McAleese

Defense Funding Prognosis McAleese & Associates, P.C. 21515 Ridgetop Circle Suite 100 Sterling, Virginia 20166 Tel: (703) 421-0104/Fax: (703) 421-0108 jmcaleese@mcaleese.com

Expected Outcome of 2012 Appropriations Bills

Expected Outcome of 2012 Appropriations Bills Three 2012 Appropriations Acts (Agriculture, CJS, Transportation/HUD) were Passed by Congress on November 17. 2011 Base Actuals 2012 Base Change from 2012 SAC Subcommittee Jurisdiction (HR 1473) Request 2012 Enacted Change from 2011 Request - USDA Agriculture $20B $22B $20B $0/0% -$2B/-9% - FDA - Dept of Justice Commerce, Justice, - Dept of Commerce Science - National Science Found. $53B $58B $53B $0/0% -$5B/-5% - Transportation Transportation, HUD $55B $56B $56B +$1B/+2% $0/0% - Federal Housing Admin.The remaining nine Appropriations Bills (including Defense, and State) will likely be part of an Omnibus, with the goal of being passed by next Friday (Dec. 16), when the current CR runs out.• 302(b) allocations set by Senate Appropriations Committee in September will likely provide framework in negotiations, as they meet requirements of Budget Control Act. 2011 Base Actuals 2012 Base Change from 2012 SAC Subcommittee Jurisdiction (HR 1473) Request 302(b) Base allocation Change from 2011 Request - DoD Defense $513B $539B $513B $0/0% -$26B/-5% - Intelligence Community - DoE Energy & Water - Army Corps of Engineers Development (Civil Works) $32B $37B $32B $0/0% -$5B/-14% Financial Services, - Treasury General - Judiciary Government - GSA $22B $26B $22B $0/0% -$4B/-15% Homeland Security - DHS $42B $44B $41B -$1B/-2% -$3B/-7% - Smithsonian Institution Interior, - EPA Environment - Interior $30B $31B $29B -$1B/-3% -$2B/-6% - HHS Labor-HHS- - Dept of Education Education - Dept of Labor $157B $181B $157B $0/0% -$24B/-13% Legislative Branch - Congress $5B $5B $4B -$1B/-20% -$1B/-20% - MilCon - Military Family Housing Military - Defense Base Closure Construction & VA Accounts - Veterans Affairs $73B $74B $73B $0/0% -$1B/-1% State, Foreign - State Operations - USAID $48B $51B $45B -$3B/-6% -$6B/-12%

Over-arching Themes that will drive DoD Resourcing

DoD is currently ≈ $150B above inflation-adjusted Defense Funding“Peaks”; and ≈ $300B above post-conflict Defense Funding “Troughs”. (Total Defense BA in constant 2011 Dollars)• Question is not “If”, but how-fast Defense Funding correction occurs; and whether cuts are responsibly-targeted or arbitrary. Iraq/ Afghanistan 800 Korea Reagan 700 Buildup Vietnam 600 Historic “Peak” 500 Billions Historic “Floor” 400 300 200 100 0 FY 50 FY 52 FY 54 FY 56 FY 58 FY 60 FY 62 FY 64 FY 66 FY 68 FY 70 FY 72 FY 74 FY 76 FY 78 FY 80 FY 82 FY 84 FY 86 FY 88 FY 90 FY 92 FY 94 FY 96 FY 98 FY 00 FY 02 FY 04 FY 06 FY 08 FY 10 Source: DoD: National Defense Budget Estimates for FY2011 (Green Book)

HASC portrays -$474B immediate 2012-2021 Defense Cuts, as absolutely flat-lining DoD Topline Funding, (once Inflation is removed). $536B $533B $531B $529B $527B $525B $521B $519B $518BSource: HASC Chairman McKeon’s Letter to the Super-Committee (Figure 1 – National Defense Base Budget Topline; Jan. 2012 – Implementation of BCA Sequestration).

OMB “Pass-back” Guidance to DoD on FY2013 Budget• Provides $523B in 2013 DoD Base budget and $83B in 2013 OCO. (68K US Troops in OEF). 2011 2012 2013 2014 2015 2016 2017 Enacted RequestFY2012 Presidents Base Budget $528.95 $553.02 $570.72 $586.35 $598.17 $610.57 $621.56[Old FYDP]FY2013 Fiscal Guidance $525.35 $523.89 $533.01 $545.43 $555.95 $567.96[New Plan]Savings -$27.67 -$46.82 -$53.33 -$52.73 -$54.64 -$53.60[Annual cut from 2012-2016 Plan] (-5%) (-8%) (-9%) (-9%) (-9%) (-9%)Base Budget Adjustments -$0.47 - - - -$0.435FY2013 Presidents Base Budget $533.02 $545.44 $555.94 $567.97 $528.95 $553.02 $523.42[% yr/yr growth] (+2%) (+2%) (+2%) (+2%)FY2013 Presidents OCO Budget $159.06 $117.58 $82.53 $50.00 $50.00 $50.00 $50.00[2014-2017 Placeholder]Total Defense Discretionary $605.96 $583.02 $595.44 $605.94 $617.97• This confirms flat-lining of DoD’s 2013-2017 Base Funding.• -$260B in 2013-2017 initial BCA “Cuts” are actually forfeiture of planned future DoD growth.• This does NOT include any adjustments for potential January 2013 Sequestration.• Expect ≈ 50% of flat-lining “Cuts” to come from Procurement; ≈ 20% from new “Efficiencies” (O&M); and ≈ 30% from Force Structure reductions (Milper). This is consistent with previous McAleese projections.

Secretary Panetta confirms that 2013-2017 Budget/FYDP will contain ≈ -$260B Cuts (≈ -$52B/-9%/year); with rest of -$474B Cuts in Outyears. (Press Conference of Secretary Panetta and Chairman Dempsey, Thursday, November 10, 2011)• “That [-$450B 2012-2021 Budget Control Act cut] translates into around $260 billion over five years as part of the [2013-2017] budget that will be submitted in February.”• “*I+f the supercommittee fails to reach an agreement…the penalty for that is sequester. And this sequester approach would virtually double the size of the cuts that we face here at the Defense Department.”• “All of these cuts would take effect in January of 2013…we would have a year where sequester would hang as a shadow over this department.”• “*C+utting in excess of 20 percent in every area, sequester will lead to a hollow force.”• “Its a ship without sailors. Its a brigade without bullets. Its an air wing without enough trained pilots. Its a paper tiger…”• “Its a force that suffers low morale, poor readiness and is unable to keep up with potential adversaries. In effect, it invites aggression.”• “*M+y message to the Congress is that it must show the necessary leadership by doing the job that theyve been asked to do. That means identifying savings in the two-thirds of the federal [Entitlement] budget that still has yet to be considered for deficit reduction, along, in my view, with additional revenues.”

Secretary Panetta’s “Sequester-impact” Letter threatens specific Program Terminations. (November 14, 2011 Letter to Sens. McCain & Graham) • “If the maximum sequestration is triggered, the total cut will rise to about $1 trillion compared with the FY2012 plan.”FY 2013 Effects: • “*I+f the President utilizes his authority to exempt military personnel funding, then we estimate that the remainder of the FY2013 defense budget would be cut by about $100 billion, about 23 percent …” • “If Congress agrees by vote, we would have the flexibility to apply sequester cuts as the Administration recommends. But even with flexibility, cuts of this magnitude would be highly disruptive. …” • “We could not afford to exempt major weapon programs (Joint Strike Fighter, P-8 aircraft, ground combat vehicle, ships) from cuts.” • “We would have to look at reductions in training.” • “Absent Congressional approval, current law does not provide flexibility. It dictates that sequester cuts must be applied in equal percentages to each ‘program, project, and activity’.” • “A 23 percent cut in ship and military construction projects would render them unexecutable – you cannot buy three quarters of a building.” • “A 23 percent cut in weapons program would drive up unit costs and lead to reductions in quantity of one third or more.”Longer Term Effects: • “Reductions at this level would lead to:” • “The smallest ground force since 1940.” • “A fleet of fewer than 230 ships, the smallest level since 1915.” • “The smallest tactical fighter force in the history of the Air Force.”

