Future Years Defense Program: Lower Inflation Outlook Was Most
Significant Change From 1996 to 1997 Program (Letter Report, 12/12/96,
GAO/NSIAD-97-36).

Pursuant to a congressional request, GAO compared the Department of
Defense's (DOD) fiscal year (FY) 1997 Future Years Defense Program
(FYDP) with the FYDP for FY 1996, focusing on the: (1) impact of the
reduction in the inflation rate on DOD's 1997 FDYP; (2) major program
adjustments from the 1996 FDYP to the 1997 FDYP; and (3) implications of
these changes for the future.

GAO found that: (1) as a result of projecting significantly lower
inflation rates, DOD calculated that its future purchases of goods and
services in its 1997 FYDP would cost about $34.7 billion less than
planned 1 year ago in its 1996 FDYP; (2) according to DOD, the assumed
increased purchasing power that resulted from using the lower inflation
rates allowed DOD to include about $19.5 billion in additional programs
in fiscal years 1997 through 2001 than it had projected in the 1996
FYDP, and permitted the executive branch to reduce DOD's projected
funding over the 1997 through 2001 period by about $15.2 billion; (3)
resource allocations in the 1997 FYDP vary considerably from the 1996
FYDP as a result of the lower inflation projections, program transfers,
and program changes; (4) the projected savings from the latest round of
base closures and realignments changed considerably from the 1996 FYDP
to the 1997 FYDP; (5) in the 1996 FYDP, DOD estimated savings of $4
billion from base closures, but the 1977 FDYP projected savings of only
$0.6 billion, because the 1996 FDYP projected savings based on interim
base closing plans that subsequently changed, and military construction
costs related to environmental cleanup of closed bases are projected to
be $2.5 billion higher than anticipated in the 1996 FDYP; and (6) a
comparison of the 1996 and 1997 FYDPs also shows that DOD plans to
reduce active duty force levels, but if DOD is precluded from carrying
out its plan to achieve a smaller force, it will have to make other
adjustments to its program.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-97-36
     TITLE:  Future Years Defense Program: Lower Inflation Outlook Was 
             Most Significant Change From 1996 to 1997 Program
      DATE:  12/12/96
   SUBJECT:  Defense budgets
             Future budget projections
             Budget cuts
             Inflation
             Reductions in force
             Base closures
             Base realignments
             Allocation (Government accounting)
             Defense procurement
IDENTIFIER:  DOD Future Years Defense Program
             Consumer Price Index
             DDG-51 Destroyer
             C-130 Aircraft
             V-22 Aircraft
             Kiowa Helicopter
             Navy Theater Ballistic Missile Defense Program
             LHD-1 Amphibious Ship
             F/A-18C/D Aircraft
             SDI Theater High Altitude Area Defense System
             UH-60 Helicopter
             
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Cover
================================================================ COVER


Report to Congressional Requesters

December 1996

FUTURE YEARS DEFENSE PROGRAM -
LOWER INFLATION OUTLOOK WAS MOST
SIGNIFICANT CHANGE FROM 1996 TO
1997 PROGRAM

GAO/NSIAD-97-36

Future Years Defense Program

(701090)


Abbreviations
=============================================================== ABBREV

  BEA - Bureau of Economic Analysis
  CBO - Congressional Budget Office
  DOD - Department of Defense
  FYDP - Future Years Defense Program
  GDP - gross domestic product
  OMB - Office of Management and Budget
  TOA - total obligational authority

Letter
=============================================================== LETTER


B-275478

December 12, 1996

The Honorable John R.  Kasich
Chairman, Committee on the Budget
House of Representatives

The Honorable Charles E.  Grassley
The Honorable William V.  Roth, Jr.
United States Senate

At your request, we compared the Department of Defense's (DOD) fiscal
year 1997 Future Years Defense Program (FYDP) with the FYDP for
fiscal year 1996.  Specifically, we determined (1) the impact of the
reduction in the inflation rate on DOD's 1997 FYDP, (2) the major
program adjustments from the 1996 FYDP to the 1997 FYDP, and (3) the
implications of these changes for the future. 


   BACKGROUND
------------------------------------------------------------ Letter :1

In 1995, we compared the 4 common years (1996-99) in DOD's 1995 and
1996 FYDPs and reported that DOD projected substantial shifts in
funding priorities.\1 Specifically, about $27 billion in planned
weapon system modernization programs had been eliminated, reduced, or
deferred to 2000 or later.  Also, the military personnel, operation
and maintenance, and family housing accounts had increased by over
$21 billion and were projected to continue to increase to 2001 to
support DOD's emphasis on readiness and quality-of-life programs. 
Moreover, the total DOD program was projected to increase by about
$12.6 billion. 

The Secretary of Defense wants to reform the acquisition process and
reduce and streamline infrastructure to help pay the billions of
dollars that DOD projects it will need to modernize the force.  In
our September 1995 report, we said that although DOD anticipated
reducing infrastructure to achieve substantial savings, our analysis
of the 1996 FYDP showed that savings accrued or expected to accrue
from base closures and a smaller force appeared to be offset by
increased funding for other infrastructure priorities, such as base
operations and management headquarters.  In May 1996, we analyzed the
infrastructure portion of DOD's 1997 FYDP and reported that
infrastructure costs are projected to increase by about $9 billion,
from $146 billion in 1997 to $155 billion in 2001.\2

The FYDP includes anticipated future inflation.  Therefore, changes
in anticipated inflation affect the projected cost of the FYDP.  The
Secretary of Defense testified in March 1996 that the 1997 FYDP,
which covers fiscal years 1997-2001, includes the funds to buy all of
the programs in the 1996 FYDP plus billions of dollars in additional
programs at less cost overall.  According to DOD, the increase in
programs at lower projected costs results because inflation estimates
were substantially reduced for future DOD purchases, from 3 percent
to about 2.2 percent for fiscal years 1997-2001. 


--------------------
\1 Future Years Defense Program:  1996 Program Is Considerably
Different From the 1995 Program (GAO/NSIAD-95-213, Sept.  15, 1995). 

\2 Defense Infrastructure:  Costs Projected to Increase Between 1997
and 2001 (GAO/NSIAD-96-174, May 31, 1996). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

As a result of projecting significantly lower inflation rates, DOD
calculated that its future purchases of goods and services in its
1997 FYDP would cost about $34.7 billion less than planned 1 year ago
in its 1996 FYDP.  According to DOD, the assumed increased purchasing
power that resulted from using the lower inflation rates (1) allowed
DOD to include about $19.5 billion in additional programs in fiscal
years 1997-2001 than it had projected in the 1996 FYDP and (2)
permitted the executive branch to reduce DOD's projected funding over
the 1997-2001 period by about $15.2 billion. 

The price measure the executive branch used in its inflation
projections for future purchases in the 1997 FYDP had inherent
limitations and has since been improved.  If the executive branch
decides to use the improved price measure to price its 1998 budget,
DOD may need to adjust its program as a result of that transition. 
Office of Management and Budget (OMB) officials told us they have not
decided what price measure they will use to forecast inflation for
the 1998 FYDP.  Using projected inflation rates based on a different
price measure from that used by the executive branch, the
Congressional Budget Office (CBO) estimated that the future cost of
DOD's purchases through 2001 would decline by only about $10.3
billion, or $24.4 billion less than DOD's estimate. 

Resource allocations in the 1997 FYDP vary considerably from the 1996
FYDP as a result of the lower inflation projections, program
transfers, and program changes.  For example, (1) the procurement
accounts decreased about $26 billion from the 1996 FYDP to the 1997
FYDP--including about $15.3 billion due to lower projected inflation
rates and about $10.4 billion from program transfers to research,
development, test, and evaluation accounts; (2) the operation and
maintenance accounts decreased by about $10 billion due to lower
projected inflation rates; and (3) the research, development, test,
and evaluation accounts increased by $11 billion primarily due to
transfers from the procurement accounts and program changes. 

The projected savings from the latest round of base closures and
realignments changed considerably from the 1996 FYDP to the 1997
FYDP.  In the 1996 FYDP, DOD estimated savings of $4 billion from
base closures; however, the 1997 FYDP projects savings of only $0.6
billion.  This is because (1) the 1996 FYDP projected savings based
on interim base closing plans that subsequently changed and (2)
military construction costs related to environmental cleanup of
closed bases are projected to be $2.5 billion higher than anticipated
in the 1996 FYDP. 

A comparison of the 1996 and 1997 FYDPs also shows that DOD plans to
reduce active duty force levels.  The smaller force planned for
fiscal years 1998-2001 would bring force levels below the minimum
numbers established by law.  If DOD is precluded from carrying out
its plan to achieve a smaller force, it will have to make other
adjustments to its program. 


   1997 FYDP REFLECTS INCREASED
   PURCHASING POWER DUE TO LOWER
   PROJECTED INFLATION
------------------------------------------------------------ Letter :3

The executive branch substantially reduced its forecast of the
inflation rate for fiscal years 1997 through 2002, resulting in a
decline in the estimated costs of DOD's purchases of about $45.7
billion, including about $34.7 billion over the 1997-2001 FYDP
period.\3 However, the price measure used in the executive branch's
projections had inherent limitations and has since been improved. 
Using a different price measure, CBO projected a much smaller drop in
inflation and estimated that the future cost of DOD's purchases would
be reduced by only about $10.3 billion over the 1997-2001 period. 


--------------------
\3 DOD's nonpay and nonfuel purchases subject to this lower inflation
rate range from about $138 billion to about $166 billion for fiscal
years 1997-2001, over 50 percent of DOD's budget. 


