FBIQ’s Federal Public Sector Market Forecast

 

 

From 1974 through 2010 annual federal contract spending increased 97.3% of the time. Defense spending rose and fell. Domestic spending had ups and downs, but in that 36-year span, total federal contract spending increased every fiscal year but one. 1986 federal contract spending fell 0.5% when President Reagan, a Democrat-controlled House and a Republican-controlled Senate passed a comprehensive tax reform bill and paid for it. 

For 36 years, the biggest challenge for most federal contractors was getting on the escalator. Times have changed. From FY11 through FY15, contractors faced the first sustained market downturn in the past 40 years. Annual federal contract spending fell 21.4% from its record $560 billion peak in FY10 to $440 billion in FY15. 

Two major factors contributed to that decline. The first occurred when President Obama signed the $787 billion American Recovery and Reinvestment Act (ARRA) into law on February 17, 2009. The massive stimulus bill softened the blow of the great recession triggered by the 2008 housing and financial market collapse and created a bubble in the federal procurement spending market by inflating FY08, FY09 and FY10 contract spending. The second occurred in August 2011 with adoption of the Budget Control Act (BCA). The BCA set 10-year discretionary spending caps enforced by across-the-board spending cuts called sequesters. 

The BCA was implemented to reassure financial markets after bipartisan deficit reduction talks between President Obama and Speaker Boehner (R-OH) stalled. On July 25th, the Speaker and the President issued separate statements saying they were unable to reach agreement on a plan to reduce projected deficits by $4 trillion over 10 years, a target that had broad bipartisan support. The dual announcements prompted a US debt downgrade and a 14% market correction that increased uncertainty and worries that a sluggish US economy would go into recession. In that setting, Vice President Biden and Senate Republican Leader McConnell (R-KY) lead the negotiations that produced the BCA. The law created a “Super Committee” to identify deficit reduction measures that would be fast-tracked through Congress and outlined a sequester-based enforcement mechanism if Congress failed to meet prescribed deficit reduction targets. 

In December 2011, the Super Committee failed to identify additional deficit reduction measures triggering a January 2013 BCA sequester. At that time, Defense Secretary Panetta reassured US military leaders that sequester would “never happen.” We disagreed. Our December 2011 forecast predicted that Congress would delay and reduce the initial sequester before allowing it to occur in the spring of 2013. Our team also argued that despite what the BCA law said, sequester would disproportionately impact federal RDT&E, investment, working capital and procurement accounts as the Administration and Congress worked to minimize furloughs. That’s exactly what happened.

Since adoption of the BCA there have been four bipartisan budget agreements. All but one reduced planned BCA sequesters with a bipartisan agreement on budget offsets. The Bipartisan Budget Act of 2018 (BBA18) broke that mold. President Trump and a Republican-controlled Congress boosted the BCA caps by adding $274 billion over 2 years to projected deficits.

FY18 spending bills implementing BBA18 were adopted in March 2018 triggering a back-loaded 6-month $195 billion ($78 billion for defense and $117 billion for non- defense agencies) spending spree. How could agency spending increase more than the FY18 caps? Because first half FY18 agency spending was restricted. The Defense Department was limited by BCA sequester targets and civilian agencies were limited by President Trump’s proposed non-defense spending cuts. BBA18 removed those those limitations.

Recent FBIQ reports have focused on agency operational uncertainty as October 1st approaches. Absent a change in law they face a $126 billion (roughly 10%) sequester — $71 billion on defense and $55 billion on non-defense agencies. With little political incentive for either President Trump or Speaker Pelosi (D-

CA) to compromise, a budget agreement is unlikely to emerge before November. As a result, we expect a significant slowdown in federal procurement spending by September that extends into December.

Despite that fiscal year-end challenge, annual FY19 federal contract spending should set a record (see Chart I).

Annual appropriations are a leading indicator for procurement spending changes. When the final data on FY18 spending is in, federal contract spending should approach the FY10 record. For FY19, BBA18 caps FY19 annual discretionary spending growth for DoD at 1.9% and for non-defense agencies at 2.4%. We expect FY19 federal contract spending to grow faster than agency top line budgets.

How? Congress knows that complex procurements take time. Generally, defense procurement funding is available for three years. For example, the House- passed FY20 Defense Appropriations bill makes aircraft procurement funding available through FY22 (3 years). Shipbuilding funds are available for five years (through FY24). Similarly, House- passed Veterans Affairs funding for

the Electronic Health Records project is available for 3 years. The House makes proposed FY20 Decennial Census funding available for 3 years.

The back-loaded FY18 process for all federal agencies shifted more of those procurement increases into FY19 and FY20 than a normal funding cycle. Similarly, we expect the back- loaded FY19 appropriations process for non-defense agencies impacted by the partial government shutdown to push more FY19 procurement activity for those agencies into FY20.

Finally, a large and growing share of federal procurement activity is funded through mandatory spending that continues until a law altering the program passes. According to OMB, annual federal mandatory spending will increase 11% in FY19.

