We have changed our perennially optimistic view of the prospects for long term real growth in the Pentagon budget and now believe that the recent amendment to the Budget Control Act for FY 2018 and 2019 will delineate the high water mark in defense spending for several years.
Ever since the Budget Control Act (BCA) forced a cut of $35B (6.6%) in the Pentagon's baseline budget in FY13 compared to FY12, Congress has biannually increased the ceiling on baseline spending. By FY17 it was within ~1% of the previous high water mark of $528B albeit with 12% less buying power.
Much of the reduced buying power has been mitigated through greater use of Overseas Contingency Operations (OCO) funding to which the BCA caps do not apply. Compare the $163B in OCO funding appropriated in 2010 to support ~200K troops in Iraq/Afghanistan with the $83B in OCO funding appropriated in 2017 to support less than 10% of that number, ~19K troops, in Iraq, Afghanistan and Syria today.
On Feb 8, the President signed a two year budget deal that finally restores DoD buying power to the FY11 level by FY19. The chart from DoD's PresBud 19 budget brief shows the dramatic restoration. It also shows that the two year increase in the ceiling stops the bleeding but doesn't erase the $406B in lost buying power that has aggregated over the past five years.
While increased ceilings for defense and non-defense discretionary spending for FY18 and 19 have been signed into law, the appropriations of monies are still not finalized. Congress must complete an omnibus spending bill before the current Continuing Resolution expires on March 23. Right now (March 5) another shut down does not seem likely.
The FY20-24 budget that the Pentagon is now developing is likely to bring substantive programmatic and budgeting changes when it appears next February. This is the first full budget cycle of the new Administration. Only now have the key Pentagon policy billets been filled that usually drive major budget change within the building. The new National Defense Strategy prioritizes preparedness for war and modernization of key capabilities like nuclear forces, space and cyberspace and missile defense. All of that will require money. The chart shows the Pentagon's assumptions about its future resources to fund its new strategy.
While defense resources look great in FY18 and 19, we think that this is the high water mark (in constant dollars). Here's why we're not overly optimistic about FY20 and beyond:
- The House seems increasingly likely to flip Democratic this November and the Senate is clearly in play. Legislation is going to be even more difficult with a split Congress/Presidency than it is now.
- The Administration has made it clear that its FY20 budget proposal has to be more robust than what it is going to propose for FY19 because of its new defense strategy (not to mention that 2020 is an election year!). SecDef Mattis has testified that he must have 3% real growth for the next five years if he is going to restore readiness by 2022. Unless the BCA is again amended, the Pentagon will be on track for a $50B reduction in FY20.
- When the new Congress begins consideration of the FY20 budget (just a little over one year from today!), $1T+ annual deficits resulting from the Republican tax cut will be clearly visible as will the resulting fiscal pressure on entitlements and Democratic non-defense goals. Defense hawks are going to be in a bad place...
