DOD officials bracing for inflation squeeze with final FY-23 topline guidance

By Jason Sherman / December 5, 2021

SIMI VALLEY, CA -- The Defense Department is awaiting "passback" guidance from the White House, a topline allocation that will allow Pentagon leaders to lock in the fiscal year 2023 budget proposal and account for inflation forecasts that could significantly diminish weapon system buying power.

Senior officials attending the Reagan National Defense Forum here said during interviews on the sideline of the conference that they had not yet seen the "passback" memo federal agencies typically receive in late November from the Office of Management and Budget that sets a final budget request topline amount.

In late May, OMB forecast DOD would receive a $730 billion base budget allowance for the FY-23 request, a 2% increase above the administration's $715 billion request for FY-22. Congress has proposed adding to the FY-22 topline, which is still pending.

If OMB sticks with that FY-23 allowance, inflation could eat into modernization plans.

"We're going to have a pay raise as [Defense] Secretary [Lloyd] Austin said, we're going to do a civilian pay raise, we've increased the amount for" basic housing, said a senior defense official. "Inflation: I think didn't the Fed[eral Reserve] came out with something saying that 6% is not transitory? That's all putting pressure on the budget. So, we're going to have to look at how we're going to move forward."

Federal Reserve Chairman Jerome Powell, during a Nov. 30 Senate hearing, did not use the word "transitory" to describe the current inflation rate in departure from prior characterizations, which many finance experts interpreted to mean the current 6% inflation rate-- exceeding the central bank's 2% target --- is here for the long term.

Long-term inflation translates to higher costs for programs funded in the Pentagon's research and development accounts, procurement accounts, and operations and maintenance accounts.

"If DOD does not get a budget that grows with the rate of inflation, DOD will face harder program choices -- it will have to cut current programs to carve out funds for new ones or do the opposite," Byron Callan, a defense expert at Capital Alpha, wrote in a Nov. 28 note to Wall Street investors. "It could also lean harder on contractors to maintain cost discipline, with a risk of more stringent contract types with the most difficult one fixed price for development work."

Army Chief of Staff Gen. James McConville said the service plans to protect its priority projects in the event inflation deals a blow to its near-term spending plan.

"If we don't cover inflation . . . we believe there'll be pay increases which our troops certainly deserve and we're going to have to pay for them," he said. "And so, the budget from the Army standpoint, is: We're managing priorities. You know, we know exactly what our priorities are, and we're going to deliver the best army we can with the resources that we have."

Navy Secretary Carlos del Toro said increased inflation has far-reaching consequences across the enterprise.

"The costs to all the services actually are severely impacted which makes it more critically important to get the resources that are necessary because the threat doesn't change much just because inflation is going up," del Toro told Inside Defense. "We have commitments that we have to keep. . . . Pay raises need to continue and we need to ensure that the armed services in general have the resources necessary to meet those demands that are being driven by inflation. In addition, to the greatest threat that's being presented by China, basically, to our economic security."

He noted China built 20 ships last year, is on pace to build another 20 this year and could have a 466-ship fleet by 2030.

"Unquestionably, we're going to need more resources to ensure that we have the capacity and the lethality and the capability that's necessary to deter China in the Indo-Pacific," del Toro said.

He added that he is bullish that the White House will provide a topline that supports the Navy’s requirements.

"I think the secretary of defense and the president clearly understand the threats that we face as a nation, that we are going to require more resources for the Navy-Marine Corps team in the Indo Pacific as sort of the lead service -- working very closely in a joint warfighting environment with our Air Force brethren and our Army brethren -- to meet the growing threat that's presented by China," del Toro said.