April 29, 1999

CBO ANALYSIS, OTHER STUDIES RAISE SERIOUS DOUBTS
ABOUT COSTLY MILITARY PAY AND PENSIONS BILL
Yet Congressional Leaders Consider Adding Bill to Emergency Supplemental

In late February, the Senate passed S. 4, legislation to increase military pay, pensions, and educational benefits. Cost estimates that the Congressional Budget Office has issued show this legislation to be very expensive; it would cost $63 billion over the next 10 years, with costs rising after that until they eventually reached approximately $15 billion a year.

An important Congressional Budget Office study issued just a week after the Senate passed the legislation finds the two basic premises on which the bill rests — that the 1986 military pension reforms the bill would repeal are causing serious retention problems in the armed forces, and that there is a large and growing pay gap between civilian and military pay — are not supported by the evidence and appear not to be valid.⁽¹⁾ CBO director Dan Crippen wrote in his letter transmitting the report: "The findings raise questions about the benefits of repealing the [1986] law. Increasing retirement benefits might not stem a decline in retention if that decline resulted from [other] factors....Instead, such increases could divert resources away from more cost-effective forms of compensation or other pressing defense needs without solving the department's personnel problems."⁽²⁾

Nevertheless, the Congressional leadership is said to be considering designating S. 4 as emergency legislation and adding it to the pending emergency supplemental appropriations bill. This action is being considered despite the fact that the House Armed Services Committee has not yet taken any action on this legislation and the Senate Armed Services Committee rushed the bill through Committee in early February without a hearing and through the Senate floor just ahead of release of the CBO report.

Additional studies of military pay and pension issues have recently been completed or are nearing completion. Their findings add to the doubts about the wisdom of the bill. According to a report in Defense Week, preliminary findings from a GAO study on military pensions scheduled for release in June are generally consistent with the CBO findings. A recent study by a West Point economist on the effect of the 1986 military pension reforms on retention also finds essentially the same results as CBO. (A second CBO study on military pensions is due in late spring. A Defense Department study on retention and military pensions is nearing completion as well.)

Prudent policymaking would defer further action on this legislation for a few months until the reports nearing completion are released so Members of Congress can better judge the needs in these areas and how best to respond to them. Prudent policymaking also would defer action until Congress identifies how it would finance the costs of this legislation; the legislation contains no "offsets" to pay for any of its provisions.

A pause in action on this legislation also might serve another purpose as well — enabling policymakers to take a deep breath and contemplate how this bill has gotten to its present stage. Essentially, this legislation has triggered a bidding war. In releasing its FY 2000 budget, the Administration proposed expensive increases in military pensions that many analysts believe to be excessive and that the CBO findings do not support. Then Senator John Warner, Chairman of the Senate Armed Services Committee, introduced a bill more expansive and costly than the Administration's. Subsequently, amendments making the bill still more costly were added in Committee from both sides of the aisle. Amendments further swelling the cost were added on the Senate floor. The CBO cost estimate of S. 4, as the Senate approved it, shows the following:

• The legislation increases discretionary spending by $46 billion over the next 10 years, with the costs rising every year. These costs reach $6.7 billion a year by 2009 and would continue to rise for a number of years after that.

• The bill also increases entitlement costs, hiking them $15.6 billion over the next 10 years. In addition, the bill loses close to $1 billion in revenues over this period, bringing the legislation's total 10-year cost to $62.6 billion.

• The $15.6 billion figure for the bill's entitlement costs over the next 10 years greatly understates the costs of the legislation when it is fully in effect. Most of the bill's increased entitlement costs for military pensions do not occur until after the end of the 10-year budget period.
  
  CBO estimates that when the costs reach their full dimensions, entitlement costs for military pensions will rise 11 percent above what they would cost under current law; this would result in increased costs of about $5 billion a year. Entitlement costs for veterans readjustment benefits (essentially educational benefits) also would rise rapidly. By 2009, the cost of veterans readjustment benefits would reach $4 billion a year, nearly triple what CBO projects these benefits would cost under current law. These costs, as well, would rise further in years after that.  When fully in effect, the bill as a whole would cost more than $15 billion a year.

Costs of this magnitude would necessarily affect other parts of the budget in future years including, most likely, other parts of the defense budget. This is true even if the legislation is classified as "emergency spending," a step that would remove the legal requirement for the bill's costs to be offset or to count against the discretionary spending "caps." Added expenditures of the dimensions that S. 4 entails almost certainly would affect funding for domestic and other defense programs because less room would remain in the budget for other needs. In addition, the costs of this legislation would reach their full dimensions during the years the baby boom generation is retiring in large numbers; CBO forecasts that budget deficits will return in those years. The likely result of the legislation in those years thus would be deeper cuts in other programs, higher taxes, or larger deficits.

