[Senate Hearing 108-991]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-991

                           PROPOSED LEASE OF 
                       BOEING 767 TANKERS BY USAF

=======================================================================

                                HEARING

                               before the

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 3, 2003

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation
                            
  
                                   ______

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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                     JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska                  ERNEST F. HOLLINGS, South 
CONRAD BURNS, Montana                    Carolina, Ranking
TRENT LOTT, Mississippi              DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas          JOHN D. ROCKEFELLER IV, West 
OLYMPIA J. SNOWE, Maine                  Virginia
SAM BROWNBACK, Kansas                JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon              JOHN B. BREAUX, Louisiana
PETER G. FITZGERALD, Illinois        BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada                  RON WYDEN, Oregon
GEORGE ALLEN, Virginia               BARBARA BOXER, California
JOHN E. SUNUNU, New Hampshire        BILL NELSON, Florida
                                     MARIA CANTWELL, Washington
                                     FRANK R. LAUTENBERG, New Jersey
      Jeanne Bumpus, Republican Staff Director and General Counsel
             Robert W. Chamberlin, Republican Chief Counsel
      Kevin D. Kayes, Democratic Staff Director and Chief Counsel
                Gregg Elias, Democratic General Counsel
                
                
                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on September 3, 2003................................     1
Statement of Senator Brownback...................................    17
Statement of Senator Burns.......................................    16
    Prepared statement...........................................    16
Statement of Senator Cantwell....................................     9
Statement of Senator Fitzgerald..................................    12
    Prepared statement...........................................    13
Statement of Senator Inouye......................................    65
Statement of Senator Lautenberg..................................    14
Statement of Senator McCain......................................     1
Statement of Senator Stevens.....................................     5
Statement of Senator Sununu......................................    16

                               Witnesses

Bolkcom, Christopher, Specialist in National Defense, 
  Congressional Research Service.................................    56
    Prepared statement...........................................    57
Curtin, Neal P., Director, Defense Capabilities and Management, 
  United States General Accounting Office........................    42
    Prepared statement...........................................    46
Ellis, Steve, Vice President of Programs, Taxpayers for Common 
  Sense..........................................................    87
    Prepared statement...........................................    88
Holtz-Eakin, Hon. Douglas, Director, Congressional Budget Office.    29
    Prepared statement...........................................    31
Miller, Eric, Senior Defense Investigator, Project On Government 
  Oversight......................................................    94
    Prepared statement...........................................    95
Nelson, Dr. J. Richard, Assistant Director, Cost Analysis and 
  Research Division (CARD), Institute for Defense Analyses (IDA).    84
    Prepared statement...........................................    85
Roche, Hon. James G., Secretary, United States Air Force.........    18
    Prepared statement...........................................    20
Sams, Jr., Lt. Gen. John B., (USAF, Retired), Program Manager, 
  USAF 767 Tanker Program, Military Aerospace Support, The Boeing 
  Company........................................................    82

 
                           PROPOSED LEASE OF 
                       BOEING 767 TANKERS BY USAF

                              ----------                              


                      WEDNESDAY, SEPTEMBER 3, 2003

                                       U.S. Senate,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 2:32 p.m. in Room 
SR-253, Russell Senate Office Building, Hon. John McCain, 
Chairman of the Committee, presiding.

            OPENING STATEMENT OF HON. JOHN McCAIN, 
                   U.S. SENATOR FROM ARIZONA

    The Chairman. Good afternoon.
    In his farewell address in 1961, President Dwight 
Eisenhower warned of the need to protect democratic processes, 
stating, ``In the councils of government, we must guard against 
the acquisition of unwarranted influence, whether sought or 
unsought, by the military industrial complex. The potential for 
the disastrous rise of misplaced power exists and will 
persist.'' He also cautioned against the folly of living for 
today and plundering the resources of tomorrow.
    While the Air Force's costly proposal to lease a hundred 
Boeing refueling tankers cannot be said to endanger the 
foundations of our democracy, the circumvention of process and 
reason in this case brings to mind Eisenhower's admonitions. 
The question that Congress and the Administration must ask and 
answer is not whether proceeding with this lease proposal is in 
Boeing's best interest, but whether it's in the best interest 
of our country.
    Months after the tragedy of September 11 oppressed the 
commercial aircraft market and Boeing lost out on a bid for the 
joint strike fighter, Congressional appropriators--
Congressional appropriators, not authorizers--added a rider to 
the 2002 defense appropriations bill authorizing the Air Force 
to lease up to a hundred Boeing 767s for use as aerial 
refueling tankers, without a hearing. This leasing authority, 
which ultimately could cost taxpayers tens of billions of 
dollars, was given to and the acquisition was zealously pursued 
by the Air Force despite the fact that the military had not 
previously indicated an urgent need for new tankers.
    I want to repeat, the military had not previously indicated 
an urgent need for new tankers, and leasing the aircraft will 
cost the American taxpayers billions more than buying them 
outright.
    Just because the Department of Defense was authorized by an 
appropriations rider to lease the tankers does not mean that it 
should. But with Congress' blessing, it is about to. Three of 
the four Defense committees that are required to approve the 
lease have already done so. Two of the three committees that 
approved the multi-billion dollar proposal did so without a 
hearing. Without a hearing. And none of the three could have 
reviewed the final lease, since certain clauses in it are still 
being negotiated.
    The Senate Armed Services Committee, which, under the 
chairmanship of Senator Warner, did not rush through its 
approval of the lease prior to the August recess, is holding a 
hearing on the proposal tomorrow morning.
    It was reported that, just yesterday, Air Force Secretary 
Roche said the lease could still collapse if the parties can't 
resolve two key contract terms. If these terms, which deal with 
capping Boeing's profit and ensuring that the government 
receives a good deal on price, are as critical as the Secretary 
indicates, the Senate Armed Services Committee should not 
decide whether to approve the lease until all the lease terms 
and conditions are resolved and made known.
    The lack of scrutiny this deal has received until now is 
extraordinary, particularly at a time when our budget deficit 
is burgeoning and the extent of our financial obligations in 
Iraq is just now being understood. The Committees that signed 
off on the deal did so before hearing from experts, both in and 
out of Congress, who have assessed this unprecedented 
transaction.
    Just last week, CBO, the Congressional Budget Office, 
issued a report concluding that the proposed lease simply is 
not permitted by law and that the additional cost of leasing, 
as opposed to buying the planes outright, will be considerably 
more than the Air Force claims.
    Yesterday, the Department of Defense Inspector General 
opined that only should a formal AOA analysis of alternatives 
have been conducted, but also that leasing the aircraft and 
then returning them to the special-purpose entity appears to be 
an inefficient use of money. In addition, he questioned why the 
Air Force did not acquire fewer planes until the fundings 
obtained through the budget process to purchase the aircraft 
and it can be shown that the tanker meets warfighter 
requirements, and noted that the Federal Government assumes 
greater financial risk with a lease than a procurement.
    The Congressional Research Service and the General 
Accounting Office also have raised serious questions about this 
transaction. CRS has, among other issues, examined the 
controversial question of the alleged ``urgent need'' for these 
tankers. GAO has also expressed concerns with claims about the 
``urgent need'' to recapitalize the tanker fleet, the total 
cost of the program, and to the extent to which the proposal 
complies with the law.
    An editorial in the Wall Street Journal this morning 
suggested that there was a consensus on the urgent need to 
replace the current tankers. The editors are apparently unaware 
that the Air Force and Boeing found no such need in a study 
they conducted last year. In addition to CRS, the DOD Inspector 
General, and GAO, officials at OMB, and many other experts also 
have questioned the urgency of the tanker replacement, 
suggesting that the tanker fleet is in good condition and can 
perform its mission until it can be replaced over time in the 
most cost-effective way. It would have helped this Committee 
and the American taxpayers if a thorough study and analysis had 
been made, which, to this day, it has not.
    A number of taxpayer and public interest groups also have 
raised questions with the proposed lease, with perhaps the 
strongest statement in opposition coming from the Nonpartisan 
Citizens Against Government Waste, who today issued a press 
release characterizing the lease as, quote, ``expensive 
unnecessary budget-busting, scandalous, and the worse example 
of corporate welfare and backroom dealmaking in recent 
memory.''
    In addition to receiving information from others who have 
examined the proposal, the Committee undertook its own inquiry 
into the process by which this lease was developed. The story 
that is told by the documents provided voluntarily to the 
Committee by Boeing, and, to a much more limited extent, by the 
DOD and OMB, is one of extremely aggressive sales pitch, not 
only by a company whose mission is to protect its shareholders 
and to make profitable deals, but by the United States Air 
Force, whose mission is very different.
    From the beginning, the Air Force appeared not so much to 
negotiate with Boeing as to advocate for it, to the point of 
appearing to allow the company too much control, not only over 
pricing and the terms and conditions of the contract, but 
perhaps also over the aircraft's capabilities.
    I might add there is a news media report today that there 
is a inquiry of criminal behavior on the part of a member of 
DOD at that time, who now works for Boeing.
    The documents obtained provide a troubling view of the 
extent to which the company, and not the military, controlled 
this acquisition. They do not answer, however, why Congress 
bypassed the normal review process and authorized, nor why the 
DOD, OMB, and the White House signed off on, an extraordinarily 
costly method of acquiring planes from a single source without 
ever clearly establishing the need for them or conducting an 
analysis of alternatives. I know of no time in history when an 
analysis of alternatives was not conducted.
    Certainly serious concerns with the cost of the lease and 
its compliance with leasing criteria were raised by officials 
within the Department of Defense and OMB. Even after the Air 
Force announced, in May of this year, that DOD had approved the 
lease, the Department's Office of Program Analysis and 
Evaluation, which provides independent analytic advice to the 
Secretary of Defense, opined that the proposal did not meet 
legal requirements.
    Last year, before the budget deficit ballooned and before 
we incurred the obligation to reconstruct Iraq, then-director 
of OMB, Mitch Daniels, wrote to me that, ``I believe it would 
be inconsistent with OMB's circulars and 3 irresponsible to 
support any lease proposal which would cost taxpayers more than 
direct purchase.'' Yet even the Air Force's report to Congress, 
which CBO says seriously understates the difference in cost, 
admits that leasing the planes and then buying them is more 
expensive than a direct purchase.
    It remains unclear how OMB's concerns about the price of 
the planes were resolved. We will hear today from a now-analyst 
hired by the DOD to determine how much the government should 
pay for the Boeing tankers. This expert concluded that, 
factoring in a generous profit from the company, the cost of a 
767 tanker, with more features than the one we propose to 
lease, should be $120.7 million. Despite this, the Air Force 
has apparently agreed that Boeing will get paid $131 million, 
in 2002 dollars, and subject to cost escalation, for each 
aircraft, although as a CBO report explains, taxpayers actually 
will end up paying at least $161 million per plane in lease 
payments, interest payments, and payments to buy the plane at 
the end of the lease period.
    Although lease proponents claim that taxpayers are being 
protected both by price concessions demanded and secured by the 
government and by proposed lease terms that control costs, it 
is unclear how far these protections go. Price reductions 
obtained shortly before the lease, was approved by the DOD, 
seemed to have been accompanied by reductions in aircraft 
capability and by an implicit promise that the government would 
acquire at least 200 tankers from Boeing. That we should be 
acquiring the first 100 by circumventing the authorizing 
process in Congress and a meaningful analysis of alternatives 
by the military is troubling enough. That the Administration 
would promise to acquire twice as many planes without better 
justifying the needs for this sole-source contract is mind-
boggling.
    The value of any concessions on the price of the plane must 
also be considered against the overall value to Boeing of the 
lease. An aspect of the lease that until now has received 
almost no attention is a $5 billion-plus maintenance contract 
for the new tankers that the Air Force has negotiated with 
Boeing. Five billion dollars. That represents about 25 percent 
of the total cost of actually acquiring the tankers, and it 
appears to have been negotiated as a sole-source contract. Why 
the Air Force decided not to seek competitive bids for the 
aircraft maintenance is unclear. Why it agreed to pay $5 
billion-plus for a maintenance contract, when Boeing had, in 
2001, sent an unsolicited bid to the Air Force offering to 
maintain tankers for $2 million per plane per year, perhaps a 
quarter of what the Air Force now has agreed to pay, is 
unexplained.
    Can it be said that the government really got a lower price 
when the lease proposal covering the acquisition includes an 
enormous maintenance contract for the seller? The fungibility 
of Boeing's compensation seems to have been appreciated by the 
Air Force. And, in one communication, the Air Force wrote to 
Boeing that while DOD's marching orders were to negotiate a 
contract not to exceed $131 million, ``We can modulate as 
necessary to make everyone happy while keeping the NTE number 
intact.''
    We're all disposed, in these times, to give leeway to 
claims of military necessity. But the case for urgent need that 
lease supporters claim justifies this extraordinary transaction 
simply has not yet been made. The economic case is also 
wanting. It is considerably more expensive to lease rather than 
to buy the aircraft. And the CBO stated in its report, ``Rather 
than eliminating difficult budgetary decisions, the lease 
merely postpones them.'' This sounds very much like the 
``living for today and plundering the resources of tomorrow'' 
that President Eisenhower warned us about over 40 years ago. 
It's not too late to heed that warning.
    Senator Inouye?
    Senator Inouye. I'd like to wait until the question period.
    The Chairman. Senator Stevens?
    Senator Stevens. Mr. Chairman--
    The Chairman. I apologize. Senator Fitzgerald was here 
first.
    Senator Fitzgerald?
    Senator Fitzgerald. Thank you, Mr. Chairman.
    Senator Stevens. Just a minute. I was here before anybody 
else started. So----
    The Chairman. Were you? Okay.
    Senator Stevens?
    Senator Stevens. Long before.
    Senator Fitzgerald. I apologize. Senator Stevens may go.
    Senator Stevens. I said hello to Peter as he came in.
    The Chairman. I apologize.
    Senator Stevens?

                STATEMENT OF HON. TED STEVENS, 
                    U.S. SENATOR FROM ALASKA

    Senator Stevens. Mr. Chairman, I'm happy to get a chance to 
once again try to get the record straight on this matter.
    In 1998, I took a trip, as Chairman of the Appropriations 
Committee. Senator Inouye and I went throughout the Middle 
East, and we had discussions with a considerable number of 
pilots. At that time, the pilot list rate was down. It was an 
extremely difficult period. And we came across, I came across, 
the concept of the age of this fleet. As a matter of fact, 
these tankers predate Eisenhower's Administration.
    The average age of them is 43 years. There are 544 of them. 
If we followed the normal period of what we call 
``recapitalization'' and acquired them by buying them one by 
one, it would take us 70 years to do that. We already have had 
at least one crash of one of these KC-135s that are in the 
current fleet, because of corrosion, lost four people on that 
plane. We also had a situation where, due to the lack of a jack 
screw--now, a jack screw may not mean anything to many people, 
but it does to me, because the Alaska Airlines plane that 
crashed out in California and killed about 40 of my friends 
from Alaska was found to be the fault of a jack screw. When 
they found that the jack screws were a questionable item on 
these planes, they were all--the entire tanker fleet was 
grounded, and the Air Force had to go out and manufacture 200 
new jack screws because they don't make them anymore.
    Now, we're both pilots, Mr. Chairman, but I was a cargo 
pilot, and I view this from an entirely different way you do. I 
just do not understand why we should put people that fly planes 
in combat that were made before their grandfathers were in the 
military.
    We have a situation here now that is misunderstood by a lot 
of people. In 1999, I approached Boeing--they didn't approach 
me--I asked them would it be possible to put sleeves in the 
767s. Some of them may remember that. In Alaska, we put sleeves 
in old DC-3s and C-46s and fly fuel around our state. I 
wondered could we put sleeves in the 767s. That looked like it 
was a pretty difficult proposition, so I urged them to take a 
look at really trying to find a way to solve this problem. And 
I pointed out we lease housing, we lease tankers for the Navy, 
we lease automobiles, we lease almost everything except the 
White House and the Capitol. Now, when it comes right down to 
it, this leasing proposition has been a good proposition for 
business, and, in the long-run, it would be a good proposition 
for the government.
    One of the things that is missed is at least one third of 
this fleet is grounded at any one time because of maintenance 
problems. At least one third. Inoperable. Our whole strategy is 
based upon--air strategy--is based on the refueling capability 
of our Air Force.
    Now, I believe that the difficulty we're having with these 
planes--and we are having difficulty with them--if one third of 
them are redlined at any one time--redline: don't fly--then 
clearly we don't have 544 planes; we have less than 400 that 
are flyable. And if you talk to some of the people that have 
been flying over there during this last combat, both in 
Afghanistan and Iraq, you'll find they all think about the age 
of this equipment. And it's time, high time, we realized that 
they have to be replaced. If we let this fleet age any more, we 
will lose the key to our strategy, as far as the defense of 
this country is concerned, and that's the refueling capability 
of our Air Force.
    Now, I've seen a lot of things that have come from your 
office and from some of the people that you've just mentioned 
about my role in this, and even to commenting about the 
campaign contributions that I received in 2002, which I did 
receive and they're reported. This issue started long before 
that campaign started, and I've been involved in this thing for 
a long time.
    I have pursued the concept of trying to assist and maintain 
our Air Force as number one. Now, there are other nations of 
the world that are buying refueling capability; not in the 
quantities that we maintain them, obviously. Italy, other 
countries, are buying the refueling capability to refuel by 
air.
    I do believe that there is no question in--there can be no 
question that the age of these airplanes are an issue. It is 
``the'' issue, as far as I'm concerned.
    We have, now, the concept of leasing 100 planes. Those will 
enable us to retire the oldest of the KC-135E aircraft. The 
cost avoidance, in maintenance alone, to do so is $5.5 billion. 
None of that is figured into the figures you mentioned. Neither 
CBO nor GAO or the Library of Congress took into account the 
savings from not having to have these planes redlined to the 
extent that they are now. By the Fiscal Year 2011, these 100 
tankers will be delivered. But if we were to buy those 100 
tankers under the normal procedures, it would take 30 years to 
do so.
    Now, I concur with the judgment of the Department of 
Defense with regard to this lease. I challenge anyone about any 
backroom dealing or anything else. We offered that amendment. 
It was right in front of God and everybody. It was in the bill 
when it was reported. It was there to be debated. As a matter 
of fact, there was some debate about it. And if I understand 
the Constitution, a law is a law when passed by Congress. 
There's nothing that says the Appropriations Committee can't 
find a way to enact a law that's necessary, if it is necessary, 
and we've done it repeatedly, and often at the request of the 
Armed Services Committee.
    So this is not a jurisdictional fight. It's not a 
philosophical fight. It basically is a fight over who initiated 
the concept and whether it's a valid one. I initiated it, and 
I'm proud to claim it as my own. And I believe that the work 
that's been done by the Department of Defense and by the OMB 
has protected the taxpayers' interests and, what's more, will 
protect the lives of many, many more young men and women who 
are out there flying these planes day and night. If one time, 
if just one time, one of those tankers is not supposed to be 
where it should be in order to refuel a flight of high-
performance planes, we'll not only lose the tanker, but we'll 
lose the planes, too.
    Now, it's high time we realized we should--incidently, I 
fault the Armed Services Committee for not having looked into 
this before. Why shouldn't they have looked into the concept of 
how old these planes are? These are the oldest combat planes 
they're flying today. The oldest. And they should be retired as 
quickly as possible.
    My last comment, as I'm sure my friend from Hawaii will 
remember, we had a little occasion where we took a flight to 
Saudi Arabia at the request of the Executive Branch. It 
required flying all night and being refueled over London. As we 
were approaching London, we found we're suddenly letting down, 
going to land. And we did land. And I inquired, ``Where was the 
tanker?'' The answer was, ``The pilot was pregnant and was 
having some pains so we couldn't find a replacement pilot in 
time, so the easiest thing was to bring you down.'' Well, that 
was good for us; we were right over London. What if it had been 
someone else? What if it had been someone else somewhere else 
who had a problem with a pilot who had to turn around and go 
back because of the failure of his or her airplane, and not 
keep the commitments that they had?
    Now, I believe, Mr. Chairman, it's going to be a long 
afternoon. I have to tell you now, I have to go to the White 
House at 4:30, but I will return as quickly as possible.
    But, again, I hope personalities will stay out of this, 
because I'm frank, and, as I've said, I hope it's plain to 
everyone that no one from Boeing came to me. I went to them. 
And it was long before any campaign contributions were made to 
me for that last election. But, as a matter of fact, if you 
want to look at it, I think Boeing spent--Boeing employees have 
been contributing to my campaigns since 1962.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator Stevens. I can assure you 
I have made no comments concerning campaign contributions and--
have not and will not. I have known you for many years and know 
of your integrity.
    I would like to submit for the record at this time the DOD 
document showing the mission capability rates.
    [The information referred to follows:] 
    
    
    
  
    The Chairman. KC-135, 85 percent. KC-10, 75 percent. E-3, 
77 percent. C-141, 69 percent. KC-135 has the highest mission 
capability of any aircraft in the inventory.
    Senator Stevens. Those are the ones that are not in depot.
    The Chairman. This is the--
    Senator Stevens. The ones I mentioned are in depot.
    The Chairman. This is their whole fleet, I would say.
    Senator Cantwell?

               STATEMENT OF HON. MARIA CANTWELL, 
                  U.S. SENATOR FROM WASHINGTON

    Senator Cantwell. Thank you, Mr. Chairman. I appreciate you 
holding this hearing, and I appreciate the time and attention 
that you have given to this issue, because clearly the one 
thing that we want to make sure of is that we do give the 
attention to the analysis of this proposal and that the public 
is comfortable that it is in the public interest and is not 
only in good stead for what the military needs, but is in the 
best interest of the taxpayers.
    Not to get into a debate about when and where the tanker 
idea first came from, though, I do think it is helpful to go 
through a few points.
    I first became involved in this issue more than two years 
ago, when I went to visit constituents in my district, the 
Fairchild Air Force Base in Washington State. It's one of the 
premier sites and locations for refueling tankers. It was clear 
to me then, as it is clear now, that we were in need of help on 
these tankers.
    The base was proposing a budget, approved by the Air Force, 
that showed a huge increase to deal with this problem. And at 
an average age of over 40 years, the KC-135 planes are the 
oldest in the Air Force, older than virtually all the 
commercial aircraft and older than most of the pilots that fly 
them. And unlike other planes in our military, these planes and 
their mission cannot be duplicated. As a result, we are dealing 
with aging planes that need to be replaced.
    The KC-135s were originally designed for a 25-year life 
span. And now they are showing extreme wear and tear. That 
should be of no surprise to a plane that was supposed to be a 
25-year life span. Corrosion and supportability and technical 
obsolescence are keeping many of these planes out of service 
and are leading to unreliable tanker fleet.
    I think due to the age of the tanker fleet, at one time--
there are almost 200 KC-135 tankers, about 20 percent of the 
fleet, on the ground waiting for maintenance. And currently, 
these maintenance costs, can average three to four hundred days 
for each plane. And these maintenance needs will only increase 
and lead to a decrease in availability.
    So how did we get into this situation? And did we ever hear 
before about tankers before the 2001 legislative session? I 
would advocate that there was a lot of discussion about tankers 
prior to that and that this is not a new issue.
    First of all, in fact in 1989, the Air Force identified the 
need for modernization of equipment with a statement of need 
for KC-135 replacement. Later in 1996, the GAO concluded that 
the aging KC-135s had led to a skyrocketing increase in 
maintenance costs and a decrease in availability. The report 
emphasized that the KC-135s may not satisfy the future 
requirements. It urged the Air Force to develop a plan to 
replace the tankers, and it highlighted the KC-135's particular 
susceptibility to corrosion damage.
    It was surprising, but maybe not surprising to others who 
were here, that also in 1997 the RAND Corporation identified 
the aging aircraft, and specifically the corrosion issue, as 
what it called a ``crisis on the horizon.'' And the National 
Research Council identified seven specific corrosion concerns 
for the KC-135 tanker. Also, we heard, in 1998, the Air Force 
Deputy Chief of Staff of Installations and Logistics testify 
that the KC-135 had extensive structural corrosion and 
deteriorated electrical wings that went beyond its ability to 
be fixed.
    The Air Force, in 2001, found that the existing fleet, 
keeping it until 2040, which is something that I think deserves 
a lot of attention of how and why it was that we thought this 
fleet could last to 2040, much beyond what we're talking about 
today, would add an additional $17.8 billion to the life cycle 
of the planes and that the fleet will experience decreased 
availability due to the time in depot maintenance.
    So our military now depends on the KC-135s for 90 percent 
of its refueling for Navy, Air Force, and Marine aircraft 
involved in regional conflicts around the world, not to mention 
our own increased homeland security issues. And as we look to 
reshape our military posture by the base closures that we're 
talking about, we will need to increase our dependence on these 
tankers to ensure our dominance of the skies.
    So we cannot, I believe, Mr. Chairman, ignore the need to 
modernize the capable tanker fleet and make sure that we are 
upgrading these in the important time frame that is important 
to delivering the services that they were meant to do.
    Now, we've heard a lot about numbers, and I am sure we're 
going to spend the next several hours hearing about lots of 
different prices, lots of different models, and lots of 
different assumptions, and I doubt, for a second, that any of 
us will all be on the same model, the same assumptions, and the 
same prices for any of our discussions. That makes this very 
challenging.
    But I would like to be clear, I think the only reasonable 
comparison that should be made are the two options of leasing 
the planes or keeping the status quo. I say that because while 
some have tried to compare the lease to a purchase, the fact of 
the matter is that we are in a fiscal situation in which an 
outright purchase of these aircraft is simply not feasible. 
Indeed, an outright procurement of 100 tankers would require 
140 percent increase in the annual Air Force appropriations. 
Not only is that impractical, but it would require us to put 
off other important procurement programs.
    We have major systems that Congress and the Air Force have 
put ahead of the tanker replacement. Now we are in a situation 
where we're finding out that the need is more dire than maybe 
we had previously anticipated. The result has been this 
proposal that is before us today. And that is not to say that 
any of the Members of this Committee or various other people 
haven't brought forward this proposal. I'm simply saying, as a 
Member who went back, prior to my two-year time period here in 
the Senate, to look at this issue. I found lots of evidence and 
lots of discussion about the tanker issue.
    But is this a cost-effective deal? In considering the cost-
effectiveness of this proposal, we must recognize the savings 
that we'll gain by not keeping on the status quo process, which 
I think is unacceptable.
    If we do not replace these aircraft now, we are facing 
skyrocketing maintenance and modification costs. For the 
modifications alone, keeping the old planes will cost the 
taxpayers over $5 billion to upgrade, not to mention the 
estimated $17.8 billion in additional maintenance increase 
attributed to the effects of aging if we keep the status quo 
proposal.
    What are the protections for the taxpayers? In addition to 
what I think these cost savings are on maintenance, the lease 
proposal provides good protections for the taxpayers, in that, 
first, they have gotten the lowest price on the 767 that has 
been offered in 17 years. It includes an MFN clause that 
ensures taxpayers will get the best deal offered on this planet 
anytime in the future. Fourth, it requires an independent audit 
of this information, and it gives the Air Force the ability to 
make adjustments or to get out of this platform option if it so 
chooses.
    I believe the tanker lease before is the result of two 
years of hard work, a lot of discussion. Yes, Mr. Chairman, 
maybe not enough discussion here in the Senate or--but I know 
the Armed Services Committee will have its opportunity 
tomorrow, as well. But I think the American people can be proud 
that we were able to find a solution that brings substantial 
cost savings and effective safeguards for the taxpayers. And I 
am particularly proud that the Air Force has found a solution 
in an American product.
    Boeing has been an industry leader in the tanker market for 
years, in other points of my chart. And as the gentleman from 
Alaska has said, the seven-six transport platform has become a 
solid product. It is being chosen by other countries as a 
tanker platform. And I don't think that it should be lost on 
this Committee that the alternative to this product comes from 
Airbus. Not that I want to get into a large discussion about 
unfair subsidies that Airbus receives, at this time, but I'm 
sure that this Committee is going to be discussing a great deal 
in the future.
    However, at this time I do believe that it's important that 
the American people know that we are giving our fighters, our 
men and women in the Air Force, a product that we should be 
proud of and that it will be made by American workers. I think 
the taxpayers should know that they are getting a good deal at 
a moment when national security is important to all of us and 
that we give the men and women the best product and the most 
cost-effective product that we can give them today.
    I do applaud you, Mr. Chairman, for having this hearing. It 
has given all of us more time to focus on this issue and more 
time to realize that this is a good deal for the taxpayers and 
a good deal for national security.
    The Chairman. Thank you.
    Senator Fitzgerald?

            STATEMENT OF HON. PETER G. FITZGERALD, 
                   U.S. SENATOR FROM ILLINOIS

    Senator Fitzgerald. Thank you, Mr. Chairman. Thank you for 
holding this hearing. Mr. Secretary, thank you for being here, 
and all of our witnesses.
    As disparate as the testimonies, thus far, or the opening 
statements have been, I guess I have to say I agree with parts 
of all of the statements that have been made. I do agree that 
there is a need to upgrade the tanker fleet for the United 
States Air Force. But, on the other hand, I am troubled by how 
we're going about it. I'm troubled by the so-called lease 
before us. And there are three points that I'm going to want to 
ask questions about.
    Number one, I have looked--as I understand the transaction, 
the title to the tankers would be in a trust of which the 
trustee would be the Air Force. In other words, the Air Force 
will be the legal title holder to the property. The Air Force 
would also be the lessee under the lease. In effect, the Air 
Force would be both the lessor and the lessee. This indicates 
to me that this arrangement that we have before us is not in, 
in fact, a lease. If it were a lease, the title to the property 
would be in the name of a bona fide and independent third 
party. I think this is actually a sale-and-purchase transaction 
masquerading as a lease. And I think that's the same conclusion 
that the Congressional Budget Office came to. And, in fact, 
there's a handout on my desk--I don't know--I believe it's the 
CBO who put this out, but they point out that this trust is 
controlled by the Air Force, and they question the arrangement 
here.
    All of the experts that I have read, on both sides of this, 
agree that it costs more to do this arrangement than it would 
to just do a straight-up sale and purchase. I'm wondering if 
the right thing to do, if there is consensus in Congress that 
the Air Force does need new tankers, if we shouldn't just do a 
straightforward acquisition. If it's necessary to cut out some 
of the red tape in our procurement process--and I'm hesitant to 
do that, because there are a lot of safeguards in our 
procurement code, for the taxpayers--but we could probably pass 
legislation that would make it easy to cut through some of that 
red tape and do a straight-up purchase and sale.
    What is before us here is a complex structured financing 
transaction that really could have been taken straight out of 
the Enron playbook. I went through all the documents that Enron 
submitted to this very Committee a year ago, and I remember 
talking about all these special-purpose entities and trusts of 
which Enron was in control. In this case, the Air Force seems 
to be just using this special-purpose entity in a way that it 
is very troubling, that obscures the true cost of the tankers, 
that makes a very--it takes away all transparency to the deal. 
And from a Congress and a Committee, especially, that roundly 
condemns similar deals that we saw emanating from Wall Street 
in the advanced stages of the 1990s bull market, I would be 
remiss if I were not to comment on that.
    So I think the bottom line is here, we ought to have a 
discussion--why not just buy these tankers, go through the 
ordinary budget and appropriations process? I understand 
there's a supplemental appropriations bill, military 
appropriations bill, coming up to fund the Iraq War. Maybe now 
is the time to consider this. I don't like us going around 
doing an end-run around our budget and appropriations process. 
I think it's a very bad precedent. I agree with the CBO that 
this is not a true lease.
    And I'm also wondering if that isn't why the Air Force has 
come to Congress in the Congressional Committees asking for 
approval. I've read the authorization that Congress passed last 
year, and it does not require the Air Force to come back to any 
of the four Committees of Congress for approval. You can enter 
into a lease. Are you coming back and asking to get our seal of 
approval from Congress because you're concerned it really isn't 
a lease and it doesn't comply with this? That will be one of 
the things that I'll want to address.
    And, with that, thank you all for being here, and we'll 
look forward to your testimony.
    [The prepared statement of Senator Fitzpatrick follows:]

   Prepared Statement of Hon. Peter G. Fitzgerald, U.S. Senator from 
                                Illinois
    Good afternoon. I want to join my colleagues in welcoming the 
distinguished witnesses who are present today.
    I would like to thank Chairman McCain for holding this timely and 
important hearing on the lease of Boeing Company aerial refueling 
tankers to the U.S. Air Force.
    Our nation's military currently is operating at a heightened level 
of activity as we continue to engage in the global war on terrorism. As 
a consequence, it is vital that our armed forces increase their agility 
and flexibility as necessary to respond quickly and decisively anywhere 
in the world. Air refueling tankers enable other aircraft to fly 
farther, stay airborne longer, and carry more weapons, equipment and 
supplies--both at home and around the world.
    The Air Force has stated in its report to Congress that the urgency 
for these aircraft arises from increased utilization and age of the 
existing fleet of aerial refueling tankers made up primarily of the KC-
135s. The cost to operate the existing fleet has been rising while the 
fleet's operational availability has decreased due to corrosion, major 
structural repairs and increased rates of inspection.
    I look forward to hearing from our witnesses today regarding three 
areas of concern to me.
    First, the arrangement proposed by the Air Force is not a true 
lease. Under the arrangement, the owner of the tankers would be a trust 
of which the Air Force itself, as I understand it, would be the 
trustee. As trustee of the trust, the Air Force would actually be the 
legal title holder of the tankers. As the legal owner of this property, 
the Air Force would in effect be both the lessor and the lessee under 
the so-called lease. That makes no sense. For this and several other 
reasons, the Congressional Budget Office determined that the 
arrangement is in fact a sale and a purchase and that the transactions 
should be reflected in the Federal budget. If this were a real lease, 
the legal title holder to the property would be an independent and bona 
fide third party, not the Air Force itself
    Second--if the arrangement between the Air Force and Boeing is not 
a lease but rather a sale and purchase, isn't the arrangement simply a 
legal construct to circumvent the congressional budget and 
appropriations process? Congress has roundly condemned the discredited 
financial practices of Wall Street in the advanced stages of the late 
1990s bull market. The arrangement under review today is a complex, 
byzantine transaction that obscures the true cost of the tankers and 
reduces the transparency of the arrangement. This legal construct comes 
straight out of the Enron structured finance playbook.
    Most, if not all, parties to and external reviewers of the tanker 
arrangement agree that it would save the taxpayers money to buy the 
tankers outright rather than to use the arrangement the Air Force is 
here proposing. Which leads to my third question, which is what is the 
public policy rationale in favor of going about this acquisition in one 
way when we could go about it another way and save hundreds of 
millions, if not billions of dollars. We're talking about money from 
the paychecks of millions of Americans. We should treat their money 
with greater respect in my judgment.
    It appears that the better approach is for Congress to take the 
bull by the horns and exercise its responsibility through the 
appropriations process. The Congress soon will consider a supplemental 
appropriations bill for Iraq. Why couldn't this appropriations bill 
serve as the vehicle to consider and debate the outright purchase of 
the tankers? If such funding were included in the supplemental, not 
only would the timing for delivery of the first aircraft be parallel 
with the proposed lease, but it also could expedite the delivery 
schedule of the remaining aircraft. If necessary, Congress could 
consider adding provisions which would reduce the red-tape associated 
with the government procurement process.
    The arrangement that the Air Force has negotiated appears to be the 
actual sale and purchase of the tankers masquerading as a lease. It 
looks like we don't have to wait until tomorrow night's NFL opener here 
in Washington to see electrifying plays. The proposal before us is a 
naked end run around the budget process. It deserves to be tackled 
before it crosses the line of scrimmage. We have to play tough defense 
with taxpayers' dollars--even when military spending is at issue.
    Again, I thank the witnesses for appearing today, and I look 
forward to hearing their testimony. Thank you, Mr. Chairman.

    The Chairman. Senator Lautenberg?

            STATEMENT OF HON. FRANK R. LAUTENBERG, 
                  U.S. SENATOR FROM NEW JERSEY

    Senator Lautenberg. Thanks, Mr. Chairman. And I'm sorry to 
extend this part of the program, but I do have an interest.
    And I'm curious about why three Senate Committees are 
holding hearings this week on the leasing deal with Boeing. 
It's a huge leasing arrangement, which is open-ended in terms 
of cost, although some estimate that it could be as large as 
$26 billion.
    And I want to set the record straight. If the Air Force 
needs this as a critical device for them to perform the 
valuable service they do, then I think that ought we not to be 
looking at some of the alternatives, which are to renovate and 
upgrade the present fleet, which can be done at a considerably 
less cost.
    But I have three primary concerns about this leasing 
proposal. First, the expense. It's unclear whether they're 
fully necessary for the military. And I hope that we'll be able 
to discuss this. The Air Force, like all the other government 
entities, should be aware of the fact that we don't have enough 
money to do lots of things that we need to do for--the military 
included, obviously. It shouldn't throw away any dollars on 
corporate appetites, especially when the government deficit is 
so enormous.
    Second, I am a strong advocate of open, competitive bidding 
by private companies before they're awarded contracts or leases 
by the United States Government. I'm concerned that because of 
Boeing--and it's a terrific company, done a lot of good 
service, but the fact is, we have a larger audience to be 
concerned about than Boeing's immediate needs, and this lease 
would be given without an independent evaluation of whether it 
could best meet the Air Force's needs.
    And earlier in this session, I was able to pass a 
bipartisan amendment to the Department of Defense authorization 
bill that states that DOD has to comply with the competitive 
contracting laws with any contract awarded for reconstruction 
activities in Iraq. And, similarly, when one of our largest 
military suppliers are leasing aircraft to the United States 
Air Force, I want to know what other companies might have been, 
if any, for this deal, one of which, if not the largest, 
commercial lease in U.S. history.
    And, thirdly, I've noticed that the Administration has a 
strong will to privatize federal jobs in first looking toward 
privatizing the federal air traffic controllers, and now 
Secretary Rumsfeld is changing the personnel system in the 
Department of Defense to allow for outside contractors to do 
typically federal work, although I understand why, in some 
cases, the private sector is well suited for defense-related 
jobs. I'm worried about this trend. What does it mean to the 
effectiveness of the safety and security functions of our 
Government and its performance, as well as the future interests 
and the reward for loyalty by our Federal employees? This 
leasing arrangement for 767s with Boeing will certainly set a 
precedent, and we ought to have a clear understanding of what 
significance this precedent has.
    So I look forward to hearing from the witnesses about this 
arrangement, and I reiterate the importance of transparency in 
all government contracts. And I don't know that anybody feels 
like we've seen all of the details here that we have to.
    And I took an earlier look at a GAO report and saw their 
estimate of what the difference might be, in terms of an 
outright purchase, in terms of the savings that we might have. 
And what is the fondness of this lease arrangement, when it 
looks like, by any stretch of the imagination, it's going to 
cost more to do than a--more to deal with than a straight 
purchase?
    So, Mr. Chairman, I look forward to hearing from our 
witnesses.
    The Chairman. Thank you.
    Senator Sununu?
    Excuse me. Senator Burns?
    Senator Burns. Pardon?
    [Laughter.]
    The Chairman. Senator Burns?

                STATEMENT OF HON. CONRAD BURNS, 
                   U.S. SENATOR FROM MONTANA

    Senator Burns. Mr. Chairman, in the essence of time, I 
would submit my statement and listen to the testimony.
    The Chairman. Thank you very much, Senator Burns.
    [The prepared statement of Senator Burns follows:]

   Prepared Statement of Hon. Conrad Burns, U.S. Senator from Montana
    Thank you, Mr. Chairman. I would like to thank all of you for being 
here today to testify and discuss the Boeing 767 tanker lease proposal.
    The men and women of our active, Guard and Reserve components have 
seen an increased operations tempo (optempo) over the past few years, 
in particular over the last year or so. This increased optempo does 
not, however, come without costs. Short lead times for call-ups, 
coupled with uncertain or lengthy periods of service can make life very 
difficult on our service members. Increased operations also wear and 
tear on already aging equipment. Nowhere is this truer than the stress 
that is being placed on our tanker fleet.
    On 23 May 2003, the Department of Defense (DOD) announced they 
would proceed with the lease of 100 Boeing KC-767A air refueling 
aircraft. These 767s would replace 120 KC-135E tankers, the oldest of 
all Air Force aircraft, at an average of 43 years. The KC-767 can 
offload 20 percent more fuel than the KC-135 and can itself be refueled 
in flight. The Air Force has said that it needs to retire as many as 
500 KC-135 tankers during the next decade and plans to retire its KC-
135E fleet by 2007. Pentagon officials have said the lease deal would 
allow the Air Force to begin replacing the aging refueling tanker fleet 
three years earlier than planned. The Air Force has also said it needs 
to lease because it does not have enough money in its long-range budget 
to buy the aircraft as part of its annual budget process.
    There is no question that the U.S. Air Force needs more refueling 
tankers. The importance of these tankers cannot be overstated. Our 
fighter aircraft and bombers are able to stay in flight and kill their 
targets only because they can refuel in the air. There is no doubt 
these tankers are needed. There is also no doubt that the current 
tanker fleet is in bad shape. Personnel say that the aircraft are 
difficult to maintain and that parts are hard to find. The Air Force 
needs tankers now.
    Employers, communities and families have been incredibly 
understanding and supportive of the brave men and women in our 
volunteer service. However, one can only be supportive and 
understanding for so long. I cannot--cannot--knowingly and willingly 
send our military men and women out to protect freedom in equipment 
that is dangerously aged and deteriorating. I cannot bear to think that 
because Congress failed to act, needless deaths occurred because the 
aircraft we made these men and women fly were inadequate and literally 
falling apart in the sky. Families, friends and communities will not 
understand this, nor should they. Critics of this lease proposal will 
talk a lot about cost--and they should, as we should always take cost 
into careful consideration. However, the cost of unnecessary deaths due 
to faulty equipment--a problem that could and should be fixed 
expeditiously--is a cost too high for any of us to incur. I know that 
many of you are aware of this and are working toward a solution.
    Our military has performed nobly in the latest missions with which 
they have been tasked--the Global War on Terrorism and Operation Iraqi 
Freedom, just to name a few. The United States military is an extremely 
skilled, capable force, responding to various missions across this 
Nation and across the world. They must have the tools and equipment to 
do the job and return home safely.
    I pledge to do what I can to make sure that our military has the 
support they need to get the job done and return home safely.
    Again, I thank all of you for being here today. I look forward to 
the discussion this afternoon. Thank you.

    The Chairman. Senator Sununu?

               STATEMENT OF HON. JOHN E. SUNUNU, 
                U.S. SENATOR FROM NEW HAMPSHIRE

    Senator Sununu. Thank you, Mr. Chairman. I also will submit 
any formal statement for the record in writing. Thank you very 
much.
    The Chairman. Without objection.
    Senator Brownback?

               STATEMENT OF HON. SAM BROWNBACK, 
                    U.S. SENATOR FROM KANSAS

    Senator Brownback. Thank you, Mr. Chairman. And thank you 
for your holding the hearing, and thank you for your passionate 
thoughts on the subject. I always respect the efforts that you 
put forward on all the issues, and you're a fabulous 
legislator.
    This program is important to the Nation. The Air Force is 
currently operating with a fleet of struggling refueling 
aircraft. These flying gas stations are indispensable to 
today's military. And, unfortunately, the current fleet is old 
and falling apart. Military pilots in their early 20s are now 
flying the same aircraft their grandfathers flew, and, of 
course, that's only if the aircraft are flying at all. Each 
tanker is grounded nearly one year out of every five for 
repairs and maintenance. In fact, after seeing these aircraft, 
Secretary Roche, who's here with us today, called their 
condition, quote, ``scary.'' I share the Secretary's concerns.
    The current fleet of the KC-135s is an aging fleet, 
estimated to cost the Air Force more than $5 billion in 
maintenance and repair cost over the next 15 years. The fleet 
is in such bad condition, it is estimated that 40 percent of 
the aging tanker fleet is unavailable on any given day because 
of maintenance and repairs. By stalling this deal, we're 
stalling the safety of our nation's service men and women who 
operated these tankers.
    This deal is not only important to the Nation, it's 
important to my state, of Kansas. Since September 11, Kansas 
has suffered tremendous layoffs in the aviation manufacturing 
sector. This deal would bring much-needed work to the state of 
Kansas, where Boeing has a large presence. And I realize that's 
a selfish interest to Kansas, but it's certainly an important 
one to me in my state. It's estimated that this 767 tanker 
lease program can result in more than 1,350 direct jobs and 
3,100 multiplier jobs. Wichita was one of the hardest hit 
communities from September 11. And to stall this deal only 
means stalling much-needed help into that community.
    And I have a chart I just want to show to remind some of 
the Committee Members. After September 11, one of the leading 
businesses hit in this country was the aviation manufacturing 
sector. That was one of the most direct hits after September 
11. Boeing, you can see, has lost 27 percent of its jobs--
Cessna, Raytheon. That number is actually higher. This chart is 
based on March figures of the first quarter of this year.
    I understand and respect the Chairman for his concern, and 
particularly for his attention to frivolous use of taxpayer 
dollars. However, this lease deal is not a case of frivolous 
spending. I'm sure that throughout today's hearings we will 
hear about the difference in cost between leasing and 
purchasing these aircraft.
    I'd like to bring to the attention of the Committee an 
editorial that was published in today's Wall Street Journal 
that the Chairman mentioned that is in favor of the lease 
arrangement. I think this editorial puts the issue in some 
perspective.
    I want to thank our witnesses for being here today, and I 
look forward to the discussions that we have on this important 
long-term arrangement for the U.S. Government.
    The Chairman. Thank you.
    I would like to welcome our witnesses, the Honorable James 
G. Roche, the Secretary of the United States Air Force; the 
Honorable Douglas Holtz-Eakin, Director of the Congressional 
Budget Office; Mr. Neal Curtin, Director of Defense 
Capabilities and Management of the United States General 
Accounting Office; and Mr. Christopher Bulkcom, a specialist in 
National Defense at Congressional Research.
    I thank all the witnesses for being here, and I appreciate 
your patience as we proceeded through the opening statements, 
which were too lengthy, including my own.
    I want to thank you, Secretary Roche, for agreeing to 
appear here today. I know it is not usual practice to appear 
before a Committee other than the Armed Services or 
Appropriations Committees, so I thank you for being here today. 
And please proceed, Secretary Roche.

         STATEMENT OF HON. JAMES G. ROCHE, SECRETARY, 
                    UNITED STATES AIR FORCE

    Secretary Roche. Mr. Chairman, thank you very much. I am 
honored to be here with you today, sir. And thank you, Senator 
Inouye and Members of the Committee.
    It's my honor to testify on our need to begin the 
modernization of our air refueling fleet in the United States 
Air Force. The air refueling capability is absolutely vital to 
our Nation.
    As we recently demonstrated in our war on terrorism, the 
Air Force tanker fleet was a critical force enabler that 
allowed our coalition force to operate over distant 
battlefields. In Afghanistan, air refueling made joint 
operations in a distant landlocked nation possible. In Iraq, 
our ground forces' overwhelming speed, fire power, and decisive 
maneuver were enabled by air dominance made possible through 
thousands of air refueling sorties.
    Mr. Chairman, of the roughly 69,000 sorties in Operation 
Iraqi Freedom to date, roughly 10,000 have been tanker 
aircraft. Our ability to rapidly project air, land, and sea 
forces around the globe is critical to our Nation's security 
strategy and increasingly relies on air-to-air tankers. This 
dependence and the advance stage of the Nation's air refueling 
aircraft fleet drive our urgency to recapitalize, as well as 
the requirement to maintain aircraft available over the United 
States as part of Operation Noble Eagle.
    Today, the on-average 42-plus or 43-year-old KC-135 
represents 82 percent of our combat air refueling capacity. The 
544 KC-135s on duty today have the oldest average fleet age of 
any Air Force combat aircraft. And the ``E'' model, the ones we 
specifically wish to replace, all 131 one of them, are now 44 
years old, on average.
    During Iraq Freedom, we restricted the deployment of these 
aircraft to the European theater to support the air bridge and 
global power operations due to operation limitations and 
maintenance concerns. They were unsuited for the high 
temperatures and short runways in the area of operations, and 
they had insufficient fuel capacity and less efficient engines. 
Further, the Air Mobility Command commander was concerned about 
their reliability. Thus, they were used only between major AMC 
hubs, where sufficient support was present.
    Yet while demand for these assets are increasing, the data 
show their availability steadily decreasing while the costs to 
keep them flying are also increasing. Since Operation Desert 
Storm, mission-capable rates are down 7 percent overall. 
Program depot maintenance costs tripled, depot work packages 
doubled, and the depot flow days more than doubled primarily 
due to the challenges posed by aging aircraft. For instance, 
Mr. Chairman, 30 percent of all of the hours spent on the 
aircraft in depot are corrosion-related.
    At any given time, roughly one third of the KC-135 tanker 
fleet is not mission capable, and Senator Stevens is correct, 
the mission-capable rates of those aircraft not in long-term 
depot.
    The Chairman. Excuse me. My information, Mr. Secretary, is 
that currently there are less than 90 KC-135 tanker backlog in 
the depot out of 545. Is that incorrect?
    Secretary Roche. Yes, sir. I think that's the backlog. I'm 
talking about the aircraft mission-capable rates do not include 
those planes that are in the depot. They are the planes not in 
the depot. Just as the mission-capable rates that have been 
discussed, Mr. Chairman, differ between those aircraft that 
were used in the operation and those that were kept back at 
home. So, for instance, in the case of the 135E, sir, we only 
used 36 of the 131 to go forward, and we tried to use our best 
aircraft. Therefore, you're quite correct, the mission-capable 
rates of those aircraft were 93 percent. Of their sister 
airplanes that stayed behind, it was, like, 75 percent, sir.
    This is a compelling set of circumstances that motivates us 
to begin recapitalizing our Nation's force. The principal 
reason for posing a lease is the advantage it affords for 
quickly delivering needed tankers to our warfighters without 
requiring significant up-front funding.
    I would be glad to address the questions that were asked 
earlier, sir, in the course of questions and answers.
    We looked at several alternatives to our tanker needs. We 
evaluated a tanker offering from Airbus, and we took a hard 
look at re-engineering the KC-135 Echoes. We could put new 
engines on an old air frame, Mr. Chairman, but still not stem 
the corrosion and structural challenges we currently face.
    Sir, we recognize that this lease will cost marginally 
more, from a net present value analysis, than a normal 
procurement program, and we have done this as any corporation 
would, looking at net present value and taking into account the 
time flows of monies. But in the Department's view, the 
immediate long-term benefits, including operational savings, 
which are not included, greatly offsets the upfront cost of the 
lease option--or the additional cost, excuse me. We can lease 
and deliver 100 KC-767 tankers five years sooner than we can 
under a normal procurement program, yet the net present value 
of the two alternatives is within $1.5 million per copy, per 
plane.
    To purchase these aircraft on the same schedule, we would 
need $5 billion in additional funding through Fiscal Year 2006 
and more than $11 billion more across future years Defense 
program. The lease is a unique way of doing business that is 
not applicable, in my mind, to many other Defense programs. But 
this proposed contract provides numerous safeguards to protect 
the government's interests.
    In addition to the business considerations that make this 
approach attractive, there are compelling operational benefits 
to the KC-767 tanker. It can offload 20 percent more fuel than 
the 135E it will replace. And unlike the typical KC-135, it can 
be refueled in flight, thus permitting consolidation of fuel. 
That's one of the reasons, sir, we can take 131 and replace 
them easily with 100. The 767 tanker also has the capability to 
refuel probe-and-boom-equipped aircraft on every mission. And 
of our operations, our tanker operations in Afghanistan and 
over Iraq, in each case over 50 percent of our tankings were 
for non-Air Force aircraft--for Navy, Marine Corps, and 
coalition aircraft, all of whom use probe-and-drogue.
    This aircraft will be able to operate from many more 
runways than KC-135. It also reconfigures convertible freighter 
for passengers, cargo, and Med-Evac missions, which will enable 
it to be part of our overall lift.
    Mr. Chairman and Members of the Committee, when the tanker 
fleet was only 17 years old, the Defense Department--at that 
time, Secretary Brown, then followed by Secretary Weinberger--
was able to capitalize on the investment made by the Douglas 
Company in the DC-10, the billions of dollars the company had 
made, and as this program, the DC-10, was ending its commercial 
life, were able to capitalize on that and acquire 60 KC-10s, 
tankers. We would like to do the same.
    We are delighted, we are blessed that they did that, 
because the most significant aircraft for refueling our Navy 
and Marine Corps sister services, as well as coalition 
aircraft, have been the KC-10. It gave us a chance to exploit 
an advantage with having a commercial--coming down. It gives us 
a chance to save money by retiring difficult-to-maintain, 
expensive-to-maintain ``E'' models. By leasing, we are able to 
distribute the costs over a longer period of time and, 
therefore, not have to disrupt combat capability of other 
programs. And we get a more efficient and effective system to 
our warfighters sooner, thus reducing the risk of any class 
problem that might occur to the class of aircraft.
    Thank you, Mr. Chairman.
    [The prepared statement of Secretary Roche follows:]

         Prepared Statement of Hon. James G. Roche, Secretary, 
                        United States Air Force
    Chairman McCain, Senator Hollings and Distinguished Members of the 
Committee:

    Thank you for the opportunity to appear before you today. In light 
of your busy schedule of such high-profile hearings on the Columbia 
Accident Investigation, Space Exploration, Internet Taxes, Cloning, and 
the Hydrogen Fuel Cell Research, it is my honor to appear before a 
committee with jurisdiction over such cutting edge issues. Today, this 
committee has called me to testify on a matter that involves not only 
interstate commerce, but a matter of this Nation's top military 
priorities--the KC-767A Multi-Year Aircraft Lease Pilot Program. In so 
doing, I will attempt to clarify the details of the tanker lease 
proposal that was permitted by Congress nearly two years ago. Since 
that Act was passed, the Air Force has maintained, and I have testified 
on record, that there are three hurdles that this proposal must clear 
before we will conclude any deal. First, the proposal must provide 
joint and coalition warfighters a long-term solution for our advanced 
air refueling requirements. Next, any proposal must make logical 
business sense that capitalizes on current market conditions and 
practices. And third, the proposal and the vital capabilities it 
provides this Nation must be advantageous for America's taxpayers. I am 
proud to be here today to acknowledge that those three hurdles have 
been cleared.
    Before I begin, I must commend the men and women who fly, maintain, 
and deliver the impressive combat capability that is our topic today. 
Without these incredibly talented uniformed and civilian airmen, this 
discussion would be irrelevant. These airmen, the heart of our air 
refueling force, operate everyday all over the globe. From active duty 
and our Reserve Component units, we draw our vital tanker capabilities 
from places like Phoenix, Arizona; Hickam Air Force Base, Hawaii; 
Eielson Air Force Base, Alaska; Forbes Field and McConnell Air Force 
Base, Kansas; Key Field in Mississippi; Bangor, Maine; Scott Air Force 
Base, Illinois; Pease Air National Guard Base in New Hampshire; Grand 
Forks, North Dakota; Beale Air Force Base, California; Tampa, Florida; 
and Fairchild Air Force in Spokane, Washington.
    During the past two years, these airmen and our tanker fleet have 
been tested hard, flying Operation NOBLE EAGLE (Homeland Defense), 
Operation ENDURING FREEDOM (Afghanistan), and Operation IRAQI FREEDOM 
(Iraq). And they delivered far more than could reasonably be expected 
while operating and maintaining the oldest fleet in the United States 
Air Force inventory.
Current status of fleet
    Tanker dependence in recent wars and the advanced age of the 
Nation's air refueling aircraft fleet drive the Air Force's urgency to 
recapitalize as soon as possible. Today, a single 44-year-old aircraft 
type, the KC-135, supports eighty-two percent of our combat air 
refueling capability. Beginning manufacture under the Eisenhower 
administration, 732 KC-135s entered military service between 1957 and 
1965. The remaining 544 KC-135s on duty today have the oldest average 
fleet age of any Air Force combat aircraft, and the ``E'' model (131) 
is 44 years old on average. It is the old KC-135Es we seek to replace 
soonest. The ongoing war on terrorism heightens our concerns regarding 
these aging aircraft. Our new ``steady state'' includes tankers 
supporting fighters defending the homeland as well as the need to 
maintain the Nation's global reach capability.
    Aircraft life can be measured in three ways--usage (flight hours), 
physical age (years), and utility (usefulness). The KC-135's physical 
age is the driving need to recapitalize. Through the 1990s, the KC-135 
fleet started to show its age. In 1991, Air Force Materiel Command 
initiated aging aircraft inspections and repairs to maintain the 
airworthiness of this legacy fleet. By 2000, thirty-two percent of the 
KC-135 fleet (a significant portion of this Nation's overall Air Force 
refueling capability) was unavailable due to programmed depot level 
maintenance as the number and complexity of repairs drastically 
increased. This reduced the refueling capability to our warfighters and 
caused a backlog at the depot facilities, as the average number of days 
in depot-level maintenance peaked at over 400 days.


    Annual depot price per aircraft grew significantly as the fleet 
availability decreased. The combination of increasing costs and 
decreasing availability projected into the future compels the Air Force 
to act now to balance cost, capability, and risk; it compels us to 
begin recapitalization of the KC-135 fleet.
    Although General John Jumper, our Chief of Staff, and I have 
visited the depot at Tinker Air Force Base to investigate the condition 
of our KC-135s, we do not rely on our observations or anecdotal 
evidence alone. Independent teams, including teams from Office of the 
Secretary of Defense, the GAO, and many others, that have visited the 
KC-135 depot maintenance line at Tinker Air Force Base unanimously 
recognized the risk that this 44-year-old aircraft could encounter a 
fleet-grounding event, negatively impacting combat operations across 
all services and coalition partners.
    It should be noted that aircraft corrosion is a significant concern 
for aging aircraft, both military and civilian. Congress enacted the 
Aging Aircraft Safety Act, Title IV of Public Law 102-143, in October 
of 1991 after the in-flight structural damage of a Hawaiian Airlines 
737 in April 1988. As you may remember, corrosion had so weakened the 
fuselage of the aircraft that it burst when it reached altitude and 
could not sustain the pressure differential between the pressurized 
cabin and the atmosphere outside. The Federal Aviation Administration 
has enacted additional rules regarding corrosion and inspections for 
corrosion since it is of such critical concern for aging aircraft.
    The KC-135E fleet--our oldest--is beset with problems that 
adversely impact its utility to the Air Force, our sister services, and 
our friends and allies. The planes are operating under flight 
restrictions pending interim repair of an engine strut--interim repair 
costs $150 thousand per aircraft, must be complete by September 2004. 
If the repairs are not made at that time, the unrepaired aircraft must 
be grounded. The interim repair will only last for five years at which 
time the permanent repair must be made. Permanent repair of the engine 
strut would cost $2.9 million per aircraft. If the permanent repairs 
are not made, the unrepaired aircraft in that case must also be 
grounded. We are facing a continual set of repairs and maintenance 
actions that only delay that event. There is also the KC-135 fuel 
system, which requires repair to deteriorating internal corrosion 
barriers. Those repairs are estimated to cost $500 thousand per 
aircraft. Of course, there are always the ``unknown unknowns'' which 
become much more prevalent in aging hardware--for example, 40 percent 
of the KC-135 fleet was non-mission capable from September 1999 to 
February 2000 as a result of a requirement to replace the horizontal 
stabilizer trim actuator--an unexpected event that grounded a major 
portion of our fleet.
Requirement for recapitalization
    The cost of continuing to operate the existing KC-135 air refueling 
force will continue to escalate dramatically. Corrosion, major 
structural repairs, and an increased rate of inspection are major 
drivers for increased cost and time spent in depot. More time in the 
depot directly decreases operational aircraft availability. Operational 
availability is expected to continue to decrease throughout the 
remainder of the KC-135's lifespan. Under these conditions of 
increasing costs and steadily declining availability and performance, 
combined with the increasing operational demands, actions to replace 
the KC-135 must begin now.
    Our proposal--using commercial airline bodies as tanker platforms--
is not without precedent. In the late 1970s, Secretary of Defense 
Harold Brown began to buy DC-10 aircraft converted into tankers, and 
Secretary Weinberger continued the program, resulting in the 60 KC-10s 
that ultimately became our lifeblood. The airplane had been designed 
and proven successful as a platform, the result of investment by the 
contractor, not the taxpayer. In hindsight, the success of the KC-10 
fleet (59 of 60 are still in the inventory) proves the wisdom of 
Secretaries Brown and Weinberger's decision to buy commercially 
developed aircraft, even though the KC-135 fleet at that time was only 
16 to 18 years old.
    In the case of the KC-135, military aircraft was specially 
developed for the Air Force. From this model the industry created the 
commercial carrier, the B-707. These commercial airplanes have been 
retired for the most part in favor of newer airplanes. In this case, it 
was the contractor who benefited from the investment made by the Air 
Force.
    You will recall that we capitalized the original 732 KC-135s at a 
rate of 90 aircraft per year. To recapitalize the 544 that remain at an 
economical but affordable rate could take more that 30 years. We may 
already be behind the power curve. We can no longer accept the risk of 
these venerable aircraft continuing their age-induced death spiral 
without taking immediate action. A realistic replacement program will 
take decades to recapitalize a fleet of this size. Even beginning 
today, some of our KC-135s will pass their 70th birthday before they 
retire.
Operational need for tankers
    We do not propose leasing tankers as a bailout for Boeing or any 
other aircraft manufacturer. We propose leasing tankers because we need 
tankers to fight our Nation's wars, and we do not believe we should 
take the risk to wait for years before we begin.
    The Air Force tanker fleet delivered over 375 million pounds of 
fuel during 30 days of Operation IRAQI FREEDOM, ninety percent of the 
total fuel delivered by all joint and coalition forces. In addition, 
our tanker fleet participated in air bridge operations, long-range 
strike missions, and other global commitments during this time. This 
great feat allowed Air Force strike aircraft to put relentless pressure 
on the Iraqi leadership and the Iraqi armed forces. It was the key to 
24-hour airborne surveillance. Aerial refueling was the reason that the 
Air Force could dedicate so many assets to on-call close air support, 
on-call strikes on time-sensitive targets, and on-call support for our 
highly successful special operations forces.
    But more than just an Air Force asset, our tanker capability 
enables the combat capabilities that our sister services and coalition 
partners bring to the fight. For instance, tankers made it possible for 
Navy and Marine fighters to launch from carriers in the Persian Gulf 
and strike targets deep inside Iraq. Tankers permitted C-17s to take 
off from Italy and drop Army paratroopers in northern Iraq. United 
States Air Force air refueling aircraft delivered over 90 percent of 
fuel offloaded to our sister services and allies during OIF. On a 
global scale, General John Handy and his folks at U.S. Transportation 
Command managed the tanker air bridge throughout these campaigns, 
simultaneously sustaining our airlift to the theater while our combat 
forces continued to deter our enemies in the Pacific. Without these 
vital refuelings, troops and materiel that our Nation needed halfway 
around the world would have been less effective and slower to respond, 
jeopardizing our ability to project global land, sea, and air power.
    Air refueling tankers enable our entire force to protect our 
homeland, conduct combat operations, and provide humanitarian relief 
around the world. They enable other Air Force, Navy, Marine Corps and 
allied aircraft to fly farther, stay airborne longer, and carry more 
weapons, equipment, and supplies. As we just experienced in Operation 
ENDURING FREEDOM and Operation IRAQI FREEDOM, the Air Force tanker was 
a critical force enabler and force multiplier that allowed our 
coalition force to operate over a distant battlefield. Air refueling 
tankers ensure our Nation has the global reach to respond quickly and 
decisively anywhere in the world. In short, our National Security 
Strategy is unexecutable without air refueling tankers.
Need/utility of these tankers
    But again, 90 percent of our current air refueling fleet rests in 
this single aged weapon system. In fact, the warfighter had to adapt 
his basing plan to address the limitations of the ``E'' model of the 
KC135. During Operation IRAQI FREEDOM, the ``E'' models were deemed 
incapable of sustained operations in the AOR due to the high 
temperatures and shorter runway lengths in theater and the lower fuel 
capacity and less efficient engines of the ``E'' model. We found use 
for them in EUCOM locations during the war, but their support was 
limited to airbridge, homeland defense, and global power operations. 
The KC-767A, however, will truly enhance our warfighting flexibility. 
We will replace 131 KC-135Es with 100 KC-767As, and increase our 
capabilities.
    The KC-767A is a tanker version of the long-range commercial 
aircraft. This tanker was developed and commercially offered to the 
international community by the Boeing Company as the Global Tanker 
Transport Aircraft (GTTA). Italy was the first customer, ordering four 
aircraft, and has been followed by Japan. The KC-767 tanker will be the 
world's newest and most advanced tanker. It can offload 20 percent more 
fuel than the KC-135E, and unlike the E-model, but like the KC-10, can 
itself be refueled in flight. The KC-767 Tanker also has the capability 
to refuel probe-and receptacle-equipped aircraft on every mission--an 
enormous benefit for joint operations. While the KC-767 will have 
roughly the same maximum fuel offload as the KC-135R, it can takeoff at 
maximum gross weight in approximately 3500 ft less runway--hence, along 
with greater operational capabilities, the KC-767A is able to operate 
from four times as many runways as the KC-135. As delivered, the KC-
767A will be configured as a convertible freighter being able to carry 
all passengers (approximately 200) or all cargo (19 pallets vs. 6 on 
the KC-135).
    It will have a digital cockpit, cargo door, auxiliary fuel tanks, 
remote air refueling boom operators station, centerline hose drum unit, 
crew rest facilities, larger 120 kilovolt-Ampere generators, advanced 
air refueling boom, and aeromedical evacuation capability.


Alternatives considered
    In selecting the KC-767A, the Air Force considered a variety of 
airframes and acquisition strategies. By DOD regulations, the Air Force 
was not required to conduct an Analysis of Alternatives (AOA) for the 
KC-767 tanker lease, the reasons for which I will address in more 
detail later. Even though the Air Force did not complete a formal AOA 
on the KC-767A, we performed several trade analyses to ensure the KC-
767A was the right solution to meet the operational requirements.
    Maintain current force structure: The Air Force first considered 
maintaining the current force structure. The damaging effects of aging 
quickly became apparent from KC-135 depot work. The unpredictable 
nature of age-related corrosion--its timing, location, and extent--
increases our concern for the risk of an event that would ground the 
KC-135 fleet. Thus, continuing the status quo was rejected because of 
unpredictable and potentially calamitous operational mission impacts.
    Re-engine: The Air Force also quickly recognized that re-engining 
the venerable KC-135Es did not address the aging issues, risks to our 
combat operations, or increasing costs. Re-engining would amount to 
spending billions of dollars for only a 20 percent improvement over KC-
135E capability, but without addressing the ``old iron'' that needs 
replacing. Re-engining was not selected as the solution.
    Commercial alternative: The Air Force considered acquisition of 
commercial derivative platforms in tanker configurations. This strategy 
acquires air refueling tankers derived from commercially available 
airframes to avoid the high costs of new aircraft research and 
development. The use of a commercial-based airframe forges synergy with 
industry in worldwide logistics networks and other support. The 
question then became: How can we get these mission critical assets to 
the warfighter in the most expeditious way, at a reasonable cost to 
taxpayers? Our answer: lease a tanker aircraft that is already 
commercially available.
    In February 2002, the Air Force issued a Request for Information 
(RFI) to both Boeing and European Aeronautic Defense and Space Company 
(EADS) to evaluate available technologies and associated risks. 
Consideration of acquisition of commercially derived platforms included 
the B757, B767, B777, and the Airbus A330 in tanker configurations, 
considering both a lease option and a direct purchase. Based on the 
responses to the RFI, the Boeing 767 was found to be the most 
favorable. The Boeing 757 was too small to replace KC-135 one-for-one, 
and would drive additional manpower requirements on a tanker force that 
is already limited by available crews. The Boeing 777 required almost 
twice as much ramp space as a KC-135--more than a KC-10--but had a 
reduced fuel offload capability when compared to the KC-10. Further, 
the B777 required significant engineering analysis and design work to 
be modified into a tanker, including the possibility of a shortened 
fuselage to accommodate a refueling boom during takeoff. The Boeing 767 
was selected over EADS aircraft as a result of its favorable design, 
schedule, risk factors, and proven boom technology.


    To begin the recapitalization of the 544 KC-135 aircraft, the Air 
Force considered two primary alternatives as acquisition strategies--a 
traditional procurement of 100 KC-767A aircraft, and an operating lease 
of commercially derived air refueling tankers in accordance with 
section 8159 in FY02 legislation. In addition, the Office of the 
Secretary of Defense Leasing Review Panel considered several alternate 
procurement approaches in contrast to the lease or planned purchase, 
including purchases on the same delivery schedule as the lease and 
applying the funding stream required for a lease to a more traditional 
purchase program. The Secretary of Defense determined that the lease 
option best satisfied this Nation's military needs.
    The Air Force, with permission from Congress, began negotiations 
with Boeing for an operating lease of 100 commercially developed KC-
767A air refueling tankers. At the time of the FY04 President's Budget 
submittal, negotiations for the lease were unfinished. Plan A, a KC-X 
procurement program, was included in the President's FY04 budget, with 
the program to begin, because of affordability constraints, in FY06. 
This program in the FY04 PB would deliver one tanker to the warfighter 
in FY09. The 100th aircraft would be delivered in FY16.
    In contrast, under the negotiated lease, the contractor will 
deliver 60 new tankers to the warfighter by FY09, and deliver all 100 
by FY11 which is five years sooner than the FY04 PB procurement 
program. This plan provides for a quicker start to recapitalization of 
the tankers. To match such a recapitalization schedule under a purchase 
option would require billions of additional dollars to be invested 
during the FYDP as well as waivers of various acquisition rules. Since 
those funds are already committed to other uses, there would have to be 
significant restructuring and/or cancellation of ongoing and planned 
programs.
Business case analysis
    Obviously, cost is a big driver when choosing an acquisition 
strategy. In isolation, a leasing strategy requires additional funds in 
then-year dollars relative to the cost of a traditional purchase. 
Economic considerations, however, are not limited to expected funding 
flows, which ignore the time-value of money. To account for this time-
value of money and gain insight into the economic implications of 
leasing as an acquisition strategy, Office of Management and Budget 
Circular (OMB) A-94 directs a present value comparison between the 
proposed lease and a hypothetical purchase based on the same delivery/
return profile. The financial analysis for the A-94 test is highly 
sensitive to the underlying assumptions such as purchase price, 
expected inflation and appropriate discount rate. Since OMB oversees 
governmental leases, the A-94 analysis, and the defining requirements 
for an operating lease, the Air Force consulted them in developing its 
analytic assumptions. Applying the A-94 test the Air Force determined 
that the net present value of the multiyear lease option and a 
traditional purchase option results in an net present value difference 
favoring a purchase by $150 million--about 1 percent of the total cost. 
These calculations do not take into account any operational savings 
which the lease would permit to accrue sooner.
    The advantages in schedule and reduced impact to currently budgeted 
programs outweighed the results of the A-94 analysis and drove the 
leasing decision. The Air Force and Department of Defense selected 
leasing as the acquisition strategy primarily based on affordability--
by reducing the near-term cost--and minimizing the budgetary impact to 
our plans for getting accelerated capability of the new weapon system 
to our frontline troops.
    Under the lease option, the Air Force can afford to field this new 
fleet of tankers at a quicker pace than under a traditional purchase 
plan. Jumpstarting replacement of the older, less-capable tankers 
enables faster modernization of air expeditionary forces. The lease not 
only advances the first delivery by three years, it puts the 100 
aircraft fleet at the disposal of our frontline commanders for combat 
operations by FY11, five years ahead of the planned purchase. If we 
were to purchase these aircraft in a traditional buy on the same 
delivery schedule, while maintaining our financial top-line, we would 
have to take billions of dollars out of other important programs.
Implementation plans
    Under this Pilot Program, the Air Force intends to lease 100 KC-
767A aircraft with Congressional approval of the New Start 
notification. The lease program will be sole source, using terms and 
conditions germane to commercial aircraft leases and commercial 
business practices in accordance with the Federal Acquisition 
Regulation and section 8159. Terms and conditions of the lease 
arrangement meet all requirements of the FY02 Defense Appropriations 
Act including OMB Circular A-11 criteria for an operating lease. Full 
details of the lease are included in the Report to the Congressional 
Defense Committees.
    This will be a three-party contract between the U.S. Government, 
Boeing Integrated Defense Systems, and a third-party Trust, the KC-767A 
USAF Tanker Statutory Trust. The Trust will issue bonds on the 
commercial market based on the strength of the lease contract with the 
U.S. Government (rather than the credit worthiness of Boeing), will buy 
the aircraft from Boeing, and will lease them to the Government. The 
Trust will not make a profit but will provide for the funds necessary 
to pay bondholders and pay off the debt after the sale of the aircraft. 
Any residual funds acquired from the possible sale of the aircraft 
subsequent to lease termination will be refunded to the Government as 
an overpayment.
    The contract will include ``Most Favored Customer'' clauses stating 
that if Boeing sells comparable aircraft (up to 100) during the term of 
the contract for a lesser price, the Government will receive an 
equitable adjustment. Besides being a fixed-price contract, and to 
further guarantee the taxpayers receive a favorable deal, Boeing has 
agreed to a Return-on-Sales (ROS) cap of 15 percent, whereby in 2011, 
any ROS in excess of 15 percent in either commercial or military 
manufacturing centers will be returned to the Government. Again, this 
is something unprecedented in military acquisitions.
    It is not unexpected that new ways of doing business might raise 
questions or controversies. There have been several questions with 
respect to this arrangement that I would like to address.
    Analysis of alternatives: As stated earlier, the Air Force was not 
required to conduct an Analysis of Alternatives (AOA) for the KC-767 
tanker lease. There is no statutory requirement to conduct an AOA. 
Regulatory requirements for AOAs are contained in our DoD instruction, 
Operation of the Defense Acquisition System, which provides for their 
flexible application. Under ``Plan A,'' an AOA was planned to 
complement the work done under the Tanker Requirements Study and the 
Economics Service Life Study, to lead to a traditional purchase 
beginning with the delivery of one aircraft by 2009. However, the 
operational requirements of the Global War on Terror and the increased 
demand on the tanker fleet highlighted the need to accelerate the 
recapitalization of this national asset. ``Plan B,'' this lease 
program, addressed the critical need the Congress and we saw for jump-
starting recapitalization and it made good business sense.
    In fact, it is not unusual for a major program to not conduct an 
AOA. The GAO has previously stated (NSIAD-94-194), ``Applicable defense 
acquisition regulations allow management discretion in these matters 
for the purpose of minimizing development time and reducing costs.'' 
There is additional precedence for not completing an AOA when either 
the item is a commercial product or there is a low-risk in delivering a 
product that will be militarily useful. The Air Force did not complete 
an AOA for the C-130J program since this was an acquisition of a 
commercial product that had already been marketed to foreign 
customers--similar to the KC-767A Tanker. No AOAs were conducted for 
programs such as the KC-10 or the F/A-18 E/F.
    Even though the Air Force did not complete a formal AOA on the KC-
767A, we performed several trade analyses to ensure the KC-767A was the 
right solution to the operational requirements. We looked at 
maintaining the status quo, but we judged the risk too high to not 
begin the recapitalization effort now as a result of 9/11, increased 
tanker operations tempo for homeland defense and Operation ENDURING 
FREEDOM, increased operations and support costs and risks of an aging 
fleet (catastrophic/grounding event that would significantly erode our 
ability to meet our mission). We evaluated the feasibility of re-
engining KC-135Es, but this does not reduce the aging aircraft risk--we 
would still have old aircraft that will need to be recapitalized, and 
the payback of the re-engining cost AND retirement savings [if we were 
allowed to retire 31 KC-135Es] exceeds 11 years. We researched using 
``stored'' commercial aircraft, but all the aircraft had high hours, 
different engines, required heavy modifications and there were 
insufficient numbers of aircraft available to be cost effective. We 
investigated using a commercial fee-for-service, but while this has 
been successful in Navy training scenarios, it did not meet our overall 
operational requirements. We looked at other operational commercial 
platforms to include an Airbus 330, Boeing 757 and Boeing 777. The 
Airbus 330 had significant technical risk with integrating boom 
technology into the aircraft. The B-757 could not carry enough fuel to 
make it an efficient tanker. The B-777 was too large, reducing the 
airfields where the aircraft could be deployed. Finally, we researched 
the feasibility of building a new tanker from the ground up, but this 
alternative carries a much higher cost and developmental risk, and 
would not be available within the time-frame the KC-767As would be 
delivered. The decision to select Boeing was based on Boeing's response 
to our RFI, including its favorable design, schedule, risk factors, and 
boom technology.
Why we need tankers so urgently despite the 2001 Economic Service Life 
        Study Report that intimated that the current fleet would last 
        until 2040
    Much has been made about the ESLS's prediction that we could 
operate the current tanker fleet until 2040. What is rarely mentioned 
is that even the optimistic 2001 Study predicted that Operations and 
Sustainment (O&S) costs would increase 43 percent by 2040 with 15 
percent decrease in availability. The study assumed only 1 percent/year 
cost growth, but even in as little time as 18 months, that figure was 
seen as flawed. The updated report raised that figure to 1.5 percent/
year. The study was based on statistical calculations, but actual depot 
sales rates show much greater increases in O&S costs. There have been 
several studies regarding the aging aircraft.
    1995 Fatigue Life Study: Boeing and the C/KC-135 SPO continued 
their evaluation of the KC-135 expected service life with a fatigue 
analysis in 1995. This analysis indicated that the KC-135R fleet would 
not exhibit significant fatigue damage, in the absence of corrosion or 
widespread fatigue damage, until 70,000 flight hours (66,000 for the 
KC-135E).
    The Air Force and industry debate over the unknown effects of 
corrosion on fatigue life prompted the C/KC-135 SPO to contract with 
Boeing to update the fatigue life to include effects of increased 
stress from corrosion-associated material thinning. Using this combined 
``net-area'' fatigue/corrosion life, the KC-135R service life was 
adjusted to 39,000 flight hours and the KC-135E life was adjusted to 
36,000 hours. Today, the average flight-hour distribution for R models 
is 16,000-17,000 hours, and 17,000-19,000 hours for the E models. An 
Air Force/industry ``Blue Ribbon Panel'' convened in 1996 and 
acknowledged operation of the fleet out to 2040 is achievable, assuming 
aggressive corrosion control. Further analysis would conclude that the 
KC-135 service life is actually limited by age in years, not flight 
hours.
    As early as the Air Mobility Master Plan of 1995, Air Mobility 
Command (AMC) acknowledged corrosion as a ``major factor in the 
continued service life of the KC-135 forces.'' At that time, AMC 
pursued corrosion forecasting technologies and planned on initiating 
replacement of the KC-135 fleet in FY07 pending verification of the 
magnitude of the corrosion problem. The 1998 Air Mobility Master Plan 
again noted that corrosion studies were required with a notional 
replacement date of FY13. However, as more and more of these 
inspections took place, it was obvious by 2001, that our reports may 
have been overly optimistic. In Air Force studies conducted in 2001 we 
proposed a notional replacement date of FY10.
    The depot level maintenance cost growth experienced due to the 
aggressive maintenance practices implemented with the Aging Aircraft 
Program caused concern within AMC. The Mobility Master Plan of 2000 
called into question the high cost required to maintain the aging KC-
135 fleet. The plan states, ``The major factor limiting structural life 
is fleet corrosion. Previous studies did not include corrosion as a 
significant factor in the service life, nor did they address increased 
costs and decreased availability that would result from the aggressive 
maintenance practices required to maintain adequate safety margins.'' 
Consequently, previous service life estimates and projected retirement 
dates may be overly optimistic.
    1994-1995 RAND studies: The Air Force contracted RAND to conduct 
aging aircraft studies based on commercial and military aircraft fleets 
in order to determine the feasibility of long-term sustainability of 
the Air Force's aging fleets. RAND completed a series of five studies 
beginning in 1994 and ending in 1999. These studies raised technical 
concerns regarding the (1) viability of retaining commercial aircraft 
past their design lives, (2) viability of retaining Air Force aircraft 
past their design lives, (3) potential maintenance cost growth 
associated with aging aircraft, (4) potential engine cost growth, and 
(5) projection of Air Force fleet-specific Program Depot Maintenance 
(PDM) and engine cost growth through 2022. The results of the studies 
concluded that ``major support challenges may result from corrosion, 
insulation cracking, composite delamination, and other material 
degradation processes for which there are no scientific aging models or 
relevant historical experience. Most important, many of the challenges 
associated with aging material have emerged with little or no warning. 
This raises the concern that a new challenge may suddenly jeopardize an 
entire fleet's flight safety.'' The final study recommended a three-
pronged strategy for maintaining aging aircraft: (1) risk management 
strategy to identify age-related hazards that affect cost and safety 
hazards and develop solutions to reduce their effects, (2) fleet 
contingency strategy to reduce aircraft design and production lead 
times of obsolete replacement parts to minimize fleet-wide failures, 
and (3) mission management strategy to implement acquisition and 
retirement plans that balance fleet ages within mission areas, making 
the Air Force less dependent upon a particular fleet of aging aircraft.
    The Air Force has implemented two out of three prongs of RAND's 
strategy for maintaining aging aircraft. The C/KC-135 SPO's Aging 
Aircraft Program created a risk management strategy by establishing 
Major Structural Repairs and tracking their repair. The SPO also 
developed fleet contingency strategies by contracting with new vendors 
for obsolete parts. The Air Force partially implemented a mission 
management strategy with the acquisition of the KC-10s; however, 90 
percent of the refueling fleet still resides within the KC-135 fleet, 
creating the potential for fleet-wide system failure. At least partial 
recapitalization of the KC-135 fleet is needed to satisfy all of RAND's 
recommendations.
    1996 GAO study: The GAO drafted this report in 1996 to validate Air 
Force actions to preserve its aging tanker fleet and to examine the 
effects of increased demands on the services' air refueling fleets 
after Operation DESERT STORM. The study noted that ``the Air Force's 
principal tanker aircraft--the KC-135s--are 30 to 40 years old and, as 
a result, are taking progressively more time and money to maintain and 
operate.'' The results of the study noted, ``Air Mobility Command 
doubts that the KC-135 can be economically operated beyond 2020.'' This 
is the result of projected cost-per-flying-hour increases of 24 percent 
from 1996 to 2001, and historical depot labor hour increases of 36 
percent, and depot flow day (aircraft time spent in depot) increases of 
55 percent from 1991 to 1995. The study recommends recapitalizing the 
air refueling fleet with a ``dual-use replacement aircraft (that) could 
fulfill both airlift and air refueling missions.''
Negotiated Price
    The Air Force negotiated this agreement at the highest levels 
possible. We employed standard commercial ``best'' business practices 
as we negotiated the deal. We firmly believe that the Air Force price 
is the best price--the best price that can be achieved in the 
commercial market place in the real world. The difference is primarily 
one of assumptions. The Air Force treated the tanker lease as a 
commercial item. The Air Force followed the guidance for buying 
commercial items contained in Federal Acquisition Regulation (FAR) Part 
12. In addition, Section 8159 of the FY02 DoD Appropriations Act 
specifically authorized the Air Force to use terms and conditions that 
are customary in non-Government leases. The final price is a product of 
a careful analysis and market research by the Air Force and extensive 
price negotiations with the contractor. We believe the Air Force has 
received a fair and reasonable price under the lease. However, we are 
not relying solely on our price analysis. The lease agreement contains 
most favored customer provisions and a 15 percent limitation on the 
contractor's total return on sale for the tankers. In addition, the 
contractor bears the risk of delivering conforming aircraft at a fixed 
price.
    Also, the aircraft price must be viewed in a larger context. The 
aircraft must meet the performance specifications stated in the 
contract and must have a high [80 percent] operational availability 
rate. The contractor must maintain the aircraft to the specifications 
and the high (80 percent) availability rate throughout the term of the 
lease.
    In contrast, the study conducted by IDA used a different basis of 
estimate; they looked at the manufacturing process used, associated 
development costs, risk management, and contract type. Nonetheless, the 
Air Force capitalized on much of the additional information derived 
through the review by the Office of the Secretary of Defense in our 
final negotiations.
Programmed retirements
    Our plan to retire 68 KC-135Es in FY04 will increase fleet 
utilization by freeing money and personnel that would be required for 
maintaining KC-135Es that could be used on KC-135Rs. This is true even 
if we do not lease the 767. This retirement of 13 percent of the fleet 
would result in only 4 to 5 percent decrease in average sortie 
generation. If we only retire 12 aircraft in FY04 versus going with the 
original 68-reduction plan, we would need approximately $40M FY04 
dollars to cover the additional costs of keeping the E's around. This 
is based on three additional Programmed Depot Maintenance requirements 
at approx $8M a piece and thirteen additional engine overhaul 
requirements at $962K a piece. Additionally, we will need to replace 
$75M in funds offset in FY04 to divest 44 tankers. This includes flying 
hours and military personnel costs. The total bill in summary: added 
DPEM costs plus FY04 offset, $40M + $75M = $115M. The ``retire 12 in 
FY04'' plan has no monetary impact on the ``68-reduction'' plan in FY05 
and FY06, assuming that we use FY05 to ``catch up'' on aircraft 
retirements, but may require some operational workaround to account for 
the rapid retirement.
Conclusion
    I want to thank the Committee for allowing the Air Force to share 
its concerns about the need for a new tanker. I believe the KC-767A 
Multi-Year Aircraft Lease Pilot Program offers us the opportunity to 
jumpstart recapitalization of our aging KC-135 tankers. Recent events 
and increased requirements to support homeland defense have spotlighted 
our reliance on these critical refueling assets. Tanker dependence in 
recent wars and the advanced age of the Nation's air refueling aircraft 
fleet drive the Air Force's urgency to begin recapitalization as soon 
as possible. The negotiated lease proposal would provide for the 
delivery of 60 aircraft within the FYDP and field the 100th aircraft by 
2011, five years faster than current purchase plans. This minimizes 
near-term budgetary impact to other important programs.
    I fully support this leasing alternative to provide the warfighters 
with new equipment as quickly as possible. This leasing program 
supports the Air Force's essential mission requirements that support 
the defense of America.
    I appreciate the support provided by Congress and look forward to 
answering any questions this Committee has about best satisfying our 
warfighter needs in the future. Thank you for the opportunity to 
provide this statement for the record.

