Will inflation cause a $110 billion loss in DoD buying power between FY21-FY23?

A new paper from recent AcqTalk guest John Whitley and two PPBE Reform commissioners David Norquist and Lisa Disbrow has been released: “How Inflation Hurts America’s National Defense and What We Can Do About it.”

The report finds that because FY23 budget was submitted before the recent bout of inflation, it does not include those impact that are expected to occur. It also impacts previous budgets such as FY22 and FY21 being executed today, with an unexpected inflation impact of 2.3 percent for FY21 and 4.7 percent in FY22. The total loss in buying power for FY21-FY23 is projected at $110 billion, $42 billion of which in FY23.

Here are the two recommendations to help solve budget challenges in FY23:

• Restore Buying Power in 2023 Budget: Congress should add at least $42 billion to the FY 2023 defense budget to reflect updated inflation information and avoid lost buying power.
• Minimize Harm from a Continuing Resolution: If FY 2023 begins on a CR, Congress should adjust this CR for inflation and allow for new starts and procurement quantity changes to avoid creating further program delays.

On the first point, it is not clear how to allocate that $42 billion increase. Should all programs across the board get the same percentage increase? Or should it depend on specific price indexes for each industry or sector? Certainly the latter would take quite a bit of analysis and time.

The paper notes that the House and Senate versions of the NDAA recommended a $37 and $45 billion increase to the DoD topline. But these are the results of programmatic increases, supposedly based on previous pricing. So if Congress added 10% to the production quantity but inflation is unexpectedly 10% higher than estimated, DoD is right back to where it started on that program.

On the Continuing Resolution, which releases funds at the same rate as the previous year, the paper finds that DoD would lost $6 billion in buying power every month the CR endures. That doesn’t factor in the inefficiencies from not being able to start new things or change procurement quantities according to program plans.

The paper has three other recommendations on execution challenges, I will touch on just one:

• Stabilize Acquisition Programs: Congress should direct that contract prices are adjusted for inflation. Programs that are currently being executed and that were priced prior to the onset of inflation should be adjusted to correct for unexpected inflation. Future contracts should include an automatic inflation adjustment clause.

As DPC director John Tenaglia said, there’s not really a contractual path to reopen contracts and re-price them based on inflation. The government didn’t direct these changes in supplier prices. And in any case, most of the fixed price contracts from FY21 and early in FY22 will have fixed price suppliers, so the pain if any is at the lower tiers.

Of course, DoD could terminate many of these contracts for convenience and re-issue them with new pricing. That would be a huge administrative burden, and contractors will have to demonstrate with cost data the impacts. But I don’t think that would happen unless the DoD primes or their suppliers are signaling major financial issues to their shareholders as a result.

Here is a sampling of net change in free cash flow from last three quarterly statements: