Stephan Rice

On August 1, 2012, Acting OMB Director Jeffrey Zients and Deputy Secretary of Defense Ashton Carter testified before the House Armed Services Committee on how OMB and DoD intend to implement sequestration – i.e., the mandatory budget cuts currently scheduled to occur on January 2, 2013, pursuant to the Budget Control Act of 2011.

Director Zients’ testimony was anxiously awaited in the hopes that he would clarify how OMB intends to apply sequestration at the “program, project, or activity” level.  Generally speaking, sequestration requires that OMB apply uniform cuts to each nonexempt budget account, and that this same percentage reduction then be evenly applied to each “program, project, or activity” within each such nonexempt account.  This clarification of how OMB intends to construe the phrase “program, project, or activity” is necessary to determine the level at which the cuts will occur, and in turn, to predict how particular contracting opportunities would be affected by sequestration. 

An example – while admittedly a little simplistic – helps demonstrate this point.  Imagine that a nonexempt DoD project subaccount is intended to fund contracts at Site A and Site B in fiscal year 2013, each valued at $1,000,000, thus giving that project subaccount a $2,000,000 balance.  According to Secretary Carter’s testimony, DoD expects that sequestration will result in a 10 percent reduction from each nonexempt account, and by extension, from each program, project, or activity within that account.  But absent further guidance from OMB, it is not clear how that 10 percent reduction would impact the individual contracts in our theoretical subaccount. 

At one end of the spectrum, OMB could require that the reduction flow down to the individual contract level, meaning that the 10 percent ($200,000) reduction from our theoretical subaccount would need to be evenly applied among Sites A and B, leaving each with a budget of $900,000.  While this would be an administrative nightmare to implement across the entire universe of DoD contracts, it seems consistent with the general purpose of the threatened sequestration – i.e., to evenly and inflexibly spread the pain of the budget cuts so that both political parties have a vested interest in reaching the budget targets set under the Budget Control Act of 2011 and thereby avoiding sequestration. 

At the other end of the spectrum, OMB could direct that the reduction be applied at the program, project, or activity subaccount level, but not at the individual contract level.  While our theoretical subaccount would see the same 10 percent reduction from $2,000,000 to $1,800,000 as in the example above, here the agency would have discretion of how to divide that remaining $1,800,000 for the work at Sites A and B.  For instance, the agency could fully fund the work at Site A at $1,000,000, and fund the work at site B at only $800,000. 

Because of the variations in contract value that could result under these different applications of the sequester, knowing how OMB will apply the sequester is critical for a contractor at our hypothetical Sites A and B to plan for the year ahead.

Unfortunately, Director Zientz and Secretary Carter declined to spell out how the phrase “program, project, or activity” would be construed.  Secretary Carter, however, hinted that the cuts would not flow down to the individual contract level within DoD, stating that DoD leadership “will take advantage of any flexibility [they] can find” to choose what reductions they make to reach the target cuts.  But any such attempt to find flexibility is tempered by two factors. 

First, many large-scale items in the DoD budget – e.g., military construction, acquisition of aircraft, ships, and major combat vehicles, etc. – are specifically named and appropriated for in the annual budget.  DoD would likely have very little flexibility to avoid uniform cuts to these specifically identified programs, projects, and activities.  Indeed, Secretary Carter seemed to acknowledge this in his testimony, specifically identifying the type and number of certain aircraft and ground vehicle acquisitions that would need to be reduced from the President’s budget request should sequestration occur. 

Second, just prior to the hearing, OMB notified Congress that military personnel programs (i.e., military payroll) will be exempt from sequestration.  While this allays some concerns within the military of a potential Reduction in Force or pay stoppage, it also means that military contracting accounts may need to absorb even greater cuts in order to meet the required level of reductions from the overall DoD budget.

So in the end, Director Zients’ and Secretary Carter’s testimony provided some clues as to OMB’s and DoD’s intended approach to sequestration, but ultimately left the most important question for contractors unanswered.