Republicans have decided to focus their attempts to balance the budget on cutting federal employment. Problem is, the entire federal payroll (excluding the Postal Service) is less than $150 billion and the deficit is well over a trillion dollars. Further, the Republicans exempt the employees of the Departments of Defense, Homeland Security and Veterans Affairs, leaving only $60 million in payroll to freeze. And since a big chunk of the remaining funds go to workers playing a central role in either collecting revenues or managing the expenditure of trillions of dollars in Social Security, Medicare and other programs, the freeze would likely lead to more waste, overpayment and lost revenue collections than it would save.
But there is a place where conscientious budget cutters can find real money. Ten years ago we were spending $200 billion a year on federal contracting. By 2008, the last year for which numbers are available, the total had jumped to more than $500 billion or 43 percent of all discretionary spending. Many of those contracts are highly competitive, with narrow margins and good value for the government. But many others are not.
A report I recently completed for the Center for American Progress examines one particular set of contracts involving the purchase of a vaccine for exposure to Anthrax. Normally it is virtually impossible to estimate the profit margin that a government contractor is making on a particular contract with information available in the public domain. This contract was different, however, because the contractor was a public corporation which had only one product and only one customer. Because the Securities and Exchange Commission requires disclosure of revenues and expenditures to stock holders, it is possible to see how much it cost the company to produce what it was selling to the federal government.
In the Form 10K released by this contractor in March, the company disclosed that its revenues for the sale of its vaccine totaled $217 million. The cost of sales according to the report was only $46 million. Further research indicated that the company has enjoyed such margins for nearly a decade with sales exceeding $1.3 billion and expenses of less than $0.3 billion.
The company, Emergent BioSolutions, argues that such margins are justified because it has faced a high level of financial risk in being a provider to the government. But an examination of the risks it has faced since its founding in 1998 turned up a remarkable lack of risk compared to almost any other type of commercial endeavor. The vaccine which is now sold under the name of BioThrax was developed by the U.S. Army in the 1960s. The license to manufacture the vaccine was obtained by the state of Michigan and the state also built the facilities used for manufacture. Those facilities were bought by Emergent with a down payment of $2.25 million. They were then upgraded almost entirely at the expense of the U.S. government.
The price of the vaccine was raised from a little less than $3 a dose which the government was paying to the state of Michigan to $10.60 a dose after Emergent took over. The price was then inexplicably raised again to more than $27 a dose—yielding the enormous profit margins detailed in the company’s annual report. To protect those hefty margins, Emergent has probably the largest and most expensive lobbying team in Washington when lobby expenditures are compared to company revenues.
We don’t have any idea how many high profit margin contracts the government has and it is only a result of the rather odd business model of this company that its high margins were uncovered. Annual reports for companies that have multiple products and sell to customers other than the government ordinarily yield little information that would permit an estimation of the markup they get out of their government sales.
I think that needs to change. Contract officers and corporate officers should be required to jointly certify that a contract does not have a margin exceeding a certain threshold -- for instance 30 percent.. If either can’t make that certification, notice should be provided to the agency and department heads, to the Office of Management and Budget, the Comptroller General and the appropriate committees in Congress. Each of these entities would be responsible for challenging the contract and determining if the risk faced by the contractor merited such margins.
Most government contractors are able to perform well for their stockholders while charging the government margins of less than 10 percent. When contract officers agree to margins three times that size, others in government should know about it.
Scott Lilly is a senior fellow at the Center for American Progress and former clerk and staff director of the House Appropriations Committee.