GAO

United States General Accounting Office

Staff Study

October 1999 BUDGET ISSUES

Budgeting for Inflation 

in Civilian Agencies

GAO/AIMD-00-14

Page 1 GAO/AIMD-00-14 Budgeting for Inflation

Preface

In recent years, the Department of Defense (DOD) has experienced 

increases in purchasing power (called inflation dividends) that occur when 

inflation is lower than had been projected at the time funds were requested. 

DOD has used those savings to fund a larger program without requesting or 

receiving additional resources. In 1998, DOD calculated that lower-thanexpected inflation would reduce fiscal years 1999 through 2003 

procurement costs, i.e., nonsalary purchases, by $21.3 billion compared to 

what had been projected 1 year earlier.1

 Of this amount, $2.8 billion, or 

approximately 1 percent of DOD’s annual budget, was savings estimated 

for fiscal year 1999. DOD was allowed to keep these savings and, in some 

cases, authorized to redirect funds to programs and purposes other than 

those originally planned, authorized, and appropriated. 

Given DOD’s experience, the question of whether civilian agencies should 

also identify the effect of lower inflation on their funding requirements has 

been raised. To understand better the challenges to developing this 

capability in civilian agencies, this staff study describes how inflation is 

treated currently in budgeting for DOD and civilian discretionary nonpay 

activities. We developed case studies in three civilian agencies: the 

Department of the Interior’s Bureau of Land Management (BLM), the 

Department of Energy’s (DOE) Office of Environmental Management, and 

the National Aeronautics and Space Administration (NASA). We also 

reviewed our prior work pertaining to inflation changes in both civilian 

agencies and DOD and obtained written responses from DOD to questions 

on how it budgets for inflation. We have not included a discussion of 

funding for civilian and military pay because decisions on annual increases 

are not tied to the rate of inflation. However, these costs can be more 

significant than the costs associated with nonpayroll-related inflation since 

federal agencies are required to absorb these increases. 

Results in Brief For a number of reasons, DOD has experienced greater changes in 

purchasing power due to inflation and has a better ability to track these 

changes than civilian agencies. More specifically, DOD is able to identify 

changes in inflation because of three factors not found in most civilian 

agencies: (1) large dollar amounts structured by function that can be 

1

When we started this study, DOD projected the cost of nonsalary purchases would grow by 

an average of 2.1 percent per year for 1999 through 2003. DOD’s most recent projections, in 

its 2000 Future Years Defense Program (FYDP), are 0.8 percent for 1999, 1.5 percent for 

2000, and 1.6 percent for 2001 through 2003. 
Preface

Page 2 GAO/AIMD-00-14 Budgeting for Inflation

aggregated to a relatively few account titles,2 (2) a budget planning process 

that spans multiple years and serves as a baseline for measuring change, 

and (3) full funding for major weapons systems and other large 

procurements, which provides appropriations up front for the total 

estimated cost of a program or project at the time it is undertaken 

regardless of when the funds will actually be obligated. 

In contrast, civilian agencies, for a number of reasons, have less potential 

to experience large changes in purchasing power due to a change in 

estimated inflation rates, and have a difficult time tracking fluctuations in 

inflation. One reason is that funding for capital assets in civilian agencies, 

with few exceptions, is fundamentally different than in DOD. For the most 

part, civilian procurement is funded on an incremental basis, that is, only 

for the amount that is expected to be obligated during the first year. Thus, 

no matter the size and length of the procurement, the annual budget 

process provides a regular opportunity to reassess (and reestimate for such 

factors as changes in inflation) an agency’s funding requirements. In 

addition, while 40 percent of federal procurement activities are carried out 

by civilian agencies, they are spread over approximately 700 disparately 

structured accounts across many agencies and individual contracts. Taking 

these factors into consideration, requiring civilian agencies to track 

changes in inflation would not be cost-effective.

