Dear Commissioners:

Earlier this year, NDIA was invited to testify before the commission on behalf of the defense industry. The commission was interested in receiving the views of the industry on the issue. At the time, I advised the commission that NDIA would survey our members for their views.

You will find attached a synopsis of the major views we received from our members. There is no consensus on a definition of capital budgeting; there are multiple concerns and views expressed about its implications; and a range of thoughts about its impact on defense. Perhaps, the most telling point is the expressed lack of information or understanding of how such a system would work.

This latter finding strongly suggests that before any significant action is taken there needs to be full and open discourse. Moreover, it is evident that a clear definition of what constitutes a capital budget item or expenditure is in order. Finally, it is imperative that careful thought and consideration is given to the implications such budgeting would have on our national security structure and posture.

I hope the attached information is helpful. If you have any questions, please feel free to contact me.
 
 

                                                                                       Sincerely,

                                                                                       (Signed)

                                                                                       Lawrence F. Skibbie
                                                                                       President
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

GENERAL COMMENTS

Company A

• interested in issue; insufficient information to fully understand implications.

• no commonly recognized definition of capital expenditures
• defense procurement is complicated

• separate capital budget free from appropriation caps, debt ceilings and program offsets would bring increased stability to defense acquisition
• strongly supported

• no comment

• few, if any, defined parameters about what would be included in such a capital budget
• few parameters on how such a budget would be dealt with on Capitol Hill
• merit to continuing to investigate the creation and operation of a separate capital budget within the defense budget

• no comment due to a lack of knowledge about the implications at this point

• any defense industry position on capital budgeting must address several issues: whether capital budgeting processes can be used in a governmental context, the role of depreciation, and the potential benefit to defense industry

• difficult to comment intelligently without specific details of the proposal or concept

DEFINITION OF CAPITAL EXPENDITURES

Company A

• no comment

• Basic criteria: helps Fed Gov't fulfill its responsibilities; i.e., national defense
• some portion of defense procurement should be suitable for inclusion
• uncertainty when assessing defense procurement accounts
• basic attributes are readily understood: tangible, physical property; something that is durable as opposed to consumables, at least in short term
• some aspects of defense spending are not so readily defined
• asset should provide some economic benefit over time, i.e., defense R&D should be treated as capital expenditure-while research is intangible, it results in more efficient tangible assets in the future
• defense assets are procured in hope they will not be used; this should not be viewed as providing a future economic benefit
• application of these criteria have arbitrary results: while aircraft carrier could be analogized to a building or other asset recognized as a capital asset, the bombs and personnel that it carries would be characterized as operating expense; may not make sense to separate the purchase of the platform from the debate over what to put on or in it.

• a new capital budget to have a chance of acceptance needs a limited, rather than broad, definition of a capital item
• removing procurement items from annual budget fights would hinder adoption of the whole idea if ammunition, consumables and services were included as capital items
• making annual capital budget appear as much as possible, like the annual appropriation for a previously approved multi-year program, would be a good start (since multi-year contracts are accepted in theory by Congress)

• no comment

• no comment

• no comment

• (their comments are discussed extensively under titles "EXTENT TO WHICH CAPITAL BUDGET CAN BE APPLIED AT THE FEDERAL LEVEL" and "ROLE OF DEPRECIATION IN GOVERNMENT FINANCE")

• no comment

NATURE OF A CAPITAL BUDGET PROCESS

COMPANY A

• no comment

• one primary conceptual justification for a capital budget: acceptable to run deficit for capital expenditures, while the operating budget should be balanced
• dichotomy: spending on capital programs is limited only by gov't's willingness to borrow; ability to spend on operating programs is constrained by the amount of total federal revenue; if gov't desires to spend more on operating programs, additional revenue must be found
• situation creates more pressures on programs that remain in operating budget-unless gov't increases taxes, operating programs are competing against each other in a finite world
• programs that are moved to the capital budget have easier time, because these are the only programs for which government seeks financing in capital markets