    The Chairman. Thank you.
    Mr. Holtz-Eakin, welcome.

STATEMENT OF HON. DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Mr. Chairman, Senator Inouye, Members of 
the Committee, thank you for the chance to be here today.
    At the request of Senator Nickles, CBO has analyzed the 
tanker lease financing plan, and I submit our report on that 
plan as my written testimony.
    In my time, let me touch briefly on three main points in 
that report, and then allow time for questions, as your 
interest indicates.
    The first point, which is illustrated in the diagram 
pointed out by Senator Fitzgerald in his opening remarks, is 
that purchases and the debt of the special-purpose entity, the 
tanker trust, should be considered Federal spending and 
borrowing. The trust exists solely for the purpose of 
purchasing these assets, and does so by borrowing money in 
order to finance that. And in the process of conducting those 
operations, the actions of the trust will be entirely 
controlled by the Air Force. For this reason, only those flows 
of money from the trust to the Boeing Corporation for purchase 
of the aircraft or from the trust to the credit markets in the 
form of construction financing or interest on bonds should be 
recorded on the federal budget. The remainder of the 
transactions between the Air Force and the trust, for example, 
should be treated as intergovernmental and not register on the 
budget.
    The Chairman. And how much is that?
    Mr. Holtz-Eakin. The flows to the Boeing Company will be on 
the average of $131 million per plane. And the total cost to 
the Air Force into the trust for purchases plus leasing, this 
is 162 million, the different represents the cost of the 
financing plan underneath this particular arrangement.
    But our view is that this particular trust should be viewed 
as part of the government. It exists to purchase these planes, 
and its spending should be considered federal spending. Its 
borrowing should be considered federal borrowing.
    The Chairman. About $30 million per aircraft.
    Mr. Holtz-Eakin. Yes.
    The Chairman. Thank you.
    Mr. Holtz-Eakin. The second point covered in the report is 
that if one were to set aside the issue of whether the trust 
is, in fact, a part of the government and look at this leasing 
arrangement as a lease, it does not satisfy the requirements to 
be treated as an operating lease in which the budgetary 
presentation would show very few entries up front and be 
heavily back-loaded, but instead should be treated as a lease-
purchase with an entry up front as the agreement to lease and 
then purchase that's entered into, changing the stream of 
budgetary flows as presented to the Congress. This is reflected 
in the first table that's included in my handout, which shows 
the difference between tanker financing as a lease-purchase, in 
the top panel, versus as an operating lease, in the middle 
panel.
    As the Members of this Committee are probably aware, 
there's a six-part test that one subjects a lease to in order 
to determine whether it's appropriate to treat it as an 
operating lease. The elements of that test are whether what is 
at hand is a general-purpose asset, whether there is a private-
sector market for this asset, whether the lease payments 
constitute more than 90 percent of the purchase--of the value 
of the asset, whether the lease contains a bargain purchase 
price as part of its arrangements, whether the lessor retains 
ownership of the asset, and whether the term of the lease is 
less than 75 percent of the asset life.
    Detailed in our report, we believe that scrutiny of this 
particular arrangement fails the test as an operating lease. 
And while we could go through on a point-by-point basis and 
examine the applicability of the criteria for an operating 
lease, I believe that the overall tenor of the arrangement is 
at odds with the spirit of an operating lease, and that even a 
close scrutiny of bright-line accounting-style tests would 
fail, and the spirit would fail, as well.
    The third main point in our report is that this approach to 
financing the purchase of these aircraft is more expensive than 
the traditional appropriations approach. Indeed, the bottom 
panel of the table, which is included in the handouts, compares 
the direct purchase of tankers. This would be the same 100 
airplanes, on exactly the same schedules. And if one were to do 
this via the appropriations process, Boeing would continue to 
receive the same $131 million for each aircraft, and the Air 
Force would, in fact--and the government pay them that much; 
however, over the life of the plan, from 2004 to 2017, the 
difference in the budgetary cost would be $5.7 billion cheaper 
in direct purchases. Or if one were to do a present value 
comparison, if one were to conduct the imaginary experiment, 
``How much would we have to set aside today in an account to 
honor the commitment to buy 100 aircraft?'' one would have to 
set aside $13.6 billion for direct purchases; whereas, one 
would have to set aside $14.9 billion to do this via the 
leasing arrangement, as proposed in the Air Force report. That 
difference, $1.3 billion, could be as large as $2 billion. It 
represents the extra cost of undertaking the purchases via an 
inefficient financing mechanism.
    And, in closing, I would point out that--
    The Chairman. Could I--
    Mr. Holtz-Eakin. Certainly.
    The Chairman.--ask you? You've got $21.5 billion if it's 
under financing plan as a lease-purchase or as an operating 
lease, and then $15.9 billion if it were direct purchase. I see 
that as a five-point-----
    Mr. Holtz-Eakin. Six.
    The Chairman.--six-billion dollar difference.
    Mr. Holtz-Eakin. The difference is due to rounding. If one 
goes out more decimals, the difference would be $5.7 billion.
    The Chairman. $5.7 billion difference between a direct 
purchase under the same schedule that the leasing is taking 
place, only with the $5.7 billion difference to the taxpayers.
    Mr. Holtz-Eakin. That's correct.
    The Chairman. Thank you.
    Mr. Holtz-Eakin. In closing, what is woven through these 
three points about in our report is that in each case the 
financing treatment transforms what is apparently a stream of 
budget authority and outlays needed in order to purchase these 
planes from being, to some extent, frontloaded to being more 
backloaded. In that process, undertaking purchases in this way 
undercuts the standard authorization appropriation process by 
placing some projects on an uneven advantage, versus others, in 
the competition for budgetary dollars. By placing these 
purchases on a level playing field, they can compete in a way 
that will reflect merely the priorities from a policy process 
and not the advantage that's gained by a special financing.
    I'd be happy to take your questions.
    [The prepared statement of Mr. Holtz-Eakin follows:]

       Prepared Statement of Hon. Douglas Holtz-Eakin, Director, 
                      Congressional Budget Office
Assessment of the Air Force's Plan to Acquire 100 Boeing Tanker 
        Aircraft
                                Contents
Summary

The Air Force's Plan to Acquire 100 Boeing Tankers

Financing Arrangements for the Proposal

The Results of CBO's Analysis

        The Tanker Financing Plan Constitutes Federal Borrowing and 
        Spending

        The Proposal Does Not Meet the Criteria for an Operating Lease

        The Proposed Financing Approach Is More Costly Than an Outright 
        Purchase

        The Air Force's Economic Analysis Understates the Cost 
        Difference

Other Considerations

        Termination Liability

        The Long-Term Affordability of Leasing and Then Purchasing 
        Tankers

TABLES

1. Comparison of Possible Budgetary Treatments of the KC-767A Tanker 
Acquisition

2. Comparison of Costs Between a Direct Purchase and the Air Force's 
Proposal

3. Major Differences Between CBO's Estimate and the Air Force's 
Estimate of the Added Cost for Leasing Versus Purchasing KC-767A 
Tankers

FIGURES

1. Costs per Aircraft Under the Tanker Financing Plan

2. Federal Outlays per Aircraft Under the Tanker Financing Plan
Summary
    The Department of Defense Appropriations Act, 2002 (Public Law 107-
117), authorized the Air Force to pursue a pilot program for leasing as 
many as 100 Boeing 767 aircraft for up to 10 years and directed the 
service to describe its plan to the Congress before entering into such 
a lease. The Air Force, Boeing, the Office of the Secretary of Defense, 
and the Office of Management and Budget (OMB) reached an agreement in 
May 2003 for the service to acquire 100 Boeing KC-767A aerial refueling 
aircraft through a complex financing arrangement. The Air Force 
submitted the required report to the Congress on July 11, 2003. In that 
report, the Air Force concludes that the proposed leasing arrangement 
meets all requirements of the Department of Defense Appropriations Act, 
2002, which specified that the terms had to be consistent with the 
criteria for an operating lease as defined in OMB Circular A-11, 
Preparation, Submission, and Execution of the Budget. The report 
further concludes that, while leasing would cost about $150 million 
more (expressed in net present value terms) than an outright purchase, 
leasing is the preferred approach because of the ``advantage it affords 
for quickly delivering needed tankers to our warfighters without 
requiring significant up-front funding.''
    After analyzing the Air Force's report and receiving additional 
information about the proposed lease from the Air Force and Boeing, the 
Congressional Budget Office (CBO) has concluded that the transaction 
would essentially be a purchase of the tankers by the Federal 
Government but at a cost greater than would be incurred under the 
normal appropriation and procurement process. The special-purpose 
entity that has been established to buy the aircraft would, in fact, be 
substantially controlled by and act on behalf of the Federal 
Government, and its transactions should be reflected in the Federal 
budget.
    Even if one were to view the arrangement as a lease, CBO's analysis 
indicates that the proposal does not meet the conditions for an 
operating lease described in the Congressional Scorekeeping Guidelines 
and in OMB Circular A-11 and thus does not comply with the terms of 
section 8159 of the Department of Defense Appropriations Act, 2002.
    Finally, CBO concludes that implementing the Air Force's proposed 
arrangement would be more expensive than the service has estimated. 
While the Air Force estimates that its proposal would cost $150 million 
more than an outright purchase, CBO's analysis indicates that the 
proposal would cost $1.3 billion to $2 billion more in present value 
terms, or 10 percent to 15 percent more than an outright purchase. On 
average, the Air Force would spend $161 million per plane in 2002 
dollars to lease and then purchase the aircraft, compared to a cost of 
$131 million per plane for an outright purchase.
The Air Force's Plan to Acquire 100 Boeing Tankers
    The Air Force plans to sign a single multiyear contract that will 
include leasing 100 KC-767A aerial refueling aircraft from a special-
purpose entity, called the KC-767A USAF Tanker Statutory Trust 2003-1 
(the Trust). The tankers will be delivered to the Air Force in six 
groups--four aircraft in 2006, 16 aircraft in 2007, and 20 planes 
annually over the 2008-2011 period. The Air Force will use each 
aircraft for six years and pay the Trust an average of $126 million a 
plane, in 2002 dollars, during that period. At the conclusion of each 
six-year period, the Air Force can return the aircraft to the Trust or 
purchase them for a price to be set when the contract is signed. The 
Air Force currently estimates the purchase price at an average of $35 
million per plane in 2002 dollars. Thus, according to its estimate, the 
Air Force will pay an average of $161 million per plane to lease and 
then purchase the tankers.\1\ The Air Force has not negotiated to 
purchase the planes directly, but on the basis of the leasing 
arrangement, CBO estimates that given multiyear procurement authority, 
the service could negotiate a contract for 100 tankers at an average 
price of $131 million per plane in 2002 dollars.
---------------------------------------------------------------------------
    \1\ Payments under the Air Force's proposal are based on a 
negotiated purchase price of $131 million in 2002 dollars. Payments 
will be adjusted for inflation using a combination of the Employment 
Cost Index and the Industrial Commodities Index.
---------------------------------------------------------------------------
    The Air Force will be able to terminate the deal prior to the 
completion of the contract by notifying the Trust one year in advance. 
However, that termination would be costly because the Air Force would 
have to make an additional payment equal to an annual lease payment on 
each aircraft and would have to reimburse the Trust for any additional 
costs that resulted from the decision to terminate.
Financing Arrangements for the Proposal
    Boeing and the Air Force have established the special-purpose 
entity to execute the leasing arrangement and to finance the 
acquisition of the aircraft. Under the financing plan established by 
the Air Force and Boeing, the Trust will buy 100 KC-767A tankers from 
Boeing at an estimated average price of $131 million per aircraft (in 
2002 dollars) and will borrow money to make progress payments to Boeing 
during the construction period for each group of aircraft.
    As Boeing completes construction of each group of tanker aircraft, 
the Trust will issue bonds in the commercial bond market. Boeing and 
the Air Force estimate that the proceeds from the bonds will need to 
equal $138.4 million per aircraft (in 2002 dollars), enough to pay 
Boeing for the remainder that it is owed for the aircraft, repay the 
principal on the construction loans, and pay interest on the 
construction loans, which the Air Force estimates at an average of $7.4 
million per aircraft.
    Press reports indicate that there will be three classes of bonds. 
The Trust, which will technically own the aircraft, will use the Air 
Force's annual lease payments to pay principal and interest on two of 
the three classes of bonds. If the aircraft are sold at the end of the 
lease term, the proceeds will be used to pay off principal and interest 
on the last class of bonds. The price the Air Force may pay to acquire 
title to the tankers will be established for all 100 planes at the time 
the contract is awarded. That amount will be equal to the principal and 
interest owed on the third class of bonds. Under the terms of the 
agreement, if the Air Force should choose to forgo purchasing the 
aircraft and the aircraft are then sold to another purchaser for more 
than the amount owed on the bonds, any profits from the sale will be 
returned to the U.S. Treasury.
    According to the Air Force and Boeing, the credit rating on the 
bonds will be based on the strength of the cash flow from the Air 
Force, rather than on Boeing's credit rating. For that reason, the Air 
Force expects that the Trust will be able to issue bonds at interest 
rates that are only slightly greater than Treasury rates. Interest 
rates on the bonds must compensate investors for the risk that the Air 
Force might terminate the contract early or might decline to purchase 
the aircraft at the end of the lease. CBO believes that the small risk 
premium estimated by the Air Force on borrowing by the special-purpose 
entity indicates that the Air Force assumes the market will perceive 
the debt as being backed by the Federal Government. (See Figure 1 for a 
graphic display of the financing arrangements.)
The Results of CBO's Analysis
    CBO reviewed the information contained in the Air Force report, 
sections of the proposed contract, and the economic analysis prepared 
to support the Air Force's decision to lease. CBO found that the 
financing plan envisioned for acquiring the tankers constitutes Federal 
borrowing and spending under standard government accounting 
principles.\2\ CBO also concludes that the proposal does not meet the 
conditions for an operating lease described in OMB Circular A-11 and 
thus does not comply with the terms of section 8159 of the Department 
of Defense Appropriations Act, 2002. While the Air Force acknowledges 
that acquiring the aircraft with this financing method is more 
expensive than purchasing them outright, its estimate of the extra 
cost--at $150 million--is much less than CBO's analysis indicates. CBO 
concludes that the Air Force would pay $1.3 billion to $2 billion 
(expressed in net present value terms) more to lease and then purchase 
the tankers than it would to purchase them outright.
---------------------------------------------------------------------------
    \2\ The 1967 Report of the President's Commission on Budget 
Concepts suggests a broad definition of Federal budget activities, with 
a few narrow exclusions. It observes that ``providing for national 
security . . . obviously constitutes activities of the Federal 
Government which should clearly be in the budget.'' Consistent with 
other recommendations by the Commission, CBO believes that when the 
government owns a significant part of an entity's assets or exercises 
substantial control over the entity's operations, that entity should be 
included in the Federal budget.


  1.  As Boeing builds the tankers, the Trust will borrow money from 
        commercial banks to make progress payments to Boeing. CBO 
        estimates that, on average, the Trust will borrow approximately 
---------------------------------------------------------------------------
        $105 million per plane for progress payments.

  2.  Shortly before the planes are delivered, the Trust will issue 
        bonds to raise $138.4 million per plane in permanent financing.

  3.  The Trust will use the bond proceeds to pay principal and 
        interest on the construction financing loans, which CBO 
        estimates will average $112.4 million per plane.

  4.  The Trust will use the rest of the bond proceeds to pay Boeing 
        the remainder it is owed on the aircraft. Total payments to 
        Boeing will equal $131 million per plane.

  5.  Boeing will transfer title to the planes to the Trust and deliver 
        the aircraft to the Air Force.

  6.  The Air Force will make lease payments totaling $126 million per 
        plane and a final payment of $35 million should it choose to 
        purchase the planes at the end of the lease.

  7.  The Trust will use the Air Force's lease and purchase payments to 
        remit $161 million in principal and interest to the 
        bondholders.

    SOURCE: Congressional Budget Office.
The Tanker Financing Plan Constitutes Federal Borrowing and Spending
    In its report to the Congress, the Air Force indicates that the 
Administration will record the tanker contract as an operating lease in 
the Federal budget once the contract is signed. Consequently, 
obligations and outlays will be recorded on a year-by-year basis, 
reflecting the lease payments due each year to the Trust. CBO believes 
that recording the transaction as such would be at odds with standard 
government accounting principles because the proposed financing 
constitutes Federal borrowing and spending. Therefore, the borrowing, 
resulting aircraft purchases, and interest payments by the special-
purpose entity established specifically for this purpose should be 
recorded in the budget at the time the Trust makes those transactions.
    The proposed contract between Boeing and the Air Force, as well as 
the financing arrangement, clearly indicates that the KC-767A USAF 
Tanker Statutory Trust 2003-1 exists solely to borrow money on behalf 
of the Federal Government to allow the Air Force to acquire an asset 
that has been built to its unique specifications. The borrowing 
activities of the special-purpose entity will be directed by a 
financing committee composed of the Air Force, Boeing, and the lease 
administrator. (The Air Force has asked Boeing to serve as the lease 
administrator.) Under the operating guidelines for the financing 
committee, the Air Force must approve all of the terms and conditions 
for the financing plan and must review and approve all financing 
documents.\3\ CBO concludes that the actions of that committee will be 
explicitly controlled by the Air Force.
---------------------------------------------------------------------------
    \3\ Boeing provided CBO with a summary of the operating guidelines 
for the financing committee. It is available upon request.
---------------------------------------------------------------------------
    Because the government will both direct and benefit from the 
Trust's financing activities (see Figure 2), the Trust will be acting 
on behalf of the government. Therefore, its borrowing and spending 
should be treated as Federal borrowing and spending and recorded 
appropriately in the budget.\4\ The parties to the lease portion of the 
contract are the Air Force and the Trust. Since the Trust is an 
instrument of the government, the government will effectively be buying 
the aircraft (via the Trust) and then leasing them to itself. To 
accurately reflect the nature of that arrangement, the Federal budget 
should report the transactions between the Trust and Boeing, and 
between the Trust and its bondholders, not the essentially 
intragovernmental transfers between the Trust and the Air Force. Thus, 
when the Trust pays Boeing for the aircraft, those payments should be 
reflected as Federal outlays. Subsequent interest payments on the 
Trust's borrowing should also be reflected as outlays when those 
payments are made. (Federal borrowing is not counted as a governmental 
receipt, and the repayment of principal is not counted as an outlay.)
---------------------------------------------------------------------------
    \4\ The Universal Service Fund is another example of a Federal 
program administered by a private agency for the Federal Government. 
The Universal Service Access Company (USAC), an independent 
organization that is regulated by the Federal Communications 
Commission, collects ``contributions'' from telecommunications service 
providers and makes payments to other service providers to ensure 
universal access to telecommunications services. Even though the 
collections and disbursements are not handled by the Treasury, USAC's 
transactions are included in the Federal budget. In 2002, the agent 
recorded revenue collections of $5.5 billion and expenditures of $5.1 
billion in the Federal budget.


---------------------------------------------------------------------------
    SOURCE: Congressional Budget Office.

    Table 1 displays how that budget authority and the associated 
outlays should be recorded in the budget compared with how CBO believes 
the department might reflect the contract in the budget. The table also 
shows CBO's estimate of the cost to purchase the tankers directly using 
traditional procurement methods. For budget purposes, all amounts are 
shown in current dollars.
    The two budgetary treatments of the financing plan differ 
substantially. If the proposed transaction is recorded as a purchase, 
budget authority over the first five years would total $17.3 billion, 
and outlays would sum to $10.1 billion. If the transaction is recorded 
as an operating lease, only $1.5 billion in budget authority would be 
shown over the first five years, and outlays during that period would 
also total only $1.5 billion, because most of the aircraft would not be 
available for leasing until 2009.


    SOURCE: Congressional Budget Office.

    NOTES: In the treatment of the financing plan as a lease-purchase, 
budget authority reflects the obligation by the Trust to purchase 
aircraft from Boeing and the obligation to make interest payments to 
creditors. Outlays reflect payments to Boeing during the time that it 
takes to construct and deliver the aircraft, as well as interest 
payments to creditors. In the treatment as a lease, budget authority 
and outlays equal annual lease payments. In the estimate of a direct 
purchase, budget authority and outlays reflect estimated costs of a 
straightforward purchase using the normal appropriation and procurement 
methods.

    The figures do not include funding for operations and support or 
for military construction projects to house and maintain the new 
tankers.

    a. If the Trust is not considered an instrument of the Federal 
Government, the acquisition should be treated as a lease-purchase. 
Consistent with Congressional Scorekeeping Guidelines and OMB Circular 
A-11, the budgetary treatment would be similar to that of a purchase.

    b. The difference in total cost between a direct purchase and 
either treatment of the financing plan is almost $5.7 billion in 
current dollars.

    In total, by CBO's estimates, acquiring the tankers through a lease 
would cost $21.5 billion over the next 14 years. In contrast, CBO 
estimates, a direct purchase of 100 tankers would cost $15.9 billion 
over the same period--but with all of the outlays recorded by the end 
of 2011.
    Budget authority and outlays for the Air Force's proposed lease 
have two compo-nents: the purchase price of the aircraft and the 
interest costs from the financing arrangement. (Those costs include the 
additional expense of borrowing money at rates that exceed Treasury's 
normal borrowing rates.) If the Air Force's proposal is recorded in the 
budget as a purchase, the purchase price of the aircraft would appear 
in the first few years when the planes were being constructed, and 
interest would be recorded annually as the lease payments were made. Of 
the $21.5 billion shown in Table 1, $17.1 billion is for the purchase 
price of the aircraft, while budget authority for the imputed interest 
would total $4 billion over the 2006-2017 period. The remaining $0.4 
billion would pay for insurance and other lease costs. Outlays for the 
purchase price, which would occur over the 2004-2011 period, would 
reflect progress payments during the construction period and final 
payments when the planes were delivered. Outlays for imputed interest 
charges would coincide with lease payments and would equal the annual 
budget authority for those charges.
    Alternatively, if one chooses not to view the special-purpose 
entity as an instrument of the government, CBO concludes the 
arrangement should be reflected in the budget as a lease-purchase, not 
an operating lease as suggested by the Air Force and Boeing. In that 
case, the budgetary treatment would be similar to that of the financing 
plan treated as a purchase (shown in Table 1).\5\
---------------------------------------------------------------------------
    \5\ For a more in-depth discussion, see Congressional Budget 
Office, The Budgetary Treatment of Leases and Public/Private Ventures 
(February 2003).
---------------------------------------------------------------------------
The Proposal Does Not Meet the Criteria for an Operating Lease
    After reviewing the details of the proposal, CBO concludes that it 
does not meet the conditions for an operating lease described in OMB 
Circular A-11 and thus does not comply with the terms of section 8159 
of the Department of Defense Appropriations Act, 2002.
    To comply with section 8159 and to be treated as an operating lease 
in the budget, the lease must meet the following six criteria:

   The asset must be a general-purpose asset, not built to 
        unique government specifications.

   There must be a private-sector market for the asset.

   The present value of the lease payments cannot exceed 90 
        percent of the asset's fair market value at the start of the 
        lease.

   The lease cannot contain a bargain-price purchase option.

   Ownership of the asset must remain with the lessor.

   The lease term cannot exceed 75 percent of the asset's 
        useful life.

    CBO has concluded that the arrangement between Boeing and the Air 
Force fails to meet the first four of these criteria and complies with 
the letter but not the spirit of the fifth.
    The Lease Must Be For a General-Purpose Asset. Operating leases 
must be for a general-purpose asset, not one that is built to the 
unique specifications of the government. An aerial refueling tanker is 
not a general-purpose asset. Although the tanker is based on Boeing's 
commercial 767-200 model, the Air Force has specified several 
significant modifications such as auxiliary fuel tanks, a refueling 
boom, a refueling receptacle, more powerful generators, and heavier 
wiring to accommodate unique military requirements. The tanker's aerial 
refueling capability serves a uniquely governmental purpose.
    There Must Be a Private-Sector Market. A private-sector market must 
exist for any asset obtained through an operating lease. The Air Force 
and Boeing assert that the lease meets this criterion because Boeing 
has offered the tanker, called the Global Tanking and Transport 
Aircraft (GTTA), for public sale. However, the only customers for the 
GTTA so far are the U.S. Air Force, the government of Japan, and the 
government of Italy, all of which plan to use the aircraft to refuel 
their military aircraft. Boeing states that there are a number of 
private companies that might purchase GTTA aircraft--Omega Air and the 
Tanker and Transport Service Company Ltd., in particular. CBO does not 
believe that those companies would buy more than a few of the tankers.
    Boeing also points out that some long-haul commercial air carriers 
may be interested in acquiring the capability for aerial refueling, but 
none currently employs the technique. CBO believes it unlikely that 
aerial refueling would make economic sense for commercial 
transportation companies because they already have access to ground-
based refueling services at airfields worldwide. Finally, while Boeing 
cites many potential customers for the freighter capability inherent in 
the tanker, how many of the 100 tankers reconfigured as freighters the 
private market would be able to absorb is unclear.
    There are only about two dozen outstanding orders for all Boeing 
767 variants. The KC-767A is derived from the Boeing 767-200C variant, 
for which Boeing has no version of 767-200 aircraft occurred in 2002, 
and Boeing has no future orders because it now produces 767 models that 
are superior to the 767-200. Thus, while there may be a private-sector 
market for a few of the aircraft that the government is acquiring, 
there is no evidence of such a market for 100 tanker aircraft.
    Lease Payments May Not Exceed 90 Percent of the Fair Market Value. 
To qualify as an operating lease, the net present value of the lease 
payments may not exceed 90 percent of the fair market value of the 
aircraft. The Air Force report indicates that the lease payments under 
the proposed financing arrangement will account for 89.9 percent of the 
fair market value of the aircraft, which the Air Force calculates at 
$138.4 million (in 2002 dollars) when the cost of the construction loan 
financing ($7.4 million per aircraft) is included. CBO believes that 
including the cost of that financing as part of the aircraft's fair 
market value is inappropriate because that cost is additional to any 
interest that would be capitalized in the price of the aircraft in the 
purchase option. When the financing cost is excluded from the 
calculation, the net present value of the lease payments accounts for 
93 percent of the fair market value.
    CBO also notes that, even using the Air Force's methodology, there 
is a significant possibility that the threshold of 90 percent of the 
fair market value could be exceeded for at least some of the groups of 
leased tankers. The lease payments are based on the Air Force's 
estimate of bond interest rates. If the rates for Treasury bonds are 
higher than the predicted value used by the Air Force, or if the spread 
on the interest rates for the bonds issued by the Trust is greater than 
predicted, lease payments will increase accordingly. Since the Air 
Force already estimates that the present value of the lease payments 
will be 89.9 percent of the fair market value, it has no margin for 
error on its estimate of interest rates.
    The Lease Cannot Contain a Bargain-Price Purchase Option. The lease 
cannot contain an option to purchase the aircraft at a bargain price. 
The agreement gives the Air Force the option to purchase the aircraft 
at any time during or at the end of the lease. The Air Force estimates 
that it could purchase the aircraft at the end of the lease for an 
average $35 million apiece (in 2002 dollars), or 28 percent of the cost 
to purchase new tankers. Since the aircraft should last at least 30 
years, the aircraft should have 80 percent or more of their life 
expectancy remaining after six years. While it is difficult to 
establish the fair market value of used tanker aircraft, CBO believes 
that paying 28 percent of the cost of a new tanker for a used aircraft 
with 80 percent of its life left constitutes a bargain purchase price.
    Ownership Must Remain With the Lessor. Under the operating lease, 
ownership must remain with the lessor, and title may not transfer to 
the government at or shortly after the end of the lease term. CBO 
believes the Trust is an instrument of the government, given the level 
of control the government exercises over its operations. Thus, the 
Trust is effectively purchasing the tankers for the government.
    However, if one chooses not to view the Trust as an instrument of 
the government, the financing arrangement technically complies with 
this criterion since the purchase option is contingent upon subsequent 
authorization and appropriation by the Congress. It seems clear for 
several reasons, however, that the Air Force fully intends to acquire 
the tankers during or at the end of the lease term.
    First, the Air Force and Boeing plan to negotiate a purchase price 
for each group of planes when the contract is awarded. The Air Force 
has the right of first refusal on the disposal of the aircraft at the 
end of the six-year term. The Air Force has also stated its intention 
to earmark funds to purchase the aircraft.
    Second, senior Department of Defense officials have stated on 
several occasions that the department has a long-term requirement for 
tankers and that the department plans to replace the entire fleet of 
KC-135 aircraft over the next 30 years. It seems implausible that the 
Air Force would return the 100 leased tankers to the Trust since the 
Air Force plans to retire 68 KC-135E tanker aircraft over the 2004-2006 
period regardless of whether the lease is approved and will retire all 
131 KC-135E aircraft by 2008 if the lease is approved. Moreover, it 
would have to accept a significant reduction in its aerial refueling 
capability if it chose not to purchase (or continue to lease) the KC-
767 tankers at the end of the six-year term.
    Finally, the Air Force's basing plan for the tankers includes more 
than $600 million in construction projects to support the permanent 
basing of the aircraft. Spending those funds would be uneconomical if 
the Air Force was seriously considering returning the aircraft at the 
end of the lease term.
The Proposed Financing Approach Is More Costly Than an Outright 
        Purchase
    The proposed financing arrangement to acquire the tanker aircraft 
is significantly more expensive than an outright purchase by the 
government because of the anticipated interest rates (which are higher 
than U.S. Treasury rates) and other costs that are unique to the 
leasing option. By CBO's estimates, total costs for a direct purchase, 
including the estimated costs for self-insurance, would be about $16 
billion (see Table 2). The Air Force reports that it will pay $17 
billion to lease the aircraft for six years and more than $4 billion to 
purchase them at the end of the lease term. Those payments include the 
interest expense on borrowing by the special-purpose entity. The Air 
Force will also pay about $400 million for insurance and other expenses 
related to the lease transactions. Thus, the Air Force estimates that 
the costs of acquiring the aircraft under the financing arrangement 
will total almost $22 billion in current dollars. On a present value 
basis, the leasing approach would cost $1.3 billion more than an 
outright purchase, CBO estimates. (The Administration uses a 
discounting methodology specified in OMB Circular A-94, Guidelines and 
Discount Rates for Benefit-Cost Analysis of Federal Programs, which, 
CBO estimates, would result in a greater cost difference of $2 billion 
relative to a purchase.)


    SOURCE: Congressional Budget Office.

    NOTE: * = Less than $500 million.

    a. If the Air Force were to purchase tankers directly, it would 
``self-insure.'' The value of insurance is shown here to make the total 
cost of the ``direct purchase'' option comparable to the Air Force's 
proposal.
The Air Force's Economic Analysis Understates the Cost Difference
    In its report to the Congress, the Air Force indicates that leasing 
100 air refueling aircraft will cost $150 million more than an outright 
purchase in net present value terms (see Table 3). CBO's analysis 
indicates that the estimate significantly understates the additional 
cost associated with the Air Force's plan. The Air Force, in fact, does 
not rule out that possibility, stating that ``had the Congress chosen 
instead to provide multiyear procurement authority and had the 
Department of Defense been able to accommodate that execution while 
preserving program stability, the [net present value] could favor 
purchase by up to $1.9 billion.'' \6\ The Air Force's report notes that 
this type of analysis is ``highly sensitive to the underlying assump-
tions'' but that ``in no case approved by OMB did the financial 
analysis indicate that the net present value of the lease option as 
being less than that of a traditional purchase.''
---------------------------------------------------------------------------
    \6\ The Air Force appears to attribute the large difference to the 
effects of multiyear procurement alone. In fact, CBO's analysis 
indicates that the assumption of multiyear procurement accounts for 
only $970 million of the $1.9 billion difference.


---------------------------------------------------------------------------
    SOURCE: Congressional Budget Office.