Background The issue of budgeting for inflation was first addressed in response to 

escalating inflation, primarily in DOD programs. Although, since 1982, DOD 

inflation estimates have often been higher than actual inflation, the reverse 

was true in the late 1960s and 1970s when the Administration 

systematically underestimated inflation in its budget requests to the 

Congress. (See “Related GAO Products.”) Until the 1970s, only shipbuilding 

appropriations allowed for anticipated inflation. By the mid-1970s, in 

reaction to escalating inflation, the Administration proposed in the 

President’s Budget request and the Congress allowed DOD to include an 

inflation allowance for certain categories of expenditures, first for major 

weapon systems, then fuel, and finally for all military procurement and 

construction spending. Eventually, defense and civilian agencies were 

2

A DOD account title (or primary account) consists of all functionally related appropriations 

accounts. For example, DOD’s Procurement account title in the President’s Fiscal Year 2000 

Budget includes 20 appropriations accounts, such as, Procurement of ammunition, Army; 

Weapons procurement, Navy; and Missile procurement, Air Force.
Preface

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allowed to include estimates for the cost of inflation in agency operating 

accounts as well.

As the rate of inflation declined, concerns shifted to the issue of 

overfunding for inflation. Beginning with DOD’s fiscal year 1987 

authorization act,3

 the Congress required DOD to monitor and report on 

changes in inflation three times a year. No comparable requirement existed 

for civilian agencies. Although this requirement was eliminated in fiscal 

year 1989 when projected savings were in decline, DOD continues to 

identify changes in inflation and adjust its estimates as necessary for its 

annual submission to the President’s Budget and the Office of Management 

and Budget’s (OMB) Mid-Session Review.4

In the 1990s, especially in recent years, spending caps have limited the 

amount of funding available for defense and civilian discretionary 

programs. The Budget Enforcement Act5

 established dollar caps on 

discretionary spending for fiscal years 1991 through 2002, which, until 

fiscal year 1998, were adjusted for inflation. Since then, budget authority 

and outlay caps in particular are almost level in dollar terms from fiscal 

year 1998 through fiscal year 2002.6

 Thus, not all agencies are funded at a 

level sufficient to keep pace with inflation. As a consequence, while lower 

inflation may, in some instances, increase the level of resources over what 

was planned, it does not necessarily produce a windfall for these agencies. 

Instead, it reduces the size of program cuts that need to be made to stay 

within funding levels and overall spending caps. 

3

The National Defense Authorization Act for Fiscal Year 1987, Public Law 99-661, 100 Stat. 

3980-81 (1986).

4

The President is required to transmit a supplemental update to the President’s Budget sent 

to the Congress the previous February. This supplemental contains revised estimates of the 

budget receipts, outlays, and budget authority for the current fiscal year and the next 5 fiscal 

years. 

5

The Budget Enforcement Act of 1990 and subsequent amendments (the Omnibus 

Reconciliation Act of 1993 and the Budget Enforcement Act of 1997) are collectively 

referred to as the Budget Enforcement Act (BEA). These acts amend the Balanced Budget 

and Emergency Deficit Control Act of 1985 (the Deficit Control Act).

6

The rate of inflation was approximately 3.4 percent in fiscal year 1991 and gradually 

decreased to approximately 2.6 percent in fiscal year 1997. According to the Congressional 

Budget Office, if 1999 appropriations equaled 1998 budget authority adjusted for inflation, 

total outlays (including those from previously enacted appropriations) for both defense and 

nondefense would exceed their respective discretionary caps by about $8 billion. 
Preface

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Budgeting for Inflation 

in the Department of 

Defense

Although DOD does not explicitly identify estimated inflation in its budget 

request, its functional structure and large account titles enable it to apply 

inflation factors to its accounts and to calculate the effect of any 

subsequent changes. In addition to DOD’s account structure, two other 

attributes help identify large savings (or losses) from changes in inflation: 

(1) a 5-year planning baseline from which to measure adjustments and

(2) full funding of major procurements, which provides funding at the time 

a project is undertaken and increases the base on which inflation factors 

are applied. 

The account structure of DOD is organized by function. In contrast, civilian 

agencies’ accounts are characterized by a mix of account orientations with 

an emphasis on programs and processes. For example, DOD’s primary 

accounts are made up of the following functional areas: Military personnel; 

Operation and maintenance; Procurement; Research, development, test, 

and evaluation; Military construction; and Family housing, as well as 

Revolving and management funds. DOD builds inflation into its budget and 

its long-term planning document−the Future Years Defense Program 

(FYDP)−and makes annual adjustments to inflation using these large 

account titles. 

DOD also is the only agency that has a long-term, structured budget 

planning process that covers a 5-year period and is adjusted annually. DOD 

constructs its budget request and FYDP on the basis of the Administration’s 

economic assumptions provided for the previous year’s budget. For 

example, the budget for fiscal year 2000 is developed assuming the rate of 

inflation contained in the fiscal year 1999 budget, but is revised to reflect 

current economic assumptions in December just before the President’s 

Budget is released. DOD uses one overall price index for all nonpayroll 

purchases except fuel. DOD applies the difference between the old rate and 

the new to each primary account using a formula based on projections of 

future inflation rates and the projected rate of spending for components 

within the accounts. 

DOD’s long-term planning estimates assume full funding for most DOD 

procurement programs. DOD procurement represents about 60 percent of 

total federal procurement activity. When a contract is fully funded, the total 

cost of the project (or a useful project segment) is estimated using current 

economic assumptions and the entire amount of budget authority is 

provided in the first year. Although DOD fully funds most procurement 

programs, DOD’s ability to track changes caused by fluctuations in 
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projected inflation provides an opportunity to review and adjust funding 

levels in the same way that the annual budget process provides a check on 

incrementally funded programs. 

Budgeting for Inflation 

in Civilian Agencies

Funding for inflation generally is not requested, funded, or tracked 

separately in civilian agencies’ nonpersonnel, discretionary budget 

requests. Although agencies are expected to build inflation into their 

submissions to OMB, there is no single inflation rate that applies across all 

agencies and the approximately 700 civilian accounts with procurement 

activities. Agencies include inflation in their estimates but, especially in 

recent years, they cannot assume that they will get sufficient funding to 

cover inflation because of discretionary spending limits. According to OMB 

officials, OMB usually allows an agency to decide how best to absorb 

inflation costs. Although civilian agencies fund 40 percent of federal 

procurements, funding is appropriated annually in increments so that there 

are opportunities to adjust for inflation in annual appropriations. Even 

when inflation rates are more favorable than estimated, not all contracts 

allow for inflation adjustments, and, in the agencies we studied, inflation is 

only one of several cost drivers. 

OMB requires that agencies build inflation into their budget estimates, but 

not as a separate cost item. Civilian agencies are instructed in OMB 

Circular A-11, Preparation and Submission of Budget Estimates, to use 

budget year numbers for nonpay costs (i.e., agencies project estimates for 

their fiscal year 1999 budget request in 1999 dollars, not in 1997 dollars, 

when the estimate is prepared). Civilian agencies thus build inflation into 

their estimates. Notwithstanding, OMB policy states that consideration of 

price changes as a factor in developing estimates does not necessarily 

mean that the full rate of anticipated inflation should be included 

automatically.7

Agencies build inflation into their funding requests to OMB by estimating 

what nonpay costs will be in the future budget year using a variety of 

7

Every budget year, OMB issues a set of economic assumptions that agencies use to 

formulate the current services baseline. The current services baseline reflects the projected 

costs of continuing federal programs without any policy changes and is included in the 

President’s Budget as one of several analytical presentations. Although civilian agencies are 

required to use OMB’s economic assumptions to construct this baseline, agencies are 

expected to use nonpersonnel inflation assumptions that best reflect their programs in their 

budget submissions to OMB. 
Preface

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indices and assumptions. Civilian agencies, with the concurrence of OMB, 

may use more than one type of price index to estimate inflation. These 

indices are based on program specific factors, such as local market 

conditions or product requirements. For example, NASA uses indices that 

represent a weighted average of Data Resources Incorporated (DRI) 

indices and the consumer price index for new initiatives. NASA’s inflation 

index tends to be 1 to 2 percent higher than the gross domestic product 

price index due to NASA’s reliance on relatively high labor rates and exotic 

materials. In another example, DOE’s Office of Environmental Management 

has developed six specialized escalation models for tracking inflation and 

other factors that affect the costs of projects. 