      LOWERED INFLATION FORECAST
      YIELDS PROJECTED $35 BILLION
      INCREASE IN PURCHASING POWER
      IN 1997 FYDP
---------------------------------------------------------- Letter :3.1

The executive branch reduced its inflation forecasts from 3 percent
per year for the period 1997-2001 to 2.2 percent per year, or 8/10 of
1 percent.\4 As a result, DOD projected that the cost of defense
purchases would decline by $34.7 billion for the 1997-2001 period and
an additional $11 billion for 2002.  Based on these projected cost
reductions, the executive branch reduced DOD's projected budgets for
fiscal years 1997-2001 by about $15.2 billion.  The executive branch
allowed DOD to retain about $19.5 billion of the projected increase
in purchasing power.  The distribution of this assumed additional
purchasing power was $4.3 billion in 1997, $3.9 billion in 1998, $4.6
billion in 1999, $3.8 billion in 2000, and $2.9 billion in 2001. 

According to DOD, about $6 billion of the $19.5 billion was applied
to the military personnel and operation and maintenance accounts for
must-pay bills such as for the military retired pay accrual and
ongoing contingency operations.  The remaining $13 billion was
applied primarily to DOD's modernization priorities.  Funding was
allocated to purchase trucks and other support equipment, accelerate
the acquisition of next generation systems, upgrade existing systems,
and fund Army base closure costs.  A detailed list of these planned
purchases is provided in appendix I. 


--------------------
\4 Inflation was forecast at 2.2 percent for all years except 1999,
for which the forecast was 2.3 percent. 


      CHANGE TO INFLATION
      FORECASTING HAS IMPLICATIONS
      FOR 1998 FYDP
---------------------------------------------------------- Letter :3.2

For more than a decade, OMB has used projections of the Commerce
Department's Bureau of Economic Analysis' (BEA) implicit price
deflator for gross domestic product (GDP) based on a "fixed-weighted"
methodology to adjust the future costs of defense nonpay purchases
other than fuel.  According to OMB officials, anecdotal information
for recent years suggests that changes in this measure have been an
accurate gauge of inflation in DOD purchases.  The fixed-weighted
methodology was used to prepare the President's fiscal years 1996 and
1997 budgets. 

Economists within the government and in private organizations
generally recognize that the implicit price deflator based on a
fixed-weighted methodology has inherent limitations, in part because
it is derived from the values of goods and services based on a fixed
base year such as 1987.  This fixed-weighted methodology has in
recent years tended to overstate economic growth and understate
inflation as time progressed beyond the base year.  Because of the
limitations in the fixed-weighted methodology, BEA switched to a new
"chain-weighted" inflation methodology, just after the President's
fiscal year 1997 budget had been prepared in January 1996.  The
"chain-weighted" methodology, which is continuously updated by using
weights for 2 adjacent years, ensures that differences in relative
prices, such as the drop in computer prices, will not distort overall
GDP statistics.  Economists have maintained that this methodology is
superior to the fixed-weighted methodology.  According to BEA
officials, the improved methodology gives a more accurate measure of
inflation because it eliminates the potential for cumulative errors
under the old (fixed-weighted) methodology.\5 For the 1997-2001
period, the executive branch projected an annual inflation rate of
2.2 percent as measured by the fixed-weighted methodology and 2.7
percent as measured by the chain-weighted methodology. 

In discussing the transition from the GDP implicit price deflator
based on fixed weights to the chain-weighted GDP price deflator, OMB
officials stated that the two differing numerical measures represent
the same inflation, in the same economy, at the same time.  According
to the officials, the difference is "precisely analogous" to
measuring the same temperature on Celsius or Fahrenheit scales.  The
only difference between the two measures is the methodology used. 
However, as a practical matter, OMB provides DOD a specific numerical
index of inflation, and DOD applies this index to estimate future
funding requirements.  Therefore, the index used has a direct impact
on DOD's estimated future funding requirements.  For example, our
analysis shows that had DOD applied the new chain-weighted inflation
assumption of 2.7 percent to develop its 1997-2001 FYDP rather than
the fixed-weighted assumption of 2.2 percent, DOD's increased
purchasing power would be only about $12.7 billion, not $34.7
billion. 

