federal and defense budget update

PRIVATE & CONFIDENTIAL

Updates on the Fiscal Cliff, Sequestration, Debt Ceiling, and Other Issues Affecting the Defense Budget in Fiscal Year 2013 and Beyond

Defense Spending Status and Outlook

March 26, 2013

PRIVATE & CONFIDENTIAL | AVASCENT | 2

Current Status Near-Term Outlook

The Continuing Resolution signed on March 26 will prevent a government shutdown

DoD is funded at about $518.1 billion in FY13, but remains subject to Sequestration

Sequestration, which remains the law, will push the base DoD discretionary topline to about $478 billion

– All major accounts (other than MilPers) will be hit, but investment accounts will be hit particularly hard

The new funding measure grants some DoD flexibility to apply cuts more carefully than the across-the-board method required by the Budget Control Act

– However, making these cuts over the latter half of the fiscal year will yield difficult outcomes

The House and Senate have passed Budget Resolutions for FY14 and beyond, although these are non-binding

– Put forward by House GOP and Senate Democrats, respectively, these have no chance of becoming law

– These indicate overall attitudes about DoD spending

Attention now turns to the FY14 budget; the Obama Administration will proposed its budget on April 8

Press reports indicate the Administration will continue fighting to lift Sequestration, at least in the near-term

– The FY14 President’s Budget could come in around $521 billion, which is well above the sequestered level of $475 billion

– This would set up a continued fight between the White House and Congressional Republicans over spending and the size of the Federal government

– It is possible that FY14 could begin in October 2013 with a Continuing Resolution

The debt ceiling must be raised on or after May 19

– The extension passed in January expires on May 18

– The Treasury Department can extend Federal finances beyond May, but action will be required by Congress at some point during the summer


Where We’ve Been Sequestration of the FY2013 budget on March 1 is the latest in a series of developments that began unfolding with the passage of the Budget Control Act in August 2011

Failure of the Super Committee (November 2011)

Budget Control Act (August 2011)

FY2013 Budget (February 2012)

Continuing Resolution for FY2013 (September 2012)

Fiscal Cliff Deadline (January 2013)

• Raised Federal Debt Ceiling

• In exchange, forced caps on discretionary spending (Defense and non-Defense) for FY13 and beyond

• Created bipartisan “Super Committee” to identify further deficit reduction measures by Thanksgiving 2011

Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sept. Oct. Nov. Dec. Jan.

2011 2012 2013

• Charged with proposing $1.2T in further deficit reduction over 10 years

• Failure to agree to a deal (and pass it in House and Senate) would prompt Sequestration of $1T in Federal spending over 10 years, including $550B from DoD

• Obama Administration proposes FY13 budget

• Includes budget levels set by the Budget Control Act

• Does not assume Sequestration, however, despite the failure of the Super Committee

• Congress passes (and Obama signs) CR to keep the Federal Government functioning through the first half of FY2013 (thru March 2013)

• Spending set slightly above FY12 levels (<1%)

• Congress agrees to extend and adjust tax cuts, delay and reduce Sequestration in FY13, and make other fiscal policy changes

Attention now shifts to April 8, when the Obama Administration will put forth its budget request for fiscal year 2014

2012 Elections (November 2012)

• Obama wins reelection

• Democrats retain control of the Senate, Republicans retain control of the House

• Lame Duck session through January 2, 2013

Debt Ceiling Lifted Temporarily (January 2013)

• House votes to lift Federal Debt Ceiling through May 18, 2013

• No action on broader spending issues

Feb. Mar. Apr. May

(March 2013)

• March 1: FY2013 discretionary budget is sequestered, per the Budget Control Act and the American Taxpayer Relief Act

• March 12/13: House GOP and Senate Democrats issue alternative long-term budget plans

• March 26: President signs full-year CR, granting DoD appropriations that remain subject to sequester

• March 27: After-Session Sequester takes a further $7B from the DoD topline


Where We Are After many twists and turns, H.R. 933 sets the FY13 DoD topline budget at about $518 billion, but it remains subject to sequester, for a final level of about $478 billion

FY12 Appropriations FY13 President’s

Budget FY13 Continuing

Resolution FY13 Appropriation

FY13 Appropriation with Sequester

$142 $135 $143 $128 $128

$197 $209 $198 $209 $188

$105 $99 $105 $99 $89

$71 $69 $72 $69 $63

$0

$100

$200

$300

$400

$500

$600

FY12 Appropriation FY13 President'sBudget (Feb. 2012)

FY13 ContinuingResolution (Sept.

2012)

FY13 Appropriation(March 2013)

FY13 Appropriation(IncludingSequester)

Revolving &Management Funds

Family Housing

MilitaryConstruction

RDT&E

Procurement

Operations &Maintenance

Military Personnel

$ B

illio

ns

September 2011 February 2012 September 2012 March 22, 2013 March 27, 2013

Source: FY13 DoD Greenbook; H.R. 933; Avascent analysis of BCA (Aug. 2011) and ATRA (Jan. 2013)


Where We Are Decline in the base budget will hit investment accounts particularly hard, although some of these reductions may not be fully felt until outlays slow in FY14 and beyond

Military Construction

RDT&E

Procurement

Operations & Maintenance

Military Personnel

Delta, FY12 to FY13*

-$3.3 billion

-29.1%

-$8.8 billion

-12.4%

-$15.7 billion

-15.0%

-$9.1 billion

-4.6%

-$14.3 billion

-10.1%

Remarks Likely Focus of Reductions

• Hardest hit among major accounts in relative terms

• All Services RDT&E accounts are cut

• Prior to Sequester, a few accounts were set to make modest gains, FY12 to FY13

• But after Sequester, only Army Aircraft and Air Force Ammo accounts will see growth

• Congress added funds to many (but not all) O&M accounts in H.R. 933 to allow DoD to sustain readiness and deployments even after sequestration

• Not subject to sequester, unlike all other major accounts

• Decline prompted by planned reduction in endstrength

Selected Accounts

*Includes Avascent’s initial estimate of sequestration by Title

• Deferral of many new-start projects

• Deferral of many new-start programs

• Potential furlough of civilians with salaries funded by RDT&E

• Probability of lower buy-rates than planned, with implications for unit cost growth

• Deferral of new-start procurements

• Unclear how DoD will revise its prior Sequestration planning, given added funds

• Civilian furloughs seem likely, however

• Not subject to sequester

H.R. 933 gives DoD greater flexibility to apportion budget cuts than the BCA allowed


Where We Are The House and Senate Budget Committees have issued competing visions for Federal spending, taxes, and implications for deficits and debt

20%

30%

40%

50%

60%

70%

80%

90%

FY9

0

FY9

2

FY9

4

FY9

6

FY9

8

FY0

0

FY0

2

FY0

4

FY0

6

FY0

8

FY1

0

FY1

2

FY1

4

FY1

6

FY1

8

FY2

0

FY2

2

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

FY9

0

FY9

2

FY9

4

FY9

6

FY9

8

FY0

0

FY0

2

FY0

4

FY0

6

FY0

8

FY1

0

FY1

2

FY1

4

FY1

6

FY1

8

FY2

0

FY2

2

Deficit/Surplus as a Share of GDP Overview of House and Senate Budget Plans

Debt Held by the Public as a Share of GDP

• The House Budget Committee prioritized a rapid reduction in Federal budget deficits and debt

• Budget would reach balance by FY23

• Deep cuts in Federal outlays relative to the CBO baseline, particularly the Medicaid program and funding for the Affordable Care Act (ObamaCare)

• No increase in tax revenues from CBO baseline

• The Senate Budget Committee put less priority on these outcomes, favoring further public investment and stimulus

• Budget would not reach balance, but would reduce deficit as a share of GDP

• Makes $733 billion in discretionary spending cuts (along with a further $242 billion in interest savings), but adds $100 billion in spending on infrastructure

• Gains $975 billion in new revenue from closing tax loopholes and expenditures

Senate Budget Cmte

House Budget Cmte

CBO (February 2013)

Actual

The House and Senate budget plans will not become law, but instead stake out the parties’ overall visions

Senate Budget Cmte

House Budget Cmte

CBO (February 2013)

Actual

Source: House Budget Committee; Senate Budget Committee


Where We’re Going The White House has revealed the basic outlines of a long-term deficit reduction plan, which offers a glimpse of what the president may propose as his FY14 DoD budget request

The White House outlined in February 2013 a plan to gain an additional $1.5 trillion in deficit reduction over ten years through a mix of spending cuts and tax increases

Budget Cuts: $1,080 billion in spending reductions Tax Increases: $580 billion in new revenue

• Replace Sequester with $200 billion in discretionary budget reductions over 10 years

• Press accounts indicate the White House would backload cuts to the latter half of the 10-year period

• $200 billion cut would be split evenly between Defense and Non-Defense discretionary spending

• Gain $400 billion in savings from Health-related reforms

• Gain $200 billion in savings from other Mandatory programs (non-health)

• Shift to Chained CPI index to limit growth in Mandatory programs

• $50 billion in new spending on “temporary growth measures”

• Gain ~$580 billion in new revenue

• Limit tax deductions to 28% for wealthiest earners

• Close various loopholes

Gaining GOP agreement on any increases in tax revenue will be extremely difficult