    Multiyear Procurement. For the lease, the Air Force and Boeing 
negotiated a price for the aircraft as delivered to the Trust on the 
basis of the assumption that the Air Force would ultimately lease and 
acquire 100 airplanes. That assumption allows Boeing to make 
investments in facilities and equipment that will reduce the total 
costs of production. It also allows Boeing to purchase parts and 
components in large quantities to get price breaks from suppliers. For 
its analysis of the purchase option, however, the Air Force assumed 
that each lot of aircraft would be bought on an annual basis (that is, 
with no assurances of subsequent purchases). Thus, no price breaks or 
production efficiencies were included in the estimated purchase prices.
    For the purchase option, the Air Force increased the price of each 
aircraft by 7.4 percent relative to the price that it used for the 
lease. CBO believes that estimating the purchase cost under the 
assumption that a multiyear contract would be granted is warranted 
because, under section 8159, the Congress has already granted authority 
for the lease and would likely grant such authority for an acquisition 
program of that size. The Air Force's statement that it did not assume 
a multiyear procurement in its analysis of a purchase because it did 
not currently have that authority is inconsistent with its budgetary 
practices for other major acquisition programs. The department does not 
currently have multiyear procurement authority for either the F-22 
fighter or the Joint Strike Fighter programs but assumes multiyear 
procurement in estimating the future purchase costs of those aircraft.
    CBO estimates that the cost to acquire 100 KC-767A tankers under 
the proposed financing arrangement would exceed the cost of purchasing 
the aircraft under a multiyear contract by $1.1 billion (expressed in 
net present value terms), an increase of $970 million relative to the 
Air Force's results. Although the Congress has already granted 
multiyear authority for the lease, in traditional procurement programs, 
that authority is frequently provided after several years of production 
prove that the program is stable. If the Congress waited until the 
third lot to grant the authority, then, by CBO's estimates, the lease 
would cost $920 million more than the purchase, an increase of $765 
million relative to the Air Force's estimate.
    Inflation of Progress Payments. The Air Force's method for applying 
inflation to progress payments is another factor that affects the 
purchase price in its analysis. During the construction period, a 
contractor is continually paying for materials and labor. If the 
government paid the contractor for the full price of the asset at the 
time of delivery, the contractor would have to borrow money to cover 
those expenses and include the full costs of that borrowing in the 
purchase price. Progress payments reimburse the contractor for the 
costs the company incurs during the construction period and reduce the 
requirement for the contractor to borrow the money to cover expenses--
resulting in a lower purchase price for the government. The government 
usually limits progress payments to a percentage of the actual costs 
incurred at the time the request for payment is made.
    In its analysis of the cost of a straightforward purchase, the Air 
Force estimated progress payments as a percentage of the tanker's 
price, which it inflated to the year of delivery. CBO believes that 
that method overstates both the amount of the progress payments and the 
total cost of the aircraft since inflation would affect the cost of 
material and labor only up to the time those costs were paid. The 
method also conflicts with the DOD Comptroller's guidance on inflation, 
which calls for inflating costs to the year the order is made, using an 
inflation index that takes into account the fact that outlays will 
occur incrementally between the date the order is placed and the date 
the asset is delivered. CBO estimates that if the cost of progress 
payments were inflated only to the time those costs were paid, then the 
cost of the leasing arrangement would exceed the cost of a 
straightforward purchase by an additional $640 million (in net present 
value terms).
    Schedule for Progress Payments. The schedule for making those 
progress payments is also a factor that affects the purchase price in 
the Air Force's analysis. For the option of purchasing the aircraft, 
the Air Force assumed that progress payments would begin approximately 
four years before the aircraft were delivered. The assumed payment 
schedule seems protracted for several reasons. First, the schedule is 
longer than that of other major aircraft procurement programs. For 
example, the budget for the C-17 transport program provides advance 
procurement funding just two years before the delivery date. Other 
procurement programs, like that for the F-22 fighter, assume that the 
majority of the progress payments are made over three years.
    Second, the Air Force's aircraft procurement programs spend, on 
average, about 90 percent of budget authority within three years after 
appropriation. In contrast, the progress-payment schedule that the Air 
Force used in calculating the costs of purchasing tankers would expend 
only 75 percent of budget authority in three years, with the last 25 
percent of the payments in the fourth year. That progress-payment 
schedule does not appear to reflect the Air Force and Boeing's plan to 
deliver the first KC-767A tanker approximately 34 months after lease 
approval and to deliver subsequent aircraft on an even faster schedule.
    Using a four-year progress payment schedule increases the cost of 
the purchase option in net present value terms because it brings 
forward a large portion of the payments into a period in which the 
discount factors have less impact. The method appears to conflict with 
the Department of Defense's Financial Management Regulation, which 
limits progress payments to a percentage of incurred costs, because it 
would make payments before work commences. Using a three-year schedule 
for progress payments (one more in line with historical outlay rates 
for procuring aircraft) would defer some payments for one year relative 
to the schedule used in the Air Force analysis and would reduce the 
cost of the purchase by about $210 million in net present value terms.
    Discount Rates and Interaction Among The Factors. The results of 
any economic analysis are sensitive to changes in the discount rate 
selected. Changes in the discount rate also affect the costs associated 
with assumptions made about multiyear procurement and progress 
payments. CBO has calculated the present value of cash flows associated 
with the planned acquisition of tanker aircraft by discounting the 
estimated cash flow for each year using the interest rate on a 
marketable zero-coupon Treasury security with the same maturity from 
the date of disbursement as that cash flow. That method--often referred 
to as the ``basket of zeros'' discounting approach--is used by both CBO 
and OMB for calculating estimates of loan subsidies under the Federal 
Credit Reform Act. Although the tanker acquisition plan does not 
explicitly involve a direct loan or Federal loan guarantee, the 
financing of tankers would result in a series of annual cash flows that 
have to be matched by the Trust's borrowing (on behalf of the 
government). Using the basket of zeros to discount that stream of cash 
flows most accurately reflects the time value of money. Under CBO's 
approach, the acquisition plan would cost about $1.3 billion more--in 
present value terms--than an outright purchase would.
    In contrast, the Air Force's analysis relied on the simplified 
discounting method provided in OMB Circular A-94, which advises using a 
single discount rate (as opposed to the ``basket of zeros''). In 
implementing the guidelines, the Air Force used a nine-year Treasury 
rate, based on a three-year construction period and a six-year lease 
term, to discount the lease payments. CBO estimates that this 
assumption would result in an additional cost to leasing of $1.7 
billion.
    However, CBO believes that if a single discount rate is used, the 
relevant period of analysis should be six years, since the Trust will 
issue bonds that mature in no more than six years. CBO estimates that 
using the Administration's method with a single six-year discount rate 
would yield an even larger present value difference--a greater cost of 
about $2 billion for the Air Force's plan.
Other Considerations
Termination Liability
    Under the terms of the agreement, the Air Force can terminate the 
lease prior to the completion of the lease term for its convenience. 
However, exercising that option would be expensive for the Air Force 
because of the requirement to pay penalty payments, unamortized costs 
of the development of the tankers, and additional costs that would 
arise from its decision to terminate. If it terminates the lease, the 
Air Force might take delivery of the tankers under construction, make 
one year's lease payment, and within a year, return them to the Trust 
along with the penalty payment. Alternatively, it might choose to pay 
Boeing for the costs of work performed before the decision to 
terminate. CBO estimates that termination liability could be as high as 
$5 billion to $7 billion in some years. Under the authority in section 
8117 of the Department of Defense Appropriations Act, 2003, the Air 
Force does not intend to set aside budget authority to cover this 
contingency and therefore would need an appropriation from the Congress 
to do so. Given the potential size of the liability and the fact that 
the Air Force does not intend to budget for it, CBO believes it is 
extremely unlikely that the Air Force will terminate the lease.
The Long-Term Affordability of Leasing and Then Purchasing Tankers
    The Air Force states that its primary reason for choosing this 
financing arrangement is the favorable budgetary treatment that it will 
receive. This treatment would allow the service to get the tankers 
today without displacing other programs from its budget. However, the 
budget will eventually have to reflect the Air Force's decision to 
acquire the tankers. When those obligations are eventually recorded, 
mostly over the 2008-2017 period, they will create additional budgetary 
pressure in those years.
    The Air Force report acknowledges that the lease is a more costly 
method to acquire the tankers, but the Air Force believes that its 
decision to pursue the method is justified by lower up-front costs. 
Total costs to the government are higher under the lease (almost $5.7 
billion in current dollars, according to CBO's estimate), however, so 
rather than eliminating difficult budgetary decisions, the lease merely 
postpones them.
    There is no reason to believe that the Air Force itself will have 
more budgetary flexibility 10 years from now than it has today. In 
2012, for example, the Air Force will be making lease payments on the 
tankers that were delivered over the 2007-2011 period--about $2.9 
billion (in current dollars) a year in payments. It will also have to 
begin purchasing the leased tankers at an estimated cost of $4.4 
billion over the 2012-2017 period. Finally, the Air Force will have to 
decide how to replace the rest of its KC-135 fleet. Should the Air 
Force choose to buy more than 100 KC-767s, it would need to start 
purchasing those additional tankers in 2011 to keep the Boeing 767-200 
production line in operation. Procuring 20 tankers annually would cost 
about $3 billion each year in current dollars, CBO estimates. Designing 
and building a new tanker would probably cost more and taker longer.
    But the Air Force will not just be buying tankers with its aircraft 
procurement funds over this period. Other Air Force programs will 
require significant sums also. According to the Administration's 
published plans and cost estimates, by 2012 the Air Force will be 
buying 110 Joint Strike Fighters annually at a cost of almost $7 
billion per year. Together, those two programs would consume about 70 
percent of estimated funding for procuring aircraft. Thus, CBO 
concludes that the Air Force will likely be faced with making difficult 
budgetary decisions over the longer term also.

    The Chairman. Thank you very much.
    Mr. Curtin?

             STATEMENT OF NEAL P. CURTIN, DIRECTOR,

              DEFENSE CAPABILITIES AND MANAGEMENT,

            UNITED STATES GENERAL ACCOUNTING OFFICE

    Mr. Curtin. Thank you, Mr. Chairman and Members of the 
Committee. I appreciate the opportunity to be here today to 
present GAO's observations on the Air Force's proposal.
    Since my full statement will be placed in the record, I 
want to take just a few minutes here to highlight some of these 
considerations.
    First, the Air Force acknowledges that leasing is more 
expensive than purchase, but its analysis indicates a net 
present value difference of only $150 million, favoring 
purchase, and that's out of a total program estimate of about 
$17 billion. Since this type of analysis is so sensitive to the 
assumptions used, we conducted additional sensitivity analysis 
to show the range of comparison between lease and purchase, and 
some of the sensitivity analysis shows the cost difference in 
favor of purchase could be as much as $1.9 billion in net 
present value; and that's an extra cost of over 10 percent for 
lease versus purchase, rather than the 1 percent extra shown in 
the Air Force report. We think----
    The Chairman. Could I interrupt a second, Mr. Curtin?
    Mr. Curtin. Sure.
    The Chairman. You're saying it's a one-point-----
    Mr. Curtin. $1.9 billion in net present value. That's 
somewhat equivalent to the CBO numbers, $1.3 billion, except 
for some differences in discount rates there. I think----
    The Chairman. That was my question.
    Mr. Curtin.--I think there's a $600 million difference in 
the interest rates.
    Mr. Holtz-Eakin. And in one of the details of our report, 
we have an estimate that's $2 billion if you use an interest 
rate assumption similar to this.
    Mr. Curtin. So we're pretty much----
    Mr. Holtz-Eakin. We're in the same ball park.
    Mr. Curtin.--the same. So that's part of the difficulty----
    The Chairman. Sure.
    Mr. Curtin.--of net present value analysis.
    Senator Stevens. Did either of your analysis include the 
savings of expenditures for maintenance?
    Mr. Curtin. No, sir, not ours.
    Senator Stevens. You don't take into account at all the 
savings of all these planes that are in platform being 
repaired.
    Mr. Curtin. Well, one comment on that. I mean, I recognize, 
yes, we'll be retiring over a hundred of these KC-135Es, and 
there are clearly maintenance savings there. The KC-767s are 
not without a maintenance cost, however. And I'm going to talk, 
in my statement, about the agreement the Air Force has made 
with Boeing to provide operations and support--you know, 
maintenance support for these aircraft, and that could be in 
the order of $6 million a year in this. It could be in the 
order of $5 billion over the course of this lease. So----
    Senator Stevens. It doesn't come close to the $5.5 billion 
savings in this estimate, in terms of----
    Mr. Curtin. Well, I think it's pretty close. We haven't 
done the analysis to compare exactly what the net difference in 
maintenance will be, but it's--it seems fairly close, from the 
analysis we've done.
    Mr. Holtz-Eakin. Mr. Senator, in our analysis, we've done 
an apples-to-apples comparison of the purchase of the same 
planes and the same schedule by two different financing 
schemes. Since the operation and maintenance would be the same 
in both cases, it's common to both, and the difference doesn't 
depend on that kind of an analysis.
    Senator Stevens. What?
    Mr. Holtz-Eakin. Ours is an apple-to-apples comparison.
    Senator Stevens. You're taking a 44-year-old plane and a 
one-year-old plane?
    Mr. Holtz-Eakin. In our analysis, we would replace the same 
old planes with the same new planes, and so the only difference 
is due to the lease method of financing the purchases.
    Senator Stevens. Now I know why we're running up such 
deficit, if that's the way you keep the books.
    The Chairman. Please proceed, Mr. Curtin. Thank you.
    Mr. Curtin. A second point. The Air Force does really not 
make a case that leasing is cheaper. Instead, the real argument 
is that there's an urgent need to begin replacing the current 
tanker fleet, and leasing provides the aircraft earlier and 
more quickly than purchase, under current budget constraints. 
Leasing would provide the first planes in August 2006. Whereas, 
under the current procurement plan in the Air Force long-term 
budget, the first planes would not be received until Fiscal 
Year 2009.
    In our view, the urgency of the need is really a matter of 
how much risk the Air Force and the Congress are willing to 
accept. The Air Force has not made replacement of the tanker 
fleet a procurement priority in past years. We pointed out, as 
Senator Cantwell mentioned, that, as far back as our 1996 
report, that, yes, even then those were 35-year-old aircraft, 
and the Air Force needed to start looking at replacement in an 
orderly manner for that KC-135 tanker fleet. The Air Force 
said, at the time, and up until about 18 months ago continued 
to say that tankers were a lower priority and replacement could 
wait until later in this decade.
    The KC-135s are increasingly difficult and expensive to 
maintain. No question. But the Air Force has been able to meet 
the heavy demands of the past two years with the existing 
fleet. The risk is that the aging planes would incur some 
fleet-wide problem in these intervening years that would 
jeopardize the mission, and there's really no way to predict 
how likely that is or how serious such a fleet-wide grounding 
might be.
    A third point. The Congress also needs to be aware that, as 
part of this lease agreement, DOD plans to contract with Boeing 
for logistic support. That will total over $5 billion during 
the period of the lease. It comes to an average of about $6.4 
million per year per aircraft for the KC-135s, in constant 
fiscal-year-2002 dollars. Boeing would handle all the 
maintenance above flight-line level.
    We don't know, at this point, to what extent the Air Force 
considered other options for maintenance, such as competition 
or public-private partnerships, which might have bee more 
economical. There are many private contractors who perform 
maintenance now on commercial 767s. We've asked the Air Force 
for documentation on how they arrived at this pricing level for 
the maintenance agreement with Boeing, but what we've gotten 
from the Air Force really did not shed much light on the real 
basis for that price.
    Fourth, there are also some issues to consider when the 
leases expire, at the end of this six-year period. Under the 
agreement, the aircraft are supposed to be returned to the 
owner, to the special-purpose entity. At that point, the 
aircraft, or the Air Force, would have made lease payments of 
about 90 percent or more of the value of the aircraft, and the 
Air Force would actually incur additional costs, estimated at 
about $778 million, to return those aircraft in the proper 
maintenance condition that's specified in the lease. But, more 
importantly, the Air Force would be losing tanker capacity if 
they actually turned those back in. They need that tanker 
capacity, and that would have to be replaced somehow. So what 
I'm really saying, I guess, is that even though the lease says, 
``We're going to turn these back after six years,'' if the Air 
Force really did that, I don't think the proposal makes much 
sense, either militarily or economically.
    So what's really going to happen, and what the Congress 
needs to be aware of, is that the Air Force will seek authority 
and funding to purchase the tankers at the expiration of the 
leases; and, therefore, the full cost of this program needs to 
include the eventual purchase of these aircraft, and that's 
estimated, by the Air Force, at about $4 billion for the full 
hundred aircraft, and that's in then-year dollars, I believe, 
in current dollars.
    The Chairman. So you tack on additional $4 billion for the 
inevitable purchase of the----
    Mr. Curtin. Down the road, we're going to have to purchase 
them.
    Moreover, the tanker fleet consists of over 500 KC-135s, as 
has already been pointed out, and all of those are aging every 
year. They were 35 years old the first time we looked at it, 
and they're 43 years old now. Ten years from now, when this 
lease program is starting to wind down, those things are going 
to be 53 years old. There'll still be 400 aircraft averaging 
50-some years old.
    So the reasonable expectation is the Air Force needs to 
continue procurement beyond this first 100, and the problem 
with the leasing proposal is that it actually complicates the 
budget situation in future years. The advantage of leasing is 
it postpones payments and stretches them out. But the downside 
of that is that you'll still be making large payments on the 
first 100 aircraft, making these lease payments, at the time 
you're going to have to come up with additional procurement 
money for any follow-on aircraft. And in one of the analyses we 
did, we showed this could result in as much as a $6 billion per 
year budget requirement just for tankers in the Air Force 
budget in that 2012 to 2014 time frame. So there are some 
savings early on, but you create this bow wave, and there's a 
chart in our statement that illustrates that.
    One final point. The lease agreement has not yet been 
finalized. The Air Force has told us the lease is still in 
draft and subject to further negotiation on a few points. So 
the Congress needs to be aware that some details of the lease 
could still change.
    Just to sum up briefly, the lease proposal is clearly more 
expensive than outright purchase, and by an amount that we 
think is greater than the amount that the Air Force analysis 
shows. So, from a purely economic standpoint, this proposal 
probably does not provide the best return for the taxpayer. So 
it really comes down to a judgment of whether other factors 
outweigh the cost, and that's the judgment you'll need to make.
    There is a need for new tankers, but the urgency of 
proceeding more quickly, three to five years more quickly, 
through this lease proposal has not been clear to has, has not 
been strongly made by the Air Force, because problems of the 
KC-135s have been known for some time and yet the Air Force has 
not made these tankers a priority for procurement funding.
    So let me stop there, and my prepared statement actually 
contains some additional issues that I'd be glad to discuss, if 
you wish, and I'd be glad to take any questions.
    [The prepared statement of Mr. Curtin follows:]

    Statement of Neal P. Curtin, Director, Defense Capabilities and 
          Management, United States General Accounting Office
    Mr. Chairman and Members of the Committee:

    I appreciate the opportunity to appear before you today to discuss 
the Air Force's report on the planned lease of 100 Boeing 767 aircraft 
modified for aerial refueling. Aerial refueling is a key capability 
that is essential to the mobility of U.S. forces. Section 8159 of the 
Department of Defense Appropriations Act for Fiscal Year 2002 
authorizes the Air Force to lease up to 100 Boeing 767 aircraft; the 
leased aircraft would be known by a new designation, KC-767A. The act 
also requires the Air Force to report to the Congress with a 
description of the proposed lease terms and conditions and any expected 
savings before proceeding. The Air Force sent its report to the 
Congress on July 10.
    You asked for our analysis of the Air Force's business case and our 
views on the proposed lease arrangement. In my statement today, I will 
(1) summarize the proposed lease as presented in the Air Force's recent 
report to the Congress, (2) present our observations on the Air Force's 
lease report and its justification for the lease, and (3) identify 
related issues and costs that we believe the Congress will want to 
consider as it assesses the Air Force's proposal.
    To summarize and analyze the report of the proposed lease, we 
reviewed the report to the Congress, examined the draft lease (which is 
still in negotiation and is subject to change), and reviewed documents 
and briefings from the Office of the Assistant Secretary of the Air 
Force for Acquisitions, Air Mobility Programs, to identify issues and 
costs that are material to the contract. We also reviewed the Air 
Force's analysis and data used in its analysis of the lease versus buy 
comparison as required by Office of Management and Budget (OMB) 
Circular A-94. Finally, we used data gathered for our ongoing review of 
tanker requirements being conducted for the House Armed Services 
Committee's, Subcommittee on Readiness.
Background
    Aerial refueling is critical to carrying out our national security 
strategy because it allows other aircraft to fly further, stay airborne 
longer, and carry more weapons, equipment, and supplies. While numerous 
military aircraft provide refueling services, the bulk of U.S. 
refueling capability lies with the Air Force's fleet of 59 KC-10 and 
543 KC-135 aircraft. These are large, long-range aircraft that have 
counterparts in the commercial airlines but have been modified to turn 
them into tankers. The KC-10 is based on the DC-10 aircraft, and the 
KC-135 is similar to the Boeing-707 airliner. Because of their large 
numbers, the KC-135 is the mainstay of the refueling fleet, and 
successfully carrying out the refueling mission depends on the 
continued performance of the KC-135. Thus, recapitalizing the fleet of 
KC-135s will be crucial to maintaining aerial-refueling capability, and 
it will be a very expensive undertaking.
    There are two basic versions of the KC-135 aircraft, designated the 
KC-135E and KC-135R. The R model aircraft has been refitted with modern 
engines and other upgrades that give it an advantage over the E model. 
The E model aircraft on average is about 2 years older than the R 
model, and the R model provides more than 20 percent greater refueling 
capacity per aircraft. The E model is located in the Air National Guard 
and Air Force Reserve. Active forces have only the R model. Over half 
the KC-135 fleet is located in the reserve components.
    The rest of the Department of Defense's (DOD) refueling fleet 
consists of Air Force HC-130 and MC-130 aircraft used by special 
operations forces, Marine Corps KC-130 aircraft, and Navy F-18 and S-3 
aircraft. However, the bulk of refueling for Marine Corps and Navy 
aircraft comes from the Air Force KC-10 and KC-135. These aircraft are 
capable of refueling Air Force and Navy/Marine aircraft, as well as 
some allied aircraft, although there are differences in the way the KC-
10 and KC-135 are equipped to do this.
The Air Force's Report on the KC-767A Aircraft Lease
    Section 8159 of the Department of Defense Appropriations Act for 
Fiscal Year 2002,\1\ which authorized the Air Force to lease the KC-
767A aircraft, specified that the Air Force could not commence lease 
arrangements until 30 calendar days after submitting a report
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    \1\ Department of Defense and Emergency Supplemental Appropriations 
for Recovery from and Response to Terrorist Attacks on the United 
States Act, 2002, Pub. L. No. 107-117, Sec. 8159, 115 Stat. 2230, 2284-
85 (2002).
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    to the House and Senate Armed Services and Appropriations 
Committees that would (1) outline implementation plans and (2) describe 
the terms and conditions of the lease and any expected savings. At 
about the same time that the Air Force submitted the required report 
(on July 10, 2003), it submitted a New Start Notification \2\ and 
stated that it would not proceed with the lease until it received 
approval from all of the committees. The House and Senate 
Appropriations Committees and the House Armed Services Committee 
approved the new start in July. We previously testified before the 
House Armed Services Committee and its Subcommittee on Projection 
Forces, and we issued a briefing report in 2002 on the status of the 
proposed lease to date (see our Related GAO Products page for a 
complete list of products to date related to refueling requirements and 
the proposed lease).
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    \2\ The New Start Notification, submitted to the Armed Services and 
Appropriations Committees on July 11, 2003, was required by section 133 
of the Bob Stump National Defense Authorization Act for Fiscal Year 
2003, and is being used by the Air Force as the trigger for executing 
the lease. Pub. L. No. 107-314, Sec. 133, 116 Stat. 2458, 2477 (2002).
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    The key elements of the Air Force's proposal, as presented in the 
report to the Congress, are summarized below:

   The Air Force proposes to lease 100 KC-767A aircraft for 6 
        years each; the first aircraft would be delivered in August 
        2006 and the final ones by the end of 2011. Leases on the final 
        group of aircraft would terminate in 2017. The report indicates 
        that the total program for the leased aircraft would cost about 
        $17.2 billion in net present value over the lease period.\3\
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    \3\ When costs and benefits are evaluated over time, a net present 
value calculation is used to account for the time value of money 
through an interest rate called a ``discount rate.''

   The Air Force's report includes an analysis required by OMB 
        Circular A-94 comparing the net present value of the lease 
        approach against that of purchasing the aircraft. The Air Force 
        acknowledges that its analysis indicated that purchase would be 
        cheaper than leasing by about $150 million in net present value 
        terms. Nevertheless, it proposes to use the leasing approach 
        because it allows the Air Force to take delivery of the 
        aircraft more quickly than it could through purchase (and avoid 
        creating major disruptions to other procurement programs for 
        which funding has already been identified in the Future Years 
        Defense Program). Specifically, the Air Force said that if the 
        aircraft were purchased at the same rate as planned under the 
        lease, it would need $5 billion more funding through Fiscal 
        Year 2006 and more than $14 billion more for the 6 years 
        reflected in the Future Years Defense Program. Under the 
        procurement budget plan that the lease would replace, the Air 
        Force would not begin acquiring new tankers until Fiscal Year 
        2009 and would not have 100 new tankers until 2016, 5 years 
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        later than planned through the lease.

   The key justification for the lease, according to the Air 
        Force, is an urgent need to replace the current fleet of KC-135 
        aircraft. The Air Force has stated that the KC-135 is aging and 
        becoming increasingly costly to operate owing to corrosion, the 
        need for major structural repair, and increasing rates of 
        inspection to ensure air safety. Moreover, the report indicates 
        that the Air Force believes it is incurring a significant risk 
        by having 90 percent of its aerial-refueling capability in a 
        single, aging airframe and that a ``fleet grounding'' event 
        could jeopardize the tanker's mission.\4\
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    \4\ A fleet grounding event would involve some systemic problem or 
equipment failure affecting all aircraft of the same type and would be 
serious enough to require replacement before the aircraft could resume 
normal operations.

   The Air Force plans to award a contract to a special purpose 
        entity (SPE), a trust to be created under the laws of Delaware, 
        that will issue bonds to raise sufficient capital to purchase 
        the new aircraft from Boeing and lease them to the Air 
        Force.\5\ The entity is to issue bonds on the commercial market 
        based on the strength of the lease and not the creditworthiness 
        of Boeing. The lease is part of a three-party contract between 
        the Air Force, Boeing, and the SPE. Figure 1 depicts the 
        relationships of the three parties to the contract and the 
        transactions that are to take place under the contract, once it 
        is signed.
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    \5\ The special purpose entity would pay the interest on the bonds 
using lease payments it receives from the Air Force and would pay off 
all the bonds at the conclusion of the lease term.
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Figure 1: Diagram of the Relationships of the Parties to the Contract 
        and the Transactions That Are to Take Place Under the Contract
        
        
   Office of Management and Budget Circular A-11 requires that 
        an operating lease meet certain terms and conditions, including 
        a criterion that the net present value of the lease payments 
        not exceed 90 percent of the fair market value of the asset at 
        the time that the lease is initiated. The report to the 
        Congress states that DOD believes the proposed lease meets 
        those criteria and that payments over the life of the lease 
        will be equal to 89.9 percent of the fair market value of the 
        aircraft. At the same time, the report points out that the 
        percentage is based on the cost to buy the aircraft--$131 
        million plus the cost of construction financing of $7.4 
        million, for a total of $138.4 million. If the fair market 
        value is assumed to be the cost to buy the aircraft, then the 
        lease payments represent about 93 percent of the fair market 
        value and would not meet the requirement.

   If Boeing sells up to 100 comparable aircraft during the 
        term of the contract to another customer for a lower price than 
        that agreed to by the Air Force, the government would receive 
        an ``equitable adjustment.'' The report also states that Boeing 
        has agreed to a return-on-sales cap of 15 percent and that an 
        audit of its internal cost structure will be conducted in 2011, 
        and that any return on sales exceeding 15 percent would be 
        reimbursed to the government.

   According to the report, if the government were to terminate 
        the lease, it must (1) do so for all of the delivered aircraft, 
        and any aircraft for which construction has not begun, (2) give 
        12 months advance notification prior to termination, (3) return 
        the aircraft, and (4) pay an amount equal to 1 year's lease 
        payment for each aircraft terminated. If termination occurs 
        before all aircraft have been delivered, the price for the 
        remaining aircraft would be increased to include unamortized 
        costs incurred by the contractor that would have been amortized 
        over the terminated aircraft and a reasonable profit on those 
        costs.

   The government will pay for and the contractor will obtain 
        commercial insurance to cover aircraft loss and third-party 
        liability as part of the lease agreement. Aircraft loss 
        insurance is to be in the amount of $138.4 million per aircraft 
        in calendar year 2002 dollars. Liability insurance will be in 
        the amount of $1 billion per occurrence per aircraft. If any 
        claim is not covered by insurance, the Air Force will indemnify 
        the special purpose entity for any claims from third parties 
        arising out of the use, operation, or maintenance of the 
        aircraft under the contract.

   At the expiration of the lease, the Air Force can return the 
        aircraft to the SPE after removing, at government expense, any 
        Air Force-unique configurations added by the Air Force after 
        delivery of the aircraft from the SPE. Alternatively, the Air 
        Force also has the option to purchase the aircraft at residual 
        value (the estimated value of the aircraft after the lease term 
        ends). However, the purchase can take place only if it is 
        authorized and funded by the Congress at or before the 
        expiration of the lease.

   The contractor will warrant that each aircraft will be free 
        from defects in materials and workmanship and that the warranty 
        will be of 36 months' duration and will commence after 
        construction of the commercial Boeing 767 aircraft but before 
        they have been converted into aerial-refueling aircraft. Upon 
        delivery to the Air Force, each KC-767A aircraft will carry a 
        6-month design warranty, 12-month material and workmanship 
        warranty on the tanker modification, and the remainder of the 
        original warranty on the commercial components of the aircraft, 
        estimated to be about 2 years.
Our Analysis of the Air Force's Report and Lease Proposal
    I will now present our observations on the Air Force's lease report 
to the Congress and on some of the details of the lease proposal. We 
believe there are a number of aspects of the report and lease that the 
Congress needs to be aware of in considering the Air Force's proposal, 
including the following:

   The cost differential between leasing and purchasing was 
        presented by the Air Force as about $150 million favoring 
        purchase in net present value terms, although the differential 
        can rise to $1.9 billion favoring purchase, depending upon the 
        assumptions used. For example, according to the Air Force 
        report to the Congress, had the Congress provided multiyear 
        procurement authority and had DOD been able to accommodate that 
        while preserving ``program stability,'' the net present value 
        could favor purchase by up to $1.9 billion.

   The Air Force report states that there is an urgent need to 
        begin tanker replacement 3 years earlier than previously 
        planned, but until recently, recapitalization of the fleet has 
        not been a high enough priority in the Air Force budget to 
        successfully compete for funding.

   The Air Force proposal may not meet all the criteria 
        specified by OMB to qualify as an operating lease since the Air 
        Force would pay 93 percent of the fair market value of the 
        aircraft if construction financing were not assumed to be 
        included in the fair market value of the aircraft.

   As required by section 8159 of the Fiscal Year 2002 defense 
        authorization act, the Air Force report to the Congress was 
        limited to the costs of leasing the aircraft. However, the 
        report does not present the total costs of this program, 
        including the costs to acquire the aircraft at the expiration 
        of the lease or to maintain the aircraft during the period of 
        the lease.
Net Present Value Analysis
    OMB Circular A-94 specifies that whenever a Federal agency needs to 
acquire the use of a capital asset, it should do so in the way that is 
least expensive to the government as a whole and further specifies how 
a lease versus purchase analysis should be conducted. Specifically, the 
circular directs a net present value comparison between the proposed 
lease and a hypothetical purchase on the basis of the same delivery and 
return profile. This approach permits an accounting for the time-value 
of money.
    In its report to the Congress, the Air Force's net present value 
calculations between the proposed multiyear lease and a hypothetical 
purchase indicate that purchasing the aircraft would be cheaper than 
leasing by about $150 million; however, the report contains a footnote 
indicating that the net present value could favor purchase by an 
additional $1.7 billion (for a total of $1.9 billion less in costs 
compared with leasing). The $1.7 billion is based on four assumptions 
(all in net present value terms). First, the Air Force assumes that 
using a multiyear contract \6\ for purchasing the aircraft would lead 
to $900 million in savings. Second, the Air Force assumes that using a 
shorter span of time for the period when progress payments \7\ are made 
would lead to another $200 million in savings. Third, it assumes that 
if a shorter span of time for calculating inflation for progress 
payments is used, then savings of $500 million will occur. Fourth, it 
assumes that if a 30 percent discount on the imputed cost of insurance 
is included (since the government self-insures), savings of $100 
million will occur.
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    \6\ In multiyear procurement, all items are bought under one 
contract as opposed to a series of annual contracts.
    \7\ Progress payments, which are made to contractors before they 
deliver items, reduce contractors' financing costs and in turn result 
in a lower purchase price for the government.
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    The net present value analysis is also sensitive to the appropriate 
discount rate and other expected inflation. The Air Force followed OMB 
guidance contained in Circular A-94 in doing its analysis, to include 
using the discount rate of 4.1 percent. Our analysis shows that a 1-
percentage point change in the discount rate can cause a change of over 
$660 million in the net present value results. Table 1 shows the 
sensitivity of the net present value analysis to different discount 
rates, including the discount rate of 4.2 percent that we would use on 
the basis of the July 10, 2003, date on which the report to the 
Congress was issued.\8\
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    \8\ The Air Force used a 9-year discount rate from Appendix C of 
Circular A-94, which is revised annually. The date of the revision used 
by the Air Force was January 2003. GAO policy for determining a 
discount rate is that it should be the interest rate for marketable 
U.S. Treasury debt with maturity comparable to the term of the project 
being evaluated. On the basis of the date the report was issued, the 
discount rate that we would use would be 4.2 percent.


    The assumptions being used for the analysis regarding rates of 
expected inflation for construction of the aircraft, for military 
construction for facilities, and for operation and maintenance are 
reasonable; however, if the actual cost increases for the construction 
of the aircraft are higher than the assumed cost increases in the Air 
Force analysis, the cost of leasing will be higher than the cost 
presented in the report to the Congress. The reverse could also be 
true.
Urgency of Tanker Replacement
    In its report to the Congress, the Air Force stated that ``our 
National Security Strategy is unexecutable without air refueling 
tankers'' and that ``the risks involved with indefinitely operating a 
fleet of aging aircraft are unacceptable.'' These statements indicate 
that tankers are, or should be, a very high priority; however, the Air 
Force has for many years faced the issue of an aging KC-135 fleet and 
yet has not planned, until recently, to begin replacing them.
    After reviewing a wide variety of Air Force reports and documents 
as well other documents, we have concluded that neither the Air Force 
nor DOD have been willing to make the difficult decision to reallocate 
procurement funds from other programs in the near term. For example, 
the Air Force put a replacement tanker program (known as the ``KC-X'') 
in its submission for the President's Fiscal Year 2004 budget. But in 
view of ``affordability constraints'' in the near term, the program 
would not begin to be funded until Fiscal Year 2006, and the first 
aircraft would be delivered in Fiscal Year 2009.
    Until the authority to lease tanker aircraft was established by 
section 8159 of the Fiscal Year 2002 Department of Defense 
Appropriations Act, we did not perceive that concern within the Air 
Force about the condition of its KC-135 fleet was serious enough to 
successfully compete with other programs for funding. Instead, the Air 
Force has expressed belief in the necessity of continuing to operate 
and sustain the 540-plus aircraft fleet for several more decades, and 
it has also expressed confidence it its ability to do so, as 
illustrated in the following:

   In our 1996 report on aging tanker aircraft,\9\ we stated 
        that procurement of a commercial-derivative aircraft could take 
        as long as 4 to 6 years and that development of a new aircraft 
        could take up to 12 years. Therefore, we stated, the Air Force 
        will need to quickly initiate studies to develop a replacement 
        strategy for mobility aircraft and should consider a multirole 
        aircraft that could be used for air mobility as well as aerial 
        refueling. In response, DOD stated that ``while the KC-135 is 
        an average of 35 years old, its airframe hours and cycles are 
        relatively low. With proper maintenance and upgrades, we 
        believe the aircraft may be sustainable for another 35 years.'' 
        Thus in 1996, the Air Force was planning to continue to rely on 
        the KC-135 aircraft until about 2030. The Air Force's comments 
        notwithstanding, we pointed out at the time of our report that 
        the long-term serviceability of the aircraft was questionable 
        and we continue to believe it.
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    \9\ U.S. Combat Air Power: Aging Refueling Aircraft Are Costly to 
Maintain and Operate, GAO/NSIAD-96-160 (Washington, D.C.: August 8, 
1996).

   The KC-135 Aircraft Sustainment Master Plan (1997), an Air 
        Force strategic guide for investment, repair, and modification 
        decisions, concluded that ``with continued aggressive 
        maintenance, the KC-135 will fly safely well beyond the FY 97-
        02 time frame.'' The report added that the aircraft can 
        continue to be a safe and affordable weapon system that will 
        meet the operational requirements well into the next century 
        ``if there is a consistent investment in maintenance and the 
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        aging aircraft programs.''

   The Air Mobility Command's Air Mobility Strategic Plan for 
        2002 (October 2001) established a time frame of Fiscal Year 
        2008-2013 to begin fielding an updated fleet of refueling 
        aircraft. However, the report also identified additional 
        problems hampering operations, including tanker aircraft and 
        aircrew shortfalls, an increase in the number of KC-135 
        aircraft in the depot, and a decrease in mission capable rates. 
        The strategic plan acknowledged that the KC-135 Programmed 
        Depot Maintenance Improvement Plan had been developed to reduce 
        the number of aircraft in the depot. In addition, the strategic 
        plan indicated that an Analysis of Alternatives would be 
        conducted over the next two years to determine the most 
        effective solution set to meet the Nation's future air 
        refueling requirements, although, to our knowledge, the 
        analysis has not been done yet.

   In the Mission Need Statement: Future Air Refueling Aircraft 
        (AMC 004-01, November 2001), the commander of the Air Mobility 
        Command (AMC) stated that the ``Air Mobility Command's priority 
        is to continue with C-17 acquisition and C-5 modernization in 
        the near term. As the airlift priority is met, AMC will begin 
        to shift resources to address the next air refueling platform 
        in the mid-to-long-term. Air Mobility Strategic Plan 2000 
        envisions KC-135 aircraft retirement beginning in 2013 with the 
        concurrent fielding of a replacement air refueling platform.'' 
        The mission need statement also stated that ``definition of 
        future air refueling mission needs and examination of 
        opportunities for technology enhancement must begin in the 
        near-term.''

   In a May 2002 response to our briefing on our preliminary 
        analysis to the Senate Armed Services Committee of the planned 
        tanker lease, the Air Force stated that while it had programmed 
        funds for a traditional replacement tanker since 2001, the 
        first new aircraft would not enter the fleet until Fiscal Year 
        2009. The Air Force maintains an aggressive program of 
        inspection and repair to keep the KC-135 fleet operational and 
        to meet mission requirements. Consequently, while the KC-135 
        fleet was built from 1957 through 1965, significant portions of 
        the aircraft have been upgraded or modified in the intervening 
        years.

   From 1975 through 1988, the Air Force replaced about 1,500 
        square feet of the aluminum skin on the underside of the wings 
        of most KC-135 aircraft with an improved aluminum alloy that 
        was less susceptible to fatigue. In addition, engine strut 
        fittings were replaced.

   Beginning in the mid-1980s, the Air Force began to replace 
        the engines of the original KC-135A aircraft. Over 410 KC-135 
        aircraft have been converted to the R model by installation of 
        fuel-efficient, quiet F108 (CFM-56) engines that enhanced the 
        aircraft's performance and capability. In addition to new 
        engines, this modification includes 25 other changes per plane, 
        including reinforced floors, new and strengthened landing gear, 
        reinforced wing structures, new engine struts, and over 12 
        miles of wiring.

   The Air Force modernized the cockpits on all of its KC-135 
        tankers through a program called PACER CRAG (compass, radar, 
        and Global Positioning System receiver) to enhance reliability, 
        maintainability, and capability.

   In addition to specific large-scale, fleet wide upgrade 
        programs such as those that I described above, most aircraft 
        have had major structural components replaced as necessary. 
        Moreover, if--as KC-135 aircraft undergo their periodic 
        programmed depot maintenance--trend analyses indicate the 
        potential for fleet wide problems, some major components may be 
        replaced on all aircraft. Examples of some of these major 
        structural repairs include segments of fuselage skins, floor 
        beams, fuselage bulkheads, and upper wing skins. As components 
        such as these are replaced, the use of new and improved 
        materials, fabrication, and corrosion prevention techniques are 
        designed to solve problems and to last for the remaining life 
        of the aircraft. In the case of the upper wing skins, for 
        example, the Air Force reported, ``as we work through the 
        fleet, this level of replacement will decrease as most of the 
        bad skins have been or shortly will be replaced. Replaced skins 
        are installed with attention to corrosion prevention and should 
        last more than 40 years.''

    Despite the Air Force's aggressive maintenance and upgrade programs 
to keep the KC-135 mission capable, since 2001, the Air Force has come 
to believe that the condition of the fleet has deteriorated to the 
point where replacement has become more urgent. For example, Air Force 
officials have cited the Air Force's Economic Service Life Study, which 
showed that program depot maintenance has become increasingly costly on 
the KC-135. Air Force officials told us that the E-model of the KC-135 
is currently operating under flight restrictions owing to corrosion.
    The KC-135 fleet averages over 40 years in age, but the aircraft 
have relatively low levels of flying hours. Flying hours for the KC-135 
averaged about 300 hours per year from 1995 through September 2001. 
Since then, utilization is averaging about 435 hours per year. The Air 
Force projects that E and R models have lifetime flying hour limits of 
36,000 and 39,000 hours, respectively--according to the Air Force, only 
a few KC-135 aircraft would reach these limits before 2040, at which 
time some of the aircraft would be about 80 years old.
    The KC-135 fleet has not been meeting its mission capable rate 
goal. Mission capable rates measure the percentage of time on average 
that the aircraft are available to perform their assigned mission. The 
Air Force has a goal of an 85 percent mission capable rate for the KC-
135 fleet. As shown in figure 2, KC-135 aircraft have not met the 85 
percent mission capable rate in any of the last 3 Fiscal Years, 
although aircraft in the active component have consistently reached a 
mission capable rate of over 80 percent.
Figure 2: Average Annual Mission Capable Rates for KC-135 Aircraft by 
        Service Component and Aircraft Type, Fiscal Year 2001-Fiscal 
        Year 2003 (July)
        
        
    By most indications, the fleet has performed very well during the 
past few years of high operational tempo. Operations in Kosovo, 
Afghanistan, Iraq, and here in the United States in support of 
Operation Noble Eagle were demanding, but the current fleet was able to 
meet the mission requirements. Approximately 150 KC-135 aircraft were 
deployed to the combat theater for Operation Allied Force in Kosovo, 
about 60 for Operation Enduring Freedom in Afghanistan, and about 150 
for Operation Iraqi Freedom.\10\ Additional KC-135 aircraft provided 
``air bridge'' support for the movement of fighter and transport 
aircraft to the combat theater, for some long-range bomber operations 
from the United States, and to help maintain combat air patrols over 
major U.S. cities since September 11, 2001.
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    \10\ Air Force officials told us that combat commanders refused to 
permit the E-model of the KC-135 to be deployed to recent combat 
theaters.
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    According to Air Force projections, the KC-135 operating and 
support costs will increase substantially in the coming years. The 
costs for the current fleet totaled about $2.4 billion in Fiscal Year 
2002 (2002 dollars). The Air Force projects that the cost will total 
about $3.5 billion (2002 dollars) in Fiscal Year 2012 for a fleet of 
510 aircraft. According to Air Force officials, increased programmed 
depot maintenance costs were a significant cause of the increase. The 
officials said that, based on historical experience, programmed depot 
maintenance costs are expected to increase about 18 percent per 
aircraft per year. By the same projections, the operating and support 
costs for the fleet of 100 KC-767A aircraft will total about $808 
million.\11\
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    \11\ The projections assume that the KC-135Es and KC-135Rs will fly 
308 and 368 hours per year while the KC-767A will fly 750 hours per 
year.
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    The concept of an aging KC-135 fleet, and the problems and costs 
associated with operating and sustaining old aircraft, is not a sudden 
manifestation, but rather a fact of life that the KC-135 support 
infrastructure has had to deal with for years. Many of the problems 
currently being reported as reasons to begin tanker recapitalization 
immediately--including corrosion, increasing operating and support 
costs, and reduced aircraft availability--are not new and were issues 
that the Air Force was addressing in the mid-1990s, when we last 
examined aerial-refueling matters and when the Air Force concluded that 
recapitalization was not urgent.
Operating Lease Requirements
    OMB Circular A-11 provides certain criteria that must be met for an 
operating lease:

   Ownership must remain with the lessor throughout the term of 
        the lease and is not to transfer at or shortly after the end of 
        the lease period.

