Defense Acquisition: Historical Insights Into Navy Ship Leasing
(Testimony, 04/21/99, GAO/T-NSIAD-99-141).

Pursuant to a congressional request, GAO discussed the Navy's decisions
in the early 1970s and early 1980s to lease Sealift Tankers, Maritime
Prepositioning Ships, and T-5 replacement tankers, and more recently,
Chouest specialized support vessels, focusing on the: (1) basis and
support for the Navy's decisions to lease rather than purchase these
vessels; (2) concerns that surrounded the decisions; and (3) legislative
and regulatory changes that have been implemented that will influence
future lease versus purchase decisions.

GAO noted that: (1) the primary reason the Navy decided to use long-term
leases to acquire auxiliary vessels in the early 1970s and early 1980s
was because available procurement funds were needed for higher-priority
combat ships, and leasing arrangements allowed the Navy to acquire the
support ships without a large, up-front obligation of procurement funds;
(2) the Navy also believed that leasing was cost-effective and helped
support the industrial base; (3) the Navy complied with existing
requirements to perform lease versus purchase cost comparisons; (4)
these comparisons concluded that leasing was cheaper than purchasing;
(5) the Navy's decision to enter into long-term leases in the early
1970s and early 1980s raised concerns regarding the budget authority
needed to make such large long-term funding commitments; (6) Congress
expressed concern about whether the Navy Industrial Fund could
adequately cover the total obligations that would accrue from these
leases; (7) to address this concern, the Navy requested and received
specific congressional authorization to carry out the acceptance
provisions of the long-term leasing contracts; (8) there were also
concerns regarding the cost-effectiveness of these leases; (9) when the
leasing decisions were made, there were limited standardized
government-wide guidelines for conducting lease versus purchase
analyses; (10) as a result, the studies used different assumptions and
methodologies in analyzing the alternatives and drew different
conclusions; (11) in 1983, GAO's report and a congressional staff study
questioned the validity of the assumptions used in the Navy's studies
and their conclusions; (12) had the Navy's studies used assumptions that
more fully reflected the government's total costs, they would have
concluded that purchasing was the cheaper alternative; (13) since the
long-term leasing decisions of the early 1970s and early 1980s, a number
of changes have occurred that will affect future long-term leasing
decisions by increasing oversight and improving cost analyses; (14)
Congress has increased visibility of and control over these types of
decisions; (15) budget-scoring guidelines increase the emphasis on
up-front budget authority by providing Congress with a mechanism to
assess the cumulative impact of long-term leasing decisions prior to the
obligation of funds; (16) tax benefits that favored leasing have been
reduced; and (17) as part of the decisionmaking process, more detailed
guidelines require that the Navy perform lease versus purchase analyses
that better reflect the government's total cost of long-term leasing
arrangements.

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

 REPORTNUM:  T-NSIAD-99-141
     TITLE:  Defense Acquisition: Historical Insights Into Navy Ship 
             Leasing
      DATE:  04/21/99
   SUBJECT:  Naval procurement
             Comparative analysis
             Leases
             Cost effectiveness analysis
             Equipment contracts
             Military cost control
             Decision making
             Military vessels
IDENTIFIER:  T-5 Tanker
             Maritime Prepositioning Ship
             Sealift Tanker
             U.S.S. Cory Chouest
             Navy Industrial Fund
             
Defense Acquisition: Historical Insights Into Navy Ship Leasing
(Testimony, 04/21/99, GAO/T-NSIAD-99-141).

Pursuant to a congressional request, GAO discussed the Navy's decisions
in the early 1970s and early 1980s to lease Sealift Tankers, Maritime
Prepositioning Ships, and T-5 replacement tankers, and more recently,
Chouest specialized support vessels, focusing on the: (1) basis and
support for the Navy's decisions to lease rather than purchase these
vessels; (2) concerns that surrounded the decisions; and (3) legislative
and regulatory changes that have been implemented that will influence
future lease versus purchase decisions.

GAO noted that: (1) the primary reason the Navy decided to use long-term
leases to acquire auxiliary vessels in the early 1970s and early 1980s
was because available procurement funds were needed for higher-priority
combat ships, and leasing arrangements allowed the Navy to acquire the
support ships without a large, up-front obligation of procurement funds;
(2) the Navy also believed that leasing was cost-effective and helped
support the industrial base; (3) the Navy complied with existing
requirements to perform lease versus purchase cost comparisons; (4)
these comparisons concluded that leasing was cheaper than purchasing;
(5) the Navy's decision to enter into long-term leases in the early
1970s and early 1980s raised concerns regarding the budget authority
needed to make such large long-term funding commitments; (6) Congress
expressed concern about whether the Navy Industrial Fund could
adequately cover the total obligations that would accrue from these
leases; (7) to address this concern, the Navy requested and received
specific congressional authorization to carry out the acceptance
provisions of the long-term leasing contracts; (8) there were also
concerns regarding the cost-effectiveness of these leases; (9) when the
leasing decisions were made, there were limited standardized
government-wide guidelines for conducting lease versus purchase
analyses; (10) as a result, the studies used different assumptions and
methodologies in analyzing the alternatives and drew different
conclusions; (11) in 1983, GAO's report and a congressional staff study
questioned the validity of the assumptions used in the Navy's studies
and their conclusions; (12) had the Navy's studies used assumptions that
more fully reflected the government's total costs, they would have
concluded that purchasing was the cheaper alternative; (13) since the
long-term leasing decisions of the early 1970s and early 1980s, a number
of changes have occurred that will affect future long-term leasing
decisions by increasing oversight and improving cost analyses; (14)
Congress has increased visibility of and control over these types of
decisions; (15) budget-scoring guidelines increase the emphasis on
up-front budget authority by providing Congress with a mechanism to
assess the cumulative impact of long-term leasing decisions prior to the
obligation of funds; (16) tax benefits that favored leasing have been
reduced; and (17) as part of the decisionmaking process, more detailed
guidelines require that the Navy perform lease versus purchase analyses
that better reflect the government's total cost of long-term leasing
arrangements.

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

 REPORTNUM:  T-NSIAD-99-141
     TITLE:  Defense Acquisition: Historical Insights Into Navy Ship 
             Leasing
      DATE:  04/21/99
   SUBJECT:  Naval procurement
             Comparative analysis
             Leases
             Cost effectiveness analysis
             Equipment contracts
             Military cost control
             Decision making
             Military vessels
IDENTIFIER:  T-5 Tanker
             Maritime Prepositioning Ship
             Sealift Tanker
             U.S.S. Cory Chouest
             Navy Industrial Fund
             
Defense Acquisition: Historical Insights Into Navy Ship Leasing
(Testimony, 04/21/99, GAO/T-NSIAD-99-141).

Pursuant to a congressional request, GAO discussed the Navy's decisions
in the early 1970s and early 1980s to lease Sealift Tankers, Maritime
Prepositioning Ships, and T-5 replacement tankers, and more recently,
Chouest specialized support vessels, focusing on the: (1) basis and
support for the Navy's decisions to lease rather than purchase these
vessels; (2) concerns that surrounded the decisions; and (3) legislative
and regulatory changes that have been implemented that will influence
future lease versus purchase decisions.

GAO noted that: (1) the primary reason the Navy decided to use long-term
leases to acquire auxiliary vessels in the early 1970s and early 1980s
was because available procurement funds were needed for higher-priority
combat ships, and leasing arrangements allowed the Navy to acquire the
support ships without a large, up-front obligation of procurement funds;
(2) the Navy also believed that leasing was cost-effective and helped
support the industrial base; (3) the Navy complied with existing
requirements to perform lease versus purchase cost comparisons; (4)
these comparisons concluded that leasing was cheaper than purchasing;
(5) the Navy's decision to enter into long-term leases in the early
1970s and early 1980s raised concerns regarding the budget authority
needed to make such large long-term funding commitments; (6) Congress
expressed concern about whether the Navy Industrial Fund could
adequately cover the total obligations that would accrue from these
leases; (7) to address this concern, the Navy requested and received
specific congressional authorization to carry out the acceptance
provisions of the long-term leasing contracts; (8) there were also
concerns regarding the cost-effectiveness of these leases; (9) when the
leasing decisions were made, there were limited standardized
government-wide guidelines for conducting lease versus purchase
analyses; (10) as a result, the studies used different assumptions and
methodologies in analyzing the alternatives and drew different
conclusions; (11) in 1983, GAO's report and a congressional staff study
questioned the validity of the assumptions used in the Navy's studies
and their conclusions; (12) had the Navy's studies used assumptions that
more fully reflected the government's total costs, they would have
concluded that purchasing was the cheaper alternative; (13) since the
long-term leasing decisions of the early 1970s and early 1980s, a number
of changes have occurred that will affect future long-term leasing
decisions by increasing oversight and improving cost analyses; (14)
Congress has increased visibility of and control over these types of
decisions; (15) budget-scoring guidelines increase the emphasis on
up-front budget authority by providing Congress with a mechanism to
assess the cumulative impact of long-term leasing decisions prior to the
obligation of funds; (16) tax benefits that favored leasing have been
reduced; and (17) as part of the decisionmaking process, more detailed
guidelines require that the Navy perform lease versus purchase analyses
that better reflect the government's total cost of long-term leasing
arrangements.

