Congress is taking action to make the Pentagon a smarter buyer — and it’s about time. According to the Department of Defense Office of Inspector General (DOD OIG), companies have overcharged the department for spare parts on multiple occasions dating back over 20 years.
One way to prevent defense contractors from price gouging further is to establish a “progress payment” program to financially incentivize companies to negotiate more fairly with the Pentagon. Under such a program, companies would receive more money up front if they met certain performance conditions and transparency standards.
With an incentive structure in place for defense contractors to meet performance standards, lawmakers could move on to bigger contracting reforms that POGO has long advocated, like lowering a mandatory reporting threshold, addressing mandatory refunds for overcharging, and refining the definition of “commercial item.” In other words, a progress payment program could kickstart congressional action to stop profiteering in the defense industry.
The best path forward for Congress to create the program and reward good contractor performance is through the annual defense policy bill. The Senate Armed Services Committee has included a Progress Payment Incentive Pilot Program in their draft of the bill. But the House and Senate still need to reconcile the differences between their versions of the bill to pass the final legislation — the fiscal year 2023 National Defense Authorization Act (NDAA).
It is critical that lawmakers retain the Progress Payment Incentive Pilot Program in the final NDAA that goes to President Joe Biden’s desk.
Trying Out Progress Payments
Designed to address constant program schedule delays and cost overruns from defense contractors, the Progress Payment Incentive Pilot Program originated in the Trump administration. It would reward contractors with up to 95% of their payments up front if they satisfied certain conditions, including meeting program goals and schedules 95% of the time in the previous fiscal year. Companies would also receive progress payments for providing the Pentagon accurate and timely certified cost and pricing data, complying with certain financial transparency requirements, and fulfilling small business subcontracting goals — including providing employment opportunities specifically for blind people and people with severe disabilities.
For a model of how this program might kickstart further reform, it’s useful to note that, in addition to the Senate NDAA, the Progress Payment Incentive program is also included in standalone legislation introduced by Senator Elizabeth Warren (D-MA) and Representative John Garamendi (D-CA). The bicameral Stop Price Gouging the Military Act would close some loopholes in acquisition law that allow companies to withhold the cost and pricing information the Department of Defense needs to negotiate good deals. It’s a bold proposal to help the department avoid getting ripped off in several ways, and its introduction marks a turning point for Congress.
The Demise of Contracting Regulations
For too long, lawmakers have ceded ground to industry lobbyists determined to keep price gouging legal. But it hasn’t always been so easy to rip off the Pentagon.
Contracting regulations are demonstrably worse today than they were in the 1980s — if you’re a taxpayer, that is. Lawmakers have gradually chipped away at the safeguards Congress previously established to ensure the Defense Department could procure the best goods and services at the best prices.
“Lawmakers have gradually chipped away at the safeguards Congress previously established to ensure the Defense Department could procure the best goods and services at the best prices.”
As a result, defense contractors have overcharged the Pentagon for decades. In 1998, the Defense Department inspector general found one company charging the Pentagon $85.02 for electrical wiring insulation previously sold to the Air Force for $8.51. The markup meant the Pentagon paid an estimated $12,870 more than necessary for wire insulation sleeves during the span of that contract alone, a striking example of government waste that grabbed POGO’s attention in the early 2000s. Since then, we’ve reported on a number of inspector general audits that revealed significant overcharging by mega-contractors like Boeing and Lockheed Martin as well as lesser-known companies like TransDigm.
These outsized profits are made possible by several problems, not least of which is how small the defense industry is. Companies have the power to set prices because there are few alternative suppliers, and the Pentagon lacks the tools it needs to check price reasonableness.
Mandatory Disclosure Threshold
Congress has incrementally raised the mandatory disclosure threshold since the 1980s, the amount the government must spend before companies have to provide the Pentagon with certified cost and pricing information, from $100,000 in 1994 to $2 million today. This means that far too often, the Pentagon can’t determine whether the prices it’s agreeing to are on par with the market because it doesn’t receive certified data from companies with contracts valued under $2 million.
It’s clear that the mandatory reporting threshold is far too high. For one striking example of the impact of increasing the threshold, we can look at spare parts supplier TransDigm, whose contracts regularly failed to meet the applicable threshold at the time. Because it slipped under the government’s radar, TransDigm was able to legally charge as much as 3,850% above the market price for at least one part, ultimately profiteering to the tune of about $21 million in under three years, according to the Pentagon inspector general.
