The Department of Defense (DOD) has been recovering nonrecurring research and development and one-time production costs on sales of weapon systems to foreign governments since 1967. The requirement to recover a proportionate amount of these costs was codified in the Arms Export Control Act in 1976, 22 U.S.C. section 2761 (e)(1)(B). The intent of the act was to control U.S. costs and the extent of weapons sales to foreign governments. The law required the recovery of costs on foreign military sales (government-to-government sales), but DOD retained its policy to collect nonrecurring costs on direct commercial sales (between the contractor and the buying entity) as it had been doing before the law was enacted. In 1992, DOD canceled its policy to recover nonrecurring costs on direct commercial sales in an effort to increase the competitiveness of U.S. firms in the world market. In 1995, a number of bills were introduced that could affect the recovery of nonrecurring costs on military sales. DOD interpreted the Arms Export Control Act as requiring the recovery of research and development costs on a pro rata basis. Between 1974 and 1977, DOD used a pro rata rate up to 4 percent of the total sales price. Currently, the services calculate the pro rata rate by dividing total research and development and other one-time production costs by the anticipated total number of units to be produced for both domestic and foreign use. A separate charge is calculated for each item of major defense equipment. The Defense Security Assistance Agency (DSAA) must approve all charges. They are published in the Major Defense Equipment List (MDEL) as part of DOD Manual 5105.38-M. DSAA officials acknowledged that the current pro rata calculation is complex and subject to error, particularly if sales fall short of or exceed projections. Nonrecurring cost charges are considered offsetting proprietary receipts and are deposited into the U.S. Treasury General Fund. They are credited to DOD’s total budget authority and total outlays but cannot be spent unless specifically appropriated. The Arms Export Control Act also specifies that waivers or reduced charges of nonrecurring costs are permitted on sales to the North Atlantic Treaty Organization (NATO) countries, Australia, New Zealand, and Japan to further standardization and mutual defense treaties. However, each waiver and reduction requires written justification. DOD collected $181 million in nonrecurring costs under the foreign military sales program in fiscal year 1994. Fiscal year 1990-92 collections total $559.4 million—$337.3 million for foreign military sales and $222.1 million for direct commercial sales. Fiscal year 1993 collections totaled $177.9 million. DSAA estimated in February 1995 that collections during fiscal years 1995-99 could amount to $845 million. DSAA based these estimates primarily on past sales. DSAA also estimated that if the charge on foreign military sales is dropped as proposed, collections would decrease by $73 million through 1999. Some collections would continue based on deliveries to be made on current contracts. (See fig. 1.) A DSAA official stated that collections would probably stop completely in fiscal year 2002 if the charge is repealed in fiscal year 1995. In May 1995, DSAA estimated that if a requirement to collect nonrecurring costs on direct commercial sales were reimposed in fiscal year 1996, it would resume collections in fiscal year 1998, given production and delivery lead times, and recover about $198 million through fiscal year 1999. Table 1 shows estimated collections on both foreign military and direct commercial sales (including a charge on direct commercial sales). DOD waived $273 million in nonrecurring costs to NATO members and Japan in fiscal year 1994, about $92 million more than DOD collected in nonrecurring cost charges in the same year. About 90 percent of the waivers involved Norway’s purchase of missiles and Turkey’s purchase of missiles, aircraft, gun mounts, sonars, and vertical launchers. DOD’s justification for the waivers involving Norway was to help achieve standardization, and the justification for waivers involving Turkey related to base rights agreements. Table 2 shows the aggregated totals of authorized waivers to NATO, 12 individual NATO countries, Australia, and Japan for fiscal years 1991 to 1994. Waivers on direct commercial sales represent sales agreements signed before the 1992 repeal. We focused our analysis on the comparison of current pro rata charges with flat rate charges of 3, 5, 8, and 10 percent on the acquisition cost of 68 weapon systems sold. First, we calculated the charges on four categories of weapons—projectiles, missiles, aircraft, and aircraft engines. The flat rate charges of 3 and 5 