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

 REPORTNUM:  T-NSIAD-99-141
     TITLE:  Defense Acquisition: Historical Insights Into Navy Ship 
             Leasing
      DATE:  04/21/99
   SUBJECT:  Naval procurement
             Comparative analysis
             Leases
             Cost effectiveness analysis
             Equipment contracts
             Military cost control
             Decision making
             Military vessels
IDENTIFIER:  T-5 Tanker
             Maritime Prepositioning Ship
             Sealift Tanker
             U.S.S. Cory Chouest
             Navy Industrial Fund
             
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ns99141t GAO United States General Accounting Office

Testimony Before the Subcommittee on Seapower, Committee on Armed
Services, U. S. Senate

For Release Expected at 2: 30 p. m. EDT on Wednesday, April 21,
1999

DEFENSE ACQUISITION Historical Insights Into Navy Ship Leasing

Statement of James F. Wiggins, Associate Director, Defense
Acquisitions Issues, National Security and International Affairs
Division




GAO/T-NSIAD-99-141

  GAO/T-NSIAD-99-141

Page 1 GAO/T-NSIAD-99-141 Navy Ship Leasing

Madame Chairwoman and Members of the Subcommittee: I am pleased to
be here today to provide some historical insights into Navy ship
leasing. At the request of this Subcommittee, we are reviewing the
Navy's decisions in the early 1970s and early 1980s to lease
Sealift tankers, Maritime Prepositioning Ships (MPS), and T- 5
replacement tankers, and more recently, Chouest specialized
support vessels. My remarks today are

based on this work and earlier GAO reviews. Specifically, I will
discuss the basis and support for the Navy's decisions to lease
rather than purchase these vessels, the concerns that surrounded
the decisions, and the legislative and regulatory changes that
have been implemented which will influence future lease versus
purchase decisions. Our report on these

issues will be available in July. Results in Brief The primary
reason the Navy decided to use long- term leases to acquire
auxiliary vessels in the early 1970s and early 1980s was because
available procurement funds were needed for higher priority combat
ships, and

leasing arrangements allowed the Navy to acquire the support ships
without a large, up- front obligation of procurement funds. 1 The
Navy also believed that leasing was cost- effective and helped
support the industrial base. At the time, the Navy complied with
existing requirements to perform lease versus purchase cost
comparisons. These comparisons

concluded that leasing was cheaper than purchasing. The Navy's
decision to enter into long- term leases in the early 1970s and
early 1980s raised concerns regarding the budget authority needed
to make such large long- term funding commitments. Congress
expressed concern

about whether the Navy Industrial Fund could adequately cover the
total obligations that would accrue from these leases. 2 To
address this concern, the Navy requested and received specific
congressional authorization to carry out the acceptance provisions
of the long- term leasing contracts. There were also concerns
regarding the cost- effectiveness of these leases.

1 At 10 U. S. C. 2401 a long- term lease is defined as a lease,
charter, service contract, or conditional sale agreement that
lasts for a period of five years or longer (including options to
renew or extend the initial term of the lease), for a period of
more than one- half the useful life of the vessel, or for a period
of three years or longer (including options to renew or extend the
initial term of the lease) when certain investment tax credits or
depreciation are claimed by the lessor. 2 At that time, the Navy
Industrial Fund was a revolving fund that provided products and
services and

was reimbursed for those products and services by its customers
out of operation and maintenance appropriations.

