Balancing defense needs against fiscal realities.

The 2005 defense budget request that the administration sent to Capitol Hill last month is an impressive attempt to balance the demands of a nation at war against the sobering fiscal picture now confronting us.

The request of $401.7 billion is about $20 billion higher than last year, and more than $30 billion above the 2003 budget--highlighting the rapidly rising curve in defense spending that ensued the 9/11 terrorist attacks.

It is becoming increasingly obvious, however, that there is much risk and uncertainty underlying this budget request.

On the one hand, the budget includes no money for the wars in Iraq and Afghanistan, or for reconstruction efforts in those nations. Neither does it include funds to cover the additional 30,000 to 40,000 troops the Army will need in the near term to meet deployment demands. The administration plans to request a supplemental appropriation in early 2005, but that leaves an estimated four-month gap when the Defense Department will have to "cash flow" the war, likely at the expense of training, readiness, research, development, testing and procurement accounts.

This being an election year, the political stakes are high. Congress is expected to let the 2005 appropriations bill sail smoothly, to avoid political backlash, even though many deficit hawks on the Hill are displeased by the administration's decision to delay the supplemental request for war expenses until after the election.

That brings up the deficit issue, also a significant factor in whether the nation realistically can sustain the current level of defense spending, let alone the higher budgets that the Pentagon projects for 2006-2009. The Congressional Budget Office forecasts that the U.S. federal deficit will reach $477 billion in 2004, heading toward a cumulative $1.89 trillion deficit by 2014.

The Pentagon's five-year spending plan shows gradual increases: $422 billion in 2006, $443 billion in 2007, $465 billion in 2008 and $487 billion by 2009. The raises mostly cover only inflation and do not account for extended deployments and contingencies associated with the war on terrorism.

With deficits on the upsurge, the pressure to curtail defense spending will intensify. On the one hand are growing expenditures in federal entitlement programs, such as Social Security and Medicare. The Defense Department also has its share of entitlement programs, even though the defense budget is considered to be discretionary spending. The Defense Health program is $17.5 billion this year. The Pentagon must also pay more than $10 billion in 2005 into an accrual fund to cover future military retirees for medical eligibility. This spending is mandated by law, pointed out Dov Zakheim, the Defense Department's comptroller. "Nearly $30 billion out of our budget is going to programs over which we really have no control," he said.

For the defense industry, the outlook is risky at best. To fix the current shortfalls in modernization programs, the military chiefs projected several years ago that procurement spending needs to level it $100 billion a year. So far, the $100 billion target has been elusive. in 2005, procurement actually falls to $74.9 billion, from last year's $75.3 billion. Zakheim said the reduction is only artificial. He explained that the Navy shifted two shipbuilding programs--the Littoral Combat Ship and the DD(X) destroyer--from the procurement to the R&D accounts. According to Zakheim, if those two ships had been funded in the procurement budget, it would have added $2 billion to the procurement accounts.

The 2006-2009 procurement forecast shows $80 billion for 2006, $90 billion in 2007, $105 billion in 2008 and $114 billion in 2009.

Those numbers are promising, but, as explained above, they are vulnerable on many fronts.

In the near term, the services have been told to not expect any increases to the top line. Congress, for its part, is likely to move money around within that top line. Senior Capitol Hill staffers recently told NDIA members that even though Congress will not add more money to the President's budget, it will shift funds around. The staffers said it's important for the service chiefs to continue to send their "unfunded requirements" lists to the Hill, to help guide the markup process.

The service chiefs understand these fiscal realities and are searching for infrastructure efficiencies. The Army chief of staff, for example, wants to increase the number of deployable units while, over time, reducing personnel overages and even going a bit deeper in eliminating structure that doesn't contribute to deployable combat power.

Ironically, as we see defense budgets climb spectacularly, the risk and uncertainty appear to be greater than ever as high "optempo" and increasing "must pays" like health costs compete with R&D, procurement, science and technology needs.

In the defense industry, it would be fair to say, there are legitimate concerns about the future. As we continue to work hard to provide the best technology and weapons systems for our military forces fighting the war on terrorism, we must ponder these fiscal realities and their implications for America's future edge on the battlefield.

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