Bank Examiner Carter: “I trust you had a good year?”

George Bailey: “A good year? Uh, well, between you and me, Mr. Carter, we're broke.” — It’s a Wonderful Life

“We’re broke.” In essence, that’s the message Deputy Secretary of Defense Bob Work delivered to Defense-Secretary-in-Waiting James Mattis at the December 5 Future Strategy Forum.

Mr. Work admitted that DoD has breathtaking liabilities—as much as $88 billion a year—that ought to be addressed before procuring a single additional plane, ship or tank. Unfortunately, the situation is even worse than that.

Military leaders have testified to the problems caused by five straight years of budget cuts and how these cuts, combined with an extraordinarily high operational tempo, have resulted in a smaller, less capable military force.

What has received less attention is the degree to which the Pentagon’s future plans bank on questionable assumptions and budgetary sleight-of-hand to balance the books for 2018 and beyond. These gimmicks include: relying on rosy future estimates for the cost of labor, fuel and currency exchange; pushing the costs of large modernization programs like the nuclear triad into the ill-defined “out years,” and using Overseas Contingency Operations funds to help cover normal DoD operating costs. Taken together, these liabilities, combined with the administration’s decision to submit budgets in excess of the Budget Control Act caps, constitute about $100 billion dollars per year of unbudgeted liabilities or risk—a staggering sum that will severely limit the new administration’s ability to quickly rebuild the U.S. military.

In October 2016 a Pentagon spokesman publicly acknowledged, and Secretary Work confirmed, what many have known for some time: that as much as half of the money requested in the DoD Overseas Contingency Operations (OCO) funding is planned to go to normal Pentagon operations such as training soldiers, steaming ships or flying planes—not the extraordinary wartime operations which OCO was designed to cover.

The President-elect’s nominee to head the Office of Management and Budget, Rep. Mick Mulvaney, (R-SC), has decried such misuse of OCO funds, calling it a “backdoor loophole” in the budget process. Considering that comment, if Congress and the country want DoD’s normal operating costs captured in the appropriations process versus the wartime funding mechanism, this $30 billion annual cost must be eventually covered in the base budget, further adding to DoD’s liabilities. And while it may be a worthy goal to move these enduring costs into the base appropriation it’s important to note that this shift by itself won’t do anything to restore military capabilities.

Here are some other liabilities Secretary Work didn’t mention:

Future Costs of Labor

Section 1009 of Title 37 United States Code requires military pay raises to equal the Economic Cost Index (ECI), a common measure of the cost of labor, unless the president invokes his authority to request an alternative pay raise. The Congressional Budget Office estimated in August that “the ECI will grow by more than 3 percent a year, on average over the next several years.” However, in its budget request, DoD has planned on much smaller raises than CBO forecasted. The 2017 DoD budget projects pay raises of only 1.6 percent for 2017-2019, and 1.8 percent and 2.1 percent for 2020 and 2021, respectively.

From 2014-2016 President Obama used his authority to lower the requested pay raises, and Congress complied. After three years of smaller than prescribed pay raises, this year Congress disregarded the president’s recommendation and set the pay raise at 2.1 percent in the 2017 NDAA, matching the growth in ECI.

Because the DoD has banked on being able to lowball military and civilian pay raises for the next five years, the liability incurred by Congress’ inconvenient compliance with law this year, and potentially in the future, will run to the tens of billions of dollars. Just next year’s change in pay will cost DoD about $800 million in 2017 than planned.

Hopeful Fuel Cost Assumptions

The DoD budget estimate projects that fuel costs for fiscal year 2017 will drop 8.2 percent from 2016. For future years, DoD used planning assumptions that reflected minor increases ranging from 4.8 percent in 2018 to only 1.8 percent in 2021. 

However, the latest forecast from the U.S. Energy Information Administration predicts crude oil prices will gradually rise, not fall, next year. And future year energy estimates vary widely, with high end price per barrel of crude oil reaching $150 by 2020. If energy costs grow at even a modest rate of 5 percent annually, the Pentagon will be short billions of dollars compared to its plan.

Living Large In an “Out-year”

Former Secretary of the Army John McHugh famously commented that he always wanted to “live in an out-year.” In Pentagonese, “out-years” fall outside the rigid five-year planning window; they are, consequently, years in which unrealistic procurement plans magically come to fruition and normal budget rules don’t apply.

DoD is notorious for planning to acquire major systems such as planes, submarines and ships in quantities that are patently unaffordable in the next five years, but will be brought on-board when the money somehow materializes in an “out-year.”

This Pentagon has double-downed on that technique. In addition to the unpaid bills associated with the recapitalization of the nuclear triad mentioned by Secretary Work, the replacement for the Ohio class submarine and many other major systems are also all awaiting an out-year deus ex machina to save the day.

For example, the Navy’s current, approved 30-year shipbuilding program only gets them to 308 ships—even though they just announced they need 355, nearly matching the president-elect’s promise to get to 350 ships. Yet when the Congressional Budget Office analyzed the Navy’s 308-ship plan, they found it would cost $3-5 billion dollars more per year than what was budgeted.

In an excellent study of the out-year issue, CSIS’s Todd Harrison suggested that just to execute the DoD’s planned modernization programs would require approximately 7 percent more funding— around $40 billion per year—than was budgeted. This includes nothing of the re-building that President-elect Trump has promised.

Other problems lie ahead. DoD has made optimistic assumptions about foreign currency exchange rates, counting on them to remain near where they are today, which is very favorable for the United States. Another liability includes Pentagon requests for changes to military health care programs that the 2017 NDAA did not fully support.

At the Bottom of a Very Deep Hole

The Pentagon has made big plans for which it lacks the money. The liabilities described above will build to about $100 billion a year over time, seriously complicating matters for a president-elect who has pledged to rebuild our depleted military.

The Pentagon can save some money through efficiencies, base realignment and closure, restructuring and better business practices, and some of these efforts are already underway. But those savings won’t be nearly enough to close liabilities of this magnitude. It’s unfortunate this critical information hasn’t been part of a national discussion by our nation’s leaders, including the president, prior to the imminent transition.

In It’s a Wonderful Life, George Bailey’s financial problems were solved with a crowdfunding solution among the residents of Bedford Falls. General Mattis won’t be so fortunate. It’s among the many challenges that the new administration’s leaders will have to grapple with in their first hundred days to begin the necessary restoration of our military.

Lt. Gen. Tom Spoehr (U.S. Army, retired) is the director of the Heritage Foundation’s Center for National Defense. He served as the Army’s Director of the Office of Business Transformation from 2013-2016.

Image: B1-B Lancer. Flickr/U.S. Air Force