Page 2 GAO/T-NSIAD-99-141 Navy Ship Leasing

When the leasing decisions were made, there were limited
standardized governmentwide guidelines for conducting lease versus
purchase analyses. As a result, the studies used different
assumptions and methodologies in analyzing the alternatives and
drew different conclusions. In 1983, our report and a
congressional staff study questioned the validity of the

assumptions used in the Navy's studies and their conclusions. 3
Had the Navy's studies used assumptions that more fully reflected
the government's total costs, they would have concluded that
purchasing was the cheaper

alternative. Since the long- term leasing decisions of the early
1970s and early 1980s, a number of changes have occurred that will
affect future long- term leasing decisions by increasing oversight
and improving cost analyses. Through legislation, Congress has
increased visibility of and control over these types of decisions.
Additionally, budget- scoring guidelines increase the emphasis on
up- front budget authority by providing Congress with a mechanism
to assess the cumulative impact of long- term leasing decisions

prior to the obligation of funds. Tax benefits that favored
leasing have been reduced. Finally, as part of the decision-
making process, more detailed guidelines require that the Navy
perform lease versus purchase analyses that better reflect the
government's total cost of long- term leasing arrangements.

Background Traditionally, the Navy has purchased its combat ships
but used long- term leases, called charter and build arrangements,
to acquire Sealift tankers, MPS vessels, and T- 5 replacement
tankers. Under these arrangements, the lessors arranged for the
construction, long- term financing, and delivery of the vessels.
The Navy leased the vessels for 20 to 25 years and agreed that it
would pay scheduled termination costs if, for some reason, it
canceled

the leases. In 1972, the Navy entered into contracts with two
contractors for the long- term lease of nine Sealift tankers.
These tankers were put into service in 1974 and 1975 but are no
longer being leased. In 1982, the Navy entered

into contracts with three separate contractors for the long- term
lease of 13 MPS vessels. The first of these was delivered to the
Navy in September

3 Improved Analysis Needed to Evaluate DOD's Proposed Long- term
Leases of Capital Equipment, (GAO/PLRD-83-84, June 28, 1983) and
Tax Aspects of Federal Leasing Arrangements, Staff of the Joint
Committee on Taxation, JCS 3- 83, February 25, 1983.

Page 3 GAO/T-NSIAD-99-141 Navy Ship Leasing

1984, and all remain under lease. Also in 1982, the Navy awarded
contracts for the long- term lease of five newly constructed T- 5
replacement tankers. The first of these tankers was delivered in
June 1985, and all remain under lease.

The Navy has used a different type of lease arrangement to acquire
the specialized support services of vessels owned and operated by
Edison Chouest Offshore. The Chouest vessels have generally been
leased on a

short- term basis less than 5 years for transportation services
and special missions, such as oceanographic surveillance and
research. Under these leases, the Navy pays for the services of
the vessel, crew, and its

operation and maintenance (O& M) on a daily use basis. In 1998,
the Navy entered into a 5- year lease for one of the Chouest
vessels under the same type of daily use arrangement. The Military
Sealift Command (MSC) is responsible for administering the
Department of Defense's (DOD) auxiliary ship leases. Since 1969,
DOD has

required its components to perform economic analyses of lease
versus purchase decisions. Lease versus purchase analyses are not
required for short- term lease arrangements.

Basis and Support for Lease Decisions

Cost- effectiveness was not the primary reason for the Navy's
decisions to lease auxiliary vessels in the early 1970s and early
1980s. According to Navy officials, the primary reason for
proposing the long- term lease approach was that available
procurement funds were needed for higher priority combat ships and
long- term leasing allowed it to meet its support requirements
without a large, up- front obligation of procurement funds. Under
these leasing arrangements, the Navy initially had assumed it
could spread payments over the length of the leases and use its
annual O& M appropriations to fund them without incurring an up-
front obligation of the total lease amount. If, instead of
leasing, the Navy had purchased these vessels, funds would have
been obligated from the Navy's Shipbuilding and Conversion
procurement appropriation; payments would have been required prior
to delivery over a relatively short construction phase; and the
purchases would have had to compete with combat ships for the
Navy's procurement funds. The Navy also maintained that long- term
leasing was a cost- effective way of acquiring the services of
auxiliary vessels. Navy lease versus purchase analyses showed that
it was less costly to lease than purchase these vessels.