percent generally resulted in lower total charges for each category of weapon systems—in the aircraft category, the charge was considerably less at 3 percent—than the total pro rata charges. Flat rate charges of 8 and 10 percent in most cases resulted in comparable or considerably higher total charges than the current pro rata charges for the four categories of weapon systems. For example, a 3-percent flat rate charged on the sale of each of 27 aircraft resulted in total charges of $20.4 million, or $9.5 million less than the $29.9 million recovered under the pro rata system. On the other hand, a 10-percent flat rate charge on the sale of each of the 27 aircraft resulted in a total charge of $67.9 million, or $38 million more than the $29.9 million recovered under the pro rata system. On the 68 weapon systems we examined, current pro rata charges ranged from 0.07 percent to 15.95 percent of acquisition cost and averaged 5.18 percent. Thus, for a given flat rate of 3, 5, 8, or 10 percent, the difference between the flat rates and pro rata charges varies widely. For example, a 3-percent flat rate would be greater than a pro rata charge for 19 of the 27 aircraft we examined whereas a 3-percent flat rate was larger than the pro rata charge for only 2 of the 13 missiles we examined. However, on some sales of commonly sold military items, DOD might not recover the same level of charges using a nominal flat rate that it would under the pro rata system. For example, DOD anticipated collections of $279 million in nonrecurring cost charges on the sales of 228 F-16 A/B aircraft and 131 F-16 C/D aircraft when they are delivered to the buying countries. A flat rate of 3 percent on these sales would yield about one-half the pro rata charges; a 6-percent flat rate would yield an amount comparable to the pro rata charges. On sales of HARM AGM-88 missiles to three countries, total pro rata charges for the 181 missiles sold amount to $3.85 million. A 3-percent flat rate on these sales would provide only 40 percent of the pro rata charges; a 7.5-percent flat rate would yield an amount comparable to the pro rata charges. Appendix I compares the current pro rata charges with flat rate charges of 3, 5, 8, and 10 percent on the weapon systems we examined. The benefit of computing nonrecurring cost charges with a flat rate is its ease of administration. In addition, some of the U.S. government’s research and development investment would be recovered, though perhaps not accurately or equitably for some specific weapons or categories of weapons. Total recoveries are affected by sales, which are affected by a buyer’s assessment of economic factors such as price, quality, availability, and competition, and must also be considered. We did not analyze flat rate charges on commercial sales because of the proprietary nature of commercial sales prices. However, DSAA officials stated that the same rate would apply to both types of sales should the nonrecurring cost charge be reimposed on direct commercial sales. We reported in 1986 that the pro rata system had inaccuracies that prevented DOD from collecting accurate nonrecurring cost charges. For example, DOD was unable to accurately predict future costs and future U.S. and foreign quantity requirements. At that time, we recommended that DOD improve the existing pro rata system or develop a new approach for recovering research and development costs. The approach we suggested was to apply a flat rate to the acquisition price of all equipment sold abroad. We reported that with the use of a flat rate, DOD would recover comparable research and development costs yet simplify the complex administrative and review process of calculating a pro rata fee. In 1986, DOD opted to retain the pro rata calculation and stated that the Arms Export Control Act would need to be revised to permit the use of a flat rate fee. DOD’s reasoning at the time was that a flat rate would not recover a “proportionate” share of investment on individual items as the law required. DSAA’s General Counsel now interprets 22 U.S.C. section 2761 (e)(1)(B) as allowing a flat rate to be collected because the law requires recovery of a proportionate amount, not a pro rata share. Thus, the DSAA General Counsel concluded that the law would not have to be amended to permit the use of a flat rate. In our view, it is not clear that DOD would have authority under current law to use a flat rate. Supporters and opponents of recovery of nonrecurring costs differ on its benefits and drawbacks. On one hand, supporters of nonrecurring cost recovery that we spoke with, including arms control advocates, argue that nonrecurring cost charges should be collected on both foreign military sales and direct commercial sales for a number of reasons.