From 1974 through 2010 annual federal contract spending increased 97.3% of the time. Defense spending rose and fell. Domestic spending had ups and downs, but in that 36-year span, total federal contract spending increased every fiscal year but one. 1986 federal contract spending fell 0.5% when President Reagan, a Democrat-controlled House and a Republican-controlled Senate passed a comprehensive tax reform bill and paid for it.

For 36 years, the biggest challenge for most federal contractors was getting on the escalator. Times have changed. From FY11 through FY15, contractors faced the first sustained market downturn in the past 40 years. Annual federal contract spending fell 21.4% from its record $560 billion peak in FY10 to $440 billion in FY15.

Two major factors contributed to that decline. The first occurred when President Obama signed the $787 billion American Recovery and Reinvestment Act (ARRA) into law on February 17, 2009. The massive stimulus bill softened the blow of the great recession triggered by the 2008 housing and financial market collapse and created a bubble in the federal procurement spending market by inflating FY08, FY09 and FY10 contract spending. The second occurred in August 2011 with adoption of the Budget Control Act (BCA). The BCA set 10-year discretionary spending caps enforced by across-the- board spending cuts called sequesters.

The BCA was implemented to reassure financial markets after bipartisan deficit reduction talks between President Obama and Speaker Boehner (R-OH) stalled. On July 25th, the Speaker and the President issued separate statements saying they were unable to reach agreement on a plan to reduce projected deficits by $4 trillion over 10 years, a target that had broad bipartisan support. The dual announcements prompted a US debt downgrade and a 14% market correction that increased uncertainty and worries that a sluggish US economy would go into recession. In that setting, Vice President Biden and Senate Republican Leader McConnell (R-KY) lead the negotiations that produced the BCA. The law created a “Super Committee” to identify deficit reduction measures that would be fast-tracked through Congress and outlined a sequester-based enforcement mechanism if Congress failed to meet prescribed deficit reduction targets.

In December 2011, the Super Committee failed to identify additional deficit reduction measures triggering a January 2013 BCA sequester. At that time, Defense Secretary Panetta reassured US military leaders that sequester would “never happen.” We disagreed. Our December 2011 forecast predicted that Congress would delay and reduce the initial sequester before allowing it to occur in the spring of 2013. Our team also argued that despite what the BCA law said, sequester would disproportionately impact federal RDT&E, investment, working capital and procurement accounts as the Administration and Congress worked to minimize furloughs. That’s exactly what happened.

Since adoption of the BCA there have been four bipartisan budget agreements. All but one reduced planned BCA sequesters with a bipartisan agreement on budget offsets. The Bipartisan Budget Act of 2018 (BBA18) broke that mold. President Trump and a Republican-controlled Congress boosted the BCA caps by adding $274 billion over 2 years to projected deficits.

FY18 spending bills implementing BBA18 were adopted in March 2018 triggering a back-loaded 6-month $195 billion ($78 billion for defense and $117 billion for non- defense agencies) spending spree. How could agency spending increase more than the FY18 caps? Because first half FY18 agency spending was restricted. The Defense Department was limited by BCA sequester targets and civilian agencies were limited by President Trump’s proposed non-defense spending cuts. BBA18 removed those those limitations.

Recent FBIQ reports have focused on agency operational uncertainty as October 1st approaches. Absent a change in law they face a $126 billion (roughly 10%) sequester — $71 billion on defense and $55 billion on non-defense agencies. With little political incentive for either President Trump or Speaker Pelosi (D-CA) to compromise, a budget agreement is unlikely to emerge before November. As a result, we expect a significant slowdown in federal procurement spending by September that extends into December.

Despite that fiscal year-end challenge, annual FY19 federal contract spending should set a record (see Chart 1).

Annual appropriations are a leading indicator for procurement spending changes. When the final data on FY18 spending is in, federal contract spending should approach the FY10 record. For FY19, BBA18 caps FY19 annual discretionary spending growth for DoD at 1.9% and for non-defense agencies at 2.4%. We expect FY19 federal contract spending to grow faster than agency top line budgets.

How? Congress knows that complex procurements take time. Generally, defense procurement funding is available for three years. For example, the House- passed FY20 Defense Appropriations bill makes aircraft procurement funding available through FY22 (3 years). Shipbuilding funds are available for five years (through FY24). Similarly, House passed Veterans Affairs funding for the Electronic Health Records project is available for 3 years. The House makes proposed FY20 Decennial Census funding available for 3 years.

The back-loaded FY18 process for all federal agencies shifted more of those procurement increases into FY19 and FY20 than a normal funding cycle. Similarly, we expect the back- loaded FY19 appropriations process for non-defense agencies impacted by the partial government shutdown to push more FY19 procurement activity for those agencies into FY20.

Finally, a large and growing share of federal procurement activity is funded through mandatory spending that continues until a law altering the program passes. According to OMB, annual federal mandatory spending will increase 11% in FY19.

Forecast

FY19 federal contract spending will grow 5-7.5% ($30-50 billion), more than twice as fast as agency top line budgets