Page 4 GAO/T-NSIAD-99-141 Navy Ship Leasing

Industrial base concerns were another factor in the decision to
lease the MPS vessels and T- 5 replacement tankers in the early
1980s. At that time, the commercial shipbuilding sector was in
decline. A Navy official stated in a 1983 hearing that projects
such as the MPS and T- 5 replacement tanker programs were needed
to prevent the potential closing of several

commercial shipyards and to protect the nation's industrial base.
4 Flexibility and cost- effectiveness are cited as the primary
reasons for leasing the Chouest vessels. Since 1988, the Navy has
entered into short- term leases that generally consist of a firm
period of 17 months or less followed by multiple option periods of
17 months or less that, when combined, do not exceed 5 years.
Additionally, in 1998, the Navy entered into a 5- year lease for
the Cory Chouest. The primary reason cited for these leases is the
flexibility they provide because the Navy does not have a defined
requirement for the extended use of these vessels. Since the
leases are for shorter periods of time, leasing is likely to be
more cost- effective

than purchasing. A lease versus purchase cost analysis is not
required for short- term leases and, therefore, such an analysis
was only performed when the Navy decided to enter into a 5- year
lease to acquire the services of the Cory Chouest.

Concerns About Decisions and Analyses

The Navy's decisions to enter into long- term leases raised
concerns about whether (1) the Navy had sufficient budget
authority to cover the total cost of the leases, especially
termination costs if the leases were canceled, and (2) the Navy's
lease versus purchase analyses adequately reflected the
government's costs. Concerns Regarding Budget

Authority After awarding the long- term leases in the early 1980s,
the Navy became

concerned about how to record total obligations lease payments as
well as potential termination costs associated with these leases
in the Navy Industrial Fund and requested a GAO legal opinion.
Congress also expressed concern whether the Navy's budget
authority would adequately cover the total obligations that would
accrue from these leases. GAO's

4 Federal Leasing Practices Hearing Before the Subcommittee on
Oversight of the Committee on Ways and Means, House of
Representatives, 98th Congress, First Session, February 28, 1983.

Page 5 GAO/T-NSIAD-99-141 Navy Ship Leasing

opinion, 5 issued in response to the Navy's request, concluded
that if the Navy Industrial Fund did not have an unobligated
balance sufficient to cover these costs upon the delivery of all
the vessels, it would be in violation of the Antideficiency Act. 6
The opinion contained suggested

actions, such as obtaining congressional authority, that the Navy
could take to prevent such a violation from occurring. The Navy
subsequently requested and received authority from Congress to
lease the vessels without having sufficient unobligated funds
available to cover the government's total obligation under the
contracts. 7 Concerns Regarding Cost- Effectiveness of Leasing

The Navy complied with DOD requirements to perform lease versus
purchase cost analyses in support of its long- term leasing
decisions. However, the guidelines that existed for such analyses
when the Navy entered into the leases for the MPS vessels and T- 5
replacement tankers

were not detailed and specific. As a result, the outcomes of these
analyses were influenced by the methodologies and assumptions used
in each study. The methodologies and assumptions the Navy used
showed leasing to be cheaper. Our 1983 review of the Navy's
decision and a study by the Joint Committee on Taxation used
different methodologies and assumptions and found purchasing to be
the cheaper alternative. For example, the Navy's lease versus
purchase cost comparison for the MPS vessels concluded that the
government would save $29. 3 million per ship by leasing the 13
MPS

vessels. However, the MPS study conducted by the Joint Committee
staff concluded that outright purchase would be cheaper by $20. 8
million per ship. Our 1983 report concluded that it would cost
between $11.9 million and $38 million more per ship to lease the
MPS vessels. The differences between the studies' conclusions are
a result of different methodologies and assumptions regarding (1)
tax revenues, (2) residual values, and (3) discount rates.

