WASHINGTON ― Inflation is now a national security issue.
The prospect of increased weapons costs and rising wages are already causing significant problems for Pentagon planners as they craft President Joe Biden’s upcoming budget proposal for fiscal 2023, defense experts say.
Complicating matters, the White House Office of Management and Budget, or OMB, has not given the Pentagon a top line for fiscal 2023, with the budget submission deadline just weeks away. Experts say that’s likely because Congress has yet to reach a longer-term spending deal for 2022 and passed a continuing resolution into mid-February instead.
“They had a budget, but I think they’re finding that because of the pay raise, and because of inflation being a lot higher than expected, they’re going to need more money,” said Todd Harrison, director of defense budget analysis at the Center for Strategic and International Studies. “To do that, you need a pass-back from OMB. That’s where they are right now, and I think that’s the option they’re most likely to pursue.”
Federal agencies typically submit budget requests to OMB in early September, and OMB decides on that request in November ― the “pass-back” phase. Though the process is often delayed, the target is for the president’s budget to be decided in December, drafted in January and submitted in early February.
Asked for comment, the Pentagon deferred to OMB, which declined to participate.
The administration’s initial plans to increase defense matched a projected 2% rise in inflation, but the Labor Department says inflation surged 6.8% in November — a 39-year high.
Related cost increases for fuel and other supplies are already forcing the Pentagon to triage its budget, according to Mackenzie Eaglen, a senior fellow at the American Enterprise Institute. She pointed to Defense Secretary Lloyd Austin’s announcement last month of a program to help struggling military families deal with inflation-related price hikes.
“Take that and multiply it across 100 other issues and priorities across the [Defense] Department, not just in terms of compensation,” Eaglen said. “What it means is a scramble to readjust.”
The annual target date for the president to release a budget proposal is February, after which House and Senate lawmakers spend much of the rest of the year debating as part of their spending deliberations.
Because of delays in crafting an FY23 budget, Pentagon officials are discussing mid- to late March for a possible rollout, according to Eaglen.
The military’s basic pay formula is due to rise by 4.6%, potentially a 20-year high, because of increased inflation and wages across the country. That formula, known as the Employment Cost Index, tracks private sector wages and often serves as the basis for pay boosts.
If that becomes the pay increase for 2023, it will be the highest boost for troops since 2003. But lawmakers could go even higher.
In October, House Armed Services Committee ranking member Mike Rogers, R-Ala., said the issue of military pay will be a top priority in next year’s budget debate, to include “significantly increasing compensation and benefits packages, particularly for enlisted personnel.” Committee Chairman Adam Smith, D-Wash., later echoed those remarks.
Pay raises can be costly. This year’s 2.7% pay raise adds about $1.4 billion in personnel costs to the military budget, and a 4.6% boost next year would be about $2.5 billion more; some Pentagon planners say that money cuts into training and modernization efforts.
How it affects modernization
The prospect of inflation-related cost increases are stoking fears in the defense sector the Pentagon will make up the difference by delaying some big-ticket modernization programs or by cutting quantities.
“They’re not making the hard choices yet, they’re working on some of it,” National Defense Industrial Association President Herbert “Hawk” Carlisle said of the budgeting delay at the Pentagon.
“From our initial view of it, it appears that some of the modernization required to counter China will be slipped to the right and in some cases be in jeopardy if the budget that appears to be coming does come out,” he added.
Experts predict rising inflation will drive up programmatic costs, especially in cases where the Pentagon signed a cost-sharing contract. Bank of America Merrill Lynch analyst Ronald Epstein said he could see defense contractors seeking to renegotiate with the government as their costs rise due to higher prices for parts, materials and labor.
“DoD is a fair customer. I think they understand that [contractor costs are rising], and their budgets are going to reflect some concessions for inflation,” Epstein said during a recent Defense One event.
Some experts predict the Biden administration will now ask for more money instead of cutting back in other areas, partly because Congress passed the FY22 defense policy bill with $25 billion more in defense spending than the president requested. Defense experts also see pressure to increase defense spending because 2023 is a midterm election year.
“It looks like from the bills that are being proposed, it seems like deficit hawks are nowhere to be found,” Morgan Stanley analyst Kristine Liwag said during the Defense One event. “It seems like the probability, in terms of just plussing up the budget, is more likely than cutting equipment volumes.”
Predictions of flat military spending early in Biden’s first year in office were upended by Congress’ willingness, on a bipartisan basis, to increase the Pentagon’s budget to keep pace with China’s growing military capabilities.
While Congress has stalled on a federal spending deal, it did pass the FY22 National Defense Authorization Act. But appropriations bills, which dictate spending levels, haven’t moved, and without a budget deal for 2022, the Defense Department is operating under a stop-gap continuing resolution, which prevents new-start programs and multiyear activities, with some limited exceptions.
The Pentagon, some defense-friendly lawmakers and the defense industry fear Congress will deadlock and adopt a yearlong CR.
Rogers, ranking member of the House Armed Services Committee, voiced frustration with the delays and blamed them on Democratic leaders in both chambers.
“I mean, these CRs are killing us,” he told Defense News. “If they do another CR in February to the end of the year, it’s going to basically cost [the Pentagon] $40 billion. It’s going to negate everything we just did in this authorization, plus more. And it’s just literally un-American if we aren’t doing a better job to provide for our military than that.”
Senate Appropriations Chairman Patrick Leahy, D-Vt., has also urged progress on appropriations during a recent floor speech, offering a reminder that the NDAA does not contain “one penny.”
“The NDAA is a promissory note. The appropriations bill is the cash,” he said.
Highlighting the partisan divide, the Senate Appropriations Committee’s ranking member, Sen. Richard Shelby, R-Ala., called for more defense funding than the NDAA authorized.
“I think that’s a good start, but that’s not what they need. They need more, and the military will tell you that,” Shelby said. “It’s better than what it was, but it’s not as good as it should be.”
By and large, appropriators are primarily focused on FY22 spending, but the subject of next fiscal year and inflation’s impact on it are creeping into their thought process. For the FY23 Pentagon budget, Shelby said inflation must be factored in ― something he said Congress will likely have to do.
“I think they’re not going to add that,” Shelby said of the Biden administration. “They have a philosophical bent. A lot of them like butter rather than guns.”
At least one key Democrat said the administration should use the NDAA’s higher top line as a starting point for its FY23 request.
“That’s usually how we operate. We start with the previous year’s budget and determine how much more we need,” said Rhode Island Democratic Sen. Jack Reed, who chairs the Senate Armed Services Committee and serves on the Appropriations Committee. “The real issue is the budget should be based upon what we need to meet the threats.”
Leo Shane III contributed to this report.
Joe Gould is senior Pentagon reporter for Defense News, covering the intersection of national security policy, politics and the defense industry.