   No bargain price purchase option is allowed.

   The lease term may not exceed 75 percent of the asset's 
        economic lifetime.

   The present value of the minimum lease payments cannot 
        exceed 90 percent of the fair market value of the asset at the 
        beginning of the lease term.

   The asset must be a general-purpose asset and not 
        government-unique.

   The asset must have a private-sector market.

    The Air Force report says that the proposal complies with all of 
the criteria.
    However, the report also points out that, depending on the fair 
market value used, the net present value of the lease payments in the 
case of the KC-767A may exceed the 90 percent of initial value 
threshold. On the one hand, if the fair market value is considered to 
include the cost of construction financing of $7.4 million per aircraft 
(or $740 million for all 100 aircraft),\12\ then the lease payments are 
estimated to represent 89.9 percent. This is the formula that the Air 
Force used to document compliance with the circular and which the Air 
Force cited in its report to the Congress; it results in a cost of 
$138.4 million per aircraft. On the other hand, if the fair market 
value excludes construction financing, it totals $131 million per 
aircraft, and the lease payments represent 93 percent, thus exceeding 
the 90 percent threshold. According to the Air Force report, 
construction financing, however, must be included to meet the OMB 
Circular A-11 requirement.
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    \12\ Construction financing will be raised by the special purpose 
entity through borrowing in order to make progress payments.
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    However, it is not clear that including the construction financing 
represents the fair market value of the aircraft. The SPE will borrow 
money on the commercial market to raise funds to pay Boeing to finance 
construction of the aircraft and will repay the banks up to $7.4 
million in interest on the loans per aircraft. Once constructed, the 
aircraft will be delivered to the SPE, and the SPE will pay Boeing $131 
million less the amount of financing already paid to Boeing for the 
aircraft. The Air Force will then lease the aircraft for up to $138.4 
million per aircraft over the life of the lease. Consequently, the $7.4 
million (reported by the Air Force as construction financing) 
represents interest on the loans to the SPE, and it is not clear that 
interest should be included in the fair market value of the aircraft.
Total Cost of the Program
    While the Air Force report includes the cost of leasing and other 
government costs such as training, as well as operations and support, 
the report does not include the costs of buying the tankers at the end 
of the lease.\13\ At the end of each 6-year lease, the aircraft are to 
be returned to the owner, the SPE, or they can be purchased by the Air 
Force for their residual value, estimated at about $44 million each in 
then-year dollars. If the aircraft are returned, the Air Force tanker 
fleet will be reduced, and the Air Force will have to find some way to 
replace the lost capability. In other words, the lease payments will 
have paid almost the full cost of the aircraft, and then the capability 
would be lost. Thus, the total cost of this 100-aircraft program should 
include the eventual acquisition cost. In addition to the cost to lease 
and subsequently purchase the aircraft, Air Force operations and 
support costs range from $4.6 billion to $6.8 billion, depending on 
which dollar calculation is used. The Air Force also plans to construct 
new facilities and would incur other costs ranging from $1.2 billion to 
$1.5 billion. Table 2 summarizes total cost in three different dollar 
calculations--then-year (or current) dollars, constant Fiscal Year 2002 
dollars, and net present value.\14\
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    \13\ The Department of Defense and Emergency Supplemental 
Appropriations for Recovery from and Response to Terrorist Attacks on 
the United States Act, 2002, Pub. L. No. 107-117, Sec. 8159, 115 Stat. 
2230, 2284-85 (2002) required that the Air Force report on the costs to 
purchase or lease the aircraft but did not require that other costs be 
reported.
    \14\ Current dollars or then year dollars are the dollar value of a 
good or service in terms of prices at the time the good or service is 
sold. These contrast with constant dollars, which measure the value of 
purchased goods or services at price levels that are the same as those 
for the base year. Constant dollars do not contain any adjustments for 
inflationary changes that have occurred or are forecasted to occur 
outside the base year. When costs and benefits are evaluated over time, 
a net present value calculation is used to account for the time value 
of money through an interest rate called a ``discount rate.''


    In addition, the Air Force will have to pay an additional estimated 
$778 million if the entire 100 aircraft are returned, to ensure that 
the aircraft are returned in the maintenance condition specified in the 
lease. For these reasons, returning the aircraft would probably make 
little sense, and the Congress will almost certainly be asked to fund 
the purchase of the aircraft at their residual value as the lease 
expires.
Related Issues and Concerns
    Our preliminary analysis indicates that certain other costs 
associated with the lease may deserve further examination by the 
Congress. Specifically, we have concerns related to contractor 
logistics support, the extent of Boeing's profit margin, and the impact 
of the lease on follow-on tanker acquisitions.
Contractor Logistics Support
    The Air Force estimates that the maintenance agreement with Boeing 
will cost between $5 billion and $5.7 billion during the lease period. 
It has negotiated a non competitive agreement with Boeing as part of 
the lease negotiations, covering all maintenance except flight-line 
maintenance, which is to be done by Air Force mechanics. This 
represents an average of about $6.4 million per aircraft per year in 
Fiscal Year 2002 dollars. We do not know how the Air Force determined 
that this was a reasonable price or whether competition might have 
yielded savings because the Air Force did not provide sufficient 
documents on a timely basis for us to evaluate its price analysis. A 
number of commercial airlines and maintenance contractors already 
maintain the basic 767 commercial aircraft and could possibly do some 
of the required maintenance if given the opportunity to compete for the 
contract.
Profit Margin
    The Air Force report indicates that Boeing can earn no more than a 
15 percent profit on the Boeing 767 aircraft and that an audit will be 
conducted after the final planes are delivered to ensure that the 
company's profit does not exceed that amount. However, since this 
aircraft is basically a commercial 767 with modifications to make it a 
military tanker, it is not clear why the 15 percent profit should apply 
to the full cost. One financial analysis published recently states that 
Boeing's profit on commercial 767 aircraft is in the range of 6 
percent.\15\ If the Air Force negotiated a lower profit margin on that 
portion of the cost, with the 15 percent profit applying only to the 
military-specific portion, this could lower the cost by several million 
dollars per aircraft. For example, assuming the commercial tanker 
portion of the cost is about $80 million, the difference between 
profits of 6 percent and 15 percent would be about $7 million per 
aircraft, or $700 million for all 100 aircraft.
---------------------------------------------------------------------------
    \15\ See Morgan-Stanley, Does 767 Tanker Equate to 700+ Comml 
Orders?, (May 30, 2003).
---------------------------------------------------------------------------
Effect on Follow-on Tanker Acquisitions
    One of the key advantages of leasing is that it enables the Air 
Force to take delivery of aircraft without the large, up-front 
obligation of funds required for purchase; thus by the end of Fiscal 
Year 2011, the Air Force will have received 100 new tankers. The flip 
side of this, however, is that payments are spread out over many years 
and represent an obligation that must be met throughout the term of the 
lease. The Air Force will be making lease payments on the leased 
aircraft through Fiscal Year 2017, and will likely pay about $4.4 
billion (in then-year dollars) in Fiscal Years 2012-17 to purchase the 
aircraft at the expiration of the lease. Funds spent during those years 
on these 100 aircraft are therefore funds that are not available for 
the procurement of additional tanker aircraft that will be needed to 
replace the remaining 400-plus aircraft in the KC-135 fleet. If the Air 
Force wants to procure additional tankers starting in this 2012-17 
period, it will need an even larger budget during those years to 
accommodate both the continuing lease payments and new procurement. 
Figure 3 illustrates the annual outlays that would be required to lease 
the aircraft as proposed and the additional outlays needed to purchase 
an additional block of 100 aircraft. This assumes that delivery of the 
additional aircraft would begin after the first 100 had been delivered. 
If additional aircraft are to be obtained before the planned end of 
delivery of the first 100 leased aircraft in 2011, then the additional 
funds for the second block of aircraft would be needed even sooner.
Figure 3: Outlays Required to Lease 100 Aircraft and to Subsequently 
        Purchase an Additional 100 Aircraft
        
        
    Mr. Chairman, this concludes my prepared statement. I would be 
happy to answer any questions that you or Members of the Committee may 
have.

    The Chairman. Thank you.
    Mr. Bolkcom?

   STATEMENT OF CHRISTOPHER BOLKCOM, SPECIALIST IN NATIONAL 
            DEFENSE, CONGRESSIONAL RESEARCH SERVICE

    Mr. Bolkcom. Mr. Chairman, distinguished Members of the 
Committee, thank you very much for inviting me to speak with 
you today.
    Before I begin, I'd like to briefly recognize my 
colleagues, sitting a couple of rows behind me here, Amy 
Belasco, Daniel Else, and Ronald O'Roarke, who are my co-
authors on a recent CRS report on this subject and are here 
today to lend their expertise to my testimony.
    I'd like to emphasize four points that I'll treat at 
greater length in my written statement and in the CRS report.
    The first point centers on the issue of urgency. The Air 
Force bases much of its argument in support of this lease in 
their assertion that they have an urgent need to replace the 
KC-135E fleet. The Air Force says that the 135s must be 
replaced quickly because the aircrafts O&M costs are rising, 
yet its operational availability is declining. High operations 
tempo, they say, is worsening both cost and availability. The 
Air Force says that corrosion problems make the 135s prone to 
catastrophic failure, and this could ground the entire fleet. 
Also, it says that the 767 production line could close soon; 
thus, we must lease now while we have the opportunity.
    There are critics of this lease, and CRS notes that some of 
their counter-arguments include that 135 costs may be 
manageable and lower than the overall costs of leasing the 767. 
Recent 135 availability is promising, and the 135's risk of 
catastrophic failure could be no worse today than it was two 
years ago, when the Air Force found it to be acceptable. Also, 
the 767 production line appears viable until at least 2006, and 
perhaps 2008.
    The second issue that CRS examined is whether the 767 is 
the best aircraft for the job. In short, no one can answer this 
definitively, because the Air Force has not, and has not been 
required to, conduct an analysis of alternatives. It is unclear 
if the 767 meets all of the service's operational requirements. 
It is also not clear that the Air Force has vigorously explored 
other options, such as purchasing surplus commercial airplanes.
    Finally, re-engining 135Es would improve tanker 
capabilities faster and at less expense than the lease, but the 
Air Forces opposes this on a few different grounds, primarily 
economic.
    The third issue that CRS examined was how much a 767 lease 
might compare to a purchase. The Air Force's July 10 report to 
Congress states that leasing the 767s would cost 150 million 
more dollars than purchasing them, when calculated on a net 
present value basis. Now, this calculation is based on a number 
of assumptions that, if treated differently, could change the 
cost comparison by hundreds of millions of dollars. One of 
these assumptions concerns a discount rate used in the net 
present value calculation. The Air Force used a nine-year 
Treasury bond rate in its discount rate. CRS's analysis 
suggests that a more appropriate discount rate would be a 
three-and-a-half to four-year Treasury bond rate, which equates 
to the average maturity of the bonds that the U.S. Government 
were to use if it were to finance the cash flows of this lease. 
Using such a discount rate would favor the purchase option by 
an additional $500 to $600 million.
    A second factor was whether multi-year procurement should 
be used in estimating the cost of the purchase. The Air Force 
argues that this multi-year lease should be compared to annual 
procurement. But there are several arguments for why multi-year 
procurement would be appropriate in the calculation. If multi-
year procurement were used to estimate the cost of a purchase, 
it would favor that option by an additional 600 million to 1.2 
billion in discounted dollars.
    The fourth and final issue that CRS examined were the 
potential budget oversight concerns that may be presented by 
this lease. If the Air Force's new start reprogramming request 
is approved, it will sign a contract committing the government 
to spend almost 25 billion, in current-year dollars, over the 
next 15 years. Starting a major Defense program without going 
through the normal appropriations and authorization process 
would be unusual, if not unprecedented. Moreover, it appears 
that the cost of the program would be subject to some market 
volatility. If bond rates, for instance, are, say, 1.5 percent 
higher or lower than currently anticipated, the program's cost 
could change, in either direction, by about 1.3 billion in 
current-year dollars.
    Lease supporters and lease critics debate whether the 
proposal complies with statutory and OMB requirements. The Air 
Force says that the 767 proposal meets all criteria for 
operating leases; however, the proposal does appear to have 
many attributes that appear more similar to a capital lease or 
a lease purchase, which would require that more costs be scored 
up front in the Air Force budget.
    In conclusion, it's not clear whether the lease is a ``good 
deal'' for the government. Based on a typical formula for 
commercial leases, the 767 proposal should cost between $59 
million and $95 million per aircraft over a six-year period. 
Instead, this lease is estimated at 166 million per aircraft, 
in current-year dollars.
    The Chairman. Repeat that, please.
    Mr. Bolkcom. Well, based on a typical formula we learned 
about in a HASC hearing in July, typically you'd expect the 
lease to cost between 59 million and 95 million per aircraft 
over a six-year period. Instead, this lease is estimated at 166 
million per aircraft, in current-year dollars.
    This concludes my remarks, Mr. Chairman. Thank you for the 
opportunity to appear today, and I look forward to your 
questions. [The prepared statement of Mr. Bolkcom follows:]

   Prepared Statement of Christopher Bolkcom, Specialist in National 
                Defense, Congressional Research Service
    Mr. Chairman, distinguished members of the Committee, thank you for 
inviting me to speak to you today about out study of the proposed KC-
767 lease. Before I begin, I would like to recognize my colleagues Amy 
Belasco, Daniel Else, and Ronald O'Rourke, who are co authors of CRS's 
recent report on this subject, and are here today to lend their 
expertise to this testimony. Importantly, while CRS undertook this 
analysis to inform the debate on congressional options, CRS takes no 
position on any particular legislative option.
    In this testimony I would like to emphasize four points that you 
will find treated at length in the CRS report published August 29. Our 
assessment suggests that there are four key issues that Congress may 
wish to address when considering the lease proposal:

   First, whether there is an urgent need to replace the KC-
        135E fleet

   Second, whether the KC-767 is the best airplane for the job

   Third, whether the cost comparison the Air Force has made 
        between leasing and procurement is authoritative, and

   Fourth, whether this lease captures the government's full 
        budgetary obligation and is a good deal for the government.
Is there an urgent need?
    The Air Force bases much of its argument in support of this lease 
on its assertion of an urgent need to replace the KC-135E fleet. The 
Air Force indicates that leasing will result in faster deliveries than 
outright purchasing.
    The Air Force makes five arguments for why replacing the KC-135Es 
must be done as soon as possible. First, because KC-135E operations and 
support costs are rising quickly. Recent Air Force studies project KC-
135 O&S costs will be 50 percent higher than projections two years ago. 
Second, these aircraft are increasingly difficult to maintain. They 
will spend more time in maintenance depots, and less time in the hands 
of our warfighters. Third,thatthese aging aircraft are becoming 
increasingly prone to catastrophic failures that could unexpectedly 
ground a large segment of the tanker fleet. The Air Force's 
difficulties in addressing the KC-135's corrosion problems are most 
frequently mentioned as an unpredictable problem that could ground the 
fleet. Air Force officials say that they have ``no confidence'' in the 
KC-135E aircraft. Fourth, the Air Force argues that Boeing's 767 
production line could close in the near future, and if the Air Force 
doesn't act now, the aircraft may not be available in the future. 
Finally, KC-135 usage rates in the post September 11 environment are 
higher than ever anticipated, which is prematurely wearing out these 
aircraft. The global war on terrorism may require the military Services 
to engage our adversaries in far flung theaters with little or 
unreliable in-theater basing. Without strategic aerial refueling 
capabilities, the Air Force argues, the United States would be nothing 
more than a regional power.
    As part of its analysis, CRS found many counter arguments to the 
Air Force's position on urgency. Critics of the Air Force position note 
that the KC-767 lease only results in faster deliveries of the aircraft 
than procurement because of the Air Force's self imposed budgetary 
constraints. Procuring these aircraft could result in deliveries at the 
same rate as leasing, but, the Air Force would have to decrease near-
term funding for other procurement programs. Thus, if the Air Force 
truly had an urgent need, critics assert, the Air Force would find 
other programs in its current plan that were less important, and make 
them bill payers for the KC-767. Along this same line of 
reasoning,lease critics argue that the Air Force has for years 
downplayed the need to recapitalize the KC-135 fleet, despite 
encouragement by organizations like the GAO, which has argued since 
1996 that the Air Force should make recapitalization a higher priority.
    Opponents of the lease are also critical of the five Air Force 
arguments outlined earlier. Critics state that the KC-135 operating 
costs are controllable and will be far lower than the overall costs of 
leasing the 767. Critics also say that while availability has been a 
problem for the KC-135 for some time, mission capable rates for the 
aircraft have been more than satisfactory, and that improvements to the 
KC-135 depots in 1999 and 2000 are now paying off in terms of faster 
maintenance turn around times. Lease critics say that the Air Force's 
depiction of the KC-135's corrosion is exaggerated, especially in terms 
of predictability. Some point to the Navy, which has been dealing with 
corrosion problems for years, and considers corrosion a ``known 
challenge'' that can be dealt with proactively. Some opponents 
characterize the KC-135's vulnerability to catastrophic failure as no 
worse today than it was two years ago, when the KC-135 Economic Service 
Life Study found it acceptable. Finally, lease critics say that 
Boeing's 767 production line is not in imminent danger of shutting 
down; that it is viable until at least until 2006, perhaps until 2008 
and even beyond.
Is the KC-767 the right airplane?
    If acquired, the KC-767 may be in DOD's inventory for 50 years. 
Therefore, the aircraft's capabilities and characteristics are an 
important consideration. Servicemen and women decades in the future 
will live with decisions made today.
    Because the Air Force has characterized its need as 
urgent,supporters ofthe KC-767 say that the number of tanker aircraft 
platform choices are limited to some degree. Designing and building an 
aerial refueling aircraft from scratch, for instance, would take too 
long. The 767 is the best aircraft available right now, lease 
supporters say.
    The Air Force says that the KC-767 is a much better aircraft than 
the KC-135. It is more capable, and flexible. It will offload more 
fuel, operate from shorter runways, and carry more cargo and personnel 
than the KC-135. Unlike the aircraft it will replace, the KC-767 is 
itself refuelable, and can use both the Air Force refueling boom and 
the Navy refueling probe and drogue system on the same mission. The Air 
Force projects that the KC-767 will be more available than the KC-135. 
It will have a higher mission capable rate, and spend less time in 
maintenance depots.
    Newer aircraft always compare favorably to old aircraft, say lease 
critics. What really counts, they say, is how well the KC-767 meets the 
Air Force's, Navy's and Marine Corps' operational requirements. Critics 
argue that the KC-767 fails to meet a few key criteria. The KC-767 will 
not, for example, be able to simultaneously refuel two aircraft with 
the probe and drogue system. Opponents also say that significant 
numbers of inexpensive surplus commercial aircraft are available that 
may be even better than the KC-767. Some assert that surplus DC-10 
aircraft could be purchased on the commercial market and converted into 
very capable KC-10 tankers for much less than the KC-7671ease. KC-1Os 
are roughly twice as capable as the KC-135. Furthermore,because the Air 
Force already operates 59 KC-10s today, it has already invested in the 
operations, maintenance, personnel and training infrastructure.
    The Air Force opposes re-engining KC-135E models, arguing that it 
is economically unviable. Too little military capability is gained for 
the financial investment,and re-engining does not address the most 
basic need, which is to extend the KC-135's lifetime. Lease opponents 
look at the economics of re-engining and come to the opposite 
conclusion. It is much cheaper, they say, than leasing KC-767s. Re-
engining merits consideration,lease opponents say, and note that 
Congress has provided funds tore-engine KC-135E aircraft for years.
Is the Air Force comparison of lease and procurement costs 
        authoritative?
    The Air Force's July 10 report to Congress states that leasing the 
767s would be about $150 million, or about 1 percent, more expensive 
than purchasing them, when calculated on a net present value basis.
    The report presents this $150-million difference (calculated on a 
net present value basis) as a single answer to the question of how the 
costs of leasing vs. purchasing the 767s compared to one another. The 
calculation, however, includes a number of assumptions and factors 
that, if treated differently, could change the outcome of the cost 
comparison, in several cases by hundreds of millions of dollars.
    Some of these assumptions could change the calculation to favor 
either the lease option or the procurement option. But other 
assumptions, if treated differently, would more likely change the 
calculation in only one direction--in favor of the procurement option.
    Perhaps the most significant factor we examined was the discount 
rate used in the net present value calculation. The Air Force used a 9-
year Treasury bond rate. Our analysis indicated that an arguably more 
appropriate discount rate would be a Treasury bond rate for bonds 
having an average maturity equal to the bonds that the U.S. Government 
would likely use if the government needed to raise the funds for the 
cash flows involved in the lease arrangement. Jane Gravelle, a CRS 
senior specialist who is an expert on discount rates assisted in this 
part of the study.
    Our analysis calculates this average maturity at something between 
3.5 and 4 years, rather than the 9-year rate used by the Air Force. 
Using a 3.5- or 4-year Treasury bond rate would favor the procurement 
option by an additional $500 to $600 million.
    A second major factor we examined was whether multiyear procurement 
should be used in estimating the cost of the procurement option. The 
Air Force report offers some arguments as to why multiyear procurement 
should not be used. But there are also arguments one could make as to 
why multiyear procurement should be used,including the fact that the 
lease inherently involves making a multiyear commitment, and that 
acquiring the aircraft through a multiyear procurement arguably would 
represent no more of a procedural innovation, and arguably less of one, 
than acquiring them through a lease.
    If multiyear procurement were used in estimating the cost of the 
procurement option, it would favor the procurement option by an 
additional $600 million to $1.2 billion.
    The use of multiyear procurement, if combined with the change in 
discount rate just mentioned, could shift the cost comparison in favor 
of the procurement option by a total of $1.1 billion to $1.8 billion.
    The five other factors we examined included the following:

   The progress payment schedule, which if done to reflect 
        other Air Force aircraft procurement programs, could favor the 
        procurement option by an additional $200 million

   The treatment of inflation on the progress payments, which 
        if done differently could favor the procurement option by an 
        additional $500 million

   The interest rates on the bonds issued by the SPE, which 
        could shift the cost comparison by about $270 million in either 
        direction for each \1/2\-point difference between projected 
        interest rates in the Air Force calculation and the actual 
        rates that occur when the bonds are issued

   The interest rates on the construction loans, which might 
        shift the cost comparison by several tens of millions of 
        dollars in either direction for each \1/2\-point difference 
        between the projected rates in the Air Force calculation and 
        the actual rates that occur when the loans are taken out

    and

   The imputed self-insurance cost that is included in the 
        procurement option. This estimate could prove to be either to 
        high or too low, possibly by tens of millions of dollars.

    The two principal implications of CRS's assessment of the Air Force 
cost comparison are as follows:

   First, the $150-million difference in net present value 
        between lease and purchase options that is presented in the Air 
        Force report is one of many possible answers to the question of 
        how the cost of the lease and purchase options compare to one 
        another. Calculating the net present values of these two 
        options involves several assumptions and factors that can shift 
        the cost comparison, in several cases by hundreds of millions 
        of dollars.

   Second, while some of the assumptions used in the 
        calculation could change the outcome to favor either the lease 
        option or the purchase option, other factors, if treated 
        differently, are more likely to change the cost calculation in 
        only one direction--in favor of the procurement option.
What budget oversight concerns are raised by the lease?
    Consideration of the Air Force tanker leasing program has been 
unconventional. The Department of Defense (DOD) did not request any 
funds for the tanker lease in either FY2003 or FY2004, and has not 
included funding for the lease in its planning document, the Future 
Years Defense Program (FYDP).\1\ The Air Force is relying on a 
provision in the FY2003 DOD Authorization Act that allows it to submit 
for approval a new start notification to the four congressional defense 
committees.\2\
---------------------------------------------------------------------------
    \1\ The Air Force did include $4.1 billion between FY2003 and 
FY2009 to buy a KC-X, an unidentified new tanker.
    \2\ Section 133 of P.L. 107-314, the FY2004 DOD Authorization Act 
gives the Air Force two ways to obtain approval of the lease: get 
specific authorization and appropriation language or get approval of a 
new start notification submitted as a reprogramming request.
---------------------------------------------------------------------------
    If the four congressional defense committees approve the Air Force 
request to spend $720,000 in 2003 for a study of tanker maintenance and 
training requirements, the Air Force will sign a contract with Boeing 
to spend $24.6 billion in current year dollars between 2003 and 2017 on 
its new 767 tanker leasing program according to the Air Force. This 
would be an unusual if not unprecedented way to approve a major defense 
program.
    First, it appears that the tanker lease may not alleviate the 
competition among programs in the Air Force budget. Operating leases 
are attractive because agencies can make smaller payments initially and 
spread out their payments rather than paying up front for a purchase. 
While the lease approach reduces Air Force budget requirements in the 
short term, it does so by pushing costs out into future years when 
potential trade-offs among programs are less visible to policy makers 
but may be equally difficult. Under the Air Force's plan, $5.5 billion 
would be needed in the first seven years of the lease--from FY2003 to 
FY2009--but $19.9 billion.would be needed in the second seven years of 
the lease--from FY2010 to FY2017.
    In later years, the Air Force could face a squeeze on funding 
because of its plans to buy the Joint Strike Fighter, the F/A-22, R&D 
on a long-range bomber and a replacement of the Minuteman 
intercontinental missile, and other programs. A recent CBO report 
predicts that funding for Air Force investment programs would need to 
grow from an average of $58 billion in FY2009 to $64 billion annually 
between 2010 and 2020 in 2004 dollars in order to fund its planned 
program.\3\
---------------------------------------------------------------------------
    \3\ Congressional Budget Office, The Long-Term Implications of 
Current Defense Plans: Summary Update for Fiscal Year 2004, July 2003, 
p. 12.
---------------------------------------------------------------------------
    DOD might also face constraints on its total resources if the 
defense budget were to rise more modestly in later years. The FY2004 
congressional budget resolution predicts that annual increases in 
spending on national defense will fall from the $20 billion to $10 
billion or less beginning in FY2009. Although those estimates could 
well change in later years, pressures on defense spending could re-
surface starting at the end of the decade with the retirement of the 
baby boom generation.
    Second, the cost of the tanker lease program is uncertain. The 
total cost of the program could rise by $4.4 billion, from $24.6 
billion to $29 billion in current year dollars if the Air Force decides 
to buy the planes as appears likely. Although the cost of DOD programs, 
and other government programs as well, often change over time, the Air 
Force proposal to lease rather than buy the planes appears to subject 
the government to the volatility of the bond markets. If interest rates 
for all three tranches of bonds to be sold on the market were to be 
higher or lower than anticipated, the cost of the program would change. 
An increase (or decrease) of .5 percent in interest rates would change 
costs by $400 million and a 1.5 percent increase (or decrease) would 
change the program's cost by about $1.3 billion. A straight purchase 
would not be affected by changes in interest rates. The Air Force also 
has not funded potential termination liabilities, which in 2011, at the 
height of the lease, could be $2.7 billion for the aircraft alone 
according to the Air Force's current estimates.\4\
---------------------------------------------------------------------------
    \4\ Air Force model 1, Business Case Analysis, July 2003. 
Termination liabilities could be substantially more if the support cost 
contract is included.
---------------------------------------------------------------------------
    Third, it is unclear whether the proposed lease complies with 
statutory and OMB requirements. To guard against agencies using 
operating leases to ``buy on the installment plan,'' the government 
adopted guidelines that specify the types of arrangements that qualify 
as operating leases. Those rules are set out in OMS's Circular A-11 and 
reflect the 1997 Budget Enforcement Act. Some observers have questioned 
whether the proposed tanker lease complies with those rules.
    Operating leases must be for commercial items with a private sector 
market. To support its case, the Air Force notes that the 767 was 
commercially developed and that Italy and Japan have bought several 
aerial refueling tankers and some other countries and commercial buyers 
have expressed interest. Critics of the lease argue that the Air Force 
variant would be substantially different from the commercial version 
(as indicated by both specific features and the difference in price) 
and suggest that the commercial market is likely to be small.
    In order to distinguish operating leases from lease/purchases or 
capital leases, OMS's Circular A-11 Score keeping Guidelines also 
specify that in operating leases, the government is not to plan to 
transfer ownership or buy the asset shortly after the end of the 
lease.\5\ The Air Force states that it would have to get authorization 
and appropriation of funds from Congress to buy the planes. DOD is 
committed to earmark an additional $2 billion in FY2008 and FY2009 to 
purchase the plane according to the Air Force's July 10, 2003 report to 
Congress.\6\
---------------------------------------------------------------------------
    \5\ 0MB, Circular A-11, Appendix A, Scorekeeping Guidelines (2002); 
these guidelines follow language in the conference report on the 1997 
Budget Enforcement Act, H. Rept. 105-217, p. 1010-p. 1011, and are 
followed by both OMB and CBO.
    \6\ U.S. Air Force, Report to the Congressional Defense Committees 
on KC767A Air Refueling Aircraft Multi-Year Lease Pilot Program, July 
10, 2003, p. A2-1.
---------------------------------------------------------------------------
    OMS's guidelines also specify that the lease is not to include a 
bargain price for later purchase so that the lease would be a way to 
buy the plane at a later point. The option price for the Air Force to 
buy the plane is about 15 percent below the price that the Air Force 
predicts the plane would command on the commercial market.\7\
---------------------------------------------------------------------------
    \7\ CRS calculation based on Air Force Modell, Business Case 
Analysis, July 2003.
---------------------------------------------------------------------------
    To ensure that decision makers see the government obligations, 
OMS's scoring rules-for counting the budget authority for the program--
are different for operating leases than for lease/purchases or a 
capital lease. The government's obligation in an operating lease is 
simply the annual payments whereas in a lease/purchase, OMB scores the 
government's obligations based on the value of the assets because the 
government plans to buy the asset at the end of the lease. In a capital 
lease, the full value of the government's obligations in present value 
terms is scored up front.
    Using a special purpose entity (SPE) also makes it more difficult 
to have visibility on the government's obligations. According to a CBO 
report, other agencies who have relied on special purpose entities have 
launched programs without ``scoring'' or counting the full potential 
scope of the government's obligations. DOD, for example, used a public/
private venture to obtain about $2.3 billion in military housing while 
recording $255 million in obligations, almost a ten to one ratio.
    For the proposed lease, an issue is: are the payments for the 
planes that the Trust makes to Boeing essentially 
governmentalobligations? The Air Force contends that the non-profit 
Wilmington Trust is a separate entity that will raise funds on the bond 
market to purchase the aircraft from Boeing and to receive lease 
payments from the Air Force to pay off those loans. Some observers, 
however, have suggested that Wilmington Trust is basically a conduit 
for the Air Force, or essentially an extension ofthe government. Under 
OMB's new guidelines issued in July after the Air Force submitted its 
lease proposal, it appears that the Wilmington Trust could be 
considered a governmental entity and the buy ofthe aircraft be scored 
as an Air Force obligation, with far larger budget requirements than 
annual lease payments.
    Fourth, and in conclusion, it is not clear that this lease is a 
good deal for the government. Some observers have questioned whether 
the proposed lease is a good deal for the government--either compared 
to a multiyear purchase of the aircraft or as a lease. GAO and others 
have raised concerns about the lack of competition for both the $17 
billion lease and the $8 billion in support costs, much of which would 
also go to Boeing.
    Compared to a multiyear buy, is the lease a good deal for the 
government in current year dollars? CRS estimates that a lease would 
cost $21.1 billion, $5.7 billion or 27 percent more than an operating 
lease that was followed by a buy of the aircraft at the end of the 
lease.\8\
---------------------------------------------------------------------------
    \8\ CRS calculations based on Air Force Modell, Business Case 
Analysis, July 2003.
---------------------------------------------------------------------------
    If the Air Force were to spend those funds on aircraft rather than 
relying on an operating lease in order to pay less in earlier years, 
those dollars would purchase about 35 more tankers.
    As a lease, it appears that the Air Force's price may be questioned 
as being above commercial rates especially in light of today's 
oversupply of commercial aircraft. Based on a formula for commercial 
leases presented by John Plueger, CEO of the International Lease 
Finance Corporation,a commercial airliner operating lease company,the 
cost ofthe Air Force six-year lease would be expected to range from $59 
million to $95 million per aircraft or about 35 percent to 57 percent 
of the value of the aircraft. The Air Force's lease, however, is 
estimated to be about $166 million in current year dollars or about 90 
percent of its market value.\9\
---------------------------------------------------------------------------
    \9\ CRS calculations based on testimony by John Plueger before the 
House Armed Services Committee, July 23, 2003, and CRS calculations 
based on Air Force Briefing to CRS, ``KC767A Report to Congress, Status 
Brief,'' July 15, 2003.
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    Why is the Air Force's price so much higher than might be expected? 
The price of the lease appears to be designed to minimize the amount of 
the loan that would be outstanding at the end of the lease, and hence 
the riskiest funds to borrow, an Air Force concern. OMS's guidelines 
cap that level at 90 percent of the value of the aircraft. Bondholders 
who finance that last 10 percent of the value of the aircraft will only 
be paid when and if the Air Force buys the plane. Because the decision 
about that final purchase has not been made and depends on 
congressional action, the Air Force believes that those bonds would 
require a high interef?t rate of about 10 percent. The Air Force 
leasing price is intended to minimize the amount of funds that would 
require that high rate.
    Mr. Chairman, distinguished members of the Committee,this concludes 
my testimony, and I look forward to addressing any questions that you 
may have.

    The Chairman. Thank you very much, Mr. Bolkom. Mr. Holtz-
Eakin, Mr. Bolkom says this deal is unusual if not 
unprecedented. Do you agree with that?
    Mr. Holtz-Eakin. Yes, we would concur.
    The Chairman. Mr. Curtin?
    Mr. Curtin. Yes. I'm not aware of anything quite like this.
    The Chairman. Secretary Roche, why wasn't a formal analysis 
of alternatives conducted on this lease purchase?
    Secretary Roche. Mr. Chairman, as you know, there's no 
requirement to do a formal analysis of alternatives. It's a 
regulatory thing, and there are examples of other programs 
where this was not done, for instance in the KC-10 acquisition 
it was not done, and there are some others, F18-EF was not 
done, C-103J. There was a discussion of this held by----
    The Chairman. The F18-EF and the KC-130J were existing 
aircraft, they were just later models.
    Secretary Roche. Yes, sir, I think we would agree that the 
F18-EF is a remarkably or dramatically larger aircraft 
containing lots of new electronics and other things.
    Mr. Curtin. My question is, why wasn't an AOA conducted on 
an issue of this magnitude and this amount of money?
    Secretary Roche. A discussion was conducted, sir, in the 
Pentagon with the head of ATNL, the acquisition executive, 
people from PANE, deputy secretary, service chiefs, service 
secretaries, going through this particular case, recognizing 
that it has to be a large airplane and recognizing there are 
only two manufacturers in the world we could really turn to. 
But yet we did look at re-engining. We did look at purchasing a 
plane from Airbus.
    We did look at used planes that might be available and we 
also looked at what might be involved in developing a new 
plane, Mr. Chairman, and felt that there was not a reason to 
spend the time to do that.
    The Chairman. You are aware that the Office of the 
Inspector General says an AOA should have been conducted?
    Secretary Roche. Yes, sir, I understand that's his opinion. 
The Under Secretary of Defense
    The Chairman. It's not just his opinion. He's the Inspector 
General of the----
    Secretary Roche. Yes, sir. With all due respect, Mr. 
Chairman----
    The Chairman. It's more than just a matter of opinion. Why 
wasn't the IDA that was conducted, why wasn't that--their 
recommendations and objections taken into consideration?
    Secretary Roche. They were, Senator, Mr. Chairman. We had a 
lot of people who have spent time on this for the last year and 
a half. There was lots of debate. When all was said and done, 
the Office of the Secretary of Defense, the Under Secretary of 
Defense for Acquisition approved the process, approved this 
lease going forward. It then went over to the Office of 
Management and Budget. They also approved it. In the course of 
that, there was much debate on both sides as to does this 
better discount rate, should you think of this as the model of 
acquiring, et cetera.
    The Chairman. But Mr. Secretary, the Institute for Defense 
Analysis said that the lease should be $120.7 million that, 
quote, should satisfy Boeing and its shareholders. They didn't 
change their position on that.
    Secretary Roche. No, sir, they didn't, but there was a 
debate as to whether that was going to be an aircraft delivered 
that was fully FAA certified. And in fact it's one thing to ask 
people for a rough order of magnitude instead of numbers, it's 
another thing to have a firm, fixed price, which this lease 
provides the taxpayers, a firm, fixed price with the exception 
as noted of interest rates. But in terms of everything else, 
there's no way we could have an overrun on this program, sir.
    The Chairman. Was there ever a formal study of the 
corrosion problems on the KC-135 conducted?
    Secretary Roche. There have been a series of studies done 
in the Air Force material command, not one that specifically 
stopped and said, let's look at all the KC-135s and see the 
degree of corrosion. There have been data that have been 
building. There's also data now available----
    The Chairman. Why we wouldn't do such a thing?
    Secretary Roche. --on our 707s that were refurbished and 
are back in service and in fact recognizing they do not act 
like brand-new airplanes but act like middle-aged airplanes.
    The Chairman. Why do we need a FAA-certified airplane?
    Secretary Roche. A tanker has to be an FAA-certified 
airplane, sir, because it goes to lots of airfields around the 
world in many countries, it flies around the United States. 
It's the same reason we can't fly certain drones over parts of 
the United States because they're not FAA certified.
    The Chairman. Do you believe it's appropriate to tell 
Boeing what the offer of the Airbus was? Do you believe that's 
appropriate?
    Secretary Roche. Sir, debriefing each party after a 
competition or request is appropriate. The use of specific 
numbers may well not have been appropriate and if it is 
proprietary information, it was absolutely inappropriate and 
that's being looked into.
    The Chairman. How do you respond to the three witnesses who 
we in Congress--represent agencies that we in Congress rely on 
for objective information to provide us with recommendations as 
to how we should conduct our business particularly in the area 
of procurement?
    Secretary Roche. Senator, it's an absolutely appropriate 
question. My sense is we have been through so many groups who 
have looked at this, who have been spent so much time on it, it 
is very complex, it does very much hinge on the type of 
assumptions you make, as have been noted. My colleagues here at 
the table have been very good to point out that if you have a 
different model for how you purchase, it'll make things swing 
in very different directions, including swing more favorable 
towards lease and to certain circumstances. So a lot of it is 
assumptions. That's why when this all came up and recognizing 
its complexity, I gave my word to you, Senator, that we would 
not move forward unless the authorizing committees also agreed 
and gave everyone a chance to take a look at this to make sure.
    The Chairman. Finally, Mr. Secretary, according to recent 
report, you said that you have not completed your negotiations 
with Boeing and that we're battling this for a while, in other 
words, have you concluded your negotiations yet with Boeing?
    Secretary Roche. No, sir. On the particular items that 
you're referring to, I can tell you that----
    The Chairman. Just answer my question. You have not 
completed your negotiations with Boeing?
    Secretary Roche. No, sir. They've made a lot of progress 
today, Senator.
    The Chairman. So what you want Congress--three Committees 
of Congress to approve of a lease that we haven't even seen, 
that you haven't even finished the details of. Remarkable.
    Secretary Roche. If I may, Senator, may I?
    The Chairman. Sure.
    Secretary Roche. Mr. Chairman, when we typically get an 
authorization and appropriation, we don't have a final contract 
that we bring forward for a committee to look at. We have a lot 
of professionals----
    The Chairman. When we purchase something, we know the full 
purchase price though.
    Secretary Roche. Senator, quite often we have estimates, 
and that's why there have been so many program overruns that 
heaven knows I've lived with. One of the attractive features of 
this is they're not.
    The Chairman. We know what the terms of the contract are, 
Mr. Roche.
    Secretary Roche. Usually, sir, quite often there are not 
the specific terms and conditions negotiated at the time of an 
appropriation. There's an amount of money and there's a model 
contract. We've sent forward the draft here----
    The Chairman. It's a contract, Mr. Roche. I've been around 
here a long time.
    Secretary Roche. Sir, also in this particular case we would 
not go forward until this was looked at by the Office of the 
Secretary of Defense and the Office of Management and Budget 
again.
    The Chairman. But you expect Congress to approve of a deal 
that you haven't even completed? Let's see, Senator Inouye.