• “Reductions of 20 percent (or about $390 billion over ten years) in investment accounts *≈$39B/year] … could lead to cutbacks in many programs … Decisions…could include:” • “Terminate Joint Strike Fighter; minimal life extensions and upgrades to existing forces ($80B);” • “Terminate bomber; restart new program in mid 2020s ($18B);” • “Delay next generation ballistic missile submarine; cut force to 10 subs ($7B);” • “Terminate littoral combat ship and associated mission modules ($22B);” • “Terminate all ground combat vehicle modernization programs; minimal life extensions and upgrades to existing forces ($17B);” • “Terminate all Army helicopter modernization programs; minimal life extensions and upgrades to existing forces ($11B);” • “Delay or terminate major space initiatives, including space protection, communications satellites, and ISR systems ($27B);” • “Terminate European missile defense ($2B);” • “Delay or terminate unmanned ISR systems ($8B); and,” • “Eliminate ICBM leg of Triad ($8B).”

DoD Deputy Comptroller, Mike McCord’s, messages to Investment Community, last week at Credit Suisse/McAleese “A&F” Conference in NYC: (November 30th/December 1st, 2011)• OSD Leadership has decided to incorporate initial Budget Control Act “Cuts” into 2013-2017 POM/Budget Plan, but NOT January 2013 Sequestration.• 2013-2017 OSD Plan is flat-lining of Base-funding, with “Cuts” being forfeiture of planned future growth. (No large cuts immediately-downward).• $260B 2013-2017 initial “Cuts” (pro-rated share of $489B 2012-2021 BCA Cuts).• OSD is allocating ≈ 50% of $53B annual “Cuts” to Procurement; ≈ 20% to additional “Efficiencies” (O&M); and remaining ≈ 30% to Force Structure reductions (Milper).• OMB/White House has formally-endorsed these actions in recent OMB “Pass-Back Guidance”, so no Sequestration impact will be visible in 2013 DoD Budget Request to Congress.

Source: Principal Deputy Under Secretary of Defense/Comptroller, Mr. Michael McCord. Credit Suisse/McAleese “Aerospace & Defense Finance” Conference. New York City. November 30, 2011

Sequester would primarily collapse Procurement, with O&M cuts to be offset through OCO, since Services cannot immediately-shed Force Structure in 2013. (Milper/O&M are “must-pay” Bills.) ($B. Inflation-adjusted.) • Historically, Procurement severely-tumbles by 50% - 75%. • Historically, O&M routinely only dips between 10% - 30%. • Historically, MilPer only falls by modest range of 15% - 35%. • Historically, RDT&E falls modest 20% - 25%, but is generally flat overall. 1956 Trough: $102B/28% 1976 Trough: $116B/31% 1998 Trough: $147B/39% 1950-2012 Average: $300 -$44B/-30% cut -$32B/-22% cut -$16B/-10% cut Contractor-accessible: $41B/11% Contractor-accessible: $46B/12% Contractor-accessible: $59B/16% • Proc: $102B • MilPer: $144B 1976 Trough: $67B/18% • O&M: $151B 1956 Trough: $62B/18% -$66B/-50% cut 1998 Trough: $57B/15% • RDT&E: $46B $250 -$184B/-75% cut -$100B/-64% cut 1956 Trough: $24B/7% 1976 Trough: $31B/8% 1998 Trough: $48B/13% +$9B/+60% increase -$10B/-24% cut -$11B/-19% cut $200 MilPer$ in Billions O&M $150 Procurement $100 RDT&E $50 $0 Source: 2012 Green Book