OMB officials told us they have not decided what methodology they
will use to project inflation for the next FYDP, which will encompass
the 1998-2003 defense program.  However, in commenting on a draft of
this report, DOD said that OMB has indicated its intention to adopt
the chain-weighted methodology for budgeting beginning with the
fiscal year 1998 submission.  In addition, the President's budget for
fiscal year 1997 emphasized the limitations of the fixed-weighted
methodology and featured the improved chain-weighted methodology in
presenting economic assumptions for the future.  If OMB uses the
improved chain-weighted methodology to provide inflation guidance to
DOD, DOD's funding estimates for fiscal years 1998 and beyond could
be affected.  For example, on a chain-weighted basis, two major
private forecasting firms currently project an inflation rate of
about 2.5 percent per year over the next 5 years, which is a decline
from the 2.7 percent chain-weighted inflation assumption that appears
in the fiscal year 1997 budget.  If OMB gives DOD an inflation
projection of 2.5 percent per year for the 1998-2003 period, a
question arises as to whether such a factor will be interpreted as an
increase (from the 2.2 percent as measured by the fixed-weighted
methodology) or a decrease (from the 2.7 percent as measured using
the chain-weighted methodology.) Without further guidance, DOD may
increase its estimates of future funding requirements for inflation
when inflation is projected to be lower than the earlier forecast. 


--------------------
\5 For a more complete discussion of the transition from the
fixed-weighted methodology to the chain-weighted methodology, see the
Budget of the United States Government, Analytical Perspectives for
Fiscal Year 1997, page 6.  For a more precise definition of these
terms, see The Economic and Budget Outlook:  An Update (The
Congressional Budget Office, Aug.  1996). 


      CBO FORECASTED AN INCREASE
      IN DOD PURCHASING POWER OF
      $10.3 BILLION IN THE 1997
      FYDP
---------------------------------------------------------- Letter :3.3

During consideration of the fiscal year 1997 defense budget, the
Chairman of the Senate Committee on the Budget requested that CBO
estimate the adjustments that should be made to DOD's budget
estimates through 2002 that would keep its purchasing power constant
given lower inflation rates.  CBO chose not to use the implicit price
deflator for GDP based on the fixed-weighted methodology that OMB had
used to calculate inflation because it had been replaced by the new
chain-weighted methodology.  Instead, CBO based its inflation
forecast on the Consumer Price Index, which measures changes in the
average cost of a fixed market basket of consumer goods and services
because that measure had not been revised.  Neither the executive
branch's nor CBO's estimate presumes any ability to forecast prices
of goods and services purchased by DOD.  Instead, the two estimates
calculate the change in a general index of inflation and assume that
prices of defense goods and services would change by the same amount. 

Using the Consumer Price Index, CBO projected a much smaller decrease
in inflation between the 2 budget years than the executive branch
did.  Whereas the executive branch projected an 8/10 of 1 percent
drop in inflation, CBO projected that inflation would drop only 2/10
of 1 percent.  As a result, CBO projected that DOD's purchasing power
would increase by only about $10.3 billion for the 1997-2001 period. 
This estimate is about $24.4 billion less than DOD's estimated $34.7
billion increase.  Further, because the executive branch reduced
DOD's estimated 1997-2001 FYDP by about $15.2 billion, CBO's estimate
indicates that DOD's real purchasing power was reduced by about $5
billion.  In action on the fiscal year 1997 budget resolution, the
Senate adjusted defense totals downward to reflect CBO's more
conservative estimate.  The House did not make any adjustments for
lower inflation.  The conference agreement on the budget resolution
recommended the Senate level for fiscal year 1997 and levels somewhat
closer to the House amounts in later years. 


   MAJOR RESOURCE SHIFTS FROM THE
   1996 FYDP TO THE 1997 FYDP
------------------------------------------------------------ Letter :4

Our analysis shows that resource allocations in the 1997 FYDP vary
considerably from the 1996 FYDP.  These resource adjustments result
primarily from inflation adjustments and transfers between accounts. 
Table 1 shows a year-to-year comparison of DOD's 1996 and 1997 FYDPs
by primary accounts. 



                                     Table 1
                     
                     Comparison of DOD's 1996 and 1997 FYDPs
                               by Primary Accounts

                              (Dollars in billions)

