GAO

United States General Accounting Office

Testimony 

Before the Subcommittee on Seapower, Committee on 

Armed Services, U.S. Senate

For Release

Expected at

2:30 p.m. EDT

on Wednesday,

April 21, 1999

DEFENSE ACQUISITION

Historical Insights Into 

Navy Ship Leasing

Statement of James F. Wiggins, Associate Director, 

Defense Acquisitions Issues, National Security and 

International Affairs Division

GAO/T-NSIAD-99-141

Page 1 GAO/T-NSIAD-99-141 Navy Ship Leasing

Madame Chairwoman and Members of the Subcommittee:

I am pleased to be here today to provide some historical insights into Navy 

ship leasing. At the request of this Subcommittee, we are reviewing the 

Navy’s decisions in the early 1970s and early 1980s to lease Sealift tankers, 

Maritime Prepositioning Ships (MPS), and T-5 replacement tankers, and 

more recently, Chouest specialized support vessels. My remarks today are 

based on this work and earlier GAO reviews. Specifically, I will discuss the 

basis and support for the Navy’s decisions to lease rather than purchase 

these vessels, the concerns that surrounded the decisions, and the 

legislative and regulatory changes that have been implemented which will 

influence future lease versus purchase decisions. Our report on these 

issues will be available in July.

Results in Brief The primary reason the Navy decided to use long-term leases to acquire 

auxiliary vessels in the early 1970s and early 1980s was because available 

procurement funds were needed for higher priority combat ships, and 

leasing arrangements allowed the Navy to acquire the support ships 

without a large, up-front obligation of procurement funds.1

 The Navy also 

believed that leasing was cost-effective and helped support the industrial 

base. At the time, the Navy complied with existing requirements to 

perform lease versus purchase cost comparisons. These comparisons 

concluded that leasing was cheaper than purchasing. 

The Navy’s decision to enter into long-term leases in the early 1970s and 

early 1980s raised concerns regarding the budget authority needed to make 

such large long-term funding commitments. Congress expressed concern 

about whether the Navy Industrial Fund could adequately cover the total 

obligations that would accrue from these leases.2 To address this concern, 

the Navy requested and received specific congressional authorization to 

carry out the acceptance provisions of the long-term leasing contracts. 

There were also concerns regarding the cost-effectiveness of these leases. 

1At 10 U.S.C. 2401 a long-term lease is defined as a lease, charter, service contract, or conditional sale 

agreement that lasts for a period of five years or longer (including options to renew or extend the initial 

term of the lease), for a period of more than one-half the useful life of the vessel, or for a period of three 

years or longer (including options to renew or extend the initial term of the lease) when certain 

investment tax credits or depreciation are claimed by the lessor. 

2

At that time, the Navy Industrial Fund was a revolving fund that provided products and services and 

was reimbursed for those products and services by its customers out of operation and maintenance 

appropriations. 
Page 2 GAO/T-NSIAD-99-141 Navy Ship Leasing

When the leasing decisions were made, there were limited standardized 

governmentwide guidelines for conducting lease versus purchase analyses. 

As a result, the studies used different assumptions and methodologies in 

analyzing the alternatives and drew different conclusions. In 1983, our 

report and a congressional staff study questioned the validity of the 

assumptions used in the Navy’s studies and their conclusions.3

 Had the 

Navy’s studies used assumptions that more fully reflected the government’s 

total costs, they would have concluded that purchasing was the cheaper 

alternative. 

Since the long-term leasing decisions of the early 1970s and early 1980s, a 

number of changes have occurred that will affect future long-term leasing 

decisions by increasing oversight and improving cost analyses. Through 

legislation, Congress has increased visibility of and control over these 

types of decisions. Additionally, budget-scoring guidelines increase the 

emphasis on up-front budget authority by providing Congress with a 

mechanism to assess the cumulative impact of long-term leasing decisions 

prior to the obligation of funds. Tax benefits that favored leasing have been 

reduced. Finally, as part of the decision-making process, more detailed 

guidelines require that the Navy perform lease versus purchase analyses 

that better reflect the government’s total cost of long-term leasing 

arrangements.

