Defense forecast: Army cash-flow troubles continue despite hefty emergency allowance.

FOR THE ARMY, the upcoming budget season is shaping up to be a competition between "boots" and "hardware," even though officials have argued that they should not have to trade one for the other.

Ultimately, they may have to, analysts predict. Unless troops are pulled out of Iraq in the coming months, the Army is likely to start the year with a budget plan that could be anywhere from $20 billion to $100 billion short of its own estimates of what it needs to keep fighting the war and to replenish equipment.

While the Army has been the largest beneficiary of emergency supplemental war appropriations in recent years, its expenses are climbing faster than Congress is able to appropriate funds, even under emergency measures. This hurts the Army; officials contend, because the emergency funds arrive at the end of the budget year and force the service to "cash flow" war expenses from its regular accounts. Not until Congress approves the emergency funds can the Army replenish its coffers. For that reason, service leaders have asked for a major increase in the regular budget for fiscal year 2008, although it is doubtful that, in the near term, it can reduce its dependence on emergency funds.

In fiscal year 2005, 20 cents of every dollar the Army spent came from emergency appropriations, noted Maj. Gen. N. Ross Thompson III, director of program analysis and evaluation. By 2006, that share was up to 42 cents, and it could be as high as 50 cents in fiscal year 2007.

"When supplementals are delayed, we cash flow out of the baseline programs," Thompson told an industry conference. "Ideally, we want the supplementals before the end of the fiscal year ... In 2003 and 2004 they were late." An early "bridge supplemental" of $70 billion appropriated for fiscal year 2007 was "helpful" in stemming cash flow problems in the Army, Thompson added.

The budget for fiscal year 2008, due before Congress next month, is not expected to fix the Army's financial predicament, analysts warned, The Army is seeking $139 billion as its baseline budget for 2008--that is nearly $45 billion more than its 2007 baseline budget. In addition, it could seek up to $80 billion over and above the $139 billion request to cover personnel, operations and equipment costs associated with the wars in Iraq and Afghanistan.

All indicators point to higher budgets for the Army in 2008. The amount of the increase, however, is not going to be as large as the Army wants it to be, analysts predict. "The Army must achieve at least a modest increase in top-line funding to avoid future competition between 'boots versus procurement,'" says James A. McAleese, a defense industry analyst at McAleese & Associates, in McLean, Va.

The political mood in Washington is working in favor of the Army in many ways, because Democratic lawmakers support an increase in the size of the active-duty force and long have endorsed boosting funding for essential war equipment. But Congress also will attempt to curb the size of emergency supplemental appropriations, which have amounted to more than $500 billion since 2002.

The Defense Department is expected to send a new emergency request of anywhere between $70 billion and $130 billion to Capitol Hill this month to cover war expenses for the second half of fiscal year 2007.

Nonetheless, Army big-ticket programs--particularly the Future Combat Systems--could see cuts and delays. The Congressional Budget Office projects the Army's modernization accounts will be $6 billion to $13 billion short of what it needs between now and 2011 to carry out existing programs.

"Congressional efforts to limit emergency supplemental spending, coupled with plans to grow Army end-strength will directly jeopardize long-term procurement priorities," McAleese said.

If and when the flow of supplemental war dollars begins to slow down, the Army will have to either downsize or give up big-ticket programs, said Cindy Williams, senior researcher at the security studies program of the Massachusetts Institute of Technology.

In recent years, the regular defense budget has shown steady increases for procurement, research and development, but personnel costs--pay, benefits, health care--have risen even more dramatically. As soon as defense spending begins to level off, which could happen once a new administration takes office or when troops begin to draw down in Iraq, personnel costs will squeeze out R&D and procurement, Williams said.

Without the huge increases in spending seen during the past five years, the services will have to make a choice between personnel and investment, she noted. The Navy and the Air Force already are moving to downsize the force so they can secure funds for their next-generation weapon systems. But the Army and the Marine Corps don't have that option until the war ends. So, for the time being, their procurement accounts in the regular budget will be tightened.

The Bush administration most probably will add $10 billion to $12 billion to the Army's regular budget in 2008, but any increase beyond that will come in emergency war funds. To illustrate the budgetary kabuki dance that lies ahead, McAleese noted that in fiscal 2007, the Army asked for $110 billion in its regular budget but received $93 billion. Then Congress added $44 billion in emergency supplemental funds, $17 billion of which was earmarked for equipment repairs. The end result is that the Army ended up $10 billion ahead of its original request, which explains why service officials have been publicly pushing for a $139 billion baseline budget.

Thompson said the Army gets only 16 percent of the Defense Department "investment" dollars that pay for next-generation technologies. The Army is pushing for a bigger share of that pie, possibly at the expense of the other services.