                                          Fiscal year
                         ---------------------------------------------
                            1997     1998     1999      2000      2001     Total
Account        FYDP      -------  -------  -------  --------  --------  ========
Military       FY 1996     $67.5    $68.2    $69.6     $70.9     $72.3    $348.5
 personnel
               FY 1997      69.8     69.2     70.0      71.1      73.1     353.2
               Increase      2.3      1.0      0.4       0.2       0.8       4.7
Operation      FY 1996      90.6     89.9     92.7      94.8      98.1     466.1
 and
 maintena
 nce
               FY 1997      89.1     88.6     90.1      92.3      95.9     456.0
               Decrease     -1.5     -1.3     -2.6      -2.5      -2.2     -10.1
Procureme      FY 1996      43.5     51.4     54.2      62.3      67.3     278.7
 nt
               FY 1997      38.9     45.5     50.5      57.7      60.1     252.7
               Decrease     -4.6     -5.9     -3.7      -4.6      -7.2     -26.0
Research,      FY 1996      32.7     31.7     30.9      30.2      30.6     156.1
 developm
 ent,
test, and      FY 1997      34.7     35.0     33.7      31.9      31.7     167.0
 evaluati
 on
         Increase      2.0      3.3      2.8       1.7       1.1      10.9
Military       FY 1996       5.1      4.6      4.4       3.8       3.9      21.8
 construc
 tion
               FY 1997       5.5      4.8      4.7       4.1       4.2      23.3
               Increase      0.4      0.2      0.3       0.3       0.3       1.5
Family         FY 1996       4.5      4.1      4.4       4.5       4.6      22.1
 housing
               FY 1997       4.0      3.8      4.1       4.1       4.1      20.1
               Decrease     -0.5     -0.3     -0.3      -0.4      -0.5      -2.0
Revolving      FY 1996       0.6      0.9      1.0       0.6       0.8       3.9
 funds
 and
undistrib      FY 1997       1.9      2.1      1.9       1.5       1.5       8.9
 uted
 continge
 ncies
         Increase      1.3      1.2      0.9       0.9       0.7       5.0
================================================================================
Total          FY 1996    $244.4   $250.8   $257.3    $267.1    $277.5  $1,297.1
               FY 1997    $244.0   $249.0   $255.1    $262.5    $270.4  $1,281.0
================================================================================
               Decrease    -$0.4    -$1.8    -$2.2     -$4.6     -$7.1    -$16.1
--------------------------------------------------------------------------------
Note:  Program estimates in DOD's FYDP are expressed in total
obligational authority (TOA).  TOA is the sum of new budget authority
provided for a given fiscal year and any other amounts authorized to
be credited to a specific fund or account during that year, including
transfers between funds or accounts.  TOA may not reflect exactly the
budget authority adjustments made in the President's budget.  Table
totals may not add due to rounding. 

Source:  Fiscal years 1996 and 1997 FYDPs. 

The following sections discuss some of the more significant changes
in each of the primary accounts. 


      MILITARY PERSONNEL
---------------------------------------------------------- Letter :4.1

Overall, funding for military personnel accounts increased by $4.7
billion for the 1997-2001 period, although DOD plans to reduce the
number of military personnel below the levels reflected in last
year's FYDP.  The increase primarily reflects (1) higher pay raises
for fiscal years 2000 and 2001 than were included in the 1996 FYDP
and (2) the transfer of U.S.  Transportation Command costs from a
revolving fund supported mainly by operation and maintenance accounts
to the military personnel accounts. 

Programs that are expected to receive the largest funding increases
are Army divisions ($1.5 billion) and Army force-related training
($1.6 billion).  Other programs are projected to be reduced.  Some of
the largest declines are projected for Army National Guard support
forces ($2.6 billion), Army Reserve readiness support ($1.6 billion),
and Air Force permanent change-of-station travel ($650 million). 

The 1997 FYDP shows that DOD plans to lower active duty force levels
in fiscal years 1998-2001.  The planned smaller force would bring
force levels below the permanent end strength levels set forth in the
National Defense Authorization Act for fiscal year 1996 (P.L. 
104-106).  Table 2 shows the minimum force levels in the law and
DOD's planned reductions. 



                                Table 2
                
                 Required Force Levels and DOD Planned
                               Reductions

                                            Planned FY         Planned
                              Required      2001 force      reductions
Service                         levels          levels       1998-2001
--------------------------  ----------  --------------  --------------
Army                           495,000         475,000         -20,000
Navy                           395,000         394,000          -1,000
Marine Corps                   174,000         174,000               0
Air Force                      381,000         375,000          -6,000
======================================================================
Total                        1,445,000       1,418,000         -27,000
----------------------------------------------------------------------
Source:  National Defense Authorization Act for fiscal year 1996 and
the 1997 FYDP. 

The Commission on Roles and Missions recommended that DOD perform a
quadrennial review to assess DOD's active and reserve force
structure, modernization plans, infrastructure, and other elements of
the defense program and policies to help determine the defense
strategy through 2005.  The National Defense Authorization Act for
fiscal year 1997 directed the Secretary of Defense to conduct the
review in fiscal year 1997.  Congress will have an opportunity to
examine the assessment and recommendations of the review.  The act
also requires the Secretary of Defense to include in the annual
budget request funding sufficient to maintain its prescribed
permanent active end strengths.\6 If DOD is precluded from
implementing its planned personnel reductions, it will have to make
other compensating adjustments to its overall program. 


--------------------
\6 The 1996 act authorized a 0.5-percent flexibility in meeting
permanent end strength levels.  This was increased to 1 percent in
fiscal year 1997. 


      OPERATION AND MAINTENANCE
---------------------------------------------------------- Letter :4.2

The operation and maintenance accounts are projected to decrease by
about $10.1 billion during the 1997-2001 period due to lower
inflation rates.  In addition, there were a number of funding
reallocations among operation and maintenance programs from the 1996
FYDP to the 1997 FYDP.  Programs that are projected to receive the
largest gains include Army real property services ($3.9 billion),
real property services training ($1.1 billion), and Navy
administrative management headquarters ($1.5 billion).  Programs that
are projected to decrease the most include Navy servicewide support
($2.1 billion); defense health programs, including medical centers,
station hospitals, and medical clinics in the United States ($2.3
billion); Army National Guard reserve readiness support ($1.4
billion); Army base operations ($4.2 billion); DOD environmental
restoration activities ($1.3 billion); and DOD's Washington
headquarters services ($1 billion). 

Projected savings from the latest round of base closures are also
less than were anticipated in the 1996 FYDP.  The 1996 FYDP projected
savings of $4 billion during 1997-2001 from the fourth round of base
closures beginning in fiscal year 1996.  The 1997 FYDP projects total
savings of $0.6 billion, $3.4 billion less than the 1996 FYDP
projection.  The decrease in savings is primarily due to higher than
anticipated base closure-related military construction costs for
environmental cleanup activities in fiscal year 1997. 

Typically, the planned costs to conduct contingency operations have
not been included in DOD's budget submission.  However, given that
forces are deployed in Bosnia and Southwest Asia and these known
expenses will continue into fiscal year 1997, DOD included $542
million for the Bosnian operations and $590 million for Southwest
Asian operations in the President's fiscal year 1997 budget.  The
Bosnian estimate was later revised to $725 million, and DOD has
informally advised the Senate and House Committees on Appropriations
of this increase.  Most of these funds are in operation and
maintenance accounts. 


      PROCUREMENT
---------------------------------------------------------- Letter :4.3

The procurement accounts are projected to decrease by about $26
billion during the 1997-2001 period.  About $15.3 billion of the
reduction can be attributed to the use of the lower inflation rate. 
A comparison of the 1996 and 1997 FYDPs indicates that about $10.4
billion of the $26 billion reduction is due to a transfer of
intelligence and classified program funding from the procurement
accounts to classified research, development, test, and evaluation
accounts.  According to DOD officials, the programs are more
accurately classified as research, development, test, and evaluation
than procurement.  The comparison also shows that DOD eliminated a
$5.4-billion program in the procurement accounts that was called
"modernization reserve" in the 1996 FYDP.  According to DOD
officials, this funding was redistributed among procurement programs. 

The 1997 FYDP continues the downward adjustments in the procurement
accounts, which we first identified in our September 1995 report on
the fiscal years 1995 and 1996 FYDPs.  We reported that the fiscal
year 1995 FYDP, which was the first FYDP to reflect the bottom-up
review strategy, reflected relatively high funding levels for
procurement of weapon systems and other military equipment.  The
funding level for procurement was estimated to be $60 billion by
fiscal year 1999.  Since the 1995 FYDP, DOD has steadily reduced
programmed funding levels for procurement in favor of short-term
readiness, quality-of-life improvements, research and development,
and infrastructure activities.  DOD now projects that the procurement
account will not contain $60 billion until 2001.  Table 3 shows DOD's
planned procurement reductions. 



                                      Table 3
                      
                         Reductions in Planned Procurement
                            Programs Since the 1995 FYDP

                               (Dollars in billions)

                                   Fiscal year
----------------------------------------------------------------------------------
FY
DP      1995      1996      1997      1998      1999      2000      2001     Total
--  --------  --------  --------  --------  --------  --------  --------  ========
FY     $43.3     $48.4     $49.8     $57.1     $60.1        \a        \a
 1
 9
 9
 5
FY      44.8      39.4      43.5      51.4      54.2     $62.3     $67.3
 1
 9
 9
 6
Ch       1.5      -9.0      -6.3      -5.7      -5.9        \a        \a
 a
 n
 g
 e
FY      43.2      43.4      38.9      45.5      50.5      57.7      60.1
 1
 9
 9
 7
Ch      -1.6       4.0      -4.6      -5.9      -3.7      -4.6      -7.2
 a
 n
 g
 e
==================================================================================
Cu     -$0.1     -$5.0    -$10.9    -$11.6     -$9.6     -$4.6     -$7.2    -$49.0
 m
 u
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 a
 t
 i
 v
 e
 r
 e
 d
 u
 c
 t
 i
 o
 n
----------------------------------------------------------------------------------
\a Not available. 

Source:  Fiscal years 1995, 1996, and 1997 FYDPs. 

In addition to the $10-billion transfer of intelligence and
classified programs, significant planned decreases in funding and
quantities of items include $2 billion for 1 Navy amphibious assault
ship (LHD-1) and $1.1 billion for 240 theater high-altitude area
defense systems.  Funding levels for some programs were increased in
the 1997 FYDP over last year's plan.  For example, $1.5 billion was
added in the 1997 FYDP for 172 Army UH-60 Blackhawk helicopters, and
$4 billion for 2 new SSN submarines. 

