Validity of Inflation Projections Used in DOD

GAO has long been concerned about the Department of Defense (DOD) using optimistically low inflation rates in estimating the cost of major weapon systems. However, recommendations GAO has made to reduce the problems and confusion caused by using low inflation rate projections have not been adopted. DOD uses Office of Management and Budget (OMB) guidance in a computer model to develop inflation rate projections for procurement, shipbuilding, research and development, operations and maintenance, and construction. DOD inflation projections cannot exceed the rates in OMB guidance. These rate projections have historically been lower than actual experience, especially since 1978. Shorter term predictions were closer to the actual rates than longer term predictions. Projections for more than 3 years in the future have been less than half of the actual inflation rate. Two major adverse effects of using low inflation rates have been: appropriations have not funded everything in the budgets, and cost estimates have been periodically increased to include actual inflation that is higher than projected or to reflect inflation rates that have been revised upward. Unless funds are reprogrammed, or there is a supplemental appropriation to cover the funding shortfall, programs face less efficient production rates, higher unit costs, and program stretchouts. Significant program stretchouts cause major program cost increases because of greater exposure to inflation. Program cost estimates are continuously increased as higher than expected inflation occurs or rate projections are revised upward. If the goals of the President's economic plan are not achieved, program cost estimates for major weapon systems will continue to increase. GAO would recommend that the DOD budget should be based on as realistic as possible inflation rates. Use of rates significantly lower than industry projections should be justified in the budget. DOD should reinstitute the use of a chart to show the effect on the program cost estimate of using different inflation rate projections, including projections at least as high as the approximate rate being experienced when the acquisition reports are prepared.