 

The Military Pension Provisions

S. 4 would largely repeal the bipartisan reforms in the military pension system enacted in 1986. Those reforms were approved not only to restrain costs but also to improve the retention of skilled personnel in the armed forces.

In the early 1980s, the military pension system was widely considered to be bloated and inefficient. OMB director David Stockman called it a scandal. The Grace Commission called for reforms in it. So did the Pentagon's own Quadrennial Review of Military Compensation. Not surprisingly, the military services resisted. The reforms eventually enacted in 1986 were considerably more modest than those the Grace Commission and various other reformers recommended.

Prior to the 1986 reforms, the military pension system was not only exceedingly generous but also functioned in a way that undermined the goal of keeping skilled personnel in the military for more than 20 years.

• The median age at which pensioners began collecting these benefits was 43. Fewer than one in six pensioners were 65 or over.

• Military personnel could retire after 20 years and immediately draw a benefit equal to 50 percent of their final basic pay; there was no requirement for a retiree to reach a minimum age such as 55 before beginning to draw benefits and no reduction in benefits for retiring at an early age. The pension benefits were fully indexed to the CPI.

• Military personnel thus could "retire" in their early 40s and begin drawing generous military pension benefits while taking a job in the private sector (often for a defense contractor) that brought its own pension benefits. Eventually, they could draw military pensions, private pensions, and Social Security simultaneously.

• Military pensions began to be paid at a younger age, lasted for more years, and provided higher lifetime benefits than virtually any other major pension system in the United States, public or private. Moreover, military personnel do not contribute anything toward their pensions. The federal government pays all pension costs.

• These generous military pensions did not benefit most members of the armed forces. Fewer than one in five officers and enlisted personnel served long enough to qualify.

• Nor did the pensions go primarily to personnel with modest incomes. A National Journal analysis of Census data for 1982 found that 60 percent of all military pension benefits were paid to individuals in the wealthiest fifth of U.S. households. Some 83 percent of the pension benefits went to individuals in the top two-fifths of households.

• Of particular importance, this system created strong incentives for skilled personnel to leave the military in their early 40s, begin drawing a military pension, and take a private-sector job providing good pay and its own pension benefits. Indeed, the military pension system was expressly designed many decades ago to induce officers to retire from the military in their early 40s so younger, more physically fit men could take their place. That made sense in the earlier part of this century when the military was far less technological and ground combat was far more common. By the mid-1980s, this policy had become counter-productive, since the military now needs to retain highly skilled, specialized personnel in their early 40s rather than to lose them. This is one of the principal reasons the 1986 reforms were enacted.

 

The 1986 Reforms

The 1986 reforms made two significant changes in the military pension system. First, those who entered the military after August 1, 1986 and retired after 20 years would receive a pension equal to 40 percent of final basic pay until they reached age 62, rather than the 50 percent of basic pay paid to those who entered the military before August 1, 1986. (Upon reaching age 62, the pension would increase to 50 percent of basic pay.) The pension level for those retiring after 30 years, rather than 20, would remain unchanged at 75 percent of final pay. The 1986 reforms thus were designed to create incentives for personnel to stay rather than leave at the 20-year point by enlarging substantially the increase in pension benefits that a service member would receive if he or she remained in the service after the 20-year point.

Second, pensions for those who entered after August 1, 1986 would be indexed by the Consumer Price Index minus one percentage point, with a full catch-up at age 62, rather than by the full CPI.⁽³⁾ This reduction would have its largest effect on those who retired and began to draw pensions at the youngest ages.

Unfortunately, the 1986 reforms had a critical flaw in their design. Instead of phasing in these changes in the pension structure over a number of years, the law simply applied the new structure to those entering the armed forces after the August 1, 1986 date. Those who entered in July 1986 qualify for pensions under the old system, while those entering the service a few weeks later are scheduled to receive significantly lower pension benefits. The legislation thus created a large "notch," or cliff, which has generated considerable resentment within the armed forces.

An appropriate remedy would be to eliminate the notch by phasing in the reduction in pension levels from 50 percent to 40 percent over a 10-year or 20-year period. This would be similar to the approach taken with regard to Social Security in 1983, when Congress phased in over 22 years the increase from 65 to 67 in the age at which beneficiaries can retire and receive full Social Security benefits.

Political pressures, however, now militate against this more-moderate, less-costly approach. The Clinton Administration proposed in its FY 2000 budget an outright repeal of the reduction from 50 percent to 40 percent of basic pay in the pension level after 20 years of service. The Senate went further; S. 4 would give armed forces personnel the choice between receiving benefits under the pre-1986 pension structure — with both the 50 percent pension level and full CPI indexing restored — and receiving benefits under the pension structure enacted in 1986 supplemented by a $30,000 lump-sum payment upon reaching 15 years of service.

