Magazine article National Defense

Sequester Sinks in, Extent of Fallout Unknown

Magazine article National Defense

Sequester Sinks in, Extent of Fallout Unknown

Article excerpt

* What a difference a year makes. Pentagon officials spent the summer of 2012 talking themselves out of the possibility that sequestration would happen. A memo from Deputy Defense Secretary Ashton B. Carter to civilian and military leaders called for the Pentagon to "continue normal spending and operations."

Carter struck a much different tone last month when he spoke at the Aspen Security Forum. "We are taking very seriously the prospect that this craziness is going to continue into the next year, because that's the path of least resistance for the political system," he said.

A budget deal that would reverse sequestration is nowhere in sight, so the Pentagon is adapting. A number of what-if scenarios emerged from the Strategic Choices and Management Review. Although the SCMR was billed as a menu of options and not a budget blueprint, it does get the Pentagon moving toward a new normal of reduced spending.

After a chaotic 2013, when the Pentagon had to slash $37 billion between March and September, Defense Department accountants ought to be better prepared for the next round. That will be a $52 billion hit for the budget year that begins Oct. 1.

It will not be pretty, Carter acknowledged. "We'll get rid of old things we don't need as fast as we can ... treat our people as decently as we can, recognizing that we're going to have to shed people."

At first glance, sequester is simple math: Each account is sliced by 10 percent. But there are variables that can result in some accounts being hit harder than others. Personnel budgets were exempted in 2013, and the administration has yet to decide whether to continue that policy in 2014. If military payroll and benefits are spared again, the remaining accounts will bear more of the brunt. Another difference from a year ago is that the Defense Department in 2013 had unspent "prior-year" appropriated funds that it could use to shore up gaps in programs that lost funding as a result of sequester. That cushion is now gone, which would leave acquisition programs in 2014 exposed to deeper reductions.

For defense contractors, the outlook is still murky, as the Pentagon has not yet terminated major programs and so far has made sequestration a slow-speed event.

"I'm still waiting for the other shoe to drop," said Tom Captain, leader of the aerospace and defense sector at Deloitte.

Remarkably, the revenue statements of major U.S. defense firms have not yet reflected the draconian sequester cuts. Because firms have been slashing costs for the past two years, they continue to make profits.

Nobody can yet predict when the bottom will fall out. "This period of uncertainty is resulting in a lot more fear about defense cuts than the reality has shown," said Captain. Even if sequester is extended into 2014, "I do not expect U.S. companies' revenues next year to shrink by 10 percent," he said. "That is because of the uncertainty and the way we're approaching sequestration." The process, although highly disruptive, is turning out to be less dramatic than what had been speculated. A recent Deloitte report noted that revenues decreased 1.3 percent in the defense sector in 2012, and operating earnings declined 1.6 percent. "The BCA [Budget Control Act] hasn't made its way to the income statements of [the top 20] defense contractors," Captain said. …

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