to adequately feed its personnel to the reserve component. Operational tempo goals are another consideration. All this seems to presage a return to a discussion of tiered readiness, something sure to generate push back from the active components.

The simple reality is that the present structure and even the targeted structure and traditional readiness goals are not all affordable under the budget levels that are specified in the BCA.

Other targeted areas in defense spending that will remain under scrutiny are overhead costs — read 20 percent staff reductions everywhere — and military compensation. Active and retired benefits — health, retired pay, basic allowance for housing, Tricare fees, pay raises — are all contentious issues as evidenced by the outcry over the reduction of the retired pay cost-of-living adjustment in the recent BBA.

It is almost certain that forces in all services will see reductions. The strategy expected to be articulated in the 2014 Quadrennial Defense Review — and particularly the “pivot to the Pacific” — will determine relative force sizes of the services.

Also, it seems that the service chiefs are prepared to accept some adjustment to pay and benefits. Odierno noted that in the 1990s, the military needed to close a pay gap. That gap is now closed, and it is time to look at sustainable pay and compensation. But further, he cautioned, any reforms need to follow a comprehensive approach, not a piecemeal series of actions. In the end, it is clear that these costs must be contained.

For the defense industrial base, decisions made over the next year could have significant implications as companies weigh their next move. Expect to see mergers and acquisitions, as well as painful downsizing and corporate restructurings.

Defense CEOs hope to see some resolution on acquisition reforms that Defense Department and congressional leaders will be considering in order to help control program costs and improve performance. These are perennial problems in the military procurement business for which there are no easy solutions.

Stay tuned. The BBA budget battle was just the opening shot. Many more really big adjustments are on the horizon.

Topics: Business Trends, Doing Business with the Government, Defense Department, DOD Budget, DOD Policy