Congressional leaders are considering waiving "use-it-or-lose-it" rules that would require the Pentagon to spend its fiscal 2018 appropriation before year's end following a series of short-term resolutions that have paralyzed appropriations efforts.
Rep. Kay Granger, R-Texas, chair of the House Appropriations Defense Subcommittee, on Feb. 22 told Defense News that Congress must act to fix an "artificial deadline" for the military to spend its budgeted funds, joining fellow Republicans Rep. Mac Thornberry of Texas and Sen. Jim Inhofe of Oklahoma in voicing support for waiving the spending requirement.
The requirement has long been a Washington battleground. Many have argued that the policy leads to inefficient and wasteful spending, as departments sometimes order frivolous expenditures such as new furniture late in a fiscal year because they have money to use and fear that if they don't spend it, their budget will be cut in future years. Congress, however, is reluctant to surrender its power of the purse, and worries it would be harder to monitor long-term Pentagon spending if balances were to build up over time.
Pentagon officials are seeking clarity on how long they have to spend 2018 funds. Image source: Getty Images.
The situation is particularly bad this year because it took lawmakers until February -- well after the fiscal year's Oct. 1 start -- to agree on a budget. Pentagon officials are gun-shy about making major appropriations decisions while operating under a continuing resolution, meaning they now have just two-thirds of the year to make a full year's worth of spending decisions.
Military leaders in early February requested spending flexibility, with Marine Corps Assistant Commandant Gen. Glenn Walters telling Congress: "We have a year's worth of money adds in '18 and five months to spend it."
Negotiations required
Sen. Dick Durbin of Illinois, the top Democrat on the Senate Appropriations Defense Subcommittee, gave Defense News a tepid response to the idea of pushing spending back, saying, "if there is a good case to be made for some flexibility," he's willing to have a discussion. It seems likely that some sort of a carryover can get through Congress, but there will likely be strings attached.
Congressional leaders could approve allowing the Pentagon to carry over a set amount, say, 5% of its total allocation, or add additional spending to the fiscal 2019 budget to offset any important funding that doesn't get done in 2018 due to time constraints. Either way, it seems certain that any agreement would not be a blank check, but rather closely monitored by Congress.
Granger has also proposed something of a blank check, a $28.6 billion fund to be used at Sec. of Defense Jim Mattis' discretion to speed a military buildup, but that seems unlikely to gain sufficient support from Congress. The Pentagon has telegraphed a desire to ramp up spending in the years to come, with Deputy Defense Secretary Patrick Shanahan telling reporters in December that he expected the budget to step up in 2018 and 2019 but said the 2020 budget request would be the "masterpiece." (https://www.fool.com/investing/2017/12/31/pentagon-admits-trump-bump-wont-happen-in-2019-pro.aspx)
Bottom line: It's never simple
For investors in defense stocks, the lesson here is that even in good times -- and Washington leaders right now almost universally support higher Pentagon spending levels -- the particulars of budgeting can get in the way of rapid growth. Shares of defense primes are all up between 44% and 70% since the November 2016 election on the prospect of increased spending, but to date, the expected revenue spikes have largely failed to materialize.
While defense majors including Lockheed Martin, Northrop Grumman, and Raytheon have enough long-term work to weather funding delays, government IT providers like Leidos Holdings, Booz Allen, and ManTech International arguably have more to lose. Though modernizing IT systems remains a Pentagon priority, those are the sorts of contracts typically held back during short-term appropriations, or when the government doesn't have full clarity about what it has to spend.
Among the primes, General Dynamics, fresh off agreeing to buy CSRA to nearly double its IT offerings, would likely be particularly interested in how allocation decisions play out.
The best outcome for defense companies is a quick outcome, no matter what the compromise is or how much funding is available for each individual agency. More than anything, what the Pentagon craves from lawmakers is certainty. The more confident defense leaders are, the more likely it is the spending floodgates will open.