Background Traditionally, the Navy has purchased its combat ships but used long-term 

leases, called charter and build arrangements, to acquire Sealift tankers, 

MPS vessels, and T-5 replacement tankers. Under these arrangements, the 

lessors arranged for the construction, long-term financing, and delivery of 

the vessels. The Navy leased the vessels for 20 to 25 years and agreed that 

it would pay scheduled termination costs if, for some reason, it canceled 

the leases. 

In 1972, the Navy entered into contracts with two contractors for the

long-term lease of nine Sealift tankers. These tankers were put into service 

in 1974 and 1975 but are no longer being leased. In 1982, the Navy entered 

into contracts with three separate contractors for the long-term lease of 

13 MPS vessels. The first of these was delivered to the Navy in September 

3

Improved Analysis Needed to Evaluate DOD’s Proposed Long-term Leases of Capital Equipment, 

(GAO/PLRD-83-84, June 28, 1983) and “Tax Aspects of Federal Leasing Arrangements,” Staff of the Joint 

Committee on Taxation, JCS 3-83, February 25, 1983.
Page 3 GAO/T-NSIAD-99-141 Navy Ship Leasing

1984, and all remain under lease. Also in 1982, the Navy awarded contracts 

for the long-term lease of five newly constructed T-5 replacement tankers. 

The first of these tankers was delivered in June 1985, and all remain under 

lease. 

The Navy has used a different type of lease arrangement to acquire the 

specialized support services of vessels owned and operated by Edison 

Chouest Offshore. The Chouest vessels have generally been leased on a 

short-term basis—less than 5 years—for transportation services and 

special missions, such as oceanographic surveillance and research. Under 

these leases, the Navy pays for the services of the vessel, crew, and its 

operation and maintenance (O&M) on a daily use basis. In 1998, the Navy 

entered into a 5-year lease for one of the Chouest vessels under the same 

type of daily use arrangement. 

The Military Sealift Command (MSC) is responsible for administering the 

Department of Defense’s (DOD) auxiliary ship leases. Since 1969, DOD has 

required its components to perform economic analyses of lease versus 

purchase decisions. Lease versus purchase analyses are not required for 

short-term lease arrangements.

Basis and Support for 

Lease Decisions 

Cost-effectiveness was not the primary reason for the Navy’s decisions to 

lease auxiliary vessels in the early 1970s and early 1980s. According to 

Navy officials, the primary reason for proposing the long-term lease 

approach was that available procurement funds were needed for higher 

priority combat ships and long-term leasing allowed it to meet its support 

requirements without a large, up-front obligation of procurement funds. 

Under these leasing arrangements, the Navy initially had assumed it could 

spread payments over the length of the leases and use its annual O&M 

appropriations to fund them without incurring an up-front obligation of the 

total lease amount. If, instead of leasing, the Navy had purchased these 

vessels, funds would have been obligated from the Navy’s Shipbuilding and 

Conversion procurement appropriation; payments would have been 

required prior to delivery over a relatively short construction phase; and 

the purchases would have had to compete with combat ships for the Navy’s 

procurement funds. The Navy also maintained that long-term leasing was a 

cost-effective way of acquiring the services of auxiliary vessels. Navy lease 

versus purchase analyses showed that it was less costly to lease than 

purchase these vessels. 
Page 4 GAO/T-NSIAD-99-141 Navy Ship Leasing

Industrial base concerns were another factor in the decision to lease the 

MPS vessels and T-5 replacement tankers in the early 1980s. At that time, 

the commercial shipbuilding sector was in decline. A Navy official stated 

in a 1983 hearing that projects such as the MPS and T-5 replacement tanker 

programs were needed to prevent the potential closing of several 

commercial shipyards and to protect the nation’s industrial base.4

Flexibility and cost-effectiveness are cited as the primary reasons for 

leasing the Chouest vessels. Since 1988, the Navy has entered into 

short-term leases that generally consist of a firm period of 17 months or 

less followed by multiple option periods of 17 months or less that, when 

combined, do not exceed 5 years. Additionally, in 1998, the Navy entered 

into a 5-year lease for the Cory Chouest. The primary reason cited for these 

leases is the flexibility they provide because the Navy does not have a 

defined requirement for the extended use of these vessels. Since the leases 

are for shorter periods of time, leasing is likely to be more cost-effective 

than purchasing. A lease versus purchase cost analysis is not required for 

short-term leases and, therefore, such an analysis was only performed 

when the Navy decided to enter into a 5-year lease to acquire the services 

of the Cory Chouest. 