Caps on discretionary spending have made it less likely that an agency’s 

funding level will accommodate increases for inflation. The Department of 

the Interior’s budget submission, which includes BLM, identified certain 

expenses, such as rent increases, security and communications charges, 

and working capital fund charges, as “uncontrollable,” and separated these 

changes in expenses from other programmatic changes. Displaying 

adjustments in what it calls uncontrollable expenses allows Interior to 

identify inflation separately. However, OMB officials told us that this type 

of budget detail has become increasingly irrelevant as annual caps hold 

many agencies’ budgets at or below a level that accommodates inflation. 

Generally, only high-priority programs receive funding to accommodate 

inflation. Also, since federal agencies are required to absorb mandatory pay 

increases, fewer funds are available for procurement activities. 

Accordingly, it cannot be assumed that a reduction in expected inflation 

will produce a funding windfall if inflation was funded partially or not 

funded at all. 

Most civilian agencies receive incremental funding for procurement 

activities, that is, they receive funding on a year-to-year basis. The annual 

budget cycle and the yearly revisions of inflation estimates provide 

opportunities for the Congress to consider inflation in making funding 

decisions for civilian agencies, although here too, discretionary caps limit 

the amount of funds available. 

During contract performance, as opposed to during an agency’s budgeting 

cycle, savings that occur due to a change in projected inflation do not 

always accrue to the government. The contract terms determine whether 

the contractor or the government bears the inflation risk and thus incurs 

the costs or reaps the benefits from a change in inflation during contract 

performance. For example, in firm fixed-price contracts, the contractor is 
Preface

Page 7 GAO/AIMD-00-14 Budgeting for Inflation

typically at risk for all aspects of contract performance and so incurs the 

costs or benefits associated with changes in inflation that are higher or 

lower than expected.8

 Thus, any inflation dividend accrues to the 

contractor, not the contracting agency. Of the agencies we studied, only 

BLM primarily uses fixed-price contracts. BLM contracts for services and 

supplies, such as hazardous materials removal, road construction and 

restoration, and fire engines.

For cost reimbursement contracts (these include cost plus fixed fee, cost 

plus incentive fee, or cost plus award fee contracts), the government bears 

the risk of inflation during contract performance and any inflation dividend 

would accrue to the government. Thus, where funds are allocated to a 

contract based on its estimated costs, including inflation, and inflation is 

less than expected, the government receives an “inflation dividend” vis-avis its budget estimate. This is more likely to occur in complex 

procurements involving multiyear contracts, such as those that occur in 

DOD. The majority of NASA’s procurement dollars involve cost 

reimbursement contracts, which are primarily associated with the Space 

Shuttle and Space Station. DOE’s Office of Environmental Management 

also primarily uses cost reimbursement contracts.

In the current economic environment, inflation is only one cost driver 

nested among other more significant cost drivers, such as changing 

technology or availability of materials and labor. Officials at NASA’s 

Langley Research Center stated that they use a “guideline audit trail” to 

track monthly changes in costs, but they do not track the details of those 

changes. An official at another agency stated that with inflation rates as 

low as they are at present, inflation currently is not a major factor in the 

escalation of costs. This official also stated that over time and over the 

development of a project, inflation virtually gets lost. 

In our earlier report on budgeting for inflation in DOD, we stated that it is 

not clear that monitoring inflation below the appropriation account level 

would be helpful or useful.9

 We believe this applies to civilian agencies as 

8

Some fixed-price contracts have economic price adjustment clauses that allow the 

contractor to be reimbursed for uncontrollable costs, including inflation. For example, 

some BLM contracts include economic price adjustment clauses, such as lease escalator 

clauses or operating cost escalator clauses (for use with services and utilities).

9

DOD Inflation: Budgeting and Monitoring Inflation Funding in the Department of 

Defense (GAO/NSIAD-88-79, April 26, 1988).
Preface

Page 8 GAO/AIMD-00-14 Budgeting for Inflation

well. DOD, like civilian agencies, uses a variety of contract types, but 

because DOD is able to build, track, and adjust inflation using a small 

number of large account titles, it does not need to go below the primary 

account level to identify savings or losses due to changes in inflation. 

DOD’s planning process, in addition to providing a baseline for measuring 

changes over multiple years, provides a top-down, integrated perspective. 

