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The House Armed Services Committee, along with the Administration, has proposed major changes in the way the federal budget accounts for the costs of military retirement. Under the proposals, the budget would reflect costs of retirement benefits being earned by today's military personnel, whereas at present it reflects only the costs of those already retired. This study, prepared at the request of the Defense Subcommittee of the House Committee on Appropriations, describes the proposals, estimates their impact on the federal budget, and cites their important advantages--as well as associated concerns and ways to minimize them.

Although the study makes no recommendations as to the merits of these specific proposals, it is the judgment of the Congressional Budget Office (CBO) that the accounting concepts underlying the proposals are sound and should be implemented. To do so would greatly improve the usefulness of the defense budget by making the full costs of military manpower more visible. It would also assist future debates over changes in military retirement benefits by clarifying long-run cost effects; this should help avoid undue emphasis on near-term economies.

Marvin M. Smith of CBO's National Security and International Affairs Division wrote the study, under the general supervision of Robert F. Hale. The author wishes to acknowledge the technical assistance provided by Toni Hustead, the Department of Defense's Actuary. (Outside assistance implies no responsibility for the final product, which rests solely with CBO.) The study also benefited from earlier analysis by Daniel F. Huck and Edgar A. Peden, formerly of CBO. Helpful assistance was also provided by Earl Armbrust, Alfred Fitt, Robert Hartman, Barbara Hollinshead, Stephanie Martin, and Neil Singer of CBO. Francis Pierce edited the manuscript, assisted by Nancy H. Brooks.
 

Alice M. Rivlin
Director
July 1983
 
 

SUMMARY

CHAPTER I. THE CURRENT ACCOUNTING PROCEDURES FOR MILITARY RETIREMENT AND PROPOSED CHANGES

CHAPTER II. EFFECTS ON BUDGET AUTHORITY AND OUTLAYS OF ALTERNATIVE APPROACHES TO ACCRUAL ACCOUNTING

APPENDIX A. BRIEF DESCRIPTION OF THE CURRENT MILITARY RETIREMENT SYSTEM

APPENDIX B. UNFUNDED LIABILITY AND THE TRUST FUND

APPENDIX C. CHANGES IN ACCOUNT STRUCTURE UNDER 75-YEAR AMORTIZATION OF THE UNFUNDED LIABILITY
 

TABLES
1.	HOW ACCRUAL ACCOUNTING WOULD DIFFER FROM PRESENT BUDGET ACCOUNTING
2.	CHANGES IN FISCAL YEAR 1985 ACCOUNT STRUCTURE UNDER ACCRUAL ACCOUNTING: HOUSE ARMED SERVICES VERSION BY FUNCTION, AGENCY, AND SUBFUNCTION
3.	CHANGES IN FISCAL YEAR 1985 ACCOUNT STRUCTURE UNDER ACCRUAL ACCOUNTING: ADMINISTRATION'S PROPOSAL BY FUNCTION, AGENCY, AND SUBFUNCTION
4.	MILITARY RETIREMENT OUTLAYS, APPROPRIATIONS, NET FLOWS INTO TRUST FUND, AND TRUST FUND BALANCES FOR HOUSE ARMED SERVICES AND ADMINISTRATION PROPOSALS, FISCAL YEARS 1985-1990
C-1.	CHANGES IN FISCAL YEAR 1985 ACCOUNT STRUCTURE UNDER ACCRUAL ACCOUNTING: HOUSE ARMED SERVICES VERSION BY FUNCTION, AGENCY, AND SUBFUNCTION
C-2.	CHANGES IN FISCAL YEAR 1985 ACCOUNT STRUCTURE UNDER ACCRUAL ACCOUNTING: ADMINISTRATION'S PROPOSAL BY FUNCTION, AGENCY, AND SUBFUNCTION

 

The true costs of military personnel include not only their costs while in service but also their pay after they retire. At a time when the Department of Defense and the Congress are forced by budgetary considerations to make difficult choices in the areas of personnel costs and weapons procurement, it is essential to be aware of the true cost of military personnel in relationship to the cost of other defense resources. Under the federal government's present accounting procedures, the budget includes the cost of benefit payments to service personnel who are already retired and to their survivors. It fails to show the liability taxpayers are incurring for the future retirement costs of military personnel now on active or reserve duty.