The majority of the differences between the Navy study and the
congressional staff study were attributed to differing assumptions
regarding how tax revenue should be accounted for. The Navy study

5 B-174839, January 28, 1983 (62 Comp. Gen. 143), Navy Industrial
Fund: Obligations in Connection With Long- term Vessel Charters. 6
The Antideficiency Act, codified at 31 U. S. C. 1341, prohibits
authorizing or incurring obligations or expenditures in excess of
amounts available in an appropriation or fund unless authorized by
law. 7 Supplemental Appropriations Act of 1983 (P. L. 98- 63).

Page 6 GAO/T-NSIAD-99-141 Navy Ship Leasing

reduced the total cost to the government of the lease by the taxes
that would be paid on interest income received by the lenders that
financed a portion of the ship's acquisition. The committee
staff's methodology did not include these taxes as a source of
government revenue. Although the methodologies and assumptions
used in both studies were acceptable under the then- existing
guidelines, in our June 1983 report, we agreed with the staff
study's assumptions because the Treasury would receive taxes on
the income earned from either a lease or a purchase.

Another key difference between the Navy and committee staff
studies was the treatment of residual values. The residual value
of a vessel is an estimate of what that vessel could be sold for
at the end of the lease term, measured in present value terms. The
Navy's study of the MPS program assumed that the vessels would
have no residual value at the end of their 25- year leases,
whereas the committee staff assumed that the residual value of the
ships would be nearly 60 percent of the original cost of the

ships. While it is not clear if a residual value of 60 percent was
appropriate, a residual value of zero was not consistent with
Internal Revenue Service (IRS) requirements at the time. Had the
residual value been assumed to be

20 percent, which would be consistent with the minimum IRS
requirements at the time, the cost advantage of leasing identified
in the Navy's study would be reduced. In our 1983 review of these
studies, we agreed with the staff study's assumption that the
vessels would have a residual value at the end of the lease terms.
Determining whether leasing is more economical than purchasing
also depends on the discount rate used to adjust the total value
of lease payments to recognize the time value of money the lost
opportunity to invest the money and earn interest. A lower
discount rate makes purchasing a more economical option, while a
higher rate makes leasing

more economical. When the lease versus purchase analyses were
performed for the long- term leasing arrangements of the early
1970s and early 1980s, there was some flexibility regarding what
discount rate should be used in the analysis. In our prior
reports, we expressed concern regarding the discount rates used in
the Navy's lease versus purchase analyses. In a 1973 report on the
Navy's analysis of the Sealift tanker

program, we found that the Navy had inappropriately selected a
high discount rate. 8 Had the Navy used the lower and more
appropriate rate, it would have found that the cost of leasing
exceeded the purchase cost. In 8 Build and Charter Program for
Nine Tanker Ships, (B-174839, Aug. 15, 1973).

Page 7 GAO/T-NSIAD-99-141 Navy Ship Leasing

our 1983 report, we questioned whether the prescribed Office of
Management and Budget (OMB) discount rate was realistic and, in
our analysis, used a discount rate based on the average yield on
marketable Treasury obligations, which we believed was a better
reflection of the government's true cost of borrowing funds.

Changes That Will Influence Future Leasing Decisions

Since the long- term leasing decisions of the early 1970s and
early 1980s, a number of changes have occurred that will affect
future long- term leasing decisions by increasing oversight and
improving cost analyses. Through legislation, Congress has
increased its visibility of and control over these types of
decisions. Additionally, scoring guidelines now provide Congress
with a mechanism to assess the cumulative impact of long- term
leasing

decisions prior to the obligation of funds. Reductions in tax
benefits and changes in how these benefits are treated in lease
versus purchase analyses minimize the loss of tax revenue and
ensure that such a loss of revenue is more fully considered in the
decision. Finally, as part of the

decision- making process, more detailed guidelines require that
government agencies perform lease versus purchase analyses that
better reflect the government's total cost of long- term leasing
arrangements.