              STATEMENT OF HON. DANIEL K. INOUYE, 
                    U.S. SENATOR FROM HAWAII

    Senator Inouye. Thank you very much. Mr. Chairman, at the 
time this arrangement was made I was Chairman of the 
Subcommittee, so I do have some interest in this matter. Is the 
KC-135 capable of being refueled in the air?
    Secretary Roche. With very few exceptions, no sir.
    Senator Inouye. Can the 767 be refueled in the air?
    Secretary Roche. Yes, sir, we have learned from the KC-10 
the value of being able to consolidate. If a gallon of gas 
costs roughly $1.50, when we price out what does it cost to 
transfer from a tanker to a jet that's over a combat area, it's 
closer to $17 per gallon. We waste a lot of money by bringing 
back fuel all the way back to refuel and take it back as 
compared to being able to consolidate. One of the great 
advantages of the KC-10 has been consolidation. It would be 
part of every one of these planes.
    Senator Inouye. In Afghanistan and in Iraq there were three 
types of aircraft, the Air Force, Navy, and Marine Corps.
    Secretary Roche. Plus coalition, sir.
    Senator Inouye. Can the KC-135E refuel all three?
    Secretary Roche. Not more than one type per flight. In 
other words, you'd have to change from either a probe or excuse 
me, a boom to a probe and drone. You could not have one mission 
and be able to handle two types of airplanes because one of the 
operational savings we see coming is if we had a mix of Navy 
aircraft and Air Force aircraft in a cap station and we had to 
maintain that cap station, today it would take us three KC-
135Es to do that or one KC-767, primarily because of the 
increased fuel and the ability to fuel two different types of 
airplanes on the same mission.
    Senator Inouye. Would that have made a difference if we had 
it?
    Secretary Roche. It would have, sir. We had enough aircraft 
in this last conflict that we were able to handle everything, 
but if we had not had the KC-10s we would have been in very 
deep hurt, because the KC-10s were one of the primary aircraft 
to refuel Navy and Marine Corps aircraft.
    Senator Inouye. One of the requirements that you specified 
for the 767 is that it had to be upgraded as a smart tanker. 
What do you mean by that?
    Secretary Roche. No monies are being spent on that. The 
idea is over time we would like to use the presence of a 
tanker, and there are many of them, to be able to add 
electronic palettes. So for instance we have a test that has 
completed that we are very much impressed by wherein we can 
roll a palette on board and create a radio relay system in an 
area without having to overuse satellites, so that we are able 
to have a local area network in effect, and that is the sort of 
a think of a smart tanker, using a tanker for more than just 
passing fuel, but while it's there having it do other things. 
In time, we believe we can put passive apertures on it and have 
those apertures communicate to something like a river joint 
aircraft for electronic warfare and be able to make use of the 
fact that we have these aircraft in the area to provide virtual 
antennas that are very large.
    Senator Inouye. Can the KC-135E do that?
    Secretary Roche. No, sir, none of them can. We could modify 
that but we don't quite have the real estate on the KC-135E. 
The communications palette does fit on an E or an R model.
    Senator Inouye. Is there any difference between the 
operating costs for 767 and 135E?
    Secretary Roche. If you take maintenance and everything 
into account, there are, Senator. I'm afraid it's not on the 
tip of my head. May I get back to you specifically on that? One 
of the features that we have put into this is because of the 
low emission capable rate overall, including aircraft and depo, 
that the requirement for the 767, and one of the reasons why 
we've done the logistic support with the contractor to begin 
with, eventually this will transfer to a partnership with one 
of our ALCs, is to specify an 80 percent mission-capable rate, 
which includes all aircraft whether they're in depo or not. But 
at any given time four-fifths of all the aircraft must be 
available.
    In the case of the KC-10 we used contractor logistic 
support and it had the highest proportionate usage rate of any 
of the tankers. In other words, we only have available at any 
given time 53 of the 59 because the others are used for 
schools, but we used 42 of that 53 throughout this OIF. That 
was much higher than anything else. In the R models, it was 
less than half, and in the case of the E models it was 36 out 
of 131. So the idea of having a specified goal for a contractor 
logistic support has proven itself in the case of the KC-10, 
and we also use it in the C-17, sir.
    Senator Inouye. This afternoon many numbers have been 
mentioned, $1.9 billion, $150 million, $130 million, et cetera, 
et cetera. In the dollar figures that we've been told, do you 
believe that factors such as re-engining, corrosion, upgrading, 
have they been factored in?
    Secretary Roche. They've not been factored in the side-by-
side analysis, the overall sense of urgency to move forward, 
yes. This begins from many different sources, in my case from 
going to Tinker air logistics command in July 2001 and being 
quite shocked by the degree of catalytic corrosion, which is a 
battery effect of moisture and dissimilar metals, and then 
doing homework on what has happened to the 707s that we're 
using for Joint Stars that we've invested to bring to a current 
condition and how do they behave. They don't behave like brand-
new aircraft. Therefore the sense that this is going on and at 
the same time after 9/11 the demand on these type of aircraft 
suggested that across the Air Force this was a much higher 
priority than it had been treated as in the past. I very much 
agree with the Chairman that in the past this was not treated 
with the degree of priority that I believe it should have been.
    Senator Inouye. In your mind as the Secretary of the Air 
Force, do you think that the taxpayer is being shortchanged?
    Secretary Roche. No, sir, I made it clear that I would not 
come back unless I felt this was a good deal for the American 
taxpayers including having these aircraft in the hands of 
warriors earlier, including being able to get the operational 
savings by having more efficient and effective aircraft in 
place, and that's why we have tried to be as transparent with 
all of the staffs, and in a year and a half of intense debate, 
I believe we've all come to closure on something that makes 
sense, and I believe it does make sense, yes, sir.
    Senator Inouye. In February of 2002, did the Air Force 
issue a request for information to both Boeing and Airbus?
    Secretary Roche. Yes, sir, we did.
    Senator Inouye. What was the outcome?
    Secretary Roche. The outcome was a comparison of the Airbus 
A-330, as I recall, the 767 as compared to the KC-135, and the 
KC-10. And the primary factors were not costs because in fact 
the Boeing plane initially was priced much higher, but that the 
size of the Airbus plane, the A-330 was a very, very large 
footprint, yet as you can go on the Internet and look up, it's 
long with very long wings which means it has a spotting factor 
that's very high but doesn't carry that much fuel proportionate 
to the fact that spotting factor is in fact bigger than a KC-
10, whereas a KC-767 is only slightly, about 25 percent larger 
than a 707 or KC-135 and has greater throughput in all but one 
scenario.
    The Chairman. Senator Stevens?
    Senator Stevens. Thank you very much. Secretary Roche, one 
of the factors that was involved in the guidelines that CBO 
used, Mr. Holtz-Eakin might want to comment after your answer, 
but I understand was whether there was a private sector market 
existing for these planes. It's my understanding that the State 
Department has offered guidelines for commercial sales of 767, 
the Italian Government has selected it for tanker missions and 
has purchased four aircraft, the Japanese have committed to buy 
four aircraft, the British have issued requests for proposals. 
Have you come to conclusion as to whether or not there is a 
private sector market existing as far as these planes are 
concerned?
    Secretary Roche. Senator, on two levels, one, there are 
countries who have observed the United States' ability to 
project its power by virtue of tanker aircraft and that they 
are asking and showing interest in this particular aircraft. 
Second, it's also a very good lifter. It has had a very good 
cargo capacity, so one could use it as a cargo aircraft as 
well, because in any of these like the KC-10s, which I'm sure 
you've been on, there's a lot of space inside that if you put 
less fuel for refueling you can use for cargo.
    Senator Stevens. I was going to ask a second question about 
that. I understand that the current aircraft configuration has 
been changed substantially, that it now includes an advanced 
flight deck, convertible cargo passenger interior, increased 
power generation, and substantial other features. Was that 
important in connection with the negotiation as far as this 
aircraft is concerned?
    Secretary Roche. Yes, sir, it increases the cost. We took 
away some of the features we had originally put in when we took 
a second look to try to have a lower price and felt for 
instance that you don't need a 4-hour turnaround, that you paid 
a lot of money to be able to have something that could convert 
very, very quickly between passengers and cargo, and so we 
tried to reduce that. That accounted for about $3 million per 
copy, but the fact that the plane is very agile means that if 
were to, for instance, have to escort a series of Marine Corps 
aircraft from Cherry Point to Japan, we would do it with these 
airplanes with half the use of fuel than we otherwise would 
because the tankers themselves can carry the cargo that 
normally you have to assign to a cargo aircraft, as well as 
being more efficient, so it's a one-half savings.
    That's one of the operational savings that we point to. We 
didn't factor those into the analysis because it's hard to say 
how often will you do that, how much will you be at war, et 
cetera. Our larger concern was that if we look from July 2002 
forward, we could not have predicted the Afghan conflict in the 
next two years nor the Iraqi conflict, but we could predict 
that the tanker aircraft were aging. Once these things 
occurred, 9/11 occurred, and that even as we speak, Senator, 
there are a number of tankers that are on alert around the 
United States plus the missions overseas, the demand on these 
was growing and it seemed sensible to hedge, especially since 
years ago when the tanker fleet was only 17 years old both the 
Congress and the administration of both parties agreed a hedge 
made sense. I think it makes even greater sense and the 100 
airplanes would do that.
    Senator Stevens. These 100 airplanes will replace at least 
131 of the old ones that are going to be retired, right?
    Secretary Roche. Yes, sir.
    Senator Stevens. In terms of the operational capability, 
have you compared those 100 to the others that will not be 
retired?
    Secretary Roche. Yes, sir. We've compared them in terms of 
how the KC-767 would compare to the 767s and in all it's better 
than the E model in every case. In the case of the R model, 
there's one condition where you have to take off and fly 3,500 
miles before you refuel an airplane and there it's slightly 
worse than an R model for reasons of just fuel consumption. 
Generally it's better across the board, and if we were to 
recapitalize beginning now, we will still have R models of the 
KC-135 flying when they're in their seventies, so it's not that 
all the 544 will retire, even though their average age is 43 
years, because some of these are going to have to last in their 
seventies, and we expect the cost of that maintenance to be 
quite high.
    Senator Stevens. Part of this conundrum is the availability 
of budget authority for the future in replacing all of these 
planes at the same time as we're going into other problems that 
you face in terms of the joint strike fighter, the F-22, and 
all those other planes that have substantial byways ahead of 
them. Do the considerations of the budget process enter into 
your decision?
    Secretary Roche. Yes, sir, absolutely. We were asked and 
pressed by the staffs and the Defense Department, could we 
afford to pay all of this and have our other programs as well? 
There are a number of programs which start to come down about 
the time that the demand for increases in this program go up, 
the FA-22 starts to come down, the C-17 starts to come down, 
and our sense, and as we demonstrated to the Department of 
Defense is, we can handle this under not heroic budget 
projections but rather flat-line budget projections for the 
future, that it could be done, yes, sir.
    Senator Stevens. Provided we have the budget authority at 
that time, the time of the transition?
    Secretary Roche. Yes, sir. The difference is now, it's 
clear if we were to try and move this to a purchase now there 
is not the budget authority available without causing severe 
harm to ourselves or our sister services.
    Senator Stevens. It may interest everyone to know that our 
Appropriations Committee is the only Committee in Congress that 
is subject to the Budget Act really in terms of the limitations 
on budget authority and outlays. My colleague reminds me of 
that from time to time, but I personally believe still this is 
in the best interest of the country to move forward and get 
these planes as quickly as possible. Thank you, Mr. Chairman.
    The Chairman. Thank you, sir. I'm told there's no 
requirement for FAA certification for military aircraft that's 
being operated by the military and for the military to fly into 
any airport or any commercial airport. I'll guess we'll have to 
find out which one of us.
    Secretary Roche. Yes, sir, I'll be glad to get back to you.
    The Chairman. I certainly flew aircraft, Mr. Secretary, 
into airports that were not FAA certified, my own experience. 
Senator Cantwell?
    Secretary Roche. Senator, may I get back to you with that 
sir?
    The Chairman. We'll supply for the record. Senator 
Cantwell?
    Senator Cantwell. Thank you, Mr. Chairman. Secretary Roche, 
you were just now making a comparison to if you wanted to get 
more KC-135s to the 767, but obviously getting more KC-135s 
isn't really an option, correct?
    Secretary Roche. No, ma'am. Those are long since out of 
production and the spare parts for them are long since out of 
production except for in small amounts.
    Senator Cantwell. So you're making a good point about the 
difference in the new model and its increased capacity but I 
just wanted to point that out for people that you can go back 
to the KC in fact, wouldn't you say that one of the great 
benefits of this proposal is that we are getting the 
engineering and production costs that I think even by CBO's 
estimate that designing and building a new tanker would 
probably cost more and take longer if we didn't have the 767 as 
the model to go from, isn't that correct?
    Secretary Roche. Yes, ma'am, that's the parallel to the KC-
10, wherein the taxpayer can benefit from commercial investment 
over many years and pick up a plane as it's near its commercial 
life in terms of new production. However, the infrastructure 
around the world, the spare parts, the inventories, the people 
who know how to maintain them are still very much around.
    Senator Cantwell. I'm not sure that any of these many, many 
models and assumptions are taking that into consideration, are 
they, other than just the overall net effect of it?
    Secretary Roche. No, ma'am. We had to approach the rules 
from OMB in terms of a purchase versus lease very specifically 
and a number of these were set to the side. I believe they add 
to the reason why I think this is a good thing to do.
    Senator Cantwell. The apples and apples comparison that was 
thrown out to net present value, you sort of answered this 
question but not in great detail. Why is a net present value 
today in an outright procurement why isn't that possible?
    Secretary Roche. I'm sorry, ma'am, why we couldn't procure 
it immediately?
    Senator Cantwell. Yes.
    Secretary Roche. Because we simply don't have the budget 
authority to do that and also our rules that we have to follow 
would have us go through a development program, we pay all the 
development costs up front, and then even as the Inspector 
General notes, who would like to see us have a prototype, learn 
that, that's all time. Time is money and that means we'd be 
living on the same existing fleet for even longer. We're not 
sure of what a 767 might cost if it was not leased in terms of 
asking a line to stay warm, if the line ran out, or if it might 
just run out, it's a commercial company, it can make decisions 
based on its shareholders' needs.
    Senator Cantwell. Isn't that part of the reason why maybe 
the decision had been delayed or prolonged before, because of 
the huge cost of an out-and-out procurement?
    Secretary Roche. I think, yes ma'am, in the case of the, up 
until the year 2001, the budget in the Pentagon was down, there 
were a number of conflicting priorities, we have found examples 
where the Congress for instance discovered how little attention 
was being paid to spare parts, and even prior to the election 
of this Administration did a lot to start putting money toward 
spare parts to get mission capability rates up. There was an 
expression called buying-down readiness which was to in fact 
defer readiness, not put in parts, so as to free up monies to 
procure because the procurement budget was so low, and I think 
the tankers viewed of what the missions expected for them were 
not viewed as an important priority item. I think the world has 
changed, and I believe that they are a very high priority item 
now.
    Senator Cantwell. On that point----
    Secretary Roche. At least to hedge against the fleet.
    Senator Cantwell. --on that point that the world has 
changed, two of your co-panelists are Mr. Curtin, who had 
admitted the GAO issued a report before saying we have a big 
problem coming at us and may have a huge bow wave of 
maintenance costs, and Mr. Bolkcom also mentioned what's 
changed in the last couple of years. They both mentioned not 
sure enough has happened or the risk assessment of what the 
next several years would be like. Could you elaborate on that 
because it seems clear to me in all the things that have 
happened in the last couple of years that the increase in 
sorties must be dramatic and the projection about increased 
sorties is not slowing down any time soon. So if the Air Force 
hasn't made that clear, there seems to be a disconnect why that 
perspective isn't more certain as to the increase in demand?
    I'm asking Secretary Roche if you would comment on what 
that actual increase in demand of sorties are because I say you 
have two panelists who are following this and aren't quite 
clear, haven't heard that message and are saying, yes, we 
believe the need is there for new 767, for the new tanker, but 
we're not sure what's transpired in the last couple years. I'm 
asking you to further explain what's transpired.
    Secretary Roche. Thank you, ma'am. I didn't realize that 
was directed towards me. The planning models that we used in 
the Department of Defense up until 2001, this Administration, 
were basically two major wars and that's all and a lot of the 
planning went for that. Our AWACs for instance are based on 
that, but the reality of life is we're in many more places at 
the same time. There was a point in time when a conflict in 
Afghanistan was viewed as one of the most stressing and we'd 
probably never do it because it's a landlocked country, that 
from the shore to the beginning of Afghanistan is 300 and some 
miles. Therefore, it's not the sort of normal place you would 
ever want to have a conflict in.
    There was not the plan to be able to have a lot going on at 
the same time and it turns out they're all far away and they 
all place great demands on aircraft, not just Air Force 
aircraft, but naval aircraft, as well as Marine Corps aircraft, 
and for a Navy plane to take off in the north Indian Ocean and 
fly into Afghanistan requires land-based tankers in addition to 
its own indigenous tankers on board the carrier which are very 
small, but once you get over land and get going, you need land-
based tankers. That was a demand we had not seen and a demand I 
did not believe that was forecasted.
    Noble Eagle was obviously never forecasted, the fact that 
we have to have multiples of tankers available and on alert 
filled in any given day to be able to service aircraft overhead 
here. There are a number of other cases where the tankers were 
planned at a much reduced rate of usage and that's gone up 
because we are flying in these other places, I said of 69,000 
sorties, we have almost as many tanker sorties as we have Air 
Force fighter bomber sorties.
    Senator Cantwell. And do you have a number on the 
percentage of increase that we've seen?
    Secretary Roche. I don't have the percentages in my head, 
ma'am, but we can get back to you for that.
    Senator Cantwell. Thank you.
    The Chairman. Senator Fitzgerald?
    Senator Fitzgerald. Thank you, Mr. Chairman. Secretary, I 
did want to go back to the issue I raised in my opening 
statement. As I said, I think it's clear, everybody who 
testified here today said we'd save more money if this were a 
straight-up purchase. I noticed that the public law that 
authorized the Air Force to enter into a lease did not 
authorize you to enter into a purchase, it only gave you one 
option to enter into a lease.
    If Congress were to give you the budget authority and 
perhaps help you cut some of the red tape out of the DOD 
procurement process, wouldn't you agree it would preferable to 
buy these tankers and save the $6 billion for the taxpayers? 
Don't you have something else you could do with that $6 
billion?
    Secretary Roche. Instinctively Senator, may I make two 
points. The notion of net present values compares streams of 
outputs over time. It is exactly as one of my colleagues 
pointed out, how much money do you have to put into a bank 
earning at a rate that is acceptable such that you can meet the 
need payments over time? A lease pushes the payments out, 
therefore dollars are worth less than current dollars. The 
purchase model we used, the classic model, if we were to have a 
situation which for instance yields something like the $1.9 
billion difference of where A, the money was available up front 
without our having to go after other programs recognizing we've 
gone 12 years with very little procurement, and the rules were 
changed so that it was not development money and production 
money, that it was the same ability to blend those and to order 
100 of something at a time as compared to a lot smaller, and 
you are able to amortize over the course of all of the 
aircraft, a lot of these if-if-ifs, which now are not permitted 
and would be a major change to our normal procurement rules, 
then the purchase starts to look much much more attractive.
    There's just no press for that, nor would we expect that to 
occur. The lease I believe is a one-time opportunity to get a 
jump start to recapitalization, but it's not something you 
would do for the rest of the force.
    The Chairman. Senator Fitzgerald, maybe Mr. Holtz-Eakin and 
Mr. Curtin might have a comment on that rather bizarre answer.
    Mr. Holtz-Eakin. Let me try to make clear the nature of the 
CBO analysis so as to alleviate any confusion about alternative 
models and the importance of net present values. The first 
point is that the decision to use 767s instead of the existing 
tankers is a policy decision. Our analysis compares alternative 
means by which the same 100 planes would be acquired by the 
U.S. government on exactly the same schedule, and in each case 
Boeing would receive these same $131 million per plane. Our 
first point is simply that these ought to be reflected on the 
budget because this special purpose entity is in fact an 
instrument of the government.
    Senator Fitzgerald. So you're saying even if we do enter 
into the proposed arrangement, that it should be reflected in 
our budget because, and you're saying that because really the 
government is going to control this trust and it really is an 
acquisition.
    Mr. Holtz-Eakin. Yes.
    Senator Fitzgerald. It is an acquisition. It's just a 
complex legal construct to evade the DOC procurement 
requirements, isn't that correct, Secretary?
    Secretary Roche. Senator, there's certainly no intent to 
evade. That's why we have made this transparent to everyone, so 
there's no intent to evade at all.
    Senator Fitzgerald. Congress is authorizing you to evade.
    Secretary Roche. The special entity does own the aircraft. 
The title to the aircraft is not in the Air Force, it's in the 
special entity.
    Senator Fitzgerald. Who's the trustee of the special 
entity?
    Secretary Roche. The Air Force, but----
    Senator Fitzgerald. Okay, that means you're the legal title 
holder.
    Secretary Roche. --no, sir, they are, under Delaware law 
they can recover the airplanes and they can sell the airplanes 
at the end of the lease. The only provisions we have are the 
price of the airplane at that time.
    Senator Fitzgerald. The legal title holder of the property 
is the trustee of the trust. You are both the lessor and the 
lessee under this. It's not a lease, it's just a complex legal 
construct to help you avoid the procurement laws that we have 
around here, and I'm very troubled by that.
    You know, we're going to have this Iraq supplemental very 
soon, it's going to authorize emergency spending without 
budgetary authority, and based on the Air Force argument of 
urgency, I would think that this deal would have much more 
merit for emergency spending than the non-emergency projects 
and earmarks that I'm sure are going to be thrown into this so-
called emergency supplemental. Why not do this straight up and 
go through the ordinary process? This is a way by going on with 
the supplemental you could avoid the problem with budget 
authority that you are so concerned about.
    Secretary Roche. From my position, I want to hedge the 
airplanes. How those airplanes are obtained is secondary to me.
    Senator Fitzgerald. Do you not care about the $6 billion 
it's going to cost extra that it's going to cost the taxpayers? 
It's coming out of people's paychecks?
    Secretary Roche. Sir, I do, but in net present value terms, 
it is not that amount. It's the time value of money and when 
the time value of money is put next to the purchase or lease, 
it's $1.5 million per plane, as we propose it, as the Office of 
the Secretary of Defense argued and manipulated, and as OMB 
approved it.
    The arguments my colleagues have to the left are not just 
with the Air Force. We've had lots of people in this for the 
last year and a half. It is not taking money from the taxpayer, 
it is the time value of money as it's spent over various years, 
but my interest is to hedge and the fastest way that I now how 
to hedge is with this lease. If there were a way to do this 
comparably with a purchase under a number of these assumptions 
which have not been available in the past, then certainly if I 
could get the airplanes more quickly I'd feel I'd be fulfilling 
my duties to the Secretary of Defense to ensure that he's able 
to make use of forces when he has to for the President.
    Senator Fitzgerald. May I ask well, I've----
    The Chairman. Senator Lautenberg?
    Senator Fitzgerald. Thank you, Mr. Secretary.
    Senator Lautenberg. Thanks, Mr. Chairman. We're obviously 
somewhat perplexed. It's not to say that those who are raising 
the questions fair that we don't believe that this 
refurbishing, this newer approach ought to be followed. The 
question is, why is it that we can so easily explain away a 
savings of $6 billion. I would vote right now if you said we 
want to buy these ignoring for the moment the process, I'd say 
yeah, fine, let's buy them. It's not that I don't want them to 
have the best capability for fueling or cargo or what have you, 
and so when I look at this and I see that we're looking at a 
savings of maybe $400 million a year if we buy them, that we're 
told that we can't get delivery at a sooner time if we buy than 
if we lease, which is certainly a reasonable question.
    Why if they're going to start to be available in 2005, what 
does it matter whether we lease it or we buy it and we're 
paying a heck of a price if you're saying, well, okay, the 
danger is imminent but we can't do the transaction the same way 
whether we're willing to commit, we do often commit to long-
term proposals when we buy an aircraft carrier, they don't 
deliver next year, we make a commitment to buy it of pay for it 
over the years as it's built.
    So Mr. Roche, I've got to confess and I come out of a 
fairly complicated business environment that I just don't get 
it, and I heard your explanation. Are we really saying, and I 
think Senator Fitzgerald kind of asked the same question, are 
we really saying that if you want to get around the red tape, 
here's a way to do it? Well, I think we ought to look at the 
tape instead of just tossing away $5.6 billion. That kind of 
money would buy us a lot right now. We need a lot more in the 
military than we thought we'd need if we look back just a 
couple years, so I say figure out a way and some of us here 
would be happy to carry the burden of trying to get a 
reauthorization or whatever else we need to get this purchase 
on the books, and why can't the delivery schedules be the same 
whether you buy it or you lease it?
    Secretary Roche. Under the laws and rules we follow, we 
would have to go through the normal process unless that process 
were changed. If the process is changed, then it's a different 
set of circumstances we would look at. We have no indication 
that that process could be changed, nor do we have an 
indication, Senator, that the monies, the budget authority 
would in fact be available. Had, and I agree very much with the 
Chairman, had earlier in the 1990s this been thought of and a 
systematic way to deal with this put in place, we wouldn't face 
the situation we face of very old airplanes that are only 
getting older with the prospect of taking a long time to 
replace them.
    Senator Lautenberg. But are they able to supply our needs 
for conflict now?
    Secretary Roche. So far they have, yes, sir. The issue as 
raised by again one of my colleagues here is, we couldn't 
predict the world in 2001, in July of what really happened 
within 24 months. I find the same situation, I can't predict 
what the next 24 months will be like, nor can I predict how 
these aircraft may behave because they are now so old we've 
never had aircraft like this, we've never had a fleet this age.
    Senator Lautenberg. Do we want to predict what wars will 
look like three years from now and vary our procurement based 
on that?
    Secretary Roche. I think in many respects, Senator, that 
Secretary Rumsfeld is directing the services to think about 
what is the more likely type of war and one feature that comes 
across a lot is they're far away.
    Senator Lautenberg. Well, they are far away and I don't 
know that we can make changes very quickly about bringing them 
closer but----
    [Laughter.]
    Secretary Roche. I don't think we'd want to, Senator.
    Senator Lautenberg. No.
    Secretary Roche. I meant far away in distance, not time.
    Senator Lautenberg. So maybe what we ought to do is get a 
couple more aircraft carriers, I don't know what the cost of 
these things are. But the fact is I think that dismissing the 
inability to predict what the future might be shouldn't cause 
us to go ahead, throw out $6 billion, $5.6 billion of the 
public's money and rush this through on a lease deal which 
frankly doesn't seem to make sense. If we need a change that we 
can save the taxpayer $5.6 billion over the next 14 years, less 
than 14 years, I'd say, hey, let's work on the changes. Would 
you endorse the purchase of this if the changes could be made 
to allow you to do the purchasing that way?
    Secretary Roche. Senator, if in fact all things could occur 
such that these planes could get there at the same rate they 
could with the lease by another means, I'd be delighted to take 
a look at that other means.
    Senator Lautenberg. Well, then why do we fall to the easy 
way and spend $6 billion?
    Secretary Roche. Granted there'll be a debate in terms of 
assumptions, but the value of doing net present value is, if 
you have an assumption of a model of purchase, a model of 
lease, and you bring it back to the same time, it's a way of 
reflecting that. My colleagues differ with what we have done 
and what the Office of the Secretary of Defense has done and 
OMB basically on what the assumptions of those models are. And 
it's I can't say they're wrong, all I can say is enough people 
who have reviewed ours and have made changes to it are now 
willing to go forward.
    The Chairman. Senator Sununu?
    Senator Sununu. Thank you, Mr. Chairman. It seems to me 
there are several questions here. First is the question of 
need, and I think Mr. Holtz-Eakin indicated this is a policy 
question, and as someone who was fortunate to fly on a 135 with 
a great National Guard refueling wing that flies out of New 
Hampshire, I will stipulate that I've never felt safer and at 
the same time I'm sure that they would love to fly newer 
planes. They do a great job, they love their work, they're 
dedicated to their country, but I'm sure that wing would love 
to have new planes. But let us at least agree or go on the 
assumption that there is a need based on age, based on a 
natural cycle of upgrading, let's stipulate at least for the 
time being that there's a need.
    The second question would be savings and the term $6 
billion is thrown around the Secretary points out, well, that's 
not really fair, you should look at net present value, fine. 
And if we're looking at gross savings, savings today that are 
looked at over the series of payments here, net present value 
is the way to look at it and we can argue whether the savings 
by purchasing is $500 million or $1 billion or $1.3 billion or 
$1.9 billion, but I think everyone including the Air Force has 
argued that there are savings with the purchase option versus a 
leasing option. Then you get to the third question, which is 
scoring, and I'm sorry to be the one to bore everyone with 
scoring, but that's really the defense that you're falling back 
on at least as far as defending the way that you're approaching 
this, Mr. Secretary, and that is, well, you have issues of 
payment streams based on purchasing versus payment streams and 
budget authority versus leasing. So I want to delve a little 
bit into these scoring issues. I assume this is a CBO document, 
is that correct?
    Mr. Holtz-Eakin. It's part of our report.
    Senator Lautenberg. Okay, this is the CBO document, this is 
the scoring, the CBO scoring that we all have to live by, love 
them or hate them, and I will put my side on the side of 
usually defending the CBO, but we've got scoring here for three 
different transactions, one is a purchase, one is an operating 
lease, and one is a purchase lease, is that correct?
    Mr. Holtz-Eakin. That's correct.
    Senator Lautenberg. Okay. Are all three of these the same 
schedule for receiving airplanes?
    Mr. Holtz-Eakin. The same 100 planes on the same schedule.
    Senator Lautenberg. Same 100 planes, and based on that 
schedule of receiving, obviously the deferred maintenance costs 
that Senator Stevens raised, it would be the same for all, 
we're protecting ourselves against increased maintenance costs 
over the same period of time, is that correct?
    Mr. Holtz-Eakin. That's exactly right.
    Senator Lautenberg. So the real question is which one of 
these scoring models do we have to or wish to use or I guess 
I'll emphasize the have to use over time, and one is the 
purchase, the other is the lease purchase, and the third is the 
operating lease. Now, Mr. Holtz-Eakin, is it your contention 
that you have to use by law the lease purchase as opposed to 
the operating lease model?
    Mr. Holtz-Eakin. That's exactly right. Of the three panels 
shown here, only two are really choices. These transactions 
should be on the budget and if treated consistently with OMB 
guidelines, they will be treated as a lease purchase, the top 
panel, which has the----
    Senator Lautenberg. And that's because of this six-part 
test, is that right?
    Mr. Holtz-Eakin. Yes, it's a six-part test.
    Senator Lautenberg. I want to go into a little detail on 
this six-part test. Senator Fitzgerald raised the issue, I 
think it was that ownership of the asset much remain with the 
lessor and we got into an argument of who's really having title 
to these planes. I'll give the Air Force that one. I'm willing 
to give them this one. The ones that stick out in my mind is 
first, the lease must be for a general purpose asset, operating 
leases must be for general purpose asset, not one that's built 
to unique specifications of the government. Now it would seem 
to me that an Air Force military refueling tanker is 
specifications, specific requirements of the Federal 
Government, would you agree?
    Mr. Holtz-Eakin. As detailed in the report, that's exactly 
what we believe.
    Senator Lautenberg. Secretary, you would disagree with 
that?
    Secretary Roche. Disagree, sir, because we in fact, as we 
did with the KC-10, we take an existing plane and try to make--
--
    Senator Lautenberg. So these planes won't be built to the 
government specifications?
    Secretary Roche. There will be a commercial plane and then 
there'll be modifications made. Now certainly the boom and the 
probe-and-drogue are military, that's absolutely right, and any 
cryptologic equipment or other source of communications 
equipment----
    Senator Lautenberg. Cockpit communications----
    Secretary Roche. --is commercial, meets GATM standards.
    Senator Lautenberg. I think that's a pretty significant 
area of disagreement. Second, a private sector market must 
exist for these assets. Now the suggestion was made that 
government purchases by Japan or by the United Kingdom 
construct a private sector market, is that your contention, 
Secretary?
    Secretary Roche. Sir, I think I said there are other 
markets because it can also be used as a lifter. The underlying 
airplane, the 767-ER200 is the aircraft of choice for air 
freighters.
    Senator Lautenberg. So someone would buy a 767 outfitted to 
act as a refueling tanker strictly for cargo purposes?
    Secretary Roche. No, sir, the plane is also a cargo carrier 
and it's designed, our specifications also design it as a cargo 
carrier. You can fill the upper half with cargo and carry less 
fuel.
    Senator Lautenberg. It just doesn't seem like it would be a 
very good private sector purchase given the cost of the 
airplanes. Third part, lease payments may not exceed 90 percent 
of the fair market value, this is obviously a technical issue, 
but it's one of the six-part test, and I guess the question is 
for the CBO, does it meet this part of the six-part test?
    Mr. Holtz-Eakin. In our view, no. The Air Force analysis 
indicates that by including the construction and financing it 
would be 89.9 percent. We don't think it's appropriate to 
include that financing, which puts it over 90 percent, that's 
subject uncertainty in the evolution of construction costs as 
well.
    Senator Lautenberg. My time is all but up. The last part is 
that there can't be a bargain purchase price, and this is one 
where we'd probably say, well, we hope there's a bargain 
purchase price at the end but unfortunately if there is a 
bargain purchase price at the end it doesn't qualify. You 
wanted to address those?
    Secretary Roche. Yes, sir, only that these same issues were 
addressed by the Office of the Secretary of Defense and 
certainly by the Office of Management and Budget, and when all 
was said and done, they approved going forward. The argument my 
colleagues have is my OMB.
    Senator Lautenberg. I appreciate that distinction but we're 
beholden to a certain extent to comply with the rules and 
requirements and the scoring requirements particular with the 
CBO.
    Secretary Roche. OMB looked at the scoring issue and 
believed that it would not be scored to begin with as a 
purchase.
    Senator Lautenberg. Finally, given that the CBO argues that 
they have to score this as a lease purchase, if you could 
answer for me, Mr. Holtz-Eakin, what is the difference in 
budget authority? We heard a lot of talk about how the budget 
authority constraints would prevent us from doing an up-front 
purchase over the first four or six years. I look at this total 
and I see that the direct purchase would require $3.6 billion 
less in budget authority over the first four years than the 
lease, is that correct?
    Mr. Holtz-Eakin. That's correct.
    Senator Lautenberg. Am I adding the right numbers?
    Mr. Holtz-Eakin. You are.
    Senator Lautenberg. Secretary, any response?
    Secretary Roche. I am not familiar with the details of 
their study. We would gladly take a look at it and give you a 
side-by-side comparison.
    Senator Lautenberg. I would appreciate that. My sense is 
that that's what the CBO attempted to do here is a fair side-
by-side comparison, apples to apples, 100 planes, same 
schedule, and at the end of the day I look at the budget 
authority and the outlays over the first three or four years, 
this critical period, and we'll all agree it's a critical 
period, and I see that it's actually less budget authority and 
less outlays if we purchase the tankers, and I would hope you 
would take a look at that.
    I'm fairly new to this discussion and I'm sorry to bore 
everybody with the scoring but it gets us into trouble, but at 
the same time, this time it may actually lead us to make a good 
decision.
    Secretary Roche. I would only point out that OMB and the 
others looked at all of this, and it's a set of assumptions and 
it's how you calculate and there are differences of opinion, 
and we've gone by the rules we were supposed to go by, which is 
through the Secretary of Defense, argue the case, then to the 
Office of Management and Budget, argue the case.
    Senator Lautenberg. Thank you very much. Thank you, Mr. 
Chairman.
    The Chairman. Senator Brownback?
    Senator Brownback. Thank you, Mr. Chairman. Thank you, 
gentlemen. I want to ask Secretary Roche, has OMB had the 
chance to review the reviews and the comments by CBO, GAO, CRS, 
have they gone through?
    Secretary Roche. I don't know, Senator. I don't know.
    Senator Brownback. You don't know whether they've had a 
chance to review any of these analyses?
    Secretary Roche. Correct, sir. I do not know if they have.
    Senator Brownback. Okay. It seems to me that that would be 
an important thing to allow them or have them to do. I wonder, 
on the report put forward by CRS, one of the questions that I 
had that I don't think has been asked and it seems like it's 
been a pretty good questioning period, has been the lease price 
that Mr. Bolkcom was saying that we're paying much higher lease 
price than we should pay as a lease price. Do I understand your 
comment, Mr. Bolkcom, on that others are questioning whether we 
ought to lease and you're questioning whether we're getting a 
very good lease price, is that correct?
    Mr. Bolkcom. It is, sir. This is based on one formula 
that's used in the leasing business.
    Senator Brownback. Okay. That's the International Lease 
Finance Corporation, it's formula. Have you had a chance to 
look at that, Secretary Roche?
    Secretary Roche. No, sir, I have not.
    Senator Brownback. Okay, because it seems like that's one 
to me I'd look at. I see your point and I was on and involved 
at this at an early stage as well and you have a lot of 
restrictions that you're having to operate under, we could look 
back now and say, well, let's change those restrictions so we 
change the environment, that's tough to do, number one, and so 
you've got to operate under those, but if we're not getting the 
best lease price, that would seem to be that's something that 
we ought to be looking at. Although having said that, this is 
one of the most reviewed financing arrangements purchases that 
I believe the U.S. military has ever done. Would you agree with 
that, Secretary Roche?
    Secretary Roche. I would think so, yes, sir.
    Senator Brownback. Have you been involved in anything with 
any more review than this one has had?
    Secretary Roche. No, Senator.
    Senator Brownback. Anywhere close to it?
    Secretary Roche. No, Senator.
    Senator Brownback. And I think everybody would agree as 
well we do need to get the tankers. This is an aging fleet and 
it's going to continue to age and it's already having corrosion 
problems so it's something we need to move forward with. We all 
want to save whatever money we possibly can on this operation 
and I know you do as well. I would hope you could look at those 
leasing formulas by this one group, now I don't know if that's 
one that could be applicable here in this particular case or 
not. Thank you, Mr. Chairman.
    The Chairman. Secretary Roche, are you familiar with a 
memorandum dated January 20 from a Mr. Ken Krieg, the Director 
of PANE, subject PANE analysis of KC-767 lease program?
    Secretary Roche. Yes I am, Senator.
    The Chairman. It says, our A-94 analysis indicates the 
provision lease costs more than the equivalent purchase of 
tanker aircraft measured, and then your dollars lease cost 
exceed by six being basically what these three are saying, our 
analysis shows the current draft lease fails to meet the 
requirement of OMB circular A-11. You're familiar with this?
    Secretary Roche. Yes, sir.
    The Chairman. What happened then?
    Secretary Roche. I'll be glad to tell you, Senator. Ken 
Krieg gave that to me. We met within 24 hours. We said, all 
right, we have to go back and make sure that each of these 
things are addressed and over the course of time since then we 
did address them, with Ken Krieg and with the Under Secretary 
of Defense for Acquisition.
    The Chairman. Well, I have also a e-mail here from Patty 
Armstead asking you to put pressure on Mike Wynn to convince 
PANE to write new letter essentially undoing the first letter. 
He said he was not going to answer, would get in trouble no 
matter how he answered. John Manning attempting to get meeting 
for you tomorrow. Rote said he was going to talk to Wolfowitz 
tomorrow.
    Secretary Roche. No, sir, I talked to Ken Krieg and in fact 
I told him, don't bother writing another letter. We understood 
these were his arguments and we worked the arguments. I don't 
know who the other people are.
    The Chairman. Well, it seems to me what they're saying here 
is still the case. The OMB circular requirements include a 
requirement the present value of the lease payments be less 
than 90 percent of the fair market value, that hasn't changed, 
no inherent economic efficiencies relative direct purchase of 
tankers, therefore more expensive in the long run, that hasn't 
changed. Everybody admits, even the Secretary of Defense admits 
that it's more expensive, measured then your dollars lease cost 
exceed purchase cost by $6.0 billion, all of these are still 
the case.
    Secretary Roche. Mr. Chairman, those were positions put 
forward by PANE to the leasing panel chaired by the Under 
Secretary of Defense for Acquisition----
    The Chairman. And it's still true.
    Secretary Roche. --also the controller.
    The Chairman. And it's still true.
    Secretary Roche. They believe, the Under Secretary of 
Defense for Acquisition, we believe that those were all worked 
through. My colleagues don't agree.
    The Chairman. How were they worked through? What has 
changed here?
    Secretary Roche. The position of those individuals based on 
further discussion.
    The Chairman. See, but the facts themselves haven't 
changed, but the position has changed.
    Secretary Roche. Chairman, a lot of those facts are based 
on assumptions and modeling.
    The Chairman. So are all facts. Well, Mr. Secretary, you 
didn't do an analysis of alternatives which is standard for 
acquisitions, even though as you mentioned there is exception, 
you didn't do a formal study of the corrosion problem, you 
overruled the Institute of Defense Analysis, which you asked to 
give the analysis, they haven't changed their position, and now 
you haven't even finished the negotiations. But you want the 
Senate Armed Services Committee tomorrow, the last Committee, 
to go ahead and approve without you having completed two, 
quote, very important aspects of it, the most favored customer, 
and the 15 percent return on sales provisions. Remarkable.
    Mr. Holtz-Eakin, Mr. Curtin, and Mr. Bolkcom, do you think 
that Congress should approve of this deal without the 
resolution of those two issues? Mr. Holtz-Eakin?
    Mr. Holtz-Eakin. No, I do not.
    The Chairman. Mr. Curtin?
    Mr. Curtin. Well, I think, Mr. Chairman, that you've got to 
consider the military need here along with the cost side. 
Clearly I concede that the cost is more expensive to lease, 
whether that's the way you want to go is your judgement based 
on whether----
    The Chairman. My question was do you think that Congress, 
the final committee, they've already gotten the three, should 
approve before those two aspects of the deal are completed?
    Mr. Curtin. No, I think they should see how those come out 
because those are pretty important.
    The Chairman. Mr. Bolkcom?
    Mr. Bolkcom. Senator, I don't have the flexibility, I'm 
afraid, of my colleagues. CRS can't really take a policy 
position, but I will just point out that on our report we find 
a number of questions that still need to be answered.
    The Chairman. Thank you very much. Any further questions or 
comments? Senator Cantwell?
    Senator Cantwell. Are we having a second panel?
    The Chairman. Yes.
    Senator Fitzgerald. Just one final question. Mr. Secretary, 
I know this is under investigation, but I am concerned about 
reports that a deputy of yours who was involved somehow in 
analyzing this transaction left the Department of Defense, left 
the Air Force in November of last year and then wound up 
working for Boeing in January. How do you prevent employees 
from in essence being rewarded by helping a private contractor 
by being given a job at that company? Are there no regulations, 
no cooling-off period in place?
    Secretary Roche. Senator, there are a lot of regulations, 
and to the best of my knowledge, Ms. Druyun followed those to 
the letter. One of them is that she not return to the Pentagon, 
not be involved in any negotiations or discussions. I've not 
seen her since she's retired, I don't know if anyone else has, 
but she has stayed far away, she's abided by those by the 
letter that the time she left, this was still a hotly debated 
subject in the Department of Defense, so she had not taken this 
to any sort of a conclusion, and the investigation as the 
Chairman points out is the use of numbers and if it's 
proprietary information of the other bidder then in fact using 
those numbers were wrong, if it's open source information, to 
be found out, but if it was proprietary it is wrong. But the 
rules for employment after working at the Department of 
Defense, especially for people in the acquisition world, are 
very strict and we make sure that they're adhered to, and if we 
find any violations we report it.
    The Chairman. Not the first time recently that Boeing has 
been in possession of proprietary information. I thank the 
panel. I thank you very much for being here.
    The next panel is Lieutenant General John B. Sams, Program 
Manager of the Tanker Program, Military Aerospace Support, The 
Boeing Company; Dr. J. Richard Nelson, Assistant Director, 
Institute for Defense Analyses, Cost Analysis and Research 
Division; Mr. Steven Ellis, Executive Director, Taxpayers for 
Common Sense; Mr. Eric Miller, Senior Investigator, Project on 
Government Oversight.
    I'd like to welcome the witnesses, and Lieutenant General 
Sams, please proceed with your testimony and you might want to 
wait a minute until we quiet things down a little bit.
    General Sams. Yes, sir, Mr. Chairman.
    The Chairman. Welcome to the witnesses. Mr. Sams, please 
proceed, General Sams.