To make matters worse, the Pentagon has little recourse to demand refunds from companies when they do price gouge. For example, an earlier DOD OIG report found that TransDigm received $16.1 million in excess profits from 2015 to 2017. Facing mounting public pressure, the company finally agreed to refund the Pentagon $16 million in May 2019. But it has since refused to refund the $20.8 million in excess profits it received from 2017 to 2019, despite congressional demands to do so.
Previous versions of one key contracting law, the Truth in Negotiations Act (TINA), contained stronger requirements for companies to issue mandatory refunds to correct overpricing. Today, the law that remains of TINA rarely triggers mandatory refunds from profiteering companies. Furthermore, it does nothing to suspend contract eligibility for companies that price gouge or refuse to give the Pentagon the information it needs to negotiate contracts fairly.
As POGO has noted previously, a high disclosure threshold and the lack of mandatory refunds aren’t the only problems. Companies like TransDigm could still avoid reporting certified data to the Pentagon at a lower disclosure threshold if the products or services they sell were considered “commercial.” The logic is that products sold to the general public are already competitively priced — at least in theory.
“The DOD IG has reported that the Pentagon will continue to be unable to perform adequate price reasonableness determinations without legislative changes.”
The problem, however, is that the defense industry has worked hard to encourage lawmakers to arbitrarily expand the definitions of commercial items and services so that today, companies that sell specialty parts to the Defense Department may receive “commercial” designations for products the general public cannot purchase. The Pentagon ends up buying goods without cost or pricing information because contractors call products “of a type” or “offered for sale” to jam defense-only items into the “commercial” definition.
It’s difficult for the Pentagon to negotiate good deals when it’s working with a $2 million disclosure threshold, an overly broad commercial item definition, and a shrinking defense industry. The DOD OIG has reported that the Pentagon “will continue to be unable to perform adequate price reasonableness determinations” without legislative changes.
The good news is that those changes may be coming: the Senate NDAA and the Stop Price Gouging the Military Act address both problems.
The truth is, the biggest losers from legislative inaction are taxpayers. Their money is wasted by lawmakers who, in the aggregate, have bent to the will of corporate defense lobbyists and weakened acquisition laws designed to prevent profiteering. Congress now has a chance to address price gouging by establishing the Progress Payment Incentive Pilot Program in the fiscal year 2023 NDAA. While the pilot program won’t immediately resolve all of the problems with defense contracting POGO has reported on for decades, it is a critical first step toward repairing a broken system.
The pilot program should be an easy sell: It would benefit contractors, the Pentagon, troops, and taxpayers. It would drive contractor performance by adjusting financing policies, addressing the longstanding issue of price gouging by military contractors at a structural level. Ultimately, the program would level the playing field and make companies better partners with the Defense Department.
“The truth is, the biggest losers from legislative inaction are taxpayers.”
There’s also a strong business case for the Progress Payment Incentive Pilot Program. The government doesn’t cover interest payments on contractors’ bank loans, so progress payments would bolster cash flow for qualifying companies. The pilot program therefore incentivizes contractors to meet transparency and performance standards and maximize advance progress payments from the Pentagon, which reduces the amount of money companies have to borrow up front. By borrowing less, companies would see healthier cash flow.
The program would benefit many small and mid-sized companies that have problems gaining access to cash. Larger contractors would receive financing based on their track records, having already raked in between one-third and one-half of $14 trillion in Pentagon spending since 2001. But with this financial power, larger contractors also have financial stability. According to the Institute for Defense Analyses, these companies were financially healthy enough to remain in the industry and sustain policy changes to drive contractor performance even in 2006. Military contractors are therefore more than capable of accommodating policies that strengthen the relationship between contract outcomes and profits.
The stakes are high when it comes to military contracting. Companies receive multiple, multi-billion-dollar Pentagon contracts to deliver goods and services on the taxpayer’s dime. Still, it’s taken decades for Congress to take meaningful legislative action to stop companies from price gouging the Pentagon.
The Progress Payment Incentive Pilot Program is a no-brainer in the NDAA this year. Congress should retain in the final bill the Senate provision to establish the program, and it should get the ball rolling on making the Pentagon a smarter buyer to prevent further waste of taxpayer dollars.