Changes to Increase Congressional Visibility and Control

Given concerns about the budgetary impact of the leases' long-
term funding commitments and uncertainties about their cost-
effectiveness, Congress established a number of statutory
conditions and requirements for entering into future long- term
leases. These requirements, now codified at 10 U. S. C. 2401,
increase congressional visibility and control over certain lease
decisions and provided for the development of more detailed
guidelines for conducting lease versus purchase cost comparisons.
In general, 10 U. S. C. 2401 requires that:

 DOD's long- term leases or charters of vessels and aircraft, or
leases or charters with substantial termination liabilities be
specifically authorized by law;

 notice of intent to issue a solicitation for such a lease or
charter be given to the Committees on Armed Services and on
Appropriations of the Senate and House of Representatives;  a
detailed description of the terms of the lease and a justification
for

entering into the lease rather than purchasing the vessel be
provided to Congress;

Page 8 GAO/T-NSIAD-99-141 Navy Ship Leasing

 an analysis comparing the costs of leasing to those of purchasing
be submitted to Congress with any request for authorization of
such a lease;

 such analysis be evaluated by OMB and the Treasury Department;
and  OMB and Treasury jointly issue guidelines for determining
under what circumstances DOD may use lease arrangements rather
than use direct

procurement. Increased Emphasis on Up- Front Budget Authority

At the time the Navy entered into the long- term leases in the
early 1970s and early 1980s, Congress' ability to assess the
cumulative impact of such arrangements prior to the obligation of
funds was limited. Since the Navy entered into these leases,
mechanisms for requesting budget authority have been more clearly
established, which increases the transparency of these

arrangements. The Balanced Budget and Emergency Deficit Control
Act of 1985, as amended by the Budget Enforcement Act of 1990 and
the Omnibus Budget Reconciliation Act of 1993, established
statutory limits on federal government spending by creating
spending caps on discretionary spending.

To track progress against and compliance with budget enforcement
requirements and spending caps, budget scorekeeping guidelines
have been established for lease- purchases, capital leases, and
operating leases. 9 If the Navy were to now enter into the types
of leases it entered into in 1972

and 1982, the current scorekeeping rules would require that the
Navy request up- front budget authority for the estimated net
present value of the government's total estimated legal
obligations over the life of the contract.

Changes That Eliminate Tax Incentives

Under leasing arrangements for the Sealift tankers, MPS vessels,
and T- 5 replacement tankers entered into prior to 1984,
shipowners qualified for special tax benefits. These benefits
included accelerated depreciation of

the ship's cost and deductions on interest payments that lowered
the shipowners' taxes. Consequently, shipowners passed some of
these benefits to the Navy in the form of lower lease payments,
which made leasing a more attractive option to the Navy. However,
these tax benefits also represented a loss of tax revenue to the
U. S. Treasury. While not impacting prior Navy leasing
arrangements, the Deficit Reduction Act of 9 OMB Circular A- 11,
July 1, 1998.

Page 9 GAO/T-NSIAD-99-141 Navy Ship Leasing

1984 modified tax laws and eliminated the benefits available to
the owners of assets leased to government entities. More Detailed
Guidelines Will Influence Future Cost Analyses

In October 1984, OMB and Treasury issued joint guidelines for
DOD's leases. These guidelines required that any special tax
benefits conveyed to the shipowner be added to the cost of a lease
in a lease versus purchase

analysis. 10 Additional OMB guidance was issued in 1992 to prevent
lease versus purchase analyses from understating the government's
total cost of leasing. Specifically, this guidance, which is to be
applied governmentwide,

prescribe that analyses (1) should add special tax benefits to the
cost of leasing and (2) should not subtract the normal payment of
taxes on the lessor's income derived from the leases from the
total lease costs. 11 Had this guidance been in place when the
Navy conducted its analyses of the MPS and T- 5 replacement tanker
lease programs, the analyses would have concluded that purchasing,
instead of leasing, was the cheaper alternative. OMB's 1992
guidance also addressed the issue of discount rates. This

guidance prescribes that lease versus purchase analyses are to use
discount rates that reflect the Treasury's borrowing rate. OMB now
annually updates the discount rates to be used in the analyses.
Current discount rates as prescribed in the OMB guidance are lower
than those

used in the past analyses, and lower rates tend to make leasing
less attractive today. Madame Chairwoman, that concludes my
statement. I will be happy to answer any questions you or any
Members of the Subcommittee may have.

10 Joint OMB and Treasury Guidelines to the Department of Defense
covering Lease or Charter Arrangements for Aircraft or Naval
Vessels, October 31, 1984.

11 OMB Circular A- 94 Guidelines and Discount Rates for Benefit-
Cost Analysis of Federal Programs, October 29, 1992.

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