Source: White House deficit reduction outline (http://www.whitehouse.gov/blog/2013/02/21/balanced-plan-avert-sequester-and-reduce-deficit)


Where We’re Going The House and Senate budget plans approved this month, as well as the White House’s notional debt reduction plan, all feature DoD budget estimates that vary only slightly in the near-term

$400

$450

$500

$550

$600

$650

$700

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23

CBO Baseline (Feb. 2013)

CBO Baseline Assuming Sequester (March 2013)

White House Deficit Reduction Plan (Feb. 2013)

House Budget Committee (March 2013)

Senate Budget Committee (March 2013)

Defense Discretionary Spending (Base Only) Under Alternative Budget Plans

Cu

rren

t Ye

ar $

Bill

ion

s

Baseline did not assume Sequestration

March 2013 “Budget Alternatives” estimated effect of Sequester in FY14 and beyond

Shifts proposed discretionary cuts to the latter years of the 10-year window

Assumes greater spending on defense than projected under either CBO baseline or sequestration

Assumes no real growth in DoD topline over time (nominal growth after FY17)

Source: CBO, “The Budget and Economic Outlook: Fiscal Years 2013 to 2023,” February 2013; CBO, "Approaches for Scaling Back the Defense Department’s Budget Plans," March 18, 2013, Table 1-1, p.9 ; House Budget Committee; Senate Budget Committee; White House deficit reduction outline


Where We’re Going With a government shutdown averted, the budget debate shifts to FY14, in which the Obama Administration may aim to roll back sequestration-level cuts

Path Forward from Sequestration

February March April May

Sequestration Deadline (March 1)

• Extended from January 2

• January 1 agreement extended deadline for Sequestration

FY13 Continuing Resolution and DoD Appropriations (March 22)

• Government shutdown averted

• Sequestration remains in force, and will be applied to toplines set by H.R. 933

• DoD granted flexibility to apply cuts outside rigid BCA guidelines

Assuming no Grand Bargain is achieved between the White House and congressional Republicans, the probability is high that FY14 will begin with another Continuing Resolution

• Debt ceiling must be raised to allow continued borrowing to finance Federal operations

• Failure to raise debt ceiling could prompt downgrade in U.S. credit rating, and rise in interest rates

• Treasury may be able to finance Federal operations into the summer via “extraordinary” measures

Revised Debt Ceiling Deadline (May 18)

June July August September

Fiscal Year 2014 Begins (October 1, 2013)

• FY2014 spending measure must be in place avoid government shut-down

• Another CR could be used as a stopgap measure

October

FY14 President’s Budget (April 8)

• President to unveil his FY14 budget following a two-month delay

• Press accounts* indicate DoD will ask for ~$521 billion, an implicit move to take away sequestration

*Source: Defense News, “New WH Plan Would Cut $100B From Defense,” March 21, 2013; InsideDefense, “Hale: DOD’s FY14 Topline To Exceed Budget Control Act Levels By Up To $55 Billion”, March 6, 2013


Where We’re Going Several outstanding questions remain for the balance of FY13 and FY14

Across the board cuts are no longer required, but deep cuts must be accommodated in a short timeframe

Among the investment accounts, many programs may be spared from very deep cuts, but others may be severely reduced to make up the balance

– Terminations, delays, and cuts in order quantities are highly likely among many programs

– Contractors will feel the effects of these cuts relatively slowly, as outlays materialize in FY14 and beyond

Among operating accounts, the Services may be able to avoid cuts in maintenance, training, and other sustainment activities that they had been planning

– Furloughs of DoD civilians still seems likely, however, starting as early as April

– While some contractor-addressable activities may see fewer cuts than previously feared, many services related to HQ support and infrastructure sustainment are at high risk

The Balance of FY13 Issues Affecting FY14

How will DoD implement deep funding reductions? Whither the FY14 topline budget?

The White House may aim to roll back sequestration, and back-load proposed discretionary cuts to the period beyond FY18

How will Congressional Republicans respond to an FY14 budget request that does not incorporate sequestration?

– There is a divide between GOP deficit/debt hawks and GOP defense hawks which the White House will try to exploit

– But the deficit/debt hawks have clearly gained the upper hand

There remains a wide divide between Democrats and Republicans in the Senate/White House and House of Representatives, respectively

– Prospects for reaching consensus on FY14 funding levels for DoD or other agencies in time for the new fiscal year in October are very small

– A CR for the opening months of FY14 currently appears to be the most likely outcome

– An FY14 CR would fund DoD at the sequestered FY13 level


www.avascent.com (202) 452-6990

federal and defense budget update

Business