Concerns About 

Decisions and Analyses

The Navy’s decisions to enter into long-term leases raised concerns about 

whether (1) the Navy had sufficient budget authority to cover the total cost 

of the leases, especially termination costs if the leases were canceled, and 

(2) the Navy’s lease versus purchase analyses adequately reflected the 

government’s costs. 

Concerns Regarding Budget 

Authority

After awarding the long-term leases in the early 1980s, the Navy became 

concerned about how to record total obligations—lease payments as well 

as potential termination costs—associated with these leases in the Navy 

Industrial Fund and requested a GAO legal opinion. Congress also 

expressed concern whether the Navy’s budget authority would adequately 

cover the total obligations that would accrue from these leases. GAO’s

4

Federal Leasing Practices Hearing Before the Subcommittee on Oversight of the Committee on Ways 

and Means, House of Representatives, 98th Congress, First Session, February 28, 1983.
Page 5 GAO/T-NSIAD-99-141 Navy Ship Leasing

opinion,5 issued in response to the Navy’s request, concluded that if the 

Navy Industrial Fund did not have an unobligated balance sufficient to 

cover these costs upon the delivery of all the vessels, it would be in 

violation of the Antideficiency Act.6

 The opinion contained suggested 

actions, such as obtaining congressional authority, that the Navy could take 

to prevent such a violation from occurring. The Navy subsequently 

requested and received authority from Congress to lease the vessels 

without having sufficient unobligated funds available to cover the 

government’s total obligation under the contracts.7

Concerns Regarding 

Cost-Effectiveness of 

Leasing

The Navy complied with DOD requirements to perform lease versus 

purchase cost analyses in support of its long-term leasing decisions. 

However, the guidelines that existed for such analyses when the Navy 

entered into the leases for the MPS vessels and T-5 replacement tankers 

were not detailed and specific. As a result, the outcomes of these analyses 

were influenced by the methodologies and assumptions used in each study. 

The methodologies and assumptions the Navy used showed leasing to be 

cheaper. Our 1983 review of the Navy’s decision and a study by the Joint 

Committee on Taxation used different methodologies and assumptions and 

found purchasing to be the cheaper alternative. For example, the Navy’s 

lease versus purchase cost comparison for the MPS vessels concluded that 

the government would save $29.3 million per ship by leasing the 13 MPS 

vessels. However, the MPS study conducted by the Joint Committee staff 

concluded that outright purchase would be cheaper by $20.8 million per 

ship. Our 1983 report concluded that it would cost between $11.9 million 

and $38 million more per ship to lease the MPS vessels. The differences 

between the studies’ conclusions are a result of different methodologies 

and assumptions regarding (1) tax revenues, (2) residual values, and 

(3) discount rates. 

The majority of the differences between the Navy study and the 

congressional staff study were attributed to differing assumptions 

regarding how tax revenue should be accounted for. The Navy study 

5

B-174839, January 28, 1983 (62 Comp. Gen. 143), “Navy Industrial Fund: Obligations in Connection 

With Long-term Vessel Charters.”

6The Antideficiency Act, codified at 31 U.S.C. 1341, prohibits authorizing or incurring obligations or 

expenditures in excess of amounts available in an appropriation or fund unless authorized by law. 

7

Supplemental Appropriations Act of 1983 (P.L. 98-63).
Page 6 GAO/T-NSIAD-99-141 Navy Ship Leasing

reduced the total cost to the government of the lease by the taxes that 

would be paid on interest income received by the lenders that financed a 

portion of the ship’s acquisition. The committee staff’s methodology did 

not include these taxes as a source of government revenue. Although the 

methodologies and assumptions used in both studies were acceptable 

under the then-existing guidelines, in our June 1983 report, we agreed with 

the staff study’s assumptions because the Treasury would receive taxes on 

the income earned from either a lease or a purchase. 