Still be alert to potential for “Boiling-the-Frog” Scenario. During 6-year period (2012-2017), White House could credibly re-implement $100B-$150B per year cuts to DoD Base Funding. (Post-Reagan Drawdown of ≈ -$150B/year (-29%), with total cuts of ≈ -$890B). ($ in B. Inflation-adjusted.) • Secretary Panetta participated in, and presided over, -$150B/year Defense Funding fall, from $524B in 1989 (House Budget Chairman), to $374B in 1998 (White House Chief of Staff) (-29% cut). Total 1989-1998 cut of -$889B. (1.7x $524B 1989 DoD Budget) $600 DoD Topline 1989: $524B 1989 Peak: $524B 1998 Trough: $374B Investment Accounts Drop of -$150B/-29% (Proc. + RDT&E) Average drop of -$17B/-3% per year $500 Procurement Total ‘89-’98 cut of -$889B (1.7x $524B ‘89 DoD Budget) RDT&E • Investment Accounts fell -$75B (-42%$ in Billions $400 MilPer 1989: $163B/31% drop), from $180B in 1989, to $105B in 1998 Trough: $109B/29% 1998. Drop of -$54B/-33% O&M Average drop of -$6B/-4% per year 1989: $166B/32% • Specifically, Procurement was slashed by 1998 Trough: $147B/39% -$64B (-53% drop), from $121B in 1989, to $300 Drop of -$19B/-11% $57B in 1998. (RDT&E only fell -$11B Average drop of -$2B/-1% per year 1989: $180B/34% (-19% drop)). 1989: $121B/23% 1989 Peak: $180B/34% 1998 Trough: $105B/28% 1989 Peak: $121B/23% $200 1989 :$59B/11% Drop of -$75B/-42% 1998 Trough: $57B/15% Average drop of -$8B/-5% per year Drop of -$64B/-53% Total ‘89-’98 cut of -$502B (2.8x ‘89 funding) Average drop of -$7B/-6% per year Total ‘89-’98 cut of -$420B (3.5x ‘89 funding) $100 1989 Peak: $59B/11% 1998 Trough: $48B/13% Drop of -$11B/-19% $0 Average drop of -$1.2B/-2% per year Total ‘89-’98 cut of -$82B (1.4x ‘89 funding) FY89 FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 • From 1989 – 1993, Sec. Panetta served as Chairman of the House Budget Committee. • From 1993 – January 1997, Sec. Panetta served under the Clinton Administration, first as OMB Director from 1993 – 1994, and then as Chief of Staff from 1994 – 1997. Source: 2012 Green Book

Back-up ChartsSequestration Prognosis

President Obama threatens to Veto any effort by Congress to suspend Sequester. (November 21, 2011, Statement by the President)• “Already, some in Congress are trying to undo these automatic spending cuts. My message to them is simple: No. I will veto any effort to get rid of those automatic spending cuts to domestic and defense spending. There will be no easy off ramps on this one”.• “We need to keep the pressure up to compromise – not turn off the pressure. The only way these spending cuts will not take place is if Congress gets back to work and agrees on a balanced plan to reduce the deficit by at least $1.2 trillion. That’s exactly what they need to do. That’s the job they promised to do. And they’ve still got a year to figure it out”.• “If we don’t act, taxes will go up for every single American, starting next year. And I’m not about to let that happen”. ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Sec. Panetta reluctantly supports President’s Veto Threat. (November 21, 2011, Official Written Statement)• “Despite the danger posed by sequestration, I join the President in his call for Congress to avoid an easy way out of this crisis. Congress cannot simply turn off the sequester mechanism, but instead must pass deficit reduction at least equal to the $1.2 trillion it was charged to pass under the Budget Control Act”.• “In my four decades involved with public service, I have never been more concerned about the ability of Congress to forge common-sense solutions to the nation’s pressing problems”.• “Since becoming Secretary of Defense, I have made it clear that the Department has a responsibility to help the country get its fiscal house in order – and we are doing that. I have been leading a strategy-driven effort to achieve the more than $450 billion in cuts over 10 years required by the Budget Control Act. We will move ahead with that plan”.• “The half-trillion in additional cuts demanded by sequester would lead to a hollow force incapable of sustaining the missions it is assigned. If implemented, sequester would also jeopardize our ability to provide our troops and their families with the benefits and the support they have been promised”.