    STATEMENT OF LT. GEN. JOHN B. SAMS, JR. (USAF, RETIRED),

           PROGRAM MANAGER, USAF 767 TANKER PROGRAM,

         MILITARY AEROSPACE SUPPORT, THE BOEING COMPANY

    General Sams. Mr. Chairman and distinguished Members of the 
Committee, my name is John Sams and I am the U.S. Air Force KC-
767 program manager for The Boeing Company. I'd like to thank 
you for providing this opportunity, sir, to provide this 
testimony today. I do not have a written statement to submit 
for the record, but instead I'm prepared to provide these very 
brief oral remarks.
    Almost 24 months ago we began this journey. We knew that it 
would be breaking new ground pursuing a federal acquisition 
regulation, FAR Part 12 commercial acquisition for 100 new 
tankers. Commercial practices like leasing are both common and 
accepted practice in the commercial aircraft business and 
business in general, but not necessarily traditional in U.S. 
Government acquisition. Indeed, if successful with a commercial 
approach to this acquisition, we could put these assets in the 
hands of our Air Force crews a full 5 years before traditional 
government FAR Part 15 acquisition.
    In the process we may perhaps jump start a recapitalization 
of the fleet of 544 KC-135s, a process that would take almost 
30 years to complete if this or follow-on aircraft were 
procured at similar rates. Perhaps we could invigorate new 
ideas that could reduce the time it takes to field new systems 
for our military by streamlining processes and reducing risk to 
the government. We also recognize that this would be a 
thoroughly staffed and scrutinized program, as well it should. 
To be successful we had to accomplish three major goals ensure 
this was good for the war fighter, validate this was a good 
deal for the United States Government, and lastly ensure it was 
a good deal for the taxpayer.
    We believe that we have achieved these goals. First, is 
this the right aircraft for the war fighter and the crews that 
will fly it? Key to successful war fighting is the ability to 
operate joint and coalition forces interchangeably and here the 
767 excels. Able to refuel both boom and drogue-capable 
receivers on the same mission, the 767 will provide enhanced 
interoperability and flexibility to the battle space. With the 
ability to itself be air-refueled as we've discussed here 
today, it could remain on station as a tanker almost 
indefinitely.
    While more than meeting the requirements of the Air Force, 
this aircraft can take off from an 8,000 foot runway, a 
standard across the world, and offload 40,000 pounds more fuel 
at 1,200 nautical miles radius of action than the aircraft it 
is replacing. It would take two KC-135s to offload as much fuel 
at that distance. On a cargo mission, the aircraft can deliver 
10 palettes at a range of over 5,000 nautical miles. It would 
take three KC-135s to deliver this many palettes, and one 
palette would be left behind on the ramp.
    If the mission is to carry military troops into forward 
locations like Mogadishu or Kandahar, places where commercial 
aircraft of the civil air reserve fleet should not go, the KC-
767A can carry up to 190 troops. It would take three KC-135s to 
deliver this many troops and 19 would be left behind on the 
ramp. Yes, this aircraft is good for the war fighter.
    Second, we must validate this as a good deal for the Air 
Force. When the negotiations began we heard estimates form 
various agencies that the lease alone would cost up to $31 
billion. In fact, after 18 months of negotiations with the Air 
Force, the actual then-year cost is about half that estimate, 
or $16.6 billion. As indicated in the Air Force report to 
Congress, when the net present value of this is taken into 
account in Fiscal Year 2002 dollars, this value is actually 
$11.4 billion, and really the way that the Government needs to, 
or validates the true cost of items is comparing like dollars, 
and that's why the net present value assessments are so 
critical, and as we've discussed here, susceptible to the 
assumptions made.
    But the Air Force only after Congressional authorization 
should certainly have the right to purchase the aircraft at the 
end of the lease. Therefore, we negotiated a purchase offer at 
the conclusion of the lease for the then-year price of $4.4 
billion. Remember these aircraft will be coming off lease 
between the years 2012 and 2017, and so we're talking about 
dollars in the 2017 time frame. And when the purchase offer is 
applied to the same net present value assessment in Fiscal Year 
2002 dollars, the value is actually $2.6 billion, and so the 
bottom line. In net present value FY 02 dollars, the total cost 
of the lease plus purchase at the end if approved by Congress 
is $14 billion.
    And the net present value assessment does not consider the 
over $5 billion in cost avoidance that was mentioned by Senator 
Stevens, which hopefully we can discuss, which is over and 
above the cost to fly and maintain the aging KC-135Es, dollars 
not spent on program depo maintenance, not spent on engine 
strut replacement, and not spent on avionics upgrades required 
on the KC-135E. Yes, I believe this is a good deal for the Air 
Force and the U.S. Government.
    Lastly but no less important than the first two goals, we 
must validate this as a good deal for the taxpayer. To address 
this issue, we had to take some extraordinary steps not common 
even in commercial FAR Part 12 acquisitions. First, we sought 
permission for the Air Force to discuss price with a commercial 
airline customer of their choosing. That's very uncommercial-
like because normally all of these arrangements are protected 
by nondisclosure statements. We had to get permission from that 
airline.
    The Air Force took advantage of this on three separate 
occasions, and Boeing was not privy to those conversations. 
Second, we validated the Air Force had not in the last 17 years 
sold this green commercial 767-200ER to any customer for less. 
We believed our commercial customers will understand that this 
is the right thing to do. Additionally, we provided most 
favored customer clauses to the Air Force contractually stating 
that we would not sell either the-200ER or the-200C, our new 
minor model for the tanker to anyone else in the future for 
less. If we do, Boeing will rebate the difference to the United 
States Government.
    Finally, we contractually stated we would cap our earnings 
on the 767 green aircraft and separately cap our earnings on 
the tanker modification to a 15 percent return on sales. This 
is not guaranteed earnings. It's a ceiling consistent with DOD 
federal acquisition regulations, contract profit guidelines. 
Yes, we believe we have negotiated a proposal that is fair and 
equitable to the taxpayer.
    Mr. Chairman and Members of the Committee, this is a very 
challenging, firm, fixed price program for the Boeing Company, 
with the risk of the development, the production, and the on-
time delivery of the aircraft squarely on our shoulders, not on 
the Government's. Thank you very much for this opportunity to 
address the Committee, and I look forward to your questions, 
sir.
    The Chairman. Thank you. Dr. Nelson.

         STATEMENT OF DR. J. RICHARD NELSON, ASSISTANT

         DIRECTOR, COST ANALYSIS AND RESEARCH DIVISION

          (CARD), INSTITUTE FOR DEFENSE ANALYSES (IDA)

    Dr. Nelson. Mr. Chairman and Members of the Committee.
    The Chairman. You need to pull the microphone over, Doctor.
    Dr. Nelson. Mr. Chairman and Member of the Committee, I am 
pleased to come before you today to talk about IDA's estimate 
of the purchase price of a KC-767A tanker combi aircraft. A 
written statement has been provided for the record. I will make 
some brief summary remarks. In January 2003, the Institute for 
Defense Analyses was tasked by the Office of the Undersecretary 
of Defense, Acquisition, Technology, and Logistics, and the 
Office of the Director, Program Analysis and Evaluation to 
estimate the unit purchase price of the KC-767A tanker combi 
aircraft. The term ``tanker combi'' indicates that the aircraft 
can serve as an air refueling tanker or carry freight or carry 
passengers or combine freight and passengers. This is the 
airplane that we addressed.
    The objective of our task was to estimate the unit purchase 
price. With regard to other issues, this was the scope of our 
task specifically. We did not investigate the condition of the 
KC-135E or R fleet or the requirement for a tanker replacement. 
We were not asked to evaluate any other aspect of the proposed 
acquisition, and therefore did not address provisions of the 
lease, financing, suitability of lease, or any alternatives to 
the proposal.
    To estimate the tanker combi unit purchase price, we 
separated our analysis into several segments. That included the 
following: the basic 767-200ER enhanced features coming from 
the Boeing 767 family selectively, some from the 300 and some 
from the 400; the combi modifications to allow for the freight 
or passenger or combination; the auxiliary fuel tanks that were 
being added to the airplane; and the tanker and other USAF 
unique modifications, including the boom, drogue, the RARO, 
those tanker mods plus also some avionics modifications such as 
Link 16. And then we also addressed development costs.
    The proposed program would use FAR Part 12 guidelines 
written for the acquisition or lease of commercial items. The 
establishment of a reasonable price under these rules would 
normally rely largely on prices for the same or similar items 
in the commercial marketplace, and since the market for large 
tanker aircraft are limited, this information was not of value 
for rigorous determination of reasonable prices. Consequently, 
while our analysis made use of commercial pricing wherever 
possible, we relied on traditional cost analysis techniques, 
where estimation by commercial pricing was not practical.
    Our analyses relied on data from a variety of public 
sources including other government sources, some of whom you've 
been hearing from today. The analyses of consultant 
organizations hired by IDA and familiar with the airline 
industry, internal IDA proprietary data and models, data 
supplied by Boeing, data provided by other aerospace suppliers, 
and data supplied by the Air Force. As a result, we feel that 
the evolution of our task through this January to May time 
period has resulted in a methodologically conservative approach 
that has produced a high quality unit price estimate.
    Our estimate is summarized according to the segments above 
in our final report. We believe that the $120.7 million per 
unit is a reasonable unit purchase price estimate for the 
proposed 100 KC-676A aircraft. IDA and the OSD sponsors have 
provided a redacted version of our report and the privileged 
information version is available in the Pentagon.
    Mr. Chairman and members of the Committee, thank you for 
your attention. I'm available for questions.
    [The prepared statement of Dr. Nelson follows:]

 Prepared Statement of Dr. J. Richard Nelson, Assistant Director, Cost 
 Analysis and Research Division (CARD), Institute for Defense Analyses 
                                 (IDA)
    Mr. Chairman and Members of the Committee, I am pleased to come 
before you today to talk about IDA's estimate of the purchase price of 
the KC-767A Tanker/Combi Aircraft.
Introduction
    In January 2003, the Institute for Defense Analyses (IDA) was 
tasked by the Office of the Under Secretary of Defense Acquisition 
Technology and Logistics and the Office of the Director, Program 
Analysis and Evaluation to estimate the purchase price of the KC-767A 
Tanker/Combi aircraft. The Tanker/Combi designation indicates that the 
aircraft can serve as an air refueling tanker or carry freight or carry 
passengers or combine freight and passengers.
Description of Proposed Aircraft as Assessed by IDA
    The KC-767A Tanker/Combi aircraft is to be based upon the 
commercial B767-200ER. Modifications would include the addition of 
features available on other Boeing 767 models, as well as changes 
required for the military application. In the tanker role, total fuel 
capacity is to be just over 200,000 pounds, including up to 41,000 
pounds carried in added auxiliary fuel tanks. The KC-767A would have 
the capability to perform refueling by both the hose/drogue and boom 
methods (not simultaneously) from the aircraft centerline and would 
also be able to receive fuel from other tanker aircraft. The cabin of 
the KC-767A is to be convertible to three configurations. In the 
passenger configuration, the KC-767A would accommodate up to 190 
passengers and 10 crewmembers. The freight configuration would allow 
carriage of up to 19 cargo pallets and 10 crewmembers. The combination 
(so-called ``Combi'') configuration is to have the capacity for 
simultaneous carriage up to 10 pallets, 10 crewmembers, and 70 
passengers.
Objective and Scope of the Task
    The objective of the IDA task was to estimate a unit purchase price 
for 100 KC-767A aircraft. We did not investigate the condition of the 
KC-135E/R fleet or the requirement for a tanker replacement. We were 
not asked to evaluate any other aspect of the proposed acquisition and 
therefore did not address provisions of the lease, financing, 
suitability of leasing, or any alternatives to this proposal. 
Consequently, the purchase price for the fleet of KC-767A aircraft is 
what I am prepared to discuss today.
Methodology and Data Sources
    To estimate the KC-767A Tanker/Combi purchase price, we separated 
the acquisition into several segments:

   Basic 767-200ER--the commercial aircraft upon which the KC-
        767A design would be based.

   Enhanced B767 Features--the features from other B767 models 
        that would be added to the basic B767-200ER design to build 
        toward the KC-767A.

   Combi Modifications--the modifications to the B767-200ER 
        that would allow the carriage of passengers, freight, or both 
        simultaneously.

   Auxiliary Fuel Tanks--the lower fuselage fuel tanks, pumps, 
        and installation materials required for additional fuel 
        capacity in the KC-767A.

   Tanker and Other USAF-Unique Modifications--the changes 
        required to give the KC-767A its refueling, fuel-receiving, and 
        military-unique capabilities.

   Development Costs--the investment required to create and 
        certify the KC-767A design.

    The proposed KC-767A program would use FAR Part 12 guidelines 
written for the acquisition or lease of commercial items. Under these 
guidelines, the contractor is not required to provide cost estimates, 
or any other data not normally supplied to commercial customers. The 
establishment of a reasonable price under these rules would normally 
rely largely on prices for the same or similar items in the commercial 
marketplace. However, the KC-767A Tanker/Combi aircraft acquisition 
involves modifications that do not easily lend themselves to this 
approach, particularly in the area of military aerial refueling 
capability. The market for large tanker aircraft is limited and of 
little value for rigorous determination of reasonable prices. 
Consequently, while our analysis made use of commercial pricing 
wherever possible, we relied on traditional cost analysis techniques 
where estimation by commercial pricing was not practical.
    Our analysis relied on data from a variety of public sources, 
including other government sources, the analyses of consultant 
organizations hired by IDA, internal IDA proprietary data and models, 
data supplied by Boeing, data provided by other Aerospace suppliers, 
and data supplied by the USAF.
Task Results
    The analysis examined the proposed aircraft in detail, and 
incorporated information provided by Boeing during and after briefings 
at their facility in Wichita, Kansas. We feel that the evolution of our 
task through the January to May time period has resulted in a 
methodologically conservative approach that has produced a high quality 
unit price estimate. We also performed an internal rate of return (IRR) 
analysis on an estimate of Boeing's initial investment and found that 
our price estimate would provide Boeing with an attractive IRR for the 
time-period, and considering the risks involved. We believe that $120.7 
million is a reasonable unit purchase price estimate for the proposed 
100 KC-767A aircraft. Our estimate is summarized in the following table 
according to the segments identified in the methodology.

                             Summary of KC-767A Tanker/Combi Purchase Price Analysis
----------------------------------------------------------------------------------------------------------------
                                        IDA Unit
                                         Price         Primary  Analysis
          Taxonomy Element              Estimate           Technique                Primary  Data Sources
                                       (FY02 $M)
----------------------------------------------------------------------------------------------------------------
Basic B767-200ER                             72.1  Commercial Pricing        Consultants, Department of
                                                                              Transportation data
Enhanced B767-200ER Features                  1.6  Commercial Pricing        Consultants, Boeing, USAF data, IDA
                                                                              models, vendor quotes
Combi Modifications                           9.5  Commercial Pricing        Consultants, public data
Auxiliary Fuel Tanks                          6.3  Cost analysis             Vendor quotes, IDA models
Tanker and Other Modifications               20.3  Cost analysis             IDA models, USAF, Boeing
Development Costs                            10.9  Cost analysis             USAF, IDA models
Total                                       120.7
----------------------------------------------------------------------------------------------------------------

    Mr. Chairman and Members of the Committee: Due to the proprietary 
information agreement that IDA has signed with The Boeing Company, I 
cannot divulge any proprietary data that we have obtained under this 
agreement. IDA and the OSD sponsors have provided a redacted version of 
our report, and the privileged information version can be read in the 
Pentagon.
    Mr. Chairman and Members of the Committee: Thank you for your 
attention. I am available for comments/questions.

    The Chairman. Thank you very much Dr. Nelson. Mr. Ellis.

          STATEMENT OF STEVE ELLIS, VICE PRESIDENT OF 
              PROGRAMS, TAXPAYERS FOR COMMON SENSE

    Mr. Ellis. Thank you. Good afternoon, Chairman McCain, 
Senator Brownback, Senator Cantwell, and thank you, Chairman 
McCain, for your strong leadership on this issue. I'm Steve 
Ellis, Vice President of Programs at Taxpayers for Common 
Sense, a national budget watchdog. My organization has closely 
analyzed the proposed lease of Boeing 767s to be converted into 
tanker aircraft since we first heard of it shortly after the 
tragic events of September 11, 2001. The heart of the 
discussion centers on three major questions: when do we need to 
replace the KC-135 fleet, with what, and what is the proper way 
to accomplish it.
    But before beginning that discussion, I have to say that we 
were shocked by the recent revelations of the back room deals 
that got the lease deal inked. This confirms to many that the 
fix was in and that the Government cares more about a company 
with deep pockets than the average taxpayer. As you read the 
recent stories detailing the efforts to seal this $30 billion 
deal, it becomes increasingly hard to figure out where the blue 
Air Force uniform ends and the pinstripe of Boeing executives 
begins. In effect, Air Force officials became the silent 
business partners of Boeing.
    Taxpayers for Common Sense understands that the Pentagon's 
Inspector General will be investigating the actions of a former 
Air Force official regarding this deal as has been previously 
discussed. We are strongly supportive of this initiative and 
hope it leads to a full investigation of the entire deal 
process. Because the deal is more than just Pentagon waste, the 
lease will have a significant negative impact on servicemen and 
women on the war fighter. The Air Force's procurement agreed to 
keep all of their acquisitions intact as part of the rationale 
for leasing, which comes out of the operations and maintenance 
coffers. How many billions of dollars in training and 
maintenance will we have to forgo to make these lease payments?
    The cost accounting gimmicks the Air Force is employing to 
hide the real cost of the lease are a sad microcosm of the 
issues we are facing budget-wide. We are staring a $480 billion 
deficit squarely in the face. We have backloaded costs into 
out-budget years and will have to service an enormous debt in 
2012 right when we are making the first decisions about buying 
the KC-767s.
    Even if you don't believe the KC-135 fleet needs to be 
replaced immediately, the issue does have to be addressed. The 
first step in this process is to evaluate the Air Force's 
predicted aerial refueling need for the next 30 to 50 years. We 
are clearly in a different climate than 40 years ago when the 
KC-135s first came on line. Different aircraft, including 
smaller, significantly more fuel efficient, unmanned aerial 
vehicles, more accurate and capable weapons that can decrease 
the number of combat sorties required, even the availability of 
leasing tanker service from private contractors in certain 
situations. To identify the true refueling need, the Air Force 
is supposed to develop an operational requirements document. 
However, the Air Force was rebuked by a Pentagon panel for 
working the equation backwards and developing requirements that 
would directly point to the KC-767.
    The next step is the analysis of alternatives. But after 
the opportunity to lease 767s as tankers presented itself, 
actually it was authorized by Congress, interest in analyzing 
alternatives waned. Now the Air Force doesn't plan to complete 
the AOA until after the lease, when only a relatively small 
final payment to purchase the KC-767s remains. I can't say what 
all the alternatives to meeting aerial refueling needs are and 
neither can anyone else in this room. We have been presented 
with an analysis of forgone conclusions, essentially launching 
the new recapitalization effort of our tanker fleet without any 
real objective analysis of our needs and options.
    We do know a few of the aerial refueling alternatives, one 
short term option to re-engine some of the KC-135Es into Rs, or 
we could use DC-10s and convert them into more KC-10s, which 
are more capable than either the Rs or the proposed KC-767. 
Finally, there are the more discussed options of leasing KC-
767s under the terms of the nearly finalized deal or buying 
them outright. Simply put, leasing to buy is always more 
expensive than an outright purchase. In certain settings, 
leasing makes sense, but it is an expensive, inefficient, and 
inappropriate route for major weapons procurement. According to 
an independent analysis, the taxpayer is paying a 19 to 27 
percent premium to lease. Those additional dollars could buy as 
many as 35 more tankers.
    In analyzing the cost of outright purchase, the Air Force 
created a straw man that ignored the potential of a multi-year 
purchase, overstated inflation costs and progress payments, 
used an improper, too-long discount rate, and devised a 
progress payment schedule that was inherently more expensive. 
Despite the Air Force's efforts to play down the savings, when 
you work the numbers, an outright purchase would be $5.7 
billion to $6.9 billion less.
    The chickens will come home to roost in 2012, when we enter 
the heart of the tanker recapitalization at the same time we 
are buying 100 joint strike fighters at a cost of $7 billion 
per year. These two acquisitions alone would gobble up 70 
percent of the Air Force's aircraft procurement budget. In 
light of all the recent questions that have been raised, I urge 
you to ask your colleagues on the Senate Armed Services 
Committee not to approve this deal. The terms and conditions of 
the lease are still not finalized and you are being asked to 
vote on it. The war fighter and taxpayers are counting on you 
to stop this juggernaut until we get answers to critical 
questions about our tanker fleet. Thank you very much.
    [The prepared statement of Mr. Ellis follows:]

    Prepared Statement of Steve Ellis, Vice President of Programs, 
                       Taxpayers for Common Sense
    Good afternoon. I'm Steve Ellis, Vice President of Programs at 
Taxpayers for Common Sense, a national non-profit budget watchdog. My 
organization has closely analyzed the proposed lease of Boeing 767s to 
be converted into tanker aircraft since we first heard of it shortly 
after the tragic events of September 11, 2001.
    Before entering the heart of the discussion: when do we need 
replace the KC-135 tanker fleet, with what, and the proper way to 
accomplish it, I have to state that even we were shocked and disturbed 
by the recent revelations of the backroom deals that got this lease 
deal inked.\1\ This turn of events confirms many American's belief that 
the fix was in and the government cares more about a company with deep 
pockets than the average taxpayer. How deep? A Defense Week article 
published yesterday documented that Boeing executives contributed 
$22,000 to Senator Stevens 2002 re-election campaign at about the same 
time the Defense Appropriations bill--which gave birth to this lease 
deal--was being considered.\2\
---------------------------------------------------------------------------
    \1\ Julian E. Barnes and Christopher H. Schmitt. ``Boeing's Big 
Bailout--Courtesy of the Air Force.'' U.S. News & World Report. August 
29, 2003.
    \2\ John M. Donnelly. ``Boeing Payments to Senator Raise 
Questions.'' Defense Week. September 2, 2003.
---------------------------------------------------------------------------
    Taxpayers for Common Sense has been disturbed by the U.S. Air 
Force's exceptionally close relationship with the Boeing Corporation 
throughout the negotiations on this lease. As you read the recent 
stories detailing the efforts to seal this $30 billion deal, it becomes 
increasingly hard to figure out where the blue Air Force uniform ends 
and the pin stripe of Boeing executives begins. In effect, the Air 
Force officials became the silent business partners of Boeing. 
Taxpayers for Common Sense wants the deal and the actions of Air Force 
and Boeing personnel fully investigated: the back scratching, the 
apparent sharing of proprietary information, the attacks on dedicated 
civil servants must be uncovered. These revelations are a clarion call 
for fundamental procurement reform.
    Before you pass this off as just more Pentagon waste, remember the 
lease deal has a significant negative impact on servicemen and women--
on the warfighter. The Air Force's procurement greed to keep all their 
other acquisitions intact is part of the rationale for leasing, instead 
of buying, the proposed KC-767. To protect other bloated acquisitions 
like the habitually over budget F/A-22 Raptor, the Air Force is raiding 
the Operations and Maintenance coffers. How many billion of dollars in 
training and maintenance will we have to forgo to make these lease 
payments?
    The cost accounting gimmicks the Air Force is employing to hide the 
real costs of the lease are a sad microcosm of the issues we are facing 
budget wide. We are staring a $480 billion deficit in the face, the 
largest ever in relative terms and more than 4 percent of Gross 
Domestic Product, approaching the mid-1980s highs.\3\ We have 
backloaded costs into out budget years and are potentially facing the 
prospect of servicing a $9.1 trillion debt in 2013, right when we are 
making the first decisions about buying the KC-767s coming off 
lease.\4\
---------------------------------------------------------------------------
    \3\ Online NewsHour. ``Federal Deficit to Hit Record $480 Billion 
in 2004, CBO Predicts.'' August 26, 2003. Available at http://
www.pbs.org/newshour/updates/deficit_08-26-03.html.
    \4\ According to independent Federal budget experts, using a 
realistic assessment of Federal government expenses, the national debt 
is projected to rise from $4.0 trillion today to $9.1 trillion by 2013. 
Richard Kogan. ``Deficit Picture Even Grimmer Than New CBO Projections 
Suggest.'' Center on Budget and Policy Priorities. August 26, 2003.
---------------------------------------------------------------------------
    In light of all the recent questions that have been raised, I urge 
you all to urge your colleagues on the Senate Armed Services Committee 
not to approve this deal. Chairman McCain, Senators Ensign and Nelson, 
you all serve on the Armed Services Committee. The terms and conditions 
of the lease are still not finalized, and you are being asked to vote 
on it. The warfighter is counting on you to stop the juggernaut pushing 
this deal until we get answers to critical questions about our tanker 
fleet.
    The questions that should be answered are: What do we need, what 
options exist to fill that need, and what is the best, most cost-
effective way to pursue that.
What Do We Need?
    Taxpayers for Common Sense, along with others, believe the Air 
Force's earlier assessments which concluded that replacement of our KC-
135 fleet \5\ is not an emergency.\6\ Instead, Department of Defense 
should develop exactly what our predicted in flight refueling needs 
will be in the next half century and how best to meet them.
---------------------------------------------------------------------------
    \5\ The Air Force's KC-135 fleet consists of 543 aircraft: 131 of 
the less capable (mostly due to engines) KC-135Es, that are used by the 
National Guard and Reserve and 412 KC-135Rs used by active duty Air 
Force and some National Guard and Reserve units. The KC-135 is similar 
to the commercial Boeing 707 airframe. The Air Force also operates 59 
of the larger KC-10 tankers, based on the DC-10 airframe. General 
Accounting Office. ``Military Aircraft: Consideration in Reviewing the 
Air Force Proposal to Lease Aerial Refueling Aircraft (GAO-03-1048T).'' 
July 23, 2003.
    \6\ Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: Key 
Issues for Congress.'' Congressional Research Service. August 29, 2003.
---------------------------------------------------------------------------
    The tragic events of September 11, 2001 were the driver for this 
lease deal. Whether you believe the deal is a bailout for Boeing or 
that the increased operations tempo of the war on terror, Afghanistan, 
and Iraq accelerated the deterioration of the KC-135s, the starting 
point for the deal remains the same.
    In February 2001, the Air Force conducted an extensive Economic 
Service Life Study (ECLS) of the KC-135s that found ``the fleet 
structurally viable until 2040.'' Additionally, the study found that 
aircraft availability would increase in the short run and then steadily 
and slowly decline until 2040. Finally, the study predicted that real 
cost growth would be 1 percent per year.\7\
---------------------------------------------------------------------------
    \7\ Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: Key 
Issues for Congress.'' Congressional Research Service. August 29, 2003. 
p2.
---------------------------------------------------------------------------
    Subsequent to the decision to pursue a lease, the Air Force began 
to claim increased maintenance concerns, a reduced mission capability 
rate (MCR) and conducted a May 2003 business cost analysis, which found 
costs increasing at a higher rate.
    Air Force maintenance concerns with the KC-135E have changed over 
time. First they were too old, but more recently officials have focused 
on the tanker fleet being unsafe because of corrosion. However, there 
is only anecdotal information and the full impact of corrosion cannot 
currently be quantified due to the limited amount of reliable data. 
Regardless, corrosion is a relatively predictable and manageable 
problem that affects ``all military assets, including approximately 
350,000 ground and tactical vehicles, 15,000 aircraft and helicopters, 
1,000 strategic missiles, and 300 ships.'' DOD-wide, aging systems have 
maintenance and corrosion issues, but services like the Navy which 
solely operates in a highly corrosive salt water environment have 
implemented effective corrosion control technologies and we urge the 
Air Force to follow suit.\8\ Additionally, the Air Force has improved 
depot maintenance for the KC-135s in recent years.\9\
---------------------------------------------------------------------------
    \8\ General Accounting Office. ``Defense Management: Opportunities 
to Reduce Corrosion Costs and Increase Readiness, (GAO-03-753).'' July 
2003.
    \9\ Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: Key 
Issues for Congress.'' Congressional Research Service. August 29, 2003.
---------------------------------------------------------------------------
    The mission capability rate is easily skewed by the time period 
selected for review. But two recent events are telling. A January 2003 
Air Force Study found the MCR for the KC-135E & R at 85 percent, the 
Air Force goal for tanker aircraft. More interestingly, the KC-135's 
had an 86 percent MCR during Operation Iraqi Freedom, a rate that 
exceeded virtually all of the Air Force's aircraft: fighters, bombers 
and KC-10 tankers.\10\
---------------------------------------------------------------------------
    \10\ Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: 
Key Issues for Congress.'' Congressional Research Service. August 29, 
2003.
---------------------------------------------------------------------------
    Even if you don't believe the KC-135 tanker fleet needs to be 
replaced immediately, the issue has to be addressed. The first step in 
this process is to evaluate the Air Force's predicted tanker or aerial 
refueling need for the next 30-50 years. We are clearly in a different 
climate than when the KC-135s first came on line: different aircraft, 
including smaller, significantly more fuel-efficient unmanned aerial 
vehicles (UAVs); much more accurate and capable weapons that can 
decrease the number of combat sorties required for mission success; 
even the availability of leasing tanker service from private 
contractors in some situations.\11\
---------------------------------------------------------------------------
    \11\ The U.S. Navy has leased tanker services and the UK's Royal 
Air Force is considering it. Christopher Bolkcom. ``The Air Force KC-
767 Lease Proposal: Key Issues for Congress.'' Congressional Research 
Service. August 29, 2003. p28-29.
---------------------------------------------------------------------------
    To identify the true refueling need, the Air Force is supposed to 
develop an Operational Requirements Document (ORD). However, it appears 
the Air Force worked the equation backwards and developed requirements 
that would point to the KC-767. In fact, the Air Force was rebuked by a 
Pentagon panel stating the ORD ``should not be written for a specific 
aircraft.'' \12\
---------------------------------------------------------------------------
    \12\ Julian E. Barnes and Christopher H. Schmitt. ``Boeing's Big 
Bailout--Courtesy of the Air Force.'' U.S. News & World Report. August 
29, 2003.
---------------------------------------------------------------------------
    The Air Force has been keen to point out how the KC-767 would 
outperform the KC-135. That comparison misses two key points. Possibly 
the most critical element of a tanker, refueling capacity, is virtually 
identical for the two aircraft. And more importantly, the comparison is 
a red herring, who cares if the KC-767 outshines the KC-135, does it 
meet our needs better than other alternatives?
What are the Options?
    The Analysis of Alternatives is a critical decision-making tool for 
guiding any major systems procurement. In the 2001 Tanker Requirement 
Study for FY05, the Air Force wrote ``The need to address KC-135 
replacement mandates an air refueling analysis of alternatives.'' \13\
---------------------------------------------------------------------------
    \13\ Rep. Roscoe Bartlett. Transcript of Projection Forces 
Subcommittee of the House Armed Services Committee Hearing on Air Force 
Air Fueling Tanker Replacement. Federal News Service transcript. June 
24, 2003.
---------------------------------------------------------------------------
    But after the opportunity to lease 767s as tankers presented 
itself--actually was authorized by Congress--interest in analyzing 
alternatives waned. Now the Air Force doesn't plan to complete the 
analysis until after the lease, when only a relatively small final 
payment to purchase the KC-767s remains, essentially launching the new 
recapitalization effort of our tanker fleet without any real, objective 
analysis of our needs or options.
    In fact, the Air Force wasn't really sure why they wanted to 
quickly lease these planes. According to recent press reports of 
internal Boeing e-mails, Dr. Marvin Sambur, Assistant Secretary of the 
Air Force (Acquisition) '' is desperately looking for the rationale why 
the USAF should pursue the 767 tanker NOW,'' and that ``Sambur is 
looking for the compelling reason the administration should do this now 
rather than push off to a future administration.'' \14\
---------------------------------------------------------------------------
    \14\ Renae Merle. ``Documents Detail Maneuvers for Boeing Lease.'' 
The Washington Post. August 31, 2003.
---------------------------------------------------------------------------
    As Representative Roscoe Bartlett (R-MD), chair of the Projection 
Forces Subcommittee of the House Armed Services Committee pointed out 
at a recent hearing on replacing the KC-135s and the lease deal, ``. . 
. here we are, about to commit $16 billion of our children's money--by 
the way, we don't have any money; we're borrowing it from our kids and 
our grandkids--so, we're about to commit $16 billion of their money, 
and we have not completed the . . . analysis of alternatives. Wouldn't 
you be a little more sanguine about spending your children and 
grandchildren's money if we had the advantage of these studies?'' \15\
---------------------------------------------------------------------------
    \15\ Transcript of Projection Forces Subcommittee of the House 
Armed Services Committee Hearing on Air Force Air Fueling Tanker 
Replacement. Federal News Service transcript. June 24, 2003.
---------------------------------------------------------------------------
    I can't say what all the alternatives to meeting our aerial 
refueling needs are . . . and neither can anyone else in this room. We 
have been presented with an analysis of forgone conclusions. Recent 
press reports have indicated that this deal won't stop at 100 aircraft, 
we're on the hook for at lease 200, maybe more.\16\
---------------------------------------------------------------------------
    \16\ Julian E. Barnes and Christopher H. Schmitt. ``Boeing's Big 
Bailout--Courtesy of the Air Force.'' U.S. News & World Report. August 
29, 2003.
---------------------------------------------------------------------------
What is the Best, Most Cost-Effective Way?
    We don't know all the possible aerial refueling alternatives, but 
we do know a few of them. One is to re-engine some or all of the KC-
135Es into ``R''s. The KC-135Rs, which are modified and re-engined, are 
more capable and should provide additional breathing room as we pursue 
a fleet replacement. Perhaps even more fruitful would be to obtain used 
DC-10s and convert them into KC-10s, which are more capable than either 
the KC-135R or the proposed KC-767. Finally, there are the more 
discussed options of leasing KC-767s under the terms of the nearly 
finalized deal, or buying them outright.
    Simply put, leasing to buy is always more expensive than an 
outright purchase. In certain settings, leasing makes sense--but it is 
an expensive, inefficient, and inappropriate route for major weapons 
procurement. For instance, leasing a car makes sense if you regularly 
buy new cars every few years. It doesn't make sense if you keep your 
car for ten years. Leasing can also make sense if you want to keep more 
cash on hand for operating needs, but you pay a premium for that. The 
proposed lease doesn't fit in either of these categories. The Air Force 
is going to buy and keep the tanker for decades, and the lease is not 
to keep more cash on hand for operations, it is to extend the Air Force 
acquisition dollars further, to buy more, with a balloon payment at the 
end.
    The Congressional Budget Office, Office and Management and Budget, 
and General Accounting Office have all raised significant concerns 
about the lease. According to their analysis, the Air Force has broken 
current Federal budgetary and lease rules, the lease terms are fiscal 
irresponsible and this deal sets a terrible financial precedent for new 
weapons system procurement. According to the Congressional Research 
Service, the taxpayer is paying a 19 percent-27 percent premium to 
lease; those additional dollars could buy as many as 35 more 
tankers.\17\ Industry experts also agree. ``It's certainly not the most 
cost-effective way to do it,'' concluded Michael Allen who is the Chief 
Operating Officer of Back Aviation Solutions, a consulting firm.\18\
---------------------------------------------------------------------------
    \17\ Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: 
Key Issues for Congress.'' Congressional Research Service. August 29, 
2003. p 67.
    \18\ David Bowermaster and Katherine Pfleger. ``Is leasing Boeing 
jet tankers best deal for U.S. Taxpayers.'' Seattle Times. May 15, 
2002.
---------------------------------------------------------------------------
    Some of these machinations can be explained by the Air Force's 
efforts to have the deal count as an operating lease, not a capital 
lease. One of the main interests of the Air Force is to hide the 
overall acquisition costs so as to avoid tightening scrutiny over 
procurement. Under an operating lease, obligations and outlays are 
recorded on a year-by-year basis instead of when the borrowing, 
purchase and interest payments are actually made. According to the 
Congressional Budget Office, the deal fails four of the six tests for 
an operating lease, and only meets the letter, not the spirit, of the 
fifth.\19\
---------------------------------------------------------------------------
    \19\ Douglas Holtz-Eakin. ``Assessment of the Air Force's Plan to 
Acquire 100 Boeing Tanker Aircraft.'' Congressional Budget Office. 
August 2003. p8-11.
---------------------------------------------------------------------------
    To be treated as an operating lease, the asset:

   Must be general purpose, not built to unique government 
        specifications--although it is based on a commercial airframe, 
        a tanker is not general purpose.