• new process should be as close as possible to current process
• new process should be submitted in three parts: the annual operating budget, the annual increment on previously approved capital items, and requests for new capital items
• Congress would be kept in the loop, while providing the kind of stability Congressionally approved multi-year programs now enjoy

• no comment

• no comment

• no comment

• (their comments are discussed extensively under titles "EXTENT TO WHICH CAPITAL BUDGET CAN BE APPLIED AT THE FEDERAL LEVEL" and "ROLE OF DEPRECIATION IN GOVERNMENT FINANCE")

• no comment

EXTENT TO WHICH CAPITAL BUDGET CAN BE APPLIED AT THE FEDERAL LEVEL TO PRIORITIZE SPENDING

COMPANY G

• concepts such as discounted cash flows, hurdle rates and costs of capital generally must be modified (in some cases, almost beyond recognition) if they are to be carried from commercial practice into the public sector
• other indirect and potentially biased mechanisms must be substituted, because one cannot directly calculate the economic return on military investments
• ambiguity inherent in such indirect measures will likely do more to confuse than clarify the debate over the appropriate levels of defense investment

ROLE OF DEPRECIATION IN GOVERNMENT FINANCE

COMPANY G

• currently, accounts in the federal budget are handled on a cash basis through the unified operating budget
• under new approach, proponents of capital budgeting would ascribe only the annual depreciation on capital assets into the annual federal operating budget, allowing borrowing on the capital budget side to finance major investments. This would change the bottom line of the operating budget and permit agencies to avoid the hurdle of facing large up front costs for major projects
• two political ramifications for defense industry are likely. (1) in order to maximize the appearance of expense, advocates of particular "investments" would try to achieve the longest possible amortization schedule to minimize the apparent costs, (2) every project or proponent would seek classification as a capital asset, thus politicizing the definition of investments
• it is clear that DoD installations would be considered capital projects and manpower spending on such things as training, etc. would not, the treatment of durables (tanks, aircraft, ships) and consumables (ammunition, rations, petroleum product stocks) is far less clear

RECOMMENDATIONS

COMPANY A

• industry should be kept fully informed
• need to distribute amplifying information to industry

• least disruptive action is to maintain unified budget, in which all federal income and expenses are shown on a common balance sheet, but then provide a separate display for capital & operating items.
• Important to maintain concept of a unified budget, because the capital markets will most likely assess the health of the federal budget on that basis
• for fiscal discipline, fiscal conservatives will encourage adoption of separate limitations on capital and operating budgets
• under current system, have statutory caps on overall discretionary appropriated programs, with separate sublimits for defense programs.
• With proper adjustment to reflect removal of some programs to the new capital budget, these statutory caps could remain in place with respect to the operating budget
• for the capital budget, a formula could be devised which limits capital borrowing to a percentage of a certain economic indicator such as gross national product
• operating &capital budgets not totally unrelated: depreciation of capital assets should be reflected in operating budget as an expense
• with defense systems can be frustrating analysis: useful life of asset is valid only if asset is not used; with defense procurement programs not certain whether asset will be used; if asset is used before its useful life, budget system must decide whether to write off remaining time; increases pressure on operating budget
• better depreciation method for capital assets may be to assign length of time of use; calculations based on expected development of next generation of elements in program.
• assets would be considered depreciated when obsolete, not necessarily when it ceased to function or was used

• design and construction of new buildings and facilities to include any installed capital equipment
• a major renovation could be considered a capital item if of very large scope
• development and production of major weapon systems including initial spares, ground support equipment, training equipment, etc. that is needed to begin operation of the system
• development and production of weapons and munitions with a unit cost greater than some threshold $ amount
• RDT&E and acquisition of test ranges and equipment

• do not change the budget process

• minimum: a defense capital budget should include the full cost of acquisition (and major overhaul resulting in substantial continuation of service life) of major combatant vessels for the Navy.
• ideal approach might be a "unified" defense budget with separate operating and capital components
• capital portion would not be subject to the existing rules on caps, pay-as-you-go, and other year-to-year constraints.