Even mundane battlefield gear is expensive, Thompson noted. The cost of equipping a single soldier for combat has increased from $7,000 to $25,000.

Most of the $17 billion allocated so far in 2007 to fix and replace hardware already has been spent, he said. The Army has estimated it will need at least $13 billion a year between 2008 and 2010 for equipment repairs.

Of the administration's upcoming request for war emergency funds for fiscal 2007, the Congressional Budget Office projects $29 billion will go to "investments," which include research, development and acquisition programs.

A broader assessment of the defense budget by CBO concludes that the administration's 2007-2012 spending plan--which does not include supplemental funds--underestimates by 12 percent to 27 percent the cost of keeping the Defense Department and the military services in business.

"Carrying out plans proposed in the five-year defense plan would require sustaining annual funding over the long term at higher real [inflation adjusted] levels than those that have occurred since the mid-1980s," CBO analysts noted. The 2007-2012 defense budget plan does not provide enough funding to pay for the Pentagon's current procurement programs and for its ambitious "transformation" efforts to modernize its weapons systems, according to CBO. Nor does the plan account for the growing costs of pay and benefits for military and civilian personnel, or the increasing expense of operating aging equipment. CBO estimated that by 2024 the average age of the Army's ground combat equipment will exceed 26 years.

A recent industry analysis projects that military procurement will grow from $105.8 billion this year to $119.1 billion in 201. But research and development spending is expected to decline from $76.1 billion this year to $70.9 billion in 2017, according to a study published by the Government Electronics and Information Technology Association. During the next 10 years, military personnel costs are expected to grow from $133.3 billion to $158.7 billion, said Cecil Black, one of the analysts who participated in the GEIA study. He projected that the regular defense budget will increase from $439.3 billion this year to $576.1 in 2017, while the supplemental appropriations will drop from $130 billion this year to $33.3 billion in 2017.

For the 10-year period, the baseline defense budget without supplementals is forecast to grow from $435.6 billion to $576.1 billion. "Despite pressure on the top line budget, it is important to note that the defense budget is at its highest level since the Korean War," said GEIA President Dan Heinemeier. "We are forecasting that the continuing need for supplemental funding through fiscal 2009 will fuel procurement account growth." In constant (not adjusted for inflation) dollars, GEIA predicted, defense budgets will peak in fiscal 2009 and then decline gradually through 2017.

A broader question that surrounds the current budget debate is how much longer the United States can continue to finance these whopping emergency supplementals.

Congress already has directed--in the 2007 defense authorization bill--that the Defense Department roll its war expenses into the regular budget beginning in 2008. This explains why Deputy Defense Secretary Gordon England modified the criteria for requesting emergency dollars from strictly war-related costs to broader categories of spending associated with the "global war on terrorism," Williams noted. "The Defense Department is seeing this coming supplemental in fiscal 2007 as the services' final opportunity to toss in whatever they want. This one may be the last one that will not go through the authorizers." Unlike regular budgets, the supplemental requests are handled only by the appropriators and get little oversight from the policy-making Armed Services committees.

By asking the services to include larger requests to pay for equipment modernization, the Pentagon is taking a gamble that could pay off, Williams added. "The administration is betting that Congress will be unwilling to vote down any amount the administration requests."

Congress, for its part, can safely be expected to approve war supplementals but lawmakers also will take bites out of the regular defense budget, so they can fund non-defense programs. In fiscal 2007, Congress sliced nearly $10 billion from the Pentagon's budget, knowing that the military eventually would get the money back in the supplemental, McAleese noted. "When the request goes to Congress, Congress likely will not give the services the full amount of the baseline request, but will give them 90 to 95 cents on the dollar, and then make up the difference in the supplemental."

This revolving funding mechanism also helps the White House keep a lid on the regular defense budget, which eats up one-half of the entire federal government's non-entitlement funds. "The White House does not want to give the Defense Department more than 50 percent of the discretionary budget," McAleese said. The White House will resist including war expenses in the budget to avoid breaking an unofficial "glass ceiling" of between $450 billion and $500 billion for the defense budget. A regular budget approaching the $500 billion mark would be unacceptable to the White House Office of Management and Budget, and would set the stage for a showdown with Congress. The supplemental funding requests do not count toward that glass ceiling, which is what makes them so attractive to the administration.

The White House already has warned Congress that the legislation that would require the Pentagon to incorporate war expenses into the regular budget may not be enforceable. Following the signing of the legislation in October, the White House issued this statement: "The Executive Branch shall construe these provisions in a manner consistent with the President's constitutional authority to recommend for the consideration of the Congress such measures as the President deems necessary and expedient."

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