Bloomberg News

White House Says No Defense Programs Are Immune to Cuts

December 27, 2012

Pentagon officials must make across- the-board reductions in weapons and research funds instead of slices that could spare some programs under the automatic federal budget cuts scheduled to take effect next week, according to the White House Office of Management and Budget.

Whether cuts are made at the so-called “program, project and activity,” level instead of in larger “accounts” such as “Air Force Aircraft” has been one of the biggest unanswered questions about what happens if the automatic cuts known as sequestration take effect at the start of the new year.

The arcane difference in how Pentagon budget cuts are implemented has major implications for defense companies because if they had greater flexibility, the military services might be able to reduce some programs more than others, according to officials and analysts.

“Investors should realize there is no safe defense haven when cuts are made at PPA level,” said Byron Callan, a defense market analyst with Washington, D.C.-based Capital Alpha Partners LLC, in an e-mail statement.

That also means no one in the defense community would be spared the pain of sequestration if President Barack Obama’s administration and Congress can’t reach an agreement to prevent more than $600 billion in automatic tax increases and spending cuts taking effect starting in January. That prospect could add to the pressure to reach a deal, especially for legislators with significant defense spending and jobs in their states or congressional districts.

Industry Warning

The Aerospace Industries Association, which represents more than 300 aerospace and defense companies and their suppliers, said yesterday that policy makers must find a way to avoid sequestration even if they can’t resolve broader conflicts over tax rates and entitlement programs such as Medicare.

“Risking American lives and livelihoods for political leverage is wrong,” Marion Blakey, the group’s president and chief executive officer, said in a statement.

Pentagon Comptroller Robert Hale told a Credit Suisse Group AG (CSGN) conference in Nov. 29: “I believe we should count on sequestration being at the line-item level for the investment accounts, maybe with some added flexibility for us if we need it.”

Pentagon budget officials and attorneys have determined that they have no flexibility in making the automatic spending reductions, which could approach $62.3 billion, some $10 billion more than previously estimated and as much as a 12 percent cut in this year’s spending.

The White House has exempted $149 billion in military pay and compensation from any cuts, leaving most of the burden on the Defense Department’s operations and maintenance, procurement and research accounts.

Navy Procurement

The Navy aircraft procurement account, for example, funds the Chicago-based Boeing Company’s (BA:US) F-18 fighter and P-8 maritime patrol aircraft and Falls Church, Virginia-based Northrop Grumman’s (NOC:US) E-2 surveillance aircraft.

If the Navy had authority to cut at the account level, it “could choose to cut one of these programs more deeply than others,” Callan wrote in a note to clients.

Asked if it was granting the Pentagon flexibility to reduce procurement and research at the broader account level, the OMB’s press office said in an e-mail statement that it wasn’t the budget office’s decision to make.

The press office pointed to the Budget Control Act language that mandates cuts at the program level: “The sequestration order would specify the reductions by budget account, and agencies would be required to apply the same percentage reductions by program, project, and activity (PPA) within each account,” OMB said.

Different Assessment

In a Nov. 16 assessment of potential reductions under the act, though, the Congressional Research Service said the budget office “has final authority in determining how sequestration is implemented.”

Even without OMB guidance, the military services “could have some limited ability to target cuts” to certain contracts within each program line “as long as the overall sequester amounts are met,” CRS analysts Amy Belasco and D. Andrew Austin wrote in the assessment.

Pentagon officials have sought to minimize the disruptive effects of sequestration on programs. “We’re not going to have to modify an awful lot of contracts,” Pentagon Undersecretary for Acquisition Frank Kendall told a Washington audience Nov. 14. “Most of the money we’re talking about that will be affected by sequestration hasn’t been put on contract yet.”

Future Contracts

“Planned contracts” will “have less money available,” he said. “In some cases, we just won’t award those future contracts. It’s not about terminating or modifying the ones we have,” Kendall said.

Pentagon leaders know that a sequester of 10 percent or more of their resources “while a blunt instrument, is manageable and probably, in the end fixable,” said Gordon Adams, a professor at American University in Washington who was an official in the White House budget office during the Clinton administration.

Most Department of Defense program officers “already know how to manage a program with 10 percent fewer resources than they had asked for; they do it all the time,” Adams said in an e-mail.

“Contractors have already been told there will be no contract cancellations, there may be changes in new contracts and some renegotiation of multi-year contracts,” he said. “So industry can take a deep breath and continue work.”

To contact the reporter on this story: Tony Capaccio in Washington at acapaccio@bloomberg.net

To contact the editor responsible for this story: John Walcott at jwalcott9@bloomberg.net


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Companies Mentioned

  • BA
    (Boeing Co/The)
    • $126.95 USD
    • -0.69
    • -0.54%
  • NOC
    (Northrop Grumman Corp)
    • $129.99 USD
    • 0.23
    • 0.18%
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