Offsetting the Defense Sequester

Replacing the sequester will be an important item on the conference committee's agenda, and it may also be the most difficult. Right now, the two parties differ as to how to replace it, with Republicans advocating for only spending cuts as offsets and Democrats seeking a mix of revenue and spending cuts. When it comes to the defense sequester, which is slated to reduce the defense budget by $490 billion over the next ten years, Democrats may be particularly wary of replacing defense cuts with cuts to non-defense programs. But there could be a way out through reforms to military-related entitlement programs, like pension benefits and TRICARE (the health care program for military personnel, military retirees, and their dependents).

Just like within the full budget, health care and retirement spending are consuming more and more of the defense budget, and are far more lavish than for civilian federal employees. Many reforms could begin to slow the growth of such benefits, and allow some readjustment of priorities toward direct defense capabilities.

Policies that affect mandatory spending for military retirement benefits and TRICARE-for-Life (the Medicare supplement for military retirees and their dependents) can help lawmakers offset the defense sequester. Such reforms could include disallowing cost-of-living adjustments until a retiree turns 62, with a one-time catch-up at that age; calculating retirement benefits based off the highest-5 instead of the highest-3 years of earnings, bringing it in line with the standard in the private sector; and increasing co-payments for TRICARE drugs. If changes are made to Medicare like restricting Medigap's coverage of 1st-dollar expenses to limit unnecessary overutilization, those same reforms could also be applied to TRICARE-for-Life, the Medigap-equivalent for military retirees.

Lawmakers could also think bigger when it comes to reform. For example, the pension benefit has a vesting period of 20 years, meaning that most service members do not qualify for a pension (according to the Defense Business Board (DBB), 83 percent do not) but also that those who do can start receiving benefits as early as age 38. The DBB recommended shifting the pension to a defined contribution system with a vesting period of 3-5 years and with benefits payable only after an age more in line with civilian federal retirement and Social Security. The federal government would provide matching contributions that would be generous by private sector standards.

While reforming defense entitlements may offer a path to ease the constraints of the sequester and restore spending on our defense capabilities, lawmakers must beware not to (accidentally or intentionally) double-count the savings. For accounting purposes, the Department of Defense “pre-funds” its health and retirement programs out of its discretionary budget authority – meaning that from a technical standpoint, a reduction in benefits could produce both mandatory savings and reduce the required budget authority for these programs. These discretionary savings, however, are phantom in nature and do not result in a reduction of money going out the door. To the extent appropriators spend up to the budgetary caps, in fact, they could clear headroom for more spending.

Legislatively, this double-counting arises because reductions in mandatory spending automatically lower necessary discretionary accrual contributions, thus providing additional headroom for new discretionary spending. Policymakers could avoid this one of three ways:

• Ignore the mandatory savings for purposes of offsetting the sequester or reaching a deficit reduction target, instead allowing the lower discretionary accruals to create more headroom within the sequester caps to fund defense priorities;
• Count the mandatory savings, but freeze accrual contributions at their current levels and dedicate contributions in excess of what is needed toward other underfunded military health and retirement trust funds;
• Count the mandatory savings, but lower the discretionary caps to account for the reduced accrual contributions without crediting savings to these lower caps;

Another way to create room within the sequester limit to fund other defense priorities would be to reform the TRICARE program for those under 65, which is consuming a larger and larger portion of the Department of Defense's (DoD) annual discretionary budget.¹ By lowering discretionary spending dedicated to health care benefits, DoD would have more funds available to spend on defense capabilities.  Enrollment fees, deductibles, and co-pays for the TRICARE programs could be increased. Or more fundamentally, military retirees under the age of 65 could be required to take employer-sponsored insurance instead of TRICARE if the offer is available, since some military retirees retire as early as 38 and many continue to work after their military service.

Used properly, "defense entitlement" reforms may provide a path forward to restore funding on defense priorities.

^{1 In general, TRICARE for beneficiaries over the age of 65 is counted as mandatory spending and as discretionary spending for those under the age of 65.}