The National Defense Authorization Act for fiscal year 1997
authorized the addition of about $6.3 billion more than the
President's budget request for procurement.  Programs receiving
significant increases include the new SSN submarine; DDG-51
destroyer; the E-8B, C-130, V-22, and Kiowa warrior aircraft; and the
Ballistic Missile Defense Program.  The report also authorized $234
million for F/A-18 C/D fighter jets that was not included in the
President's budget. 


      RESEARCH, DEVELOPMENT, TEST,
      AND EVALUATION
---------------------------------------------------------- Letter :4.4

The research, development, test, and evaluation accounts are
projected to increase by about $10.9 billion during the 1997-2001
period.  Additionally, increased purchasing power in these accounts
due to the use of the lower inflation rate is projected at about $6.5
billion.  As mentioned earlier, about $10.4 billion was transferred
from the procurement accounts.  As a result of the transfer in
programs and other adjustments, intelligence and classified programs
experienced the most growth.  Our analysis shows that the largest
increase is in advance development activities, which increased about
$3 billion per year over 1996 FYDP projections. 

The National Defense Authorization Act for fiscal year 1997
authorized the addition of about $2.6 billion more than the
President's budget for research, development, test, and evaluation. 
The largest portions of the increase went to missile defense
programs. 


      MILITARY CONSTRUCTION
---------------------------------------------------------- Letter :4.5

The 1997 FYDP projects that funding for military construction will
increase by about $1.5 billion over the 1997-2001 period compared to
the 1996 FYDP.  One reason for the increase is that the 1996 FYDP
projected savings based on interim base closing plans that
subsequently changed, and actual closing costs were higher. 
Specifically, compared to the 1996 FYDP, the 1997 FYDP reflects
spending increases in military construction expenditures of about
$2.7 billion.  The increase also reflects the transfer of some
environmental restoration funds to the military construction account
for cleanup at specific bases scheduled for closing. 


      FAMILY HOUSING
---------------------------------------------------------- Letter :4.6

DOD considers family housing a priority.  Nonetheless, when compared
to the 1996 FYDP, the 1997 FYDP shows that the family housing
accounts will decrease by about $1.8 billion.  Improvements and other
new construction are projected to decrease by about $1.3 billion
during 1997-2001.  Current family housing plans include improvements
to 4,100 housing units, construction or replacement of 2,300 units
and 13 support facilities, and the provision of $20 million for
private sector housing ventures. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :5

We received comments on this report from OMB and DOD.  DOD generally
agreed with our report and offered some points of clarification,
which we have incorporated where appropriate.  OMB indicated that the
change in inflation is important in forecasting the cost of the FYDP,
not the level of inflation.  Our review indicated, however, the level
of inflation was also important because DOD makes its cost
projections based on OMB guidance that specifies a level of
inflation, not the rate of change.  OMB and DOD comments are
published in their entirety as appendixes II and III, respectively. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

To evaluate the major program adjustments in DOD's fiscal year 1997
FYDP, we interviewed officials in the Office of Under Secretary of
Defense (Comptroller); the Office of Program Analysis and Evaluation;
the Army, Navy, and Air Force budget offices; CBO; OMB; and BEA.  We
examined a variety of DOD planning and budget documents, including
the 1996 and 1997 FYDPs and associated annexes.  We also reviewed the
President's fiscal year 1997 budget submission; our prior reports;
and pertinent reports by CBO, the Congressional Research Service, and
others. 

To determine the implications of program changes and underlying
planning assumptions, we discussed the changes with DOD, CBO, OMB,
and BEA officials.  To verify the estimated increased purchasing
power in major DOD accounts due to revised estimates of future
inflation, we calculated the annual estimated costs for each 1996
FYDP account using inflation indexes used by DOD from the National
Defense Budget Estimates for fiscal years 1996 and 1997.  The
increased purchasing power was the difference between these
calculated costs estimates and the reported 1996 FYDP account costs. 

Our work was conducted from April through November 1996 in accordance
with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :6.1

We are providing copies of this report to other appropriate Senate
and House Committees; the Secretaries of Defense, the Air Force, the
Army, and the Navy; and the Director, Office of Management and
Budget.  We will also provide copies to others upon request. 

If you have any questions concerning this report, please call me on
(202) 512-3504.  Major contributors to this report are listed in
appendix IV. 

