Senate Should Join House To Curb Defense 'Welfare'
The Pentagon should stop paying for industry mergers
The Republican-dominated Congress has been rightly criticized for adding pet projects and wasteful spending to this year's proposed defense budget. All told, the House and Senate have added more than $10 billion for some 100 items contained neither in the Pentagon's five-year plan nor in President Clinton's request.
But the GOP leadership in the House has not received credit for ending what the Wall Street Journal called a multibillion windfall the Clinton administration gave defense corporations by providing government subsidies for defense mergers and acquisitions. Unfortunately, the Senate refused to support the House in ending this egregious corporate welfare, and the issue will have to be settled in conference.
This subsidy policy was initiated in the summer of 1993 by John Deutch, then the Pentagon's acquisition czar. Without informing the Congress or even changing the federal acquisition regulations, Mr. Deutch, who now runs the CIA, allowed defense companies to begin billing the Pentagon for the costs of mergers and acquisitions. To date, the Defense Department has paid about $300 million to Hughes, Martin Marietta, Northrup Grumman, and United Defense. And over the next three years, the Pentagon will pay another $3 billion to the likes of Lockheed-Martin, Boeing, and Raytheon, unless the conference on the defense appropriations bill supports the House position.
The justification for Deutch's decision is that these subsidies have always been allowed and that they are necessary to promote the rational downsizing of the defense industry. According to the Pentagon, without these subsidies defense companies would have little incentive to merge. Since the mergers will reduce overhead costs, the Defense Department will save more money than it spends. Restructuring costs are the price we must pay today to realize cost savings tomorrow, goes the Pentagon refrain. While these reasons sound fine in theory, they are not supported by the facts.
This is indeed a new policy. From the Nixon administration through the Bush administration, the Defense Department held that government is not concerned with the form of the contractor's organization. As late as 1992, the Bush administration rejected a Hughes Aircraft request to be reimbursed for $112 million in costs resulting from its acquisition of General Dynamics Space Division.
But, more importantly, the new policy is neither necessary nor cost effective. Mergers and acquisitions always have and always will be a staple of defense industry. Just about every defense company that exists is a product of a merger, some decades old. McDonnell bought Douglas in the 1960s, General Dynamics acquired most of its major subsidiaries in the '70s and '80s, and Martin Marietta bought General Electric's defense division in the early '90s. Moreover, even in today's bull market, plenty of bidders vie for available companies. It is hard to believe that if taxpayer subsidies were not available, companies would not buy available assets if it made good business sense.
Three years ago, several firms engaged in a bidding war for LTV, and two years ago Northrup outbid Martin Marietta for Grumman. But, since the Deutch subsidy policy was initiated, the price of these mergers has escalated far above market value. Northrup paid nearly 40 percent above market value to acquire Grumman and 50 percent above to acquire Westinghouse's defense division, while Raytheon paid a similar premium to acquire E-Systems.
Nor will these mergers necessarily save the government money in the long run. The Pentagon claims that its first $300 million in subsidies will save about $1.2 billion. But in a June 1996 report justifying the first payments, its acquisition office admits that it cannot "isolate the effect of restructuring from other complex determinants of the difference between projected and actual costs." The General Accounting Office found that the projected savings are steeply inflated, while the Pentagon's inspector general could not verify them.
Moreover, even if these mergers do save the Pentagon money, will they save the government money when one factors in the cost of paying for welfare, unemployment compensation, or food stamps for the tens of thousands of workers laid off as a result?
Finally, what about the Pentagon's ability to preserve competition and control these mega-companies that the Deutch policy has spawned? Shortly after the policy was in place, Lockheed and Martin merged, and last year Lockheed-Martin bought Loral to create a $30 billion company that is larger than the Marine Corps, and that by itself accounts for 40 percent of the Pentagon's entire procurement budget. This summer, after the Senate refused to support the House position, Boeing purchased Rockwell, and two defense giants, McDonnell Douglas and Raytheon, began merger talks.
The Pentagon and the nation need a strong defense industrial base. But these subsidies are not necessary to accomplish that objective. Defense stocks are at all-time highs, and defense profits as a return on sales are 50 percent higher than they were in 1985 at the height of the Reagan buildup. In a telling remark, Norman Augustine, Lockheed-Martin's vice chairman and CEO, argued that without subsidies, the mergers are bad business deals. They are bad, all right - bad for the taxpayer.
*Lawrence J. Korb, director of the Brookings Institution's Center for Public Policy Education, in Washington, was assistant secretary of defense under President Reagan.