Another key difference between the Navy and committee staff studies was 

the treatment of residual values. The residual value of a vessel is an 

estimate of what that vessel could be sold for at the end of the lease term, 

measured in present value terms. The Navy’s study of the MPS program 

assumed that the vessels would have no residual value at the end of their 

25-year leases, whereas the committee staff assumed that the residual 

value of the ships would be nearly 60 percent of the original cost of the 

ships. While it is not clear if a residual value of 60 percent was appropriate, 

a residual value of zero was not consistent with Internal Revenue Service 

(IRS) requirements at the time. Had the residual value been assumed to be 

20 percent, which would be consistent with the minimum IRS requirements 

at the time, the cost advantage of leasing identified in the Navy’s study 

would be reduced. In our 1983 review of these studies, we agreed with the 

staff study’s assumption that the vessels would have a residual value at the 

end of the lease terms. 

Determining whether leasing is more economical than purchasing also 

depends on the discount rate used to adjust the total value of lease 

payments to recognize the time value of money—the lost opportunity to 

invest the money and earn interest. A lower discount rate makes 

purchasing a more economical option, while a higher rate makes leasing 

more economical. When the lease versus purchase analyses were 

performed for the long-term leasing arrangements of the early 1970s and 

early 1980s, there was some flexibility regarding what discount rate should 

be used in the analysis. In our prior reports, we expressed concern 

regarding the discount rates used in the Navy’s lease versus purchase 

analyses. In a 1973 report on the Navy’s analysis of the Sealift tanker 

program, we found that the Navy had inappropriately selected a high 

discount rate.8

 Had the Navy used the lower and more appropriate rate, it 

would have found that the cost of leasing exceeded the purchase cost. In 

8

Build and Charter Program for Nine Tanker Ships, (B-174839, Aug. 15, 1973).
Page 7 GAO/T-NSIAD-99-141 Navy Ship Leasing

our 1983 report, we questioned whether the prescribed Office of 

Management and Budget (OMB) discount rate was realistic and, in our 

analysis, used a discount rate based on the average yield on marketable 

Treasury obligations, which we believed was a better reflection of the 

government’s true cost of borrowing funds. 

Changes That Will 

Influence Future 

Leasing Decisions

Since the long-term leasing decisions of the early 1970s and early 1980s, a 

number of changes have occurred that will affect future long-term leasing 

decisions by increasing oversight and improving cost analyses. Through 

legislation, Congress has increased its visibility of and control over these 

types of decisions. Additionally, scoring guidelines now provide Congress 

with a mechanism to assess the cumulative impact of long-term leasing 

decisions prior to the obligation of funds. Reductions in tax benefits and 

changes in how these benefits are treated in lease versus purchase analyses 

minimize the loss of tax revenue and ensure that such a loss of revenue is 

more fully considered in the decision. Finally, as part of the 

decision-making process, more detailed guidelines require that government 

agencies perform lease versus purchase analyses that better reflect the 

government’s total cost of long-term leasing arrangements.

Changes to Increase 

Congressional Visibility and 

Control

Given concerns about the budgetary impact of the leases’ long-term 

funding commitments and uncertainties about their cost-effectiveness, 

Congress established a number of statutory conditions and requirements 

for entering into future long-term leases. These requirements, now codified 

at 10 U.S.C. 2401, increase congressional visibility and control over certain 

lease decisions and provided for the development of more detailed 

guidelines for conducting lease versus purchase cost comparisons. 