• NDIA should consult with an accounting firm that has experience with municipal budgeting, which could better present some of the advantages/disadvantages of having a federal capital budget

• any federal budget process must assure the long-term fiscal integrity of the United States gov't, specifically the implications of substitution of annual depreciation in the operating budget for the current cash accounting process requires a detailed analysis
• until the commission has more clearly defined how capital budgeting would be executed in a federal context, the industry cannot comment definitively
• it is unclear that a meaningful assessment can be made of the economic return on investment for resources committed to military capital assets
• as currently understood, modified capital budgeting techniques would be inadequate for prioritizing defense versus non-defense capital projects
• since application of private sector financial concepts to defense spending is imperfect, it is important to firewall defense accounts from non-defense accounts in both operating and capital budgets
• if there were a firewall in the capital budget separating defense and non-defense accounts, it would make sense to classify as much acquisition and R&D as possible as capital expenditures. Without the firewall, it would make sense to minimize the defense capital accounts
• unless there is permanent and rigorous firewall between defense and non-defense accounts within a federal capital budget, industry could not support such an initiative

• in recognition of the current guns vs. butter debate, making changes to the current budgeting process is fraught with danger
• no major changes to the current process (while flawed - it is understood)
• changes would probably not help the defense top line
• far more significant issues to be addressed, rather than playing "budget category games"
• modernization funding must be increased within a no-growth top line
• current defense budget currently allocated by Procurement, RDT&E, Quality of Life and Infrastructure would be better served with three major accounts: investment (Procurement and RDT&E), operating, and capital
• capital budgeting could be limited to building construction or modifications, land acquisition/divestiture and other limited categories (infrastructure, computers and software, etc.)

IMPACT ON BUSINESS

COMPANY A

• no comment

• impact depends on details of system
• Depends on whether items are considered consumables or treated as an integral part of the relevant weapon system, thus belonging in the capital budget
• operating budget designation more difficult; capital budget designation more favorable

• all current and future business would benefit from the added funding stability this proposal would provide

• no comment

• designs, produces, and overhauls two of the weapons systems requiring some of the largest per unit cost investments in the federal budget
• if a defense capital budget were to be created, an estimated 75% of current business base and 80% of future business base could be included

• no comment

• recent DoD modernization efforts have been hampered by declining budgets and internal reallocation of funds to meet contingencies
• Capital Budgeting Commission is unlikely to unleash a process which fundamentally overhauls the government process for resource allocation
• there are several scenarios which portend mostly dangers (but at least one case of potential benefit) from a limited capital budget within which allocations are made on the basis of traditional political mechanisms
• industry goals for the more limited capital budget would be to 1) protect overall defense spending from migration into non-defense accounts, and 2) prohibit reallocation of modernization funds to non-modernization accounts within the services
• it is unlikely that capital budgeting techniques will raise the priority of defense spending in the overall federal budget or block migration of resources into non-defense accounts
• non-defense accounts often have high visibility projects such as schools, hospitals and similar projects with very strong political interest and pay off
• if insufficient political discipline required the establishment of firewalls to protect defense discretionary spending from non-defense raids in the general unified budget, the need for such firewall protection in a capital budget context would probably be even higher
• if rigorous and permanent firewall between defense and non-defense accounts were established, there could be ancillary benefits for military RDA accounts
• with modernization restricted, the services have made the acquisition accounts bill payers for out-of-hide assessments - this has exacerbated an already serious situation for the defense industry
• if part of DoD funding were to come from a capital budget and only programs designated as capital investments could be funded from the resources allocated under that capital budget, there would be an internal firewall with the DoD which would preclude investment funding from being tapped for operational contingencies. This would alleviate the problem of internal diversion of funds, but without a firm and permanent firewall in the capital budget, defense accounts would probably suffer net losses.
• if a firewall is in place after 1999, there will probably be an increase of some low double digit percent amount for modernization because funds appropriated under the capital budget would no longer be available to service chiefs to cover out-of-hide operational contingency assessments such as for Bosnia - this scenario portends an increase in the business base

• no comment

CONCERNS

COMPANY F

• the need for industry to be able to readily identify those items of interest that are needed to follow the budget
• Defense Budget should not lose its visibility as a single item of importance

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