HASC Chairman McKeon announces he will sponsor legislation that prevents Sequester-cuts to DoD. (November 21, 2011, Official Written Statement)• “Now, unfortunately, America’s military is facing cuts that will devastate the armed forces and force us to break faith with service members. I do not accept that outcome”.• “I will be introducing legislation in the coming days to prevent cuts that will do catastrophic damage to our men and women in uniform and our national security. Our military has already contributed nearly half a trillion to deficit reduction. Those who have given us so much, have nothing more to give”.• “Secretary Panetta has said he doesn’t want to be the Secretary who hollows our defense. Likewise, I will not be the armed services chairman who presides over crippling our military. I will not let these sequestration cuts stand”.--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- SASC Ranking Member McCain and SASC Member Graham announce they will sponsor similar legislation to suspend Sequester. (November 21, 2011, Official Joint Written Statement)• “In addition to the negative consequences to our fragile economy, the Super Committee’s failure will trigger a draconian sequester of $600 billion in defense spending in addition to the more than $450 billion that has already been imposed on the Department of Defense”.• “These cuts are in addition to the $178 billion in spending reductions and efficiencies taken by former Secretary of Defense Gates over the next five-year plan, meaning that the impact of the Super Committee’s collapse will be a combined $1.1 trillion in cuts to defense spending over the next ten years”.• “As every military and civilian defense official has stated, these cuts represent a threat to the national security interests of the United States, and cannot be allowed to occur”.• “We are now working on a plan to minimize the impact of the sequester on the Department of Defense and to ensure that any cuts do not leave us with a hollow military. The first responsibility of any government is to provide for the common defense; we will pursue all options to make certain that we continue to fulfill that solemn commitment”.

Immediate reactions of House and Senate Leaders, to Super-Committee’s failure. (November 21, 2011, Official Written Statements)Speaker of the House John Boehner (R-OH)• “While I am disappointed, the House will forge ahead with the commitments we have made to reducing government spending and removing barriers standing in the way of private-sector job creation. Doing otherwise is not an option. This process did not end in the desired outcome, but it did bring our enormous fiscal challenges into greater focus”.Minority Leader Nancy Pelosi (D-CA)• “The plan could not be balanced because Republicans insisted on extending the Bush tax cuts for people making more than a million dollars a year and repealing the Medicare guarantee – while refusing to accept a jobs proposal. By rejecting a balanced approach, Republicans chose to keep their pledge to Grover Norquist to protect the wealthiest one percent at all costs”.Senate Majority Leader Harry Reid (D-NV)• “The sequester was designed to be painful, and it is. But that is the commitment to fiscal responsibility that both parties made to the American people. In the absence of a balanced plan that would reduce the deficit by at least as much, I will oppose any efforts to change or roll back the sequester”.Senate Minority Leader Mitch McConnell (R-KY)• “The good news is that even without an agreement, $1.2 trillion will still be cut from the deficit. Now it falls on the President to ensure that the defense cuts he insisted upon do not undermine national security, as Defense Secretary Leon Panetta has warned”.

Republican Presidential Candidates’ Positions on Defense. (Average national poll numbers from November 13 – November 30, 2011, as taken by Rasmussen Reports)Newt Gingrich (R) [26.6%]• “As American presidents have traditionally found, our nation’s peace and safety is best maintained through a robust military capacity, tireless vigilance, and a clear strategy for identifying and countering potential threats – a policy widely known as ‘peace through strength’”.• “The next administration and Congress must decisively address the following realities: … o Our military infrastructure has become dangerously outdated, with our arsenal and equipment in urgent need of new investment; o There are new emerging technologies endangering us – for example, electromagnetic pulse weapons, cyberwar, and lawfare, which we are not prepared to deal with; o American leaders are tired after seven decades of being the world’s preeminent power, and are very resistant to putting in the time and energy it will take to understand the emerging threats and the necessary responses”.Mitt Romney (R) [20.4%]• “Reverse Obama-era defense spending cuts and set a core defense spending floor of 4% GDP”.• “*P+ut our Navy on the path to increase its shipbuilding rate from nine per year to approximately fifteen per year”.• “Modernize and replace the aging inventories of the Air Force, Army, and Marines, and selectively strengthen our force structure”.• “In his first 100 days, reverse Obama-era cuts to missile defense and commit to a robust multi-layered national ballistic-missile defense system to deter and defend against nuclear attacks on our homeland and our allies”.• “Maintain robust military capabilities in the Pacific”.

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