Thus, savings (or losses) due to changes in inflation can be viewed in the 

context of overarching decisions on the appropriate level of funding for 

DOD in any single budget year. 

It would be difficult and, we believe, not cost-effective to require civilian 

agencies to monitor changes in inflation. This conclusion is based on 

several considerations: (1) the large number of small pools of resources 

potentially affected across multiple civilian agencies and contracts, (2) the 

variety of inflation assumptions used by civilian agencies in developing 

estimates, (3) obstacles to developing a baseline from which to measure 

savings and losses, including separating inflation from other cost drivers, 

(4) the current environment of low, stable inflation coupled with caps on 

discretionary spending, and (5) the prevalence of incremental 

appropriations for civilian procurement that permits adjustments already.

On September 13, 1999, we provided the Departments of Defense, Energy, 

and Interior, as well as NASA and OMB, a draft of this staff study for review 

and comment. Between September 22 and October 5, 1999, all of the 

reviewers informed us, either orally or in writing, that they agreed with the 

information presented and had no comments. 

For future contacts regarding this staff study, please contact Paul L. Posner 

at (202) 512-9573. Individuals making key contributions to the study 

included Denise M. Fantone, Hannah Laufe, and Marcus Melton.
Page 9 GAO/AIMD-00-14 Budgeting for Inflation
Page 10 GAO/AIMD-00-14 Budgeting for Inflation

Appendix I

Scope and Methodology ApendxiI

We developed case studies in three civilian agencies: the Department of the 

Interior’s Bureau of Land Management, the Department of Energy’s Office 

of Environmental Management, and the National Aeronautics and Space 

Administration. Since purchasing power increases or decreases due to 

changes in inflation, entities that spend a large proportion of their budgets 

on multiyear procurements will potentially experience greater changes due 

to inflation than those that do not. We therefore selected entities with 

relatively large dollar volumes of contracting activity, relatively large 

contracts, and highly centralized procurement and budget activities. We 

based our selections on information derived from interviews with officials 

at OMB, analysis of budget and procurement data pertaining to the case 

studies, and consultation with congressional staff.

We interviewed OMB staff familiar with OMB executive branch budget 

policies and procedures to get a governmentwide perspective on recent 

trends in funding for inflation in civilian agencies. For those programs 

selected for further study, we interviewed the agencies’ OMB program 

examiners, agency budget and procurement staff, project managers, and, 

for some programs, cost estimators. We also reviewed our prior work 

pertaining to inflation changes in both civilian agencies and DOD, and 

obtained relevant reports from the Congressional Budget Office and the 

Congressional Research Service. DOD provided us with written responses 

to questions on how it budgets for inflation. We also looked at broad trends 

in discretionary funding to provide context for our work. Our work was 

performed in Washington, D.C., and Hampton, Virginia, from August 1998 

through August 1999 in accordance with generally accepted government 

auditing standards.
Page 11 GAO/AIMD-00-14 Budgeting for Inflation

Related GAO Products

1999 DOD Budget: DOD’s Procurement and RDT&E Programs

(GAO/NSIAD-98-216R, August 14, 1998).

Department of Energy: Office of Environmental Management’s and 

Defense Programs’ Fiscal Year 1999 Budget Requests (GAO/RCED-98-

213R, July 24, 1998).

Defense Budget: Projected Inflation Savings (GAO/NSIAD-98-177R, 

May 11, 1998).

Future Years Defense Program: Lower Inflation Outlook Was Most 

Significant Change From 1996 to 1997 Program (GAO/NSIAD-97-36, 

December 12, 1996).

DOD Budget: Controls Needed Over Inflation Dividends (GAO/NSIAD-93-

62BR, December 14, 1992).

DOD Inflation: Budgeting and Monitoring Inflation Funding in the 

Department of Defense (GAO/NSIAD-88-79, April 26, 1988).

Budget Issues: Budgeting for Inflation in Selected Civil Accounts

(GAO/AFMD-86-34BR, March 20, 1986).

Budget Issues: Potential for Excess Funds in DOD-March 1986 Update

(GAO/NSIAD-86-76, March 7, 1986).

Potential for Excess Funds in DOD (GAO/NSIAD-85-145, September 3, 

1985).

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