220412_f22_on_benjamin

As inflation rises, the Pentagon could be paying more in real dollars for the same weapons systems. (Graphic by Breaking Defense)

While consumers are feeling the pinch of inflation in everyday life, the US military is feeling it to the tune of billions of dollars in spending power. In the op-ed below, AEI’s John Ferrari argues the military should’ve seen it coming, and now Congress must act to rescue a defense budget based on flawed economic assumptions.

A staggering 8.5%. This is the US government’s March inflation rate in the Consumer Price Index (CPI), released today.

About a month ago, my colleague, Elaine McCusker and I wrote that the Pentagon should, in its FY23 budget release, not hide behind “rosy assumptions and passing the buck” to wish away inflation. Unfortunately, the Defense Department’s 2023 budget not only ignores the rising inflation, it does just what we said they shouldn’t do, and the new CPI figures should continue to raise the cause for alarm.

Before addressing how the Pentagon has masked the effects of inflation, we need to understand that the past year may have lulled DoD into a false sense of complacency. Albert Einstein said that compounded interest is the “eighth wonder of the world.” The converse is that compounded inflation is exponentially destructive.

From 1973 to 1980, an eight-year period that began with a regional proxy war and a disruption to the global energy markets, inflation ranged from 5.7% to 13%. More importantly, it totaled 102% over the entire timeframe. By 1979, the pernicious effects of inflation left us with a hollow military that could not even execute the Desert One mission in Iran. We are not yet into a 1970s hyperinflation, but if Congress allows DoD to ignore inflation in the 2023 budget, the near-term effects may be just as destructive.

While Defense Comptroller Mike McCord correctly argues that the CPI is not the most accurate metric for measuring inflation across the defense enterprise, it does serve as a good proxy, and in recent testimony Chairman of the Joint Chiefs of Staff Gen. Mark Milley stated that the defense budget was built on a flawed assumption about prices.

How bad could the destructive power of our recent inflation spike be? Using the Bureau of Labor Statistics (BLS) CPI calculator, we know that the most recent compounded 15-month inflation rate (January 2021 – March 2022) is 9.91%, which is higher than the recently posted 12-month figure of 8.5%. If we look to the future, let’s assume this current 8.5% inflation rate for 2022, along with a scenario where inflation is then cut in half to 4.25% in 2023, both of which are plausible assumptions. The three-year (January 2021-December 2023) compounded inflation then is nearly 20.5%, a staggering loss in buying power for DoD and our military service members.

To put this in perspective, the Pentagon’s 2021 funding was $703 billion, so a 20.5% three-year cumulative inflation rate would mean a budget of $848B would be needed in FY23 to achieve the same buying power as DoD had in 2021. With a 2023 budget request of $773 billion, this yields a real $75 billion-plus shortfall – one the Pentagon isn’t eager to discuss. So, how did the Pentagon hide this $75 billion shortfall? Rosy assumptions and passing the buck.

The Pentagon comes to some of these rosy assumptions by using official if flawed predictions. By using the Office of Management and Budget’s (OMB) inflation forecast of 4.7% in FY22 and 2.3% in FY23, DoD effectively hides $40B+ of inflation should it remain at 8.5% and 4.25% respectively. When the spending hits the real world in 2023, those “savings” become lost procurement and diminished readiness.

So, how does “record” high defense spending provide less defense? It is called “shrinkflation.” Think of shrinkflation as what happens when you go to the store and pay slightly more for a pound of coffee than you did before, but then you find out that it is now twelve ounces in the bag instead of a full pound. You pay more and get less. The same goes with our military.

The Army shrinks from 485,000 soldiers in the active force to 473,000, a loss of 12,000 or 2.5% of capacity. The Navy shrinks from 297 ships in 2022 to having 280, a loss of seventeen ships or 5.7% of capacity. Similarly, the Air Force shrinks from 5,450 aircraft to 5,216, a loss of 234 aircraft or 4.3% of capacity. A crude approximation from the numbers above yields a loss of about 4% of our military capacity, or $30 billion.

Perhaps the worst place where both rosy assumptions and passing the buck intersect is with our military service members. Since January 2021, service members have gotten a 3% raise (2021), a 2.7% raise (2022), and now are projected to receive a 4.6% raise (2023). Using the same analysis from above, our service members could face a staggering 20.5% inflation rate, against three pay raises totaling 10.6%, a nearly 10% pay cut in real buying power. The nominee to be the vice chair of the Federal Reserve, Fed Governor Lael Brainard, recently stated that the burden of inflation “is particularly great for households with more limited resources.” We cannot do as we did in the 1970s and play “catch up” because we will destroy the finances of our junior enlisted who now have many more families than the initial post-draft forces of the 1970s.

This loss of real purchasing power will not only impact the current force, but it will also make it much more difficult to recruit. Some might say the impact will be muted because DoD is funding a special Basic Needs Allowance to lessen the needs of military members relying on food banks. It is probably a safe assumption that our recruiters will not be highlighting that our starting pay is so low that we must supplement it to keep their family above poverty levels. As a result of this real pay cut, we can expect military services to miss recruiting targets again.

While it is not possible to know whether we are entering a 1970s era of persistently high inflation, we certainly cannot afford to ignore current inflation as DoD just did. Given inflation’s destructive power, the Congress needs to be proactive so that we do not wind up with a hollow force, like we did in 1979. Given rising China threat, Russia waging war in Eastern Europe, and a destabilizing Middle East, we must guard against the financial destruction of our military.

So, what can Congress do to address this problem and ensure that we do not hollow our forces? Three things. First, take care of our military members and their families by providing a higher pay raise that better protects their purchasing power. Second, fund much of the service provided unfunded priority lists, as these lists are a great guidepost as to capabilities that are actually needed. Lastly, pass the budget on time because forcing the Pentagon to operate with another six-month continuing resolution will force them to waste money at a time when we need to make every dollar count.

Maj. Gen. John Ferrari, US Army (ret.), is a visiting fellow at the American Enterprise Institute (AEI) and is the former director of program analysis and evaluation for the US Army.