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House Begins to Cut Defense Budget

The House Armed Services Committee (HASC) approved by a 60 to 1 vote their version of the 2012 Defense Budget. This is basically similar to what was requested by the Obama Administration and reflects the first real reduction to U.S. defense spending since the attacks of 9/11.

As in previous budgets it was split into three parts: first, the base budget which funds the U.S. military and its investment, production, training and support activities; second, the cost of “Overseas Contingency Operations” (OCO) which used to be called the Global War on Terror (GWOT) which are the costs associated with operations in Iraq and Afghanistan and finally it also includes money for the Department of Energy (DOE) support to the U.S. military which is primarily related to nuclear weapons.

The base budget was about $535 billion which was a slight increase on the $533.8 billion programmed in 2010 for such activities. Due to the fact that no 2011 budget was officially passed by Congress until late in the year the Department of Defense relied on continuing resolution which restricted spending to 2010 levels. When the final budget deal was struck funding the rest of the year total planned spending remained consistent with 2010 levels. The Obama Administration had requested $548 billion with almost $160 billion for OCO. This amount was not approved or provided.

The HASC bill approved amounts to a reduction as the OCO funding was reduced to only $119 billion from the $130 billion in 2010 and the $160 billion proposed in 2011. Total spending in 2012 based on the HASC will be $690 billion including the DOE funding of $18 billion. This is a net increase over 2010 but almost $20 billion less then the planned spending in 2011.

What does this all mean for defense contractors? If the House totals hold, and after the work with the Appropriations Committee and the Senate there may be many changes in what the money is spent on, it will be the first net reduction in U.S. defense spending in 10 years. This will mean that some contracts won’t get funded and some companies will see their revenue and earnings reduced.

The cuts to OCO mean those companies heavily involved in providing support and equipment for Iraq and Afghanistan will see the first cuts. The Army’s LOGCAP IV contract provides much of this support for deployed forces and companies like DynCorp International, Fluor and KBR have received large contracts as part of it. The reduction to OCO may affect LOGCAP and those companies involved in it.

It will also mean less bullets, beans and gas will be bought to support the troops in Iraq especially. Suppliers of basic items may see reductions in the amount of items purchased from them. This includes ATK who make ammunition as well as the various gasoline refiners and providers. As the fighting in Iraq and Afghanistan winds down the DoD will be concentrating on making new weapon systems and repairing and refitting the equipment used by the military in those operations.

If and when all of the U.S. and Allied forces return from the fight there will be no need for OCO funding at all. This seems to indicate that the base U.S. defense budget will sink to about $500 – $600 billion a year. This will provide opportunities for those companies providing new, advanced weapons as well as supporting the U.S. military in its bases in the U.S., Asia and Europe. The next round of cuts though will be to this base budget. That will affect the entire U.S. defense industry and may lead to reductions in the number of contractors either through M&A or just moving to other business lines.

Defense spending has been a major prop to the U.S. economy as a whole as it supports businesses and jobs across all of the states. If the civil market has not recovered sufficiently cuts to this money will have a negative effect on many local economies across the U.S. already being experienced as some contracts are eliminated or reduced.
This HASC vote may be the first step into a period like the Nineties which saw wholesale changes to the U.S. defense industry and the countries’ industrial base as a whole.

Photo from David Paul Ohmer’s Flickr Photostream.

Article first published as House Begins to Cut Defense Budget on Technorati.

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