The Senate bill also would make veterans' readjustment benefits (i.e., educational benefits) much more generous than under current law. By 2009, the bill would increase the cost of veterans' readjustment benefits by $2.5 billion a year.

In addition, the bill would provide large military pay raises in 2000 and subsequent years that would be considerably above the general inflation rate in the U.S. economy. The pay increase would be 4.8 percent in 2000. OMB projects the CPI will rise 2.3 percent in 2000; CBO projects it will rise 2.6 percent.

 

Are Changes This Costly Warranted?

A Congressional Budget Office analysis released in early March raises doubts about the wisdom of this legislation. CBO found that contrary to the claims of S. 4's proponents, "The retirement changes enacted in 1986 appear to be having little effect on the mid-career retention of officers or enlisted personnel." CBO noted that "if the services are indeed experiencing serious retention problems, the Military Retirement Reform Act [the 1986 law] is not the cause, and repeal of that act may not solve the problems."⁽⁴⁾

The CBO study also reported that the key statistic widely cited as representing the military "pay gap" and used to justify the large military pay increases in S. 4 "does not accurately measure what it purports to." CBO concluded that relying on this statistic to set pay raises "is inappropriate."⁽⁵⁾

The CBO study examined the retention decisions of thousands of service members who began active duty shortly after the 1986 law was enacted. Some of these service members are under the pre-1986 pension system as a result of participation before August 1986 in ROTC or other accession or commissioning programs. Other service members in the study come under the new pension rules the 1986 Act established. CBO compared the mid-career decisions of these two groups of service members. The CBO report contains the following findings and conclusions:

• "If the new retirement system was having a marked effect on retention, as the Joint Chiefs of Staff have reported, CBO's analysis would most likely have shown that effect. Instead, CBO found that, in general, being under [the retirement system enacted in 1986] had no discernable effect on the mid-career retention decisions of people who began active duty in 1987."⁽⁶⁾

• "Any large declines in mid-career retention that have been observed in the armed forces probably result from other factors. Frequent, unscheduled deployments and attractive civilian job opportunities for people in particular occupations are among those other possible explanations."⁽⁷⁾

• "Most analyses of retention...indicate that dollars spent on deferred compensation, such as retirement pay, have less impact on retention than dollars spent on the pay and benefits that service members receive while still on active duty."⁽⁸⁾

 

CBO on the Military Pay Gap

One of the most striking aspects of the CBO report is its shredding of the principal arguments used by advocates of S. 4's rather costly pay raises. Supporters often contend there is a civilian-military pay gap of 13 percent. CBO reported, however, that its analysis of the pay gap "concludes that the figure commonly cited as a measure of that gap (13 percent) has no value in determining the appropriate level of military pay. It does not indicate whether the nation is treating military personnel fairly in the sense of offering them a standard of living comparable with that of other U.S. citizens."⁽⁹⁾

CBO's findings on the pay gap include the following:

• "Although it is called a measure of the pay gap, the 13 percent figure is not actually based on a comparison of civilian and military pay levels. Instead, it is a comparison of changes in pay over time. It is calculated by comparing increases in military basic pay since 1982 with increases in the ECI, an index of wages in private industry. The choice of 1982 as a starting point for the comparison is essentially arbitrary, and at most, the resulting number is a measure of changes in relative pay since that date. It indicates that overall military pay has increased more slowly than civilian pay but not whether military pay is higher or lower than civilian pay."⁽¹⁰⁾

• "In addition, the pay-gap calculation is faulty even as a measure of the changes in relative pay. On the military side, it looks only at basic pay without taking into account other factors that affect regular military compensation, such as food and housing allowances, the speed of promotion, and the financial benefits from the tax-free status of many allowances."⁽¹¹⁾

• "On the civilian side, it looks at average wage growth for workers who are typically older than members of the military and more likely to hold a college degree. Those demographic differences distort the comparison because wages of young high school graduates — a group more representative of the military — have risen less rapidly than wages of other civilians."⁽¹²⁾

• After adjusting for those factors, CBO found that since 1982, the wages of enlisted personnel have risen 3 percent to 10 percent faster than those of high school graduates with a similar age distribution. The wages of officers, in contrast, have fallen between 6 percent and 12 percent over this period, relative to the wages of college-educated civilians of similar ages. "Thus, the so-called pay gap is actually negative for enlisted personnel and positive only for officers."⁽¹³⁾