Richard Davis
Director, National Security
  Analysis


DOD'S PLANNED USE OF INCREASED
PURCHASING POWER BY SERVICE
=========================================================== Appendix I

                              (Dollars in millions)

                                                  Fiscal year
                                ------------------------------------------------
                                                                           1997-
Service/procurement item          1997    1998    1999    2000    2001      2001
------------------------------  ------  ------  ------  ------  ------  --------
Army
Base realignment and closure                      $438    $348    $145      $931
 activities
Combat support equipment                           425     440     450     1,315
M1A2 tank upgrade                  $49     $68      89      91      93       390
M2A3 tank upgrade                                  156     413     481     1,050
Apache Longbow System                                       12     123       135
Javelin medium anti-tank                           196     413     384       993
 weapon
Hellfire missiles                   94      93      99     103     110       499
UH-60 Blackhawk                     87     133     129     128     100       577
Wheeled vehicles                    45             227     212     212       696
Paladin howitzer upgrade           109                                       109
Other programs                      45      17      21      13       2        98
================================================================================
Subtotal                          $429    $311  $1,780  $2,173  $2,100    $6,793
Navy and Marine Corps
Amphibious transport (LPD)                         880                       880
Overhaul carrier                                         1,700             1,700
Guided missile destroyer (DDG-     100                                       100
 51)
F/A-18 E/F                                         100     480               580
USMC ground upgrade                        100     100     200     160       560
Enhanced modular signal              4                                         4
 processor
AV-8B procurement acceleration                      28                        28
EA6B aircraft                                               72      72       144
Cooperative engagement              89                                        89
Precision-guided munitions                         100     200     203       503
================================================================================
Subtotal                          $193    $100  $1,208  $2,652    $435    $4,588
Air Force
Expendable launch vehicles                         133     228     134       495
F-22 advanced tactical fighter                      50      88     194       332
Precision-guided munitions                          24      52      66       142
F-15/16                            274                                       274
Tactical aircraft                                  250     260     250       760
 modifications
================================================================================
Subtotal                          $274       0    $457    $628    $644    $2,003
================================================================================
Total                             $896    $411  $3,445  $5,453  $3,179   $13,384
--------------------------------------------------------------------------------
Source:  Department of Defense. 




(See figure in printed edition.)Appendix II
COMMENTS FROM THE OFFICE OF
MANAGEMENT AND BUDGET
=========================================================== Appendix I



(See figure in printed edition.)


The following are GAO's comments on the Office of Management and
Budget's (OMB) letter dated November 8, 1996. 

GAO COMMENTS

1.  We agree with OMB that estimates of the Future Years Defense
Program (FYDP) in any given year include anticipated future inflation
and that changes in anticipated inflation affect the projected cost
of the FYDP.  We have made this more explicit in our report. 
However, the levels of forecasted inflation are also important to
project future costs.  As we explain in this report, the Department
of Defense (DOD) projects costs based on OMB guidance that specifies
an annual level of inflation for the FYDP period, not the changes in
forecasted inflation. 

2.  The report was amended to reflect this comment. 

3.  As explained in comment 1, DOD projects costs based on the
forecasted inflation rates it receives from OMB.  Therefore, we
believe the forecasted inflation rates have a direct impact on DOD's
estimated future funding requirements. 

4.  Our example is meant to show how application of a specific
inflation rate to the FYDP can affect assumed purchasing power.  As
we explained previously, we believe the projected costs of the FYDP
are affected not only by the change in inflation rates but also by
the level of inflation.  OMB asserts that under its forecast, the two
inflation measures declined by the same amount.  However, the
Analytical Perspectives of the Budget for Fiscal Year 1997 shows a
smaller decrease in inflation under the chain-weighted
methodology--5/10 of 1 percent compared to 8/10 of 1 percent under
the fixed-weighted methodology.  Therefore, use of the changes in
either methodology consistently would not have yielded the same
change in the price of the FYDP. 

5.  The sentence was deleted from the final report. 




(See figure in printed edition.)Appendix III
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix I



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV

NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C. 

Robert Pelletier
William Crocker
Margaret Morgan
Scott Hornung
Charles Perdue
Bruce Kutnick
Nancy Ragsdale

OFFICE OF THE CHIEF ECONOMIST

Richard Kraschevski

RELATED GAO PRODUCTS

Defense Infrastructure:  Costs Projected to Increase Between 1997 and
2001 (GAO/NSIAD-96-174, May 31, 1996). 

Defense Infrastructure:  Budget Estimates for 1996-2001 Offer Little
Savings for Modernization (GAO/NSIAD-96-131, Apr.  4, 1996). 

Future Years Defense Program:  1996 Program Is Considerably Different
From the 1995 Program (GAO/NSIAD-95-213, Sept.  15, 1995). 

DOD Budget:  Selected Categories of Planned Funding for Fiscal Years
1995-99 (GAO/NSIAD-95-92, Feb.  17, 1995). 

Future Years Defense Program:  Optimistic Estimates Lead to Billions
in Overprogramming (GAO/NSIAD-94-210, July 29, 1994). 

DOD Budget:  Future Years Defense Program Needs Details Based on
Comprehensive Review (GAO/NSIAD-93-250, Aug.  20, 1993). 

Transition Series:  National Security Issues (GAO/OCG-93-9TR, Dec. 
1992). 

*** End of document. ***