The Administration has proposed legislation to remedy this by placing the system on an "accrual" cost basis that would include liabilities as they are incurred. The House Armed Services Committee, in the Defense Authorization Bill for Fiscal Year 1984, has reported legislation similar to the Administration's proposal; if enacted, it would take effect with the fiscal year 1985 budget.

What Accrual Accounting Is

Accrual accounting is a method of recording costs and setting aside funds in current budgets to pay the retirement annuities that eventually will be received by military personnel who are in current service. It would improve military personnel management by making the full cost of manpower more visible, as well as clarifying the full cost of any change in retirement benefits. It would not affect the amount of retirement benefits paid to an employee when he or she retires, nor would it affect the annual outlays paid by the federal government.

Most proposals, including those of the House Armed Services Committee and the Administration, would make the following major changes in the way the budget accounts for retired pay:

• A charge for retirement costs accrued by today's military personnel would be added to the defense function. This "accrual" charge would be the amount actuaries estimate would be necessary to fund the retirement benefits earned each year by today's military personnel. It would reflect expected growth in wages, prices, and interest rates.
  
  
• The defense retired pay appropriation would be transferred out of the defense function of the budget and absorbed into the trust fund discussed below. (The retired pay appropriation pays benefits to former military personnel currently on the retired rolls and to their survivors.)
  
  
• A military trust fund would be created and shown in the income security function of the budget. The fund would receive the annual accrual charge, a payment for retirement liabilities built up before the fund's existence, and interest on the trust fund balance. This trust fund would also pay all retirement benefits (both current and future) from the funds it receives.
  
  
• A board of actuaries would be created to oversee the fund and to make needed technical calculations.

Advantages and Potential Concerns

Accrual accounting would have many important advantages. It would improve manpower management by ensuring that future retired pay costs are considered during today's force structure decisions. For example, under the present budgeting system, the Administration's proposal to add 180,000 persons to the active-duty military over the next five years would have no effect on nondisability retirement costs in the current defense budget. Under accrual accounting, retirement costs would increase by $1.2 billion, thus making clear the true costs of adding personnel at the time of the decision. Similarly, accrual accounting would ensure that the Administration and the Congress faced the full costs of their pay raise decisions, which have important though long-delayed effects on retirement costs.

Accrual accounting would also aid the Congress in evaluating the long-range budgetary effects of prospective modifications in the retirement system. This should avoid undue emphasis on immediate benefit cuts that offer short-term savings.

A potential concern associated with the accrual approach is its sensitivity to technical assumptions about changes in future prices, wages, and interest rates. Different assumptions about these variables could result in different estimates of current costs, thus increasing or decreasing the defense budget. The establishment of an independent board of actuaries to determine the appropriate economic and actuarial assumptions should, however, prevent manipulation of the defense budget for political purposes through arbitrary changes in the underlying assumptions.

A switch to accrual accounting might also confuse the debate over real defense growth, since the change could affect the size of the defense budget. This concern could be overcome by restating data on past defense budgets in accrual terms.

Because it offers many advantages and no problems that cannot be overcome, accrual accounting has been widely recommended. This Administration has recommended the change, as did its predecessor. Accrual accounting has also been recommended by the General Accounting Office.

Effects on Budget Authority and Outlays

Accrual accounting would mean changes in the relative magnitudes of outlays and budget authority in various parts of the federal budget. The House Armed Services and Administration approaches would generally have similar effects and so are discussed together.

Both approaches would result in a modest decline (in any given year) in the budget authority and outlays of the defense function. The two alternatives would add the accrual charge to both budget authority and outlays in the defense function but move the financing of current retirement benefits out of the defense function into the income security function. Relative to the current accounting method, this would decrease the defense function by $0.6 billion in budget authority and outlays in fiscal year 1985. In addition, the Administration approach would also make a payment for the so-called unfunded liability--the liability built up before implementation of the new system--within the defense function, but the payment would also be offset within that function and so would not affect the total defense budget.

Both approaches would also make changes in other budget functions, including the income security function (where the trust fund would be located and from which, under the House Armed Services Committee approach, appropriations to pay off the unfunded liability would be made) and the offsetting receipts functions (where accounting transactions would occur to avoid double counting).

Outlays in the total federal budget would remain unchanged, since accrual accounting does not affect the size of retirement benefits. On the other hand, overall budget authority would increase once the budget began recognizing future retirement liabilities and the unfunded liability. CBO estimates that budget authority could increase by up to $16.1 billion in fiscal year 1985, depending on the technical assumptions chosen, particularly the period used to amortize the unfunded liability.

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