In general, 10 U.S.C. 2401 requires that:

• DOD’s long-term leases or charters of vessels and aircraft, or leases or 

charters with substantial termination liabilities be specifically 

authorized by law;

• notice of intent to issue a solicitation for such a lease or charter be given 

to the Committees on Armed Services and on Appropriations of the 

Senate and House of Representatives;

• a detailed description of the terms of the lease and a justification for 

entering into the lease rather than purchasing the vessel be provided to 

Congress;
Page 8 GAO/T-NSIAD-99-141 Navy Ship Leasing

• an analysis comparing the costs of leasing to those of purchasing be 

submitted to Congress with any request for authorization of such a 

lease;

• such analysis be evaluated by OMB and the Treasury Department; and

• OMB and Treasury jointly issue guidelines for determining under what 

circumstances DOD may use lease arrangements rather than use direct 

procurement. 

Increased Emphasis on 

Up-Front Budget Authority

At the time the Navy entered into the long-term leases in the early 1970s 

and early 1980s, Congress’ ability to assess the cumulative impact of such 

arrangements prior to the obligation of funds was limited. Since the Navy 

entered into these leases, mechanisms for requesting budget authority have 

been more clearly established, which increases the transparency of these 

arrangements. 

The Balanced Budget and Emergency Deficit Control Act of 1985, as 

amended by the Budget Enforcement Act of 1990 and the Omnibus Budget 

Reconciliation Act of 1993, established statutory limits on federal 

government spending by creating spending caps on discretionary spending. 

To track progress against and compliance with budget enforcement 

requirements and spending caps, budget scorekeeping guidelines have 

been established for lease-purchases, capital leases, and operating leases.9

 

If the Navy were to now enter into the types of leases it entered into in 1972 

and 1982, the current scorekeeping rules would require that the Navy 

request up-front budget authority for the estimated net present value of the 

government’s total estimated legal obligations over the life of the contract. 

Changes That Eliminate Tax 

Incentives

Under leasing arrangements for the Sealift tankers, MPS vessels, and T-5 

replacement tankers entered into prior to 1984, shipowners qualified for 

special tax benefits. These benefits included accelerated depreciation of 

the ship’s cost and deductions on interest payments that lowered the 

shipowners’ taxes. Consequently, shipowners passed some of these 

benefits to the Navy in the form of lower lease payments, which made 

leasing a more attractive option to the Navy. However, these tax benefits 

also represented a loss of tax revenue to the U.S. Treasury. While not 

impacting prior Navy leasing arrangements, the Deficit Reduction Act of 

9

OMB Circular A-11, July 1, 1998.
Page 9 GAO/T-NSIAD-99-141 Navy Ship Leasing

1984 modified tax laws and eliminated the benefits available to the owners 

of assets leased to government entities. 

More Detailed Guidelines 

Will Influence Future Cost 

Analyses

In October 1984, OMB and Treasury issued joint guidelines for DOD’s 

leases. These guidelines required that any special tax benefits conveyed to 

the shipowner be added to the cost of a lease in a lease versus purchase 

analysis.10 Additional OMB guidance was issued in 1992 to prevent lease 

versus purchase analyses from understating the government’s total cost of 

leasing. Specifically, this guidance, which is to be applied governmentwide, 

prescribe that analyses (1) should add special tax benefits to the cost of 

leasing and (2) should not subtract the normal payment of taxes on the 

lessor’s income derived from the leases from the total lease costs.11 Had 

this guidance been in place when the Navy conducted its analyses of the 

MPS and T-5 replacement tanker lease programs, the analyses would have 

concluded that purchasing, instead of leasing, was the cheaper alternative. 

OMB’s 1992 guidance also addressed the issue of discount rates. This 

guidance prescribes that lease versus purchase analyses are to use 

discount rates that reflect the Treasury’s borrowing rate. OMB now 

annually updates the discount rates to be used in the analyses. Current 

discount rates as prescribed in the OMB guidance are lower than those 

used in the past analyses, and lower rates tend to make leasing less 

attractive today.

Madame Chairwoman, that concludes my statement. I will be happy to 

answer any questions you or any Members of the Subcommittee may have. 

10“Joint OMB and Treasury Guidelines to the Department of Defense covering Lease or Charter 

Arrangements for Aircraft or Naval Vessels,” October 31, 1984.

11OMB Circular A-94 “Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs,” 

October 29, 1992.

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