• "The point of CBO's analysis is not that the pay-gap calculation is faulty and could be improved. The message is more fundamental: that shifts in the relative wages of military and civilian personnel, cumulated over many years, are not a useful guide for policy." ⁽¹⁴⁾

• CBO noted that a comparison of actual pay levels for civilian and military jobs might be more useful than a comparison of the rates of increase in pay. CBO pointed out that "The results of such a pay-level comparison might be surprising. Based on current military pay, CBO finds that enlisted services members earn more than about 75 percent of U.S. male high school graduates of the same age. Similarly, officers earn more than about 75 percent of U.S. college graduates of the same age. Those findings suggest that the financial rewards of military service are fair in the sense that they are more than comparable with what private-sector jobs offer most U.S. citizens. One could still argue, however, that service members deserve even more because of their exceptional quality and devotion and the sometimes arduous and dangerous conditions in which they work" (emphasis added).⁽¹⁵⁾

CBO concluded that "although the notion of a 13 percent pay gap has little to support it, that figure has been widely publicized and just as widely misunderstood."⁽¹⁶⁾

 

Other Studies

Two other recent studies have found similar results. A study by West Point economist Dean Dudley found the more generous pensions in place for those entering the armed forces before August 1986 have had little effect on retention. Dudley examined 2,263 Army officers commissioned in 1987, a group that includes some officers entitled to 50 percent pensions after 20 years due to earlier connection with ROTC or military academies, and some entitled to 40 percent pensions. (This is a similar methodology to that which CBO employed.) Dudley's study found that to date, retention rates between the two groups have been nearly identical.⁽¹⁷⁾

In addition, Defense Week reported in late February that preliminary data from a General Accounting Office study show the role of monetary factors in affecting the decisions of armed forces personnel to remain in or leave the military has been overstated and the debate on this matter has been "oversimplified" as a result.⁽¹⁸⁾ The Defense Week article reported on a briefing GAO conducted for Congressional staff on its findings. (According to some Congressional staff, the GAO has found that problems relating to work conditions, including the unavailability of spare parts and other equipment, the frequency and nature of deployments, and inadequate health care for dependents are more powerful factors in inducing personnel to leave the armed forces in mid-career than monetary factors.)

 

Conclusion

The 1986 military pension reforms were designed to control long-term entitlement costs, curb excesses in what seems to have been a gold-plated retirement program for some of those leaving the armed forces at a relatively young age, and reduce disincentives for skilled personnel to leave the military in their early 40s. These changes resulted from years of study and hearings. The question before Congress is whether these reforms should summarily be discarded, and expensive new benefits added, without considering the CBO and GAO findings and waiting for soon-to-be released studies on these issues. In light of the CBO report, the pay-raise provisions of S. 4 also appear to warrant further examination.

Suspending normal Congressional procedures, designating S. 4 as emergency legislation, and pushing it through Congress in the next few weeks would be troubling. Not only would such action lock the nation for decades to come into tens of billions of dollars of expenditures that might be unwise, but it could affect the national defense adversely. No one knows the effects the legislation would have. It could induce premature retirement from the armed forces of skilled personnel reaching the 20-year point by removing the incentives the 1986 law enacted for service members to remain beyond that point. Policymakers have rushed this legislation forward without carefully analyzing its likely effects. Furthermore, if, as seems likely, the overall defense budget is limited at some future point while the costs of S. 4 continue to mount or have already reached their full dimensions, some of those costs could squeeze out military expenditures that would be more crucial to the defense of the nation.

---

Endnotes:

1. Congressional Budget Office, "The Effects of the Military Retirement Reform Act of 1986 on Mid-Career Retention," February 1999; and Testimony of Christopher Jehn, Assistant Director, National Security Division, CBO, on military pay and benefits before the Subcommittee on Personnel of the Senate Armed Services Committee, March 3, 1999.

2. Letter of Dan Crippen, Director, Congressional Budget Office, to Senator John W. Warner, Chairman, Senate Armed Services Committee, March 2, 1999.

3. After benefits were recomputed at age 62, the annual cost-of-living adjustment would continue to be CPI minus one percentage point.

4. Testimony of Christopher Jehn, p. 1.

5. Jehn, p. 1.

6. Jehn, p. 2

7. Jehn, p. 3.

8. Ibid.

9. Jehn, pp. 3-4.

10. Jehn, p. 4.

11. Ibid.

12. Ibid.

13. Ibid.

14. Ibid.

15. Ibid.

16. Jehn, p. 5.

17. Bradley Graham, "Military Pension Maneuvers: Costly Rush to Misjudgement?" Washington Post February 11, 1999, p. A35.

18. John Donnelly, "GAO: Money Overstated as Retention Factor," Defense Week, February 22, 1999.