   There must be a private-sector market for the asset--there 
        have been a few purchasers of KC-767 aircraft, but the sales 
        have only totaled 8 aircraft, and a market for 100 simply 
        doesn't exist.

   The present value of the lease payments cannot exceed 90 
        percent of the asset's fair market value at the start of the 
        lease--the lease payments total 93 percent of the outright 
        purchase cost as determined by Boeing.\20\
---------------------------------------------------------------------------
    \20\ Air Force documents maintain that only 89.9 percent of the 
cost will be paid during the lease, but that figure includes the lease 
financing costs in the total, which of course would not be incurred in 
an actual purchase. Douglas Holtz-Eakin. ``Assessment of the Air 
Force's Plan to Acquire 100 Boeing Tanker Aircraft.'' Congressional 
Budget Office. August 2003. p10.

   The lease cannot contain a bargain-price purchase option--
        the aircraft will have 80 percent of it's useful service life 
        remaining after the six year lease, but will cost only 28 
---------------------------------------------------------------------------
        percent of the purchase price of a new KC-767.

   Ownership of the asset must remain with the lessor--
        technically, the aircraft are under control of the special 
        purpose entity (SPE) created to facilitate this deal, however 
        the government maintains significant control over the entity.

   The lease term cannot exceed 75 percent of the asset's 
        useful life--the lease would meet this criteria, using only 
        approximately 20 percent of the aircraft service life.

    Boeing and the Air Force have consistently downplayed and lowballed 
the cost of the K-767 program to taxpayers. At the May 2003 press 
conference announcing the tanker deal, then-Under Secretary of Defense 
for Acquisition Pete Aldridge answered ``yes'' when asked if $5.7 
billion in training and maintenance costs were included in the $16 
billion lease figure. In fact, the opposite is true.\21\
---------------------------------------------------------------------------
    \21\ Edward ``Pete'' Aldridge, Undersecretary of Defense for 
Acquisition, Technology and Logistics. Transcript of Department of 
Defense Briefing on Results of the Tanker Lease Agreement. May 23, 
2003. Federal News Service Transcript.
---------------------------------------------------------------------------
    In analyzing the cost of outright purchase, the Air Force created a 
``straw man'' plan that ignored the potential of a multi-year purchase, 
overstated inflation costs in progress payments, used an improper--too 
long--discount rate, and devised a progress payment schedule that was 
inherently more expensive.\22\ The Air Force's ``straw man'' plan 
resulted in purchase cost-savings of only $150 million. This lowball 
figure was prominently described in the body of the document, the fact 
that a multi-year procurement would yield a $1.9 billion savings over 
leasing was buried in a footnote.\23\
---------------------------------------------------------------------------
    \22\ Douglas Holtz-Eakin. ``Assessment of the Air Force's Plan to 
Acquire 100 Boeing Tanker Aircraft.'' Congressional Budget Office. 
August 2003. p12-15. Christopher Bolkcom. ``The Air Force KC-767 Lease 
Proposal: Key Issues for Congress.'' Congressional Research Service. 
August 29, 2003. p46-47
    \23\ Dr. James Roche, Secretary of the Air Force. ``Report to 
Congressional Defense Committees on KC-767A Air Refueling Aircraft 
Multi-Year Lease Pilot Program.'' July 10, 2003. p. 4.
---------------------------------------------------------------------------
    The Air Force still maintains that purchasing would only represent 
a $150 million savings over leasing, but independent studies found the 
actual savings would be between approximately $1.3 billion and $2.5 
billion.\24\ Adding those savings to the cost of purchasing the 
aircraft at the end of the lease and you arrive at between $5.7 billion 
and $6.9 billion saved by an outright purchase of the KC-767 over a 
lease to buy.
---------------------------------------------------------------------------
    \24\ The CBO estimated the purchase savings to be $1.3 billion--$2 
billion. Douglas Holtz-Eakin. ``Assessment of the Air Force's Plan to 
Acquire 100 Boeing Tanker Aircraft.'' Congressional Budget Office. 
August 2003. The CRS noted several of the same factors and estimated 
that savings of lease could be between $1.9 and $2.5 billion. 
Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: Key Issues 
for Congress.'' Congressional Research Service. August 29, 2003.
---------------------------------------------------------------------------
    For instance, according to the Congressional Research Service, 
``Instead of negotiating the lease price to reflect the usage--either 
the length of time or the amount of hours flown--the Air Force 
negotiated the price to minimize the financing costs and to make it 
easier for the Air Force to find resources to buy the Aircraft at the 
end of the lease.'' \25\
---------------------------------------------------------------------------
    \25\ Christopher Bolkcom. ``The Air Force KC-767 Lease Proposal: 
Key Issues for Congress.'' Congressional Research Service. August 29, 
2003. p66.
---------------------------------------------------------------------------
    Contrary to the protestations of some lawmakers, it is unlikely 
that Boeing will shut down the 767 production line in the next couple 
years. There are enough 767s on order to last until 2006, including 
seven for Japan Air Lines, an order announced over the weekend.\26\
---------------------------------------------------------------------------
    \26\ Associated Press. ``JAL orders 7 more Boeing 767s.'' September 
1, 2003.
---------------------------------------------------------------------------
    However, it is clear that the 767 line is nearing the end of its 
commercial life, especially with Boeing's new 7E7 coming on line. Being 
at the end of the line entails risks and rewards. The dwindling 
commercial sales for the 767 virtually ensures that DOD will be 
supporting a unique or orphan airframe in the later years of service 
life. It also means that because the market is sluggish, DOD should be 
getting greater price breaks. John Plueger, President and CEO of the 
International Lease Finance Corporation said that the U.S.--as possibly 
the most credit worthy purchaser--would ``certainly command the highest 
concession levels offered by any aircraft manufacturer for commercial/
civilian airliners.'' \27\
---------------------------------------------------------------------------
    \27\ ILFC leases more than 600 jet aircraft to 160 airlines 
worldwide, including 60 767s. Statement of John Plueger to House Armed 
Services Committee. July 23, 2003.
---------------------------------------------------------------------------
    However, in spite of the drop in 767 sales, and Uncle Sam's credit 
record, Boeing hasn't offered its best price. According to reports, the 
fair market value as determined by the Institute for Defense Analysis 
is around $120 million--about $11 million less than what taxpayers are 
being charged for these tankers. Even so, news reports state the only 
way we even got into the ball park of the IDA number was to promise 
Boeing that the first hundred planes would be followed by hundreds 
more.\28\
---------------------------------------------------------------------------
    \28\ 1 Julian E. Barnes and Christopher H. Schmitt. ``Boeing's Big 
Bailout--Courtesy of the Air Force.'' U.S. News & World Report. August 
29, 2003.
---------------------------------------------------------------------------
    While the Air Force and Boeing say the deal has been tailored to 
save money, the current unresolved lease terms make it impossible to 
determine how much the U.S. government, ``the new deep pockets'' 
customer will pay in the future. In fact, according to the U.S. News 
and World Report, Boeing documents point out that with a little 
political pressure, the lease deal could be worth more than $35-$40 
billion to the company.\29\
---------------------------------------------------------------------------
    \29\ Julian E. Barnes and Christopher H. Schmitt. ``Boeing's Big 
Bailout--Courtesy of the Air Force.'' U.S. News & World Report. August 
29, 2003.
---------------------------------------------------------------------------
A Political Decision
    This is really an economic bailout masquerading as a national need. 
In an October 2001 letter to President Bush, Rep. Norm Dicks (D-WA) was 
clear about the ulterior motive behind this deal--propping up Boeing. 
After discussing job losses and cancelled aircraft orders, Rep. Dicks 
stated ``that the Administration's economic stimulus package should 
include at least $2.5 billion for the purchase or lease of [767s] . . 
.'' \30\ Since then, the lease has been justified by the issue du jour. 
Jobs. KC-135 Corrosion. Increased Operations Tempo. A sweetheart deal.
---------------------------------------------------------------------------
    \30\ Rep. Norm Dicks. Letter to the President. October 4, 2001.
---------------------------------------------------------------------------
    Even Boeing's loss of the Joint Strike Fighter contract to 
Lockheed-Martin has become a rationale for this deal. A spokesman for 
Rep Jerry Lewis, the powerful Chairman of the House Subcommittee on 
Defense Appropriations said, ``There is the concern that because of the 
Joint Strike Fighter contract, something has to be done to make sure we 
support all of our industrial base.'' \31\
---------------------------------------------------------------------------
    \31\ James Dao and Laura M. Holson. ``Boeing's War Footing; 
Lobbyists Are Its Army, Washington Its Battle Field.'' New York Times. 
December 12, 2001.
---------------------------------------------------------------------------
    The consideration of the JSF contract brings up an interesting 
point. The tanker lease is structured to postpone a major acquisition 
decision to avoid making decisions today. But procrastination won't 
help. At the end of the lease, we will be forced to buy more 767s to 
both continue KC-135 replacement and keep the Boeing production line 
going. Even lease proponents like Dr. Loren Thompson of the Lexington 
Institute freely admit that ``. . . by the time this is all over, 
Boeing will sell the Air Force 600 767s for various large-body 
missions.'' \32\
---------------------------------------------------------------------------
    \32\ Vernon Loeb. ``Air Force Picks Boeing Over Airbus.'' The 
Washington Post. March 30, 2002. at D 13.
---------------------------------------------------------------------------
    But, just as we enter the heart of tanker recapitalization in 2012, 
we also will be in the middle of the JSF acquisition, buying 110 
fighters at a cost of $7 billion per year. Coupled with the tanker 
acquisition, 70 percent of the Air Force aircraft procurement budget 
would be spoken for.\33\
---------------------------------------------------------------------------
    \33\ Douglas Holtz-Eakin. ``Assessment of the Air Force's Plan to 
Acquire 100 Boeing Tanker Aircraft.'' Congressional Budget Office. 
August 2003. p. 17.
---------------------------------------------------------------------------
    There are a lot of questions about whether this is a good deal or 
the right aircraft. If members of Congress determine that we need to 
help out--bail out--Boeing, then we should debate that. Not raid our 
operations and maintenance account.
    Again, Taxpayers for Common Sense strongly urges you to oppose this 
lease. Thank you for inviting me here today. I would be happy to answer 
any questions you might have at this time.

    The Chairman. Thank you very much, Mr. Ellis. Mr. Miller, 
welcome.

            STATEMENT OF ERIC MILLER, SENIOR DEFENSE

         INVESTIGATOR, PROJECT ON GOVERNMENT OVERSIGHT

    Mr. Miller. Good afternoon. Thank you, Mr. Chairman and 
Members of the Committee, for asking me to testify today on an 
Air Force proposal to lease 100 tanker aircraft. I work as a 
defense investigator for the Project on Government Oversight, 
or POGO for short. POGO was established in 1981 and is a 
politically independent, nonprofit watchdog that strives to 
promote a government that is accountable to the citizenry. 
Because we investigate government fraud, waste, and abuse, this 
tanker proposal is right up our alley. For more than a year, 
POGO has conducted an ongoing, in-depth study of the tanker 
lease deal. In May 2002, we issued a critical report on the 
lease idea and since then we have been following this issue 
almost on a daily basis.
    You already know that virtually every government oversight 
agency that has put a pencil to this proposal has concluded it 
costs more, billions more, to lease rather than purchase these 
commercial derivative tankers. You also hopefully realize that 
the essence of this proposal is to reward Boeing Company a 
hefty contract with little or no consideration for the 
taxpayers. Clearly tanker aircraft play a vital role in the 
mission of the U.S. military, but we believe the Air Force has 
failed to provide evidence that the current KC-135 fleet is in 
urgent need of replacement. POGO hopes to advance the debate on 
this very important issue because frankly we're very concerned 
that this is a bad deal for both the Pentagon and the 
taxpayers.
    We believe this for a number of reasons. There is mounting 
evidence, much of it uncovered by your Committee's thorough 
research, that something about this lease isn't on the up and 
up. Frankly, we haven't seen a compelling case made yet that 
there is a critical need for these tankers, and even if there 
was, we'd be suspicious because the genesis of this agreement 
seems to be political. Contributing to our concern is the 
recent public release of an array of e-mails and other 
communications between Boeing and Air Force officials that 
suggest a coziness that is both unsettling and unhealthy. These 
e-mails give the appearance of an attitude that it's Boeing and 
the Air Force against the rest of the world and not one of a 
contractor/client relationship.
    There's another problem. The Federal Government should not 
reward contractors with such extraordinary handouts if they do 
not have a record of integrity in business ethics. Three Boeing 
aerospace subsidiaries recently were suspended after an Air 
Force investigation revealed that Boeing was in possession of 
thousands of pages of Lockheed Martin proprietary documents. 
Unfortunately, this latest misstep by Boeing is only one of 
many. A year-long POGO study of the top 40 federal contractors 
documented 50 instances of what we have labeled misconduct or 
alleged misconduct by Boeing since 1990, establishing Boeing as 
the federal contractor with the third highest number of such 
instances.
    Indeed, Boeing's investigation shows that as POGO's 
investigation shows that as recently as March 2003, Boeing and 
one of its subsidiaries agreed to pay an $18 million civil 
settlement with the government after being accused of 123 
charges of arms control and international traffic and arms 
regulations. Rather than sweetheart deals, the Pentagon should 
be looking at suspending repeat corporate offenders from future 
contracts and from extending existing contracts while still 
under suspension.
    Your Committee, Senator McCain, should be commended for 
taking on this controversial issue that has been fast working 
its way through other Committees with minimal examination. POGO 
hopes you will do all you can to stop it from becoming yet 
another in a series of Pentagon blunders. Thank you for 
inviting me to testify. I'm happy to answer any questions you 
have.
    [The prepared statement of Mr. Miller follows:]

    Prepared Statement of Eric Miller, Senior Defense Investigator, 
                    Project On Government Oversight
    I want to thank you for asking me to testify today on an Air Force 
proposal to lease 100 wide-body Boeing tanker aircraft--a proposal we 
believe is ill-advised for both the Pentagon and the taxpayers. The 
Project On Government Oversight (POGO) investigates, exposes, and seeks 
to remedy systemic abuses of power, mismanagement, and subservience by 
the Federal government to powerful special interests. Founded in 1981, 
POGO is a politically-independent, nonprofit watchdog that strives to 
promote a government that is accountable to the citizenry.
    For more than a year, POGO has conducted an ongoing in-depth study 
into the tanker lease proposal. In May 2002, we issued a critical 
report on the tanker lease idea, ``Fill 'Er Up: Back-Door Deal for 
Boeing Will Leave the Taxpayer on Empty.'' Only last week, we sent a 
letter to the Chairman and Ranking Member of the Senate Armed Services 
Committee urging the Committee to reject the proposal. Also, we have 
formally joined with such other public watchdog groups including 
Americans for Tax Reform, Taxpayers for Common Sense, and Common Cause 
in calling for an end to the deal. We hope the members of this 
committee will join in our fight to put an end to the unneeded and 
overpriced tanker lease.
    Since we issued our report last year, the Air Force and some 
Members of Congress have continued a full-court press to secure funding 
for the tanker lease. It has become increasing clear that the costly 
lease proposal has little to do with helping the Nation's fighting men 
and women, and everything to do with padding the bottom line of an 
already prosperous defense contractor.
    The lease idea that clearly began as a gift to Boeing has 
suspiciously morphed into a manufactured tanker shortage crisis. The 
deal was originally pitched by a few Members of Congress as a financial 
aid package of sorts for Boeing, a contractor that was ranked 15th in 
sales and 38th in profits on the 2003 Forbes magazine list. The 
company's rankings in sales and profits actually rose after 9/11.
    One of those Members of Congress doing the pitching for Boeing was 
Representative Norm Dicks, Democrat of Washington, who wrote a letter 
to President Bush on October 4, 2001, using the tragic events of 9/11 
as an excuse for promoting this bad deal.
    ``While we have promptly approved legislation that provides direct 
assistance to U.S. airlines, providing critical financial stability at 
this time, we have thus far not addressed the downstream impacts of 
this crisis, including the loss of work at Boeing,'' Dicks wrote. The 
tragic events of 9/11 should not be used as an excuse to discard common 
sense.
    Then after it became clear that the lease was more expensive than 
an outright buy, Pentagon spin doctors began telling Congress a 
different story--the converted B-767 aircraft were urgently needed to 
replace an aging fleet of KC-135 tankers, a claim that has not been 
well supported.
    Meanwhile, evidence against the lease idea has been mounting. In a 
report issued last week the Congressional Budget Office (CBO) became 
the latest government financial agency to join the chorus of critical 
voices. In fact, the CBO concluded in a damaging assessment that the 
proposed lease ``would essentially be a purchase of the tankers by the 
Federal government, but at a cost greater than would be incurred under 
the normal appropriation and procurement process.'' The CBO also said 
the proposed lease does not meet the conditions for an operating lease 
as required by Office of Management and Budget rules.
    Others, including the General Accounting Office, Office of 
Management and Budget, Congressional Research Service, and DOD 
contractor the Institute for Defense Analysis, all have suggested that 
leasing the tanker aircraft would be far more costly than purchasing 
them.
    There is another problem. The Federal government should not reward 
contractors with such extraordinary handouts who do not have a record 
of ``integrity and business ethics.'' Three Boeing space subsidiaries 
recently were suspended after an Air Force investigation revealed that 
Boeing was in possession of thousands of pages of Lockheed Martin's 
proprietary documents.
    A POGO study documented 50 instances of misconduct or alleged 
misconduct by Boeing since 1990. Indeed, POGO's investigation shows 
that as recently as March 2003 Boeing agreed to an $18 million 
settlement with the government for alleged violation of the arms 
control act and international traffic in arms regulations.
    Rather than sweetheart deals, we should be looking at suspending 
repeat corporate offenders from future contracts.
    In response to criticism of the deal, Air Force officials, 
attempting to capitalize on Congressional support for new procurement 
funding, have only muddied the waters with distorted facts and 
contradictory financial projections. Yet, they too have also admitted 
that the lease would cost more than a purchase of the tankers.
    Moreover, copies of e-mail communications between Boeing and Air 
Force officials made public by the Senate Commerce Committee last week 
point to an improper--if not outright illegal--cozy relationship 
between the defense contractor and the Pentagon. The e-mails suggest 
that the Air Force went to Boeing for ideas on how to sell the tanker 
lease rather than letting the facts speak for themselves. In a 
September 18, 2002 e-mail between two Boeing executives one told the 
other that the Air Force was ``desperately looking for the rationale 
for why the USAF should pursue the 767 Tanker NOW.''
    Another e-mail even suggested that the Air Force's former 
acquisition chief, Darleen Druyun, shared Airbus prices with Boeing 
officials before she left to go work for Boeing. This unnatural 
closeness between contractor and the Air Force should be further 
investigated before the government enters into any formal lease or 
purchase agreement for new tankers.
    Clearly, tanker aircraft play a vital role in the mission of the 
U.S. military, but the Air Force has failed to provide evidence that 
the KC-135 fleet is in urgent need of replacement. To the contrary, a 
May 2002 General Accounting Office preliminary study suggested the 
opposite, that the current fleet can be re-engined and updated to serve 
the military's mission until 2040. Air Force officials seemed to 
support the idea of keeping and renovating the current KC-135 fleet 
until the lease proposal was dangled in their faces by some Members of 
Congress eager to curry political contributions from a powerful defense 
contractor.
    One of the arguments the Air Force makes is that the tankers can 
somehow be manufactured in a shorter period of time if they are leased. 
In reality, a leased aircraft is not built any faster. If the need is 
as critical as the Air Force suggests, then the new tankers should be 
budgeted for purchase like any other procurement item.
    The Air Force's expressed concern over tanker shortages is not 
credible in light of its decision to decline the purchase of 36 new 767 
tankers two years ago at a considerably cheaper price.
    Simply put, Air Force leaders never said they even needed the 
tankers until they woke up one morning and saw a pile of money on the 
table. All of a sudden, they say the KC-135 tanker fleet is plagued 
with corrosion problems, and have even suggested that the current fleet 
of tankers is unsafe--even though the KC-135 mishap rate is lower than 
many other Air Force aircraft.
    For several reasons, POGO strongly opposes the lease idea. The CBO 
analysis claims that over the period of the lease the taxpayers will 
spend $5.7 billion more to lease the aircraft over the cost of an 
outright purchase. In all, the CBO estimates the tankers will cost $161 
million each if the Air Force exercises an option to purchase the 
aircraft at the end of the six-year lease period. An independent 
analysis by DOD contractor the Institute for Defense Analysis concluded 
that the aircraft should cost considerably less and still provide 
Boeing with a handsome profit.
    Although the Air Force has just recently complained that its fleet 
of airborne gas stations is aging, its top brass never requested 
funding from Congress until recently. The purchase of the 100 tanker 
aircraft was not even on the Air Forces's list of top 60 budget 
priorities last year. The Air Force budget wish list included requests 
for such areas as bomber and fighter upgrades, aerial drone targets, 
family housing investment, a new C-130J, and readiness spare parts.
    The Air Force most recently has claimed that the current tanker 
fleet is unsafe because of corrosion but offers no specific assessment 
of the extent of the problem. No wonder: A July 2003 GAO study 
concluded that there is no way to assess the extent of the corrosion 
problem because neither the DOD or military services have reliable 
data.
    Until recently, the Department of Defense has projected that the 
tanker fleet could be flown for decades. In fact, General Richard 
Myers, Chairman of the Joint Chiefs of Staff, has said that the KC-135 
tanker fleet is ``relatively healthy'' with ``lots of flying hours left 
on them.'' The Air Force has not publicly disclosed any studies that 
contradict Myers statements, and the recent GAO study supported his 
observations with data supplied by the Air Force.
    ``As you know they've been re-engined,'' Myers said. ``We're 
putting new avionics in the cockpit. There's been a lot of work done on 
those particular aircraft to keep them modern.''
    Myers' comments are consistent with the DOD's official position 
prior to learning of the lease proposal. In response to GAO criticisms, 
the DOD told the GAO that its tanker fleet would not need replacing for 
decades. ``While the KC-135 is an average of 35 years old, its airframe 
hours and cycles are relatively low,'' DOD responded to the 1996 GAO 
tanker requirements study. ``With proper maintenance and upgrades, we 
believe the aircraft may be sustainable for another 35 years.''
    By latest count, there are 545 KC-135 tankers in the Air Force 
fleet. Of that total, 134 are older E models and 411 are upgraded R 
models. The Air Force says it wants to use the 100 leased Boeing 
tankers to replace 127 of the 134 older E models beginning in 2006. The 
E models are the oldest and least capable tankers. For that reason, all 
of the E models currently are assigned to reserve and National Guard 
air units, while the newer R models are all part of the active Air 
Force fleet.
    While the average age of the KC-135s is high, the actual hours of 
aircraft use are relatively low, according to the GAO. The Air Force 
itself projects that the E models have a lifetime of 36,000 flying 
hours and the R models can fly for 39,000 hours.
    As of 1995, the GAO says the majority of the KC-135 fleet had 
logged a total of between 12,000 and 14,000 flight hours. From 1995 to 
late 2001, the average tanker has averaged about 300 hours a year, 
bringing the total average hours flown by most of the tankers to 
roughly 14,000-16,000, or less than half the total expected life of the 
aircraft. (The average could now be slightly higher because tanker 
hours have increased slightly since the war in Afghanistan.) By these 
calculations, not one of the E models, the oldest in the fleet, would 
reach its limit until 2040, according to the GAO.
    Even if the Air Force's recently-crafted claims that there is an 
urgent need to replace KC-135 E models were true, the GAO says the 
quickest--and cheapest--solution may be to replace the engines of the 
older tankers and upgrade to R models at a cost of $29 million each. 
That means the bill to upgrade all 127 E models otherwise being 
replaced would only total about $3.6 billion, a mere fraction of the 
CBO's $21.5 billion estimate to lease 100 new Boeing 767 aircraft.
    Even before the release last week of the communications between 
Boeing and Air Force officials, the tanker lease deal has been a 
textbook case of bad procurement policy and favoritism to a single 
defense contractor. The legislative add-on permitting the lease does 
not even attempt to cover up the acrid smell of back room dealing. It 
brashly subverts the competitive bidding process by authorizing the Air 
Force to procure 100 new tankers only if it leases them specifically 
from Boeing. Boeing could not have structured a better deal had it 
drawn the lease proposal itself.
    This appearance of favoritism was the subject of inquiry at a 
February 12, 2002, Senate Armed Service Committee hearing on the 
proposed Fiscal Year 2003 defense budget. When questioned about the 
deal, Air Force Secretary James Roche admitted that Air Force officials 
did not even discuss it with Secretary of Defense Donald Rumsfeld, 
Armed Services Democratic Committee Chairman Senator Carl Levin, or 
ranking Committee Republican Senator John Warner. Such communication is 
customary in the case of large defense appropriations.
    During the hearing, Roche was asked by Republican Senator John 
McCain if there had been discussions with Airbus, a division of 
European Aeronautic Defence and Space Company (EADS), a Boeing 
competitor also interested in selling wide-body tankers to the Air 
Force.
    ``Yes, sir. Back as far as October I made the point that if Airbus 
could come in and do something, we would be delighted to have that 
happen,'' Roche responded. ``. . . I have met with [EADS Chief 
Executive Officer] Philippe Camus and have opened up the door for him 
if he wished to do something.''
    ``But doesn't the legislation say the loan can only be Boeing 
767's?'' McCain fired back. ``Yes, sir. But if Airbus did something 
that was particularly good, I would come back to the Congress, sir,'' 
Roche said.
    Roche never did get back with Congress on the issue, but apparently 
was stung by hints of favoritism during the hearing. Only a week later, 
on February 20, 2002, the Air Force issued a formal Request For 
Information that gave interested tanker defense contractors only two 
weeks to submit a complex proposal for the lease of 100 refueling 
aircraft. Predictably, a cheaper-priced formal proposal by Airbus was 
rejected, and the Air Force is currently finalizing lease negotiations 
with Boeing.
    While the leasing of major weapons systems, aircraft, and ships are 
rare, the Boeing 767 lease proposal is not totally without precedent. 
It bears a striking resemblance to a handful of long-term lease deals 
by the Navy to quickly put several dozen tanker ships into commission 
during the 1970s and 1980s. Although at the time the leases were 
purported to be cheaper than buying the refueling ships outright, the 
GAO has since concluded the leases actually resulted in a higher cost 
to the taxpayers.
    Since the Navy leases, Congress has increased transparency of long-
term leases and tightened the process to evaluate long-term leases of 
military equipment and weapons. Through a detailed process called 
``budget scoring,'' the military services are now required to assess 
the cumulative impact of a long-term lease and compare it to the cost 
of purchasing equipment before Congress agrees to appropriate the 
funding.
    Now, there is a great danger that the Boeing tanker lease may be a 
sign of things to come and future leases could become more commonplace. 
In fact, the idea of leasing major weapons systems in the future has 
been a goal of the Pentagon since late 2001. In the name of flexibility 
the DOD has, in effect, declared war on close financial oversight of 
multi-year leasing of weapons systems, aircraft, and ships.
    In a 2001 memo, Pentagon Acquisitions Chief E.C. Aldridge, Jr., and 
DOD Comptroller Dov S. Zakheim announced a new multi-year leasing 
initiative, instructing key Pentagon officials to help ``identify 
candidate programs for acquisition by means of multi-year leases.'' 
Their memo said that long-term leasing of weapons systems has 
historically been rare because of statutory and regulatory 
``impediments.''
    POGO opposes such leases as a means for acquiring major weapons 
systems. They are likely to obligate the government to future debt that 
is not properly budgeted, costs more, and provides much less financial 
oversight.
    Thank you for inviting me to testify before the Committee. I am 
happy to answer any questions.

    The Chairman. Thank you very much, Mr. Miller. Dr. Nelson, 
help me out here. IDA was asked by the Air Force to do a study.
    Dr. Nelson. No, sir. IDA was asked by the Under Secretary 
of Defense, Acquisition, Technology, Logistics----
    The Chairman. To do a study.
    Dr. Nelson. --and the Director of PANE to do a task.
    The Chairman. And you completed that task in how long?
    Dr. Nelson. We essentially began very late in January. We 
finished our work pretty much by end of April, mid-May, and 
then we documented our results, it went to the middle of July, 
so about 6 months.
    The Chairman. So your product said that the cost per tanker 
should be $120 million each, is that correct?
    Dr. Nelson. That was our finding, yes, sir.
    The Chairman. Your finding? And yet the Air Force is about 
to enter into a deal for $131 million each, correct?
    Dr. Nelson. Yes, sir.
    The Chairman. Was there then conversations or discussions 
between you and the Secretary of the Air Force or PANE or the 
Under Secretary of Defense about the disparity, and it's a 
significant one, about what you thought what IDA analysis was 
of what should be the cost of the aircraft and what the deal 
that the Air Force is about to enter into?
    Dr. Nelson. Well, Senator, cost analysts can differ.
    The Chairman. Yes.
    Dr. Nelson. Data can be different, methods can be 
different, application of analogies, scaling, there are a 
number of ways that things can be different. We met 
periodically with our sponsors and the Air Force and exchanged 
information, discussion about how we went about certain 
elements of our analysis.
    The Chairman. Well, did they convince you that anything you 
had done was incorrect?
    Dr. Nelson. No, sir.
    The Chairman. So you still stand by your conclusions?
    Dr. Nelson. Yes, sir.
    The Chairman. Thank you. General Sams, I understand there 
are two outstanding differences as you heard earlier. Is there 
a prospect of resolving those two issues and completing and 
finalizing the leasing agreement?
    General Sams. Yes, sir, Mr Chairman. As I was briefed just 
before I came over here today by our folks who had been working 
with Air Force officials that we believe we have a path forward 
on those two issues.
    The Chairman. Thank you. Senator Cantwell? And I thank the 
witness.
    Senator Cantwell. Thank you Mr. Chairman. Mr. Ellis, you 
mentioned in your closing comments, I don't think it's in your 
written statement, but you mentioned that you urged members of 
the Armed Services Committee and others to oppose this, the 
Taxpayers for Common Sense, and you mentioned war fighters 
opposed this deal.
    Mr. Ellis. What I had said earlier----
    Senator Cantwell. I didn't know what war fighters you were 
speaking about or representing.
    Mr. Ellis. Well, earlier in my testimony I mentioned that I 
thought this was a bad deal for the war fighter, and my 
understanding is that the lease, monies for the lease, part of 
a way of making this work is that the funding doesn't come out 
of the procurement budget for the Air Force, it comes out of 
their operations and maintenance budget, and so therefore 
that's going to affect other activities. We're going to have to 
you can't get something for nothing.
    Senator Cantwell. So I think when you said war fighters 
oppose this deal, you meant you hoped war fighters would oppose 
this deal or were you saying that----
    Mr. Ellis. My statement, at least in my oral, at least what 
I believe I said, was that, at the end, was that we're counting 
on taxpayers taxpayers are counting on you to stop this 
juggernaut and that I asked you to ask your colleagues to 
oppose this, and then earlier in my testimony I said that it 
was a bad deal for the this deal is more than just Pentagon 
waste, at least it will have a significant negative impact on 
servicemen and women on the war fighter.
    Senator Cantwell. At the end you mentioned war fighters, 
that's why I just wanted to make sure that you were not trying 
that there was some group that you were representing.
    Mr. Ellis. The war fighter yeah, no I did say the war 
fighter and taxpayers, yeah, I did, you're absolutely correct, 
I apologize, and no, I believe that the war fighter, I mean, we 
look out as an organization we look out for what we think is in 
our nation's interest, what we think is in the taxpayers' 
interests and we don't think that this lease the way is 
currently structured because of where the funding comes from is 
in the war fighter's interest.
    Senator Cantwell. So that there's no----
    Mr. Ellis. That's my----
    Senator Cantwell. That's your--there's not an organization 
that you're associated with or members of your organization----
    Mr. Ellis. No.
    Senator Cantwell. Okay. Second question, you mentioned that 
you though the 70 percent increase in the budget as we moved 
forward if they went to a procurement would be a tough 
situation to handle. If you looked at the current procurement 
proposal as an increase, it would be a 140 percent increase 
today, so are you more comfortable with that?
    Mr. Ellis. I don't think that delaying tough choices is a 
very good method to approach this, and I do think that 
essentially that what we've done here with the budget scoring 
and other methods that were sort of talked about by Senator 
Sununu is we've just sort of put of the inevitable, but really 
only on the books, and so some of these discussions, I do think 
we have a car wreck going on in our procurement budget in the 
Air Force, and we're going to have to address that. And we've 
had it was interesting to hear about the FA-22 coming down 
because that would be the first time I've ever heard of the 
costs of the FA-22 coming down, that was mentioned earlier. And 
I think that a lot of the cost controls and how we're 
approaching this all have to be addressed, and I would rather 
do that sooner than wait.
    Senator Cantwell. So since these are tough decisions for 
all of us, what do you recommend? Do you think we should have a 
procurement process of 140 percent increase now, cancel other 
projects that are already on the books, which would you do?
    Mr. Ellis. What I would do is I would go through as much--
--
    Senator Cantwell. Or just continue to delay the problem?
    Mr. Ellis. No, not delay the problem, no Senator. I believe 
that we have to address the problem. I think that there are 
issues and those have to be dealt with, but I think that as the 
earlier testimony has indicated that this did not seem to 
become a calamity until just 18 months ago, which seems to me 
to be a pretty quick ramp-up on this issue. And so I think that 
this isn't an emergency right now. I think we have to deal with 
it and we have to move forward and we can't ignore it like the 
Air Force ignored it for many years. The GAO first started 
talking about the corrosion issue, for instance, in 1996, and 
they have avoided that. And I don't think that one wrong 
decision, which was ignoring the issue, should beget another 
wrong decision, which is to play smoke and mirror budget tricks 
to squeeze this in.
    Senator Cantwell. So which of those would you do, because I 
don't think the problem gets any better next year if you 
delayed it one more year. And maybe you and I differ but I 
think a lot's happened since September 11 and I think the Air 
Force should give us a percentage increase in the sortie demand 
for those refueling tankers. It's unfortunate that they didn't 
have that number, but I don't think anything gets better next 
year and I don't think anything gets better the year after 
that, so somewhere in that process you have to make a decision. 
You either have to have a huge procurement increase or you have 
to cut other things in the budget or accept a lease option. So 
I'm just trying to understand, of those three options, what 
does Taxpayers for Common Sense propose?
    Mr. Ellis. Well what I propose is that we go through the 
processes that we're supposed to and that we really analyze our 
alternatives and we look at the options. I mean, I listed a 
couple small ones as sort of a short-term issue of re-engining 
some of these, the ones that are capable of, I understand not 
all of them are, I think that we should look at whether we can 
buy used DC-10s and convert them into KC-10s, which are far 
more capable than the KC-767 is and also can accommodate more 
aircraft, and I think that we need to put everything on the 
table and that's what we should be using this next year for is 
figuring out what is the best way to do this and what's the 
best way to meet our aerial refueling needs, not to just buy 
KC-767s or lease them.
    Senator Cantwell. But in a year the same options will be 
there.
    Mr. Ellis. But we haven't looked at all the options. I 
happen to believe that there are a lot of smart people in the 
Pentagon that need to sit down and really start thinking about 
what are our needs and what is our future going to be like. 
What we've heard today is a lot of discussion about how the KC-
767 is much better than the KC-135. Absolutely, it is, the only 
thing that's pretty similar is the fact that it's just got a 
little more fuel capacity, but other than that it's a far 
better aircraft. But that's not the discussion. We should be 
talking about the KC-767 against what our actual aerial 
refueling need is, and we haven't really done that.
    Senator Cantwell. Actually I did hear that discussion 
today, but I know my colleague probably has questions too, and 
maybe if there's a second round, Mr. Chairman.
    The Chairman. Senator Brownback.
    Senator Brownback. Thanks, Mr. Chairman. General Sams, you 
had stated in your testimony that you gave the United States 
Government the best deal that you've given to any commercial 
enterprise, is that correct?
    General Sams. Yes, sir, that's correct.
    Senator Brownback. You've also stated that if you do give a 
commercial enterprise a better deal in the next two years, 
you'll come back and rebate the U.S. Government on that, is 
that correct?
    General Sams. Yes, sir, that's correct?
    Senator Brownback. And that's until the end of the contract 
with the U.S. Government, is that correct?
    General Sams. Yes, sir.
    Senator Brownback. Okay. Now looking at this from a leasing 
arrangement, does that also include, that is what you're 
talking about, as a leasing arrangement this is the best lease 
that you've offered to any commercial enterprise?
    General Sams. Actually, Senator, Boeing will not be leasing 
the airplanes as we discussed a little bit earlier. Boeing will 
do what Boeing traditionally does best and that's produce 
airplanes and then we have offered to sell those airplanes to 
the Air Force or to a leasing company. The Air Force asked us 
to facilitate leasing because that was the legislation that was 
approved. So the sale of that aircraft for the purposes of the 
767 tanker would be the same price in either direction, and in 
this case would be to a leasing company which has been 
established as a nonprofit trust.
    Senator Brownback. but that price is still, it's the best 
price that you're offering to any commercial entity and will be 
over the next two years, is that correct?
    General Sams. Actually it's the best price that we've 
offered over the last 17 years, and we will in the future sell 
no aircraft at a lesser price for the total future of the 
program.
    Senator Brownback. Dr. Nelson, there was a were you here 
for the earlier panel?
    Dr. Nelson. Yes, I was.
    Senator Brownback. There was testimony by CRS that was 
saying we're paying substantially more than we should as a 
lease proposal on this. Did you hear that?
    Dr. Nelson. Yes, I did.
    Senator Brownback. Have you had a chance to look at any of 
their analysis and compare it to yours on a leasing 
arrangement?
    Dr. Nelson. We were not tasked to look at the lease, 
Senator. We looked only at the direct purchase price.
    Senator Brownback. All right. General Sams, there's been 
a--you've had an ongoing negotiation with the Pentagon on the 
price of this product for several years now, haven't you?
    General Sams. Yes, sir, for ongoing 24 months.
    Senator Brownback. And I believe that even they've been 
able to get you down as I see in the reporting about $2 billion 
from your original asking price?
    General Sams. Yes, sir. Originally as negotiations started, 
and they are negotiations, we had offered a price in the 
neighborhood of $150 million, knowing that we would negotiate a 
price.
    Senator Brownback. Thank you very much, Mr. Chairman, for 
hosting the panel. Thank you all for being here.
    The Chairman. Do you have further questions?
    Senator Cantwell. Thank you, Mr. Chairman, if I could. I 
was just going to ask Dr. Nelson, in your report I know you 
didn't deal with the lease, but how do you deal with the 
uncertainty that the Air Force has to own up to and adhere to 
in their planning models of dealing with how change is 
occurring and how they plan for the future?
    Dr. Nelson. Well we were only tasked to look at this 
specific element of the analysis. If there were an AOA, I think 
that it would be addressed in that context with regard to 
force-level planning, total life cycle costs, and other issues.
    Senator Cantwell. And do you think that the Japanese and 
Italians are extremely wealthy countries in the sense of 
they've obviously paid a purchase price for these planes 
already which is well above the mark that you have suggested. 
What do you think is the reason for that?
    Dr. Nelson. Well, all it would be helpful to know all the 
terms of the sale. I would assume that the Japanese and the 
Italians are buying more, much more than just the airplanes. 
They buy spares, they buy training, there may be some work done 
in the buyer country which introduces other inefficiencies in 
pricing, the detailed physical characteristics might be 
different. We can't comment any further than that there are 
many issues that must be looked at in more detail.
    Senator Cantwell. And doesn't that kind of sum up what this 
afternoon has been about, that everybody has used different 
assumptions and different models and different comparisons and 
different maintenance costs and different time frames and 
different issues?
    Dr. Nelson. And different agendas.
    [Laughter.]
    Senator Cantwell. Well certainly I think it's safe to say 
that the chairman has had his agenda today heard, and he's been 
so kind to let us keep you here for a second round of 
questioning, which I very much appreciate, but I think these 
are important issues as it relates to a 1996 report basically 
saying we have a severe problem hitting us right in the face, 
and now we hear from the Air Force today that they also have to 
plan for a different level of activity than was anticipated two 
years ago. And so somehow that isn't calculated into the 
report.
    Dr. Nelson. Right. There are many issues that need to be 
considered in coming to a decision about this, and clearly the 
need is paramount, the delivery schedule, and when the 
airplanes show up, and the cost to the taxpayer, all of these 
have to be considered.
    Senator Cantwell. Thank you.
    The Chairman. I want to thank you, Senator Cantwell, thank 
the witnesses, thank you for your patience today, and we 
appreciate your testimony. This hearing is adjourned.
    [Whereupon, at 5